ML20198G027

Commonwealth Energy Sys 1997 Annual Rept

ML20198G027
Person / Time
Site:	Seabrook
Issue date:	12/31/1997
From:	Poist W COMMONWEALTH ENERGY SYSTEM
To:
Shared Package
ML20198F859	List: ML20198F851 ML20198F951 ML20198G012 ML20198G027 ML20198G035 ML20198G048 ML20198G068 ML20198G080 ML20198G102
References
NUDOCS 9812280278
Download: ML20198G027 (44)

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system Table of P ro file C o n':e n':s omnumweahh Energy System is an exempt public Comparative liighlights.

.1 utility holding company with mual revenues exceed-1 ing S1 billion and assets of approximatelt St.4 billion.

u COM/ Energy serves :Wi7.000 ek ctric customers and 237JNN) gas

> Sharehokler Irtter.

.2-3

,j

,w customers in 78 communitics in castern Massachusetts.

g y

Strong economy COM/ Energy offers a unique blend of energy supply and deliv-I" CO.tI/ Energy sernce area y

> Electric and cry services includihg electricity. natural gas. liquefied natural Gas Operations.

4-11 gas and steam. 'lhis energy diversity enhances COM/ Energy's 4

,I e u

competitive IM>siti(m in the deregulating energy industry an31

.,. /

- ' N ja s'

. %4 hk ' > Industry Restructuring reduces weather-related volatility in carnings.

i Update.

12

~

in a(klition to four regulated opmating public utility companies.

9 0

the Systein includes a steam disuibution companya company t

' > Unregulated Businesses.

. 14-15 engaged in the operation of I.NG facilities. three non-utility, unregu-Excellence in utility operations q

lativt subsidianes that are pursuing cia rgy-related business oppor-

> Imancial Section.

. 15 tunifics. and five n al state trusts.

l

..' 1 s'

l lhe System is a business trust organimi in 192fiunder the laws

> Shareholder j.

Information.

of Massachusetts.

40 1

-T 8

r.

Na EE COMEnergy

= ""

Customer choice -

. Inside back cover 1fassachusetts electric industry restructured n

Comparative Highlights DONEnergy l

Commonwealth Energy System and Subsidiary Companies i

Three Year Crow 11 e

1997 1996 1995

(%)

l Financial Data en mimons) l Operating Revenue

$ 1,041.7

$1,010.9

$929.3 2.1 Operating income

$87.7 *

$96.7

$94.5 (1.5)

. Net Income

$49.9 *

$59.2

$51.4 0.6 i

Common Share Data Earnings

$2.27 *

$2.70

$2.36 (0.3)

Dividends Paid

$ 1.57

$1.53

$1.50 1.8 Divirlend Yield 4.8%

6.6%

6.7%

Closing Market Price Range

$34hS19

$25bS21%

$23hS17%

Market Price at End of Year

$33%

$23%

$22%

Average Shares Outstanding 21,531,433 21,529,676 21,311,836 1.1 Book Value

$20.01 *

$19.31

$18.15 5.1 Dividend Payout Ratio 69.2*

56.7 63.6 Price / Earnings Ratio 14.6*

8.7 9.5 v

l l

L I

l:-at.

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• Reflects one-time charge of $10.7 million (after-tax) or 50 cents f>er sharefor Personnel Reduction Program.

1

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Massachusetts' efforts to restructure the electric utili-ty industry. In November 1997, the Governor of Shareholders Ma aam,eit,,igned inuneuegi ieu m,truner-ing electric utilities that recognizes the right to full Commonwealth Energy System's earnings per share recovery of non-mitigable, trans.t.i mn costs. As part of for 1997 were $2.27 compared to the record level of COM/ Electric's restructuring plan approved by the

$2.70 achieved last year. %e decline for the year was Department of Telecommum,eatmns and Energy (DTI,.

due to the one-time after-tax charge of $10.7 million, or

- formerly Department of Public Utilities) on 50 cents per share, resulting from the implementation February 27,1998, we wd. l mitigate our transit. ion i

of a voluntary personnel reduction program (PRP).

costs through the sale of our power plants and 17 Exclusive of this charge, earnings for 1997 would have i

pow ? contracts. M,e expect to announce the buyer 1

been $2.77 per share.

for these assets dun.ng the second quarter of 1998.

He PRP was part of the consolidation of the man-cgement of our gas and electric operations in an action New Opportunities in that will greatly enhance the competitive position of Unregulated Businesses i

both businesses through s.igmficant reduct. ions m While our primary f<>cus is on excellence in our operating costs. This resulted in the elimination of enna tausn budnese, w teel Wem am approximately 13% of our workforce, systemwide. The "EP#""

cost of the consolidation program is anticipated to be recently created non-utility, unregulated subsidiaries -

1 recovered within one year.

COM/ Energy Marketing, COM/ Energy Technologies Consolidation of Gas and ana Aamncea Enugy Systems. with these new com-panies, we have developed businesset Sat comple-Electric Operations men, ou, co,e uti11ty operations Ou, experience in The consolidation of our gas and electric operating energy markets and our knowledge of customers' divisions, and related reductions in personnel, was needs enabled us to recognize new unregulated busi-made possible by enhanced productivity and elimination ness opportunities. A more detailed discussion of of duplication throughout the company's management, these businesses is included on page 14 administrative and support ftmetions. These new effi-of this report.

ciencies, over and above the gains a cowt,

$hh h we had already achieved in control-wall street Recognizes

==

3ee e

m vaue une em c,nmp ling costs of our sumd-alone utih.ty COM/ Energy (87 "'i"e >

operations, has led to a more effi' We are pleased that Wall Street has f%4 cient and highly competitive orga-recognized the strength of our compa-E N

nization. We are making these ny, resulting in strong gains in the changes at a time of strong finan-value of our shares. COM/ Energy's cial health for the System, and market price closed 1997 at $33% per these streamlined operations will common share compared to $23% in have a positive financial impact well 1p96, an increase of almost 421 This q

into the future. Since 1990, our price appreciation, coupled with the bl workforce has been reduced front dividend payment of $1.57, resulted in employees to 1.727 at the end a total return to shareholders of E

of 1997 - a reduction of 33%

approximately 51% assuming the rein-Restructuring

"' * "" ' "' d M d " "" " "" *" "

• very favorably to the weighted average L

of the Electn.e n,ud,ciornofassoa,ieved bya peer p

Utility Industry group of 87 eiectric utilities roiiowed t, ConsoHdated Many of our changes have Value Line. Inc., and the 33% total 9,,,,,,,,,,,,

E' been made in anticipation of return of the S&P 500.

Shareholders 2

New Chief Executive Officer Announced A Message From As announced in January 1998, I am retiring on September 1,1998. Russell D.

Wright, formerly president and chief operating officer of our utility operations, has been selected as my successor efIcetive upon my retirement. Russ has been ONM &ad 1

with the System for 29 years in a variety of capacities, including six years as the System's chief financial officer. lie has played a critical role in revamping our n behalf of the board of electric operations and overseeing our efforts related to electric industry restruc.

l trustees and the many turing. Russ became vice chairman and chief executive of6cer of utility opera-members of the tions effective March 1.1998.

COM/ Energy family, I would like t u.ank Hill Poist for the outstand-Also on March 1, Deborah A. Mclaughlin, formerly vice president of customer service for utility operations, succeeded Russ as president and chief operating offi-ing e ntributions he has made to cer of utility operations. Debbie has been with the System in various positions, Commonwealth Energy System including audit manager, for the past 18 years.

ver the years.

M.e are very confident about the future. Our new management team, coupled Billjoined the company in 1971 with significant utility industry with our three-prong strategy - making our ek ctn.e and gas compam.es more cus-

.expenence and served in a num-tomer-driven, ef fic.ient and ber of positions leading to the role g1 ;.

productive; maximizing our p; '..

o president and chief operat.mg existing assets; and creat, g

,e m

g officer of Commonwealth Gas. In new opportmPies in the H

7 N'-

1992, Bill was appointed to his unregulated awna - will

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present posidon, president and allow us to continue to

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chief executive officer of

..M-

thrive in a restructured utili-t ty environment.

Commonwealth Energy System.

In Closing h

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What a ride these last several years have been! Dudas a period of 1

I would like to recognize jl unprecedented change and chal-3...

lenge for the previously staid utility what was a time of great

{

sadness for all employees

7. <

ndustry, Bill has guided the compa-ny to strategic and financial success,

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of Commonwealth Energy

{

' During his tenure as CEO, our annu-System. On August 7, as a

=

alearnings growth rate averaged result of an Lnderground e

8.5% (excluding non-recurring manhole explosion, charges) and market capitalization g.jj,m g pg,,

j Douglas Pollander, a hrsident and Chic /Erecutive O/ffcer has doubled. In the past year, Bill Cambridge Electric Light oversaw the consolidation of regulat-Company employee was killed and four other employees were injured. We have ed utility operations, dealt with mandat-taken aggressive steps to prevent the possibility of such a tragedy from eser ed deregulation. improved operating happening again.

efficiencies, and launched new non-We extend our thanks to you. our shareholders, for your confidence and con.

regulated subsidiaries. Ilis incisive tinued support of Commonweal;h Energy System. Upon my retirement,I firm.

Judgement, broad expedence and intu-ly believe that I am leaving your company in firm, committed and extremely itive vision of the future brought about capable hands.

significant benefits that will sen'e us well for many years to come.

We wish Bill and his wife, Tina, the

Sineerci, very best for a healthy, well&sened f

and satisfying retirement.

k SUU bA ll'illiam G. Poist President and Chief Executire Officer Sheldon A. Buckler Chairman of the Board of Trustees 3

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Electric and Gas Operations ed commercial / industrial electric load was up g,d Our core utility operations performed well in almost 10% over 1996 - new conunercial/indus-1997 with a robust economy adding new load trial gas load was up 30%

for future sales. Electric operations served Throughout our service area, there are 367,000 custorners, an increase of 12% over exciting new projects planned or already 1996 and our gas operations served 237,000 cus-under construction. Some examples include:

tomers, an increase of 1.1% COM/ Electric b

enjoyed record retail kwh electric sales in 1997, increasing 2.4% from the previous year. Firm

> The Route 9/ Interstate 90 crossing in bbtu gas sales for COM/ Gas, however, were Framingham, with 1.5 million square feet of down 5.6% compared to 1996, primarily due to commercial, hotel and light manufacturing.

warmer than normal weather.

A dozen buildings are u4 i planned including the Strong Economic 1

Growth

/ 4 3 650,000 square foot head-quarters of Staples, now 3

The economy is very N under construction.

strong in the areas we serve :

1<.

> The 1.2 million square with a tremendous amount

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fmt former Digital Mill of new construction and C"*P "* I" M"F""'d' I

expansion. As a result, the fz rate at which we're connect-

> Medical City, a huge ing new gas and electric load ~

one-stop shopping hospital to our system has increased Russcu D. Wrig5t, complex in Worcester.

substantially compared to N## ""#" # "' # # # " "#

the rate at which we were These three projects alone have a combined I

adding load in 1996, especially in the important forecasted annual gas load of 2.2 million therms.

commercial / industrial sector. Newly connec.

Electric

> WorldCom Corporation's 24 hour-a-day telecommunications switching center in Cambridge, with a projected annualload of 8 d /$p.

million kwh.

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> Cape Cod Mall exixmsion is planned for 1998 (PRP) that reduced our workforce by 264 peo-

, l with an estimated annualincrease of 5 million kwh.

ple in 1997. The PHP cost in severance and other benefits is expected to result in savings

> A new, $10 million marine Science of $20 million annually. Since 1990, the num-j l

Iaboratory at University of Massachusetts-ber of employees has dropped by 33%

1 l

Dartmouth, which is expected to use 1.3 million 4

Focus on Service l

kwh annually and spur growth in the k> cal marine While reducing our operational costs, we research, dustry.

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have also kept our focus on continually improv-Consolidation Of ing our service.

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Utility Operations ongoing instaliation of our aatomated j

Clearly,1997 was a year of major change for meter reading system has improved service our electric and gas opera-by eliminating estimated s

tions. The restructuring of hM bills and minimizing incon-v:

a" di venience for our customers the electric and gas utility i

!?

s; j

industries has forever g

- while slashing meter Cs j

changed our tradit.mnal way, F read.mg costs.

p i

of doing business.

!" - E Approximately 98% of e

l In anticipation of utility COM/ Gas meters and 30%

restructuring and to further of COM/ Electric meters j

strengthen our competitive a#

s are now being read elec-i position into the future, we tronically.

combined the management 4

We are continuing Deborah A. Mcl.aughlin.

]

and adnu.. trat.tve funct.mns work on our 'l, rouble Call ms President and Chicf Operating Officer Management System of COM/ Gas and COWGas and COWElectric 9

COM/ Electric. Much of which will be one of the j

1997 was spent consolidating our companies first integrated electronic trouble call sys-j and, wherever practical, merging similar tems in North America. As we discussed in l

departments for dramatic improvements in lev-last year's annual report, this system will ana-t j

els of efficiency.

lyze power outage information from cus-t Examples of the labor savings include a 25%

tomers' calls and alert dispatchers where to i

reduction in finance and accounting; a 38%

direct line crews. Activation of this system, i

reduction in facilities management; and a 26%

which had been planned for the end of 1997, j

reduction in engineering services. To achieve was delayed as we focused our efforts on i

i these savings in staffing levels, we implement-making the necessary changes to our System i

j ed a voluntary personnel reduction program Control and Data Acquisition System in i

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l preparation for the developing competitive InHOVatiVe solutions

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~8 power market and related changes required To thrive in a restructured utility environ-am by ISO New England (formerly the New ment, we have placed a renewed focus on England Power Pool). We now expect the developing creative solutions for operational new system to be fully integrated into our problems. A prime example of this is a series operations by the end of 1998.

of collaborative union / management commit-Our move in early 1998 to outsource our tees charged with revamping the pricing and information technology function is another services offered by our gas service depart-example of our service-based strategy. We con-ment. We used an innovative "open book" man-tracted with IIB 1 Global Services, Inc., the agement approach by making management and largest information tech-union employees part-nology company in the e

ners in developing a world, to provide us with financially responsible the staffing flexibility and solution.

skill pool needed to make I

'lhe result -

rapid adjustments for new

'i redesigned home heat-I services and new oppor-ing protection plans with tunities. We feel these

n. different levels of service o

capabilities will be vital as ^[

and market-based rate we move forward in a structures. 'Ihe program restructured utility world. '

was a hit, with sales COM/ Energy's more in carly 1998 to outsource the Infianna-t

"" '"* ""^ * /""d"" "** """6"' Sc"*" t"" ~'d" exceedinn expectations.

Service Excellence "thestaf)ingflexibilityandskillpoolto make rapidadjust-Our commitment to mentsfa nm senius ain/ nm opportunitia. From Idu The stune process is cur-lhian E Itossman. Director ofInfbnnation Technology and service will be seen in our John R. Ililliams,17uIvesident ofG rporate Senins.

rently be.mg applied to other service areas such Service Excellence program, making COM/ Electric the first utility in New England as rentals and warranty work.

i i

to offer cash guarantees to customers if we We continue with other innovative pro-fail to meet specific customer service promis, grams. Our " soft" shut-off program, eliminat-es related to scheduled appointments, service ing the need to physically shut off the gas after connections, street light maintenance and a customer moves, has dramatically cased sea-billing. We will be conducting a pilot for this sonal light-up ef forts, reducing labor costs and program in the second quarter of 1998 and making new service arrangements faster and umre convenient for our customers.

anticipate rolling out the full program by the end of the year. Ourintentions are to extend Maximizing Our Assets the program to COM/ Gas customers in 1999.

One of the System's strategies is to maximize 8

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in 1997, COM/ Gas revamped its gas service pra f

gram through the efforts of a series of union / man-agenent teams. One of the successful new service -

products developpl was a home heating and appli-ance protection plan which provides a gwlictable

/

revenue stream y the company, and peace of mind from potentally costly repaim for' customers.

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'q existing assets. An example of this is the result conununity groups, support for local causes j

of the recent growth in wireless technologies and employee involvement as community vol-al that has created a huge demand for suitable unteers, we are committed to being the best sites for antennas and cellular towers. We have corporate citizen possible.

found that in many cases, our existing towers, We are proud of our community outreach substations, and switching stations are desirable efforts in 1997 which included our " Season of locations and can generate revenue. We have Caring," through which 211 employees volun-completed lease agreements for numerous sites teered for a day to help out at one of 50 pro-2 1

l with major telecommunications companies and jects for 23 United Way agencies. Volunteer s a

j we are actively negotiating with others.

painted, landscaped, performed office work, We have sok! rights, nationwide, to our success-built sheds and took children on field trips.

j ful work management infor-y-

Our volunteers organized mation system (WMIS) our loth annual holiday designed by our employees to p I.

party for 150 disadvantaged j

streamline our customer p

f citikiren in the Worcester 1

a y :-

work flow. We are currently area and made contributions j

j modifying the WMIS system i

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3 to the COM, Gas Children's i

to meet the needs of gas oper-Christmas Fund, purchasing

.7 ations, with necessary nmdifi-

.. toys, clothing and food bas-cations expected to be com-kets for needy families.

pleted in about 12 months.

Our Partners in Education l'

COM/ Energy Steam program sent 150 employee The solidfinancial performance of our utility Company, a non-regulated operations contributed to COMMnergy's 51%

volunteers to assist children total uturn to shareholders in 1997.<From subsidiary, continues to leff) James EL Rappoli, Financial Vice by reading, tutoring and men-1 achieve positive results sith President and Treasurer; and Michael n Onng m 8 elementary Sullivan, Vice President, Secretary and l

revenues of almost $17 mil-General Counsel.

schools.m eight communities.

a

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lion and earnings of S1.3 million. We continue to We are also committed to safety education

]

l provide high<iuality steam service to 21 cus-programs where COM/ Gas and COM/ Electric l

tomers in Cambridge and Boston and are explor-employees teach children about electrical and a

ing opportunities to expand our steam sales into gas safety and conservation. In conjunction new markets.

with this school program, COM/ Gas received the American Gas Association's Award of Community Service -

Merit for Consumer Relations for our video Being a Good Neighbor production safeguarding your nome From Through our involvement with civic and Carbon Monoxide."

11

R E

S T R

U C

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U P

D AT E

Fq'4 Electric Industry

> mectric ca"'vanies wiu navide ~de'""" service"

^ *

• 1 priced at market rates for customers who are either LM Restructuring newtothese,viceter,ito,yocwhohaveief1 standard

%e opportunity for retail choice became a reality for offer service and are no longer served by a competitive electric customens on March 1,1998 under energy supplier.

Massachusetts legislation that provided for the full

> %e Department of Telecommunications and recovery of transition costs, rate reductions for con-Energy (DTE) is currently developing regulations that sumers, enhancements for the emironment and will establish performance-based rates based on ser-expanded protections for low-income customers.

vice quality, customer satisfaction and facility upgrades.

De electric industry restructuring bill, signed into e DTE also issued standards of conduct govern-

' law on November 25,1997, provides full recovery of ing the relationships between regulated distribution

' transition costs provided utilities do everything -

c mpanies and non-regulated affiliates. COM/ Energy's required under the legislation to mitigate the cost of holding company status already provides our electric the transition from a regulated to a competitive market.

perati ns with much of the separation that is required nis includes the divestiture of all generating facilities.

under the regulations.

As we discussed in last year's report, through our

" Competitive Challenge" plan we were the first utility in gg ggg g gg7g g y Massachusetts to propose leaving the power business He electn.. dustry restructuring bill aho m.elud-em as a way of creating a competitive power market. Our ed many provisions for the deregulat, ion of the gas plan outlining the details of how we intend to imple-utility m. dustry, which has been moving steadily ment the restructuring legislation was approved at the toward allow, g all customers to buy their gas supply m

end of February. Included in that plan was our propos-on the open market.

al for selling all of our 967 megawatts of owned genera-In July 1997, the DTE d.irected the.mvestor-owned tion and 17 power contracts as the biggest step in miti-Massachusetts gas utilities to.. iate a collaborat.ive mit gating transition costs.

process to establish a ecmmon set of gu.d.i mg prmciples Our auction is well underway and a short list of bid-and procedures for the separation of the various cost ders has been chosen. One or more buyers are expect.

components (unbundling) of natural gas.in ed to be selected in late spring. Proceeds from the sale Massachusetts.

t will be used to reduce transition costs we could incur.

As a result, COM/ Gas has j..omed other utilit.ies and Other highlights of the restructuring law include:

has taken a lead role. the Massachusetts Gas m

> Beginning March 1,1998, electric customers are Unbundling Collaborat.ive. The collaborat.ive meludes e

able to buy their electricity in the competitive numerous stakeholders ranging from local distributmn power market. Electric distribution companies will compames and gas producers to consumer advocates deliver that electricity to customers' meters and will and regulators. hs purpose,s to make recommenda-i continue to repair poles and wires and read meters.

tions on gas unbundh.ng to the DTE,.meludm.g the diffi-

. They will also be able to handle the billing for both cult issues relat.mg to p.ipeh.ne and storage the energy supply company and their own distribu-I i

capacity / cost assignments.

t,on services.

Also, related to customer choice, COM/ Gas will l

> Also beginning March 1,1998, electric distiibution Sle, by April 15,1998, revised tariffs that will meet f

l companies are offering a 10% discount to customers legislative requirements to functionally separate gas who choose not to seh ct a competitive supplier.

merchant and distribution services. Assuming the Electricity supplied by the distribution company is capacity issues are resolved, we expect to have L

known as " standard offer service." ne discount could unbundled rates approved for all customers by t

l-

. increase to 15% by September 1,1999.

November 1,1998.

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N E

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U S

I N

E S

S Unregulated Businesses tomers. % rough the use of new technologies,

~

Rapid and dnunatic changes in the electric and gas Advanced Energy Systems will be positioned to utility industiies have created a number of opportuni-provide these customers with dedicated energy ties for non-utility energy-related businesses, facilities designed to lower costs and emissions, Erough new business ventures launched in 1996 and while improving overall reliability.

1W7 - COM/ Energy Tecimologies, COM/Energv Neural Network Technology Marketing and Advanced Energy Systems-we have In 1997. Advanced Energy Systems established a moved to take advantage of these opportunities. Our joint venture with Charles River Associates - NeuCo strategy is clear - to maximize our strengths, and

- to form a company created to develop and market kverage those competenc.ies m energy-related bus.i-artificial intelligence process control. De integrated nesses, the arena we know best.

software and hardware product assists generating l

Advanced Energy to Purchase plant operators in increasing plant capacity, improv-ing fuel efficiency and reducing emissions. In our Harvard Energ"y Plant first " live" test of this advanced neumi network l

On February 5,1998, we signed a purchase and process control, we were able to lx>ost production by sale agreement that will 20 megawatts while reducing enable Advanced Energy 1

1.,[

../,

i~

NOx and CO em.issions.

Systems,Inc. to purchase f*

Medical Area Total Energy

)

~

k NeuCo's cutting-edge I

technology promises to have Plant,Inc. (MATEP) from enormous appeal to the S200 s.

Harvard Um.versity.

8 1

billion electric generating MATEI's principal asset is a '

4 market as power producers 4

chilkxl water, steam, and elec 4i face new competitive pres-tricity generating facility in j'

sures to cut costs, improve Boston's longwood Medical

,a - 1

,e N :

efficiency, and meet increas-

+

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area. The plant was built in i

s+

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ingly str.mgent environmental 1980 to serve Beth Israel i. --

regulations. Its strength is its E "

Deaconess Hospital, Brigham " *

' ' ~ " ^^" ~ ~ "

Advanced Energy Sptems'pending purchase of ability to improve fuel elfi-and M, omen's Hosp.tal, llarvard Unirenity's total energy plant will pro-ciency without major capital i

Children's Hospital, Dana-cide thefoundation for our plans to offer a compre-hensive package of energy services to a broad range expenditures, in an industry Farber Cancer Institute, the ofcommercialandindustdalcustomen. Mctured where nearly 50 percent of Joslin Diabetes Center, and in front ofour newfccility is Leonard R. Devanna, l

Harvard's medical, dental and

1. 1. 8I#'"'"/A#'#""##""D'S8*8-J public health schools. We will continue to provide all of the energy required by these customers.

Energy Connections MATEP is the largest non-utility total energy Another example of kveraging our strengths in system in New England and is a flagship operation energy-related business is the 1997 purchase of

- a complement to our existing steam system and Energy Connections by COM/ Energy Technologies.

a strong entry into a major industry sector.

Energy Connections is an energy information tecimol-MATEP will be the cornerstone of our plans to ogy company offering a bmad range of highly sophis-provide a comprehensive package of energy ser-ticated, energy-related monitoring and control pnxi-Vices to large commercial and industrial cus-ucts and senices. Energy Connections technology 14

i I

N E W B

U S

I N

E S

S Financial Section i

t can measure timemf<!ay energy use, establish h)ad profik s. detect out-ages, read meten (ekrtric, gas and water) and produce estimated bills.

'l,able of The potential market for Energy Connections is enormous, as C0ntents the Electric Power Research Institute estimates the market for these products to be $35 billion in the U.S. alone. In a competi-

> Management's Discussion and tive energy market, commercial and industrial customers need Analysis of Financial Condition l

detailed load and energy use information to negotiate the best nd Results of Operations.... 16

{

energy prices. Power marketers need a tool for portfolio manage-l ment. And, utilities need value-added services to retain their val.

> Management's Report...... 21 l

ued customers.

Energy Connections began sales activities in September 1997 and

> Report ofIndependent Public alrrady has an impressive list of premium clients in the pharmacec-Accountants............. 21 l

tical, manufacturing, industrial, tourism / hotel and health care l

industries.

> Consolidated Statements An important part of our strargy is to get our products Hncome................ 22 quickly into major markets through the creation of well j

'g

> Consolidated Statements j

planned strategic partner-

[,

I" -

of Cash Flows.......... 23 1

kr j

ships and alliances wiin industry leaders. We are cur.

> Consolidated Balance

~

rently working on the devel-k i

opment of a number of these i I

Sheets............... 24-25 n

. tn s

l partnerships with key mar-

)

g 4 - e4

> Consolidated Statements of ket players.

Capitalization......... 26 COM/ Energy i.

> Consolidated Statements of 4

Changes m Common i

Marketing

[- -

_, -- ~~- ~

Shareholders' Investment.. 27 1

Also in 1997, we estab-The potential marketfor Energy Connections technology - which can measure time +fday lished COM/ Energy electrical use, establish load profiles, detect

> Consolidated Statements of Marketing, an unregulated outages, read meters and produce bills - is Changes in Redeemable estimated at $35 billion in the U.S. alone Preferred Shares ' 27 provider of energy and ener' (From left) Robert A. Paul, President, gy-related products and ser.

CO31/ Energy Technologies and COSI/ Energy Afarkednt Edwardf Sayos. Wa Pusident.

> Notes to Consolidated vicesin the $17 billion New Sales and 3farketing, CO31/ Energy England retail electric and Technologies; and Richard L Taylor, Vice si ent, Engineering and Production, t

gas market. We are currently CO31/ Energy Technologies.

Selected Financ. l Data...... 37 ia i

doing business in five of the i

]

New England states and in New Jersey. COM/ Energy Marketing j

started selling in July 1997, and we currently serve over 600 cus.

> Comparative Statistical Data -

.............. 38-39 j

tomers. Contracts in place are valued at over $30 million for gas and 3

wholesale electricity. We expect growth to accelerate in 1998 as we add resources and expand our markets geographically.

I 15

Management's Discussion and Analysis of Financial Condition and Results of Operations Commonwealth Energy Sptem andSubsidiary Companies 1995 of a reserve (4 cents) mlatni to a conxrvation omgram Results of Operations settlernent in 1995.

Earnings and Dit'idends in March IW7, the System's lloard of Trustees Earnings and earnings per common share by organizational increased the quarteily dividend rate per share 2.6% from element for the three year period were as follows:

38% cents to 39% cents ($1.58 on an anmtalized basis).

Viis was the second consecutive year and the third time in 1997 1996 1995 four years that the lloard had voted to increase the quar-Per Per Per terly dividend rate. Dividends paid to connnon sharciand-Amount Share Amount Share Amount Share ers in 1997 were $34.1 million, representing a payout ratio (Dollars in thousands except per share amounts) of 69% of 1997 earnings per share, Electric

$34,811 $1.62 $39,667 $1.85 $32.247 $1.52 Electric Operations Gas 14,681

.68 16,229

.75 15,352

.72 Electric operating revenues for 1997 increased $38.8 million Other (579) (.03) 2,229

.10 2,687._.12 (6%) due to greater wholesale sales redecting the changing Total

$48,913 $2.27 $58,125 $250 $50,286 $2.36 capacity needs of non-affiliated utilities ($11.7 million) and the Independent System Operator (ISO) - New England (formerly parent company earnings and dividends on preferred shares were the !N.ew England Power Pool that operates a centralized facil.e allocated among the electric, gas and other operations of the system based on the Parent's equity investment in each segment.

ty to ensure reliability of service and dispatch of economically 1997 eersus 1996 available generating units throughout New England) ($11 mil-Earnings per share for the year l!FJ7 were $2.27 compared to lion) and higher retail unit sales ($2.4 million). O'fsetting the record level of $230 achieved last year. The decline for the these factors was the absence of a $4 million refund associated year was due to a one-time after. tax charge of $10.7 million, or with the 1996 power contract settlement agreement and lower 50 cents per share, that related to a voluntary personnel redne.

revenues ($2.1 million) due to the return allowed on Canal's tion program (PRP). Factors that had a positive impact on earn.

declining investment base.

ings for the year were lower operating and maintenance expenses in 1996, electric operating revenues increased $44.7 million (25 cents) that resulted, in part, from the PRIi an increase in (7.4%) due mainly to higher fuel costs of $33.9 million reuecting electric unit sales (11 cents) and the absence in 1997 of costs the increased availability of Canal's Unit 1 generating facility associated with a labor dispute in 1996 (13 cents). Earnings for that was out of service during the first seven months of 1995 for 1997 were negatively affected by the absence of a 1996 mftmd scheduled maintenance and repairs.'lhe remainder of the associatext with a power contract settlement agmement (11 cents),

change redects the $4 million refund associated with the power lower firm gas unit sak s (8 cents), costs associated with new contract settlement, the impact of higher retail unit sales ($3.9 business development (12 cents), the absence of a 1996 recogni-million), and the recovery in rates of $1.8 million for Canal's tion of the recoverability of costs associated with Canal Ekctric previously deferred postretirement benefits costs.

Company's postretirement benefits costs that were subsequently Unit sales (in Megawatthours or MWil) were as follows:

recovered in wholesale rates (5 cents) and a lower investment 1997 C Loge 1996 Change 1995 base on generation assets (6 cents).

1996 versus 1995 Residential 1,830J93 1.5 1,802,973 2.9 1,752,430 In 1996, earnings per share increased 34 cents to $2J0.

Commercial 2.506.215 3.1 2,430,188 (0.8) 2,450,390 Signifiant factors that contributui to the impmved earnings Industrial and other 459,104 2.1 449,844 1.1 445,020 l included higher fum gas (18 cents) and retail ekstric (14 cents)

Total retail 4J96,112 2.4 4,683,005 0.8 4,M7,840 I unit saks, the teftmd associated with the power contract settk' Wholesale 3,916,974 43.9 2,721,623 37.9 1,973,543 ment agreement (11 cents), lower interest costs (9 cents), and Total 8313.086 17.7 7,404.628 11.8 6.621.383 the recognition of Canal's recovery of postretimment benefits costs (5 cents). Partially offsetting these factors were costs In 1997 and 1996, retail unit sales increased due to approximate.

related to the labor dispute (13 cents), storm damage from ly 4.200 (1.2%) and 3J00 (1.00 additional customers, the signifi-llurricane Edouard (6 cents), a customer refund (5 cents in cant majority of which are permanent year round residential cus-1996 ven;us 1 cent in 1995) pursuant to a 1995 settlement tomers. The increase in the k vel of whok sale sales redected the agreement with the Massachusetts Department of increased availability of Canal Unit 1 (by STO and greater sales Tekrommunications and Energy (LYTE) (formerly the to ISO New England (by nearly 43%). The changes in whok sale Massachusetts Department of Public Utilities) that limited unit saks have little,if any, impact on net income.

Commonwealth Electric Company's return on equity, as The $38.1 million increase in fuel and purchased power defuxxl in a settlement that expired in 1997, and the reverwd in costs in 1997 was due primarily to higher wholesale unit sales 16

i I

and higher costs for replacement power reflecting the perma-during the year, as compared to milder weather in 1995 that was nent shutdown of both Connecticut Yankee during 1996 and 1.4% above nonnal. Ileating degree days were nearly 3.8% higher Maine Yankee in 1997, the latter of which was taken out of during 1996 as comparn! to 1995 and 2.3% above normal. A service in December 1996. In 1996, the cost of fuelincreased growing customer base, including customers formerly receiving by $33.9 million due primarily to the availability of Canal Unit quasi-finn sales service, somewhat offset the decline in firm sales 1, while the cost of purchased power decreased by $9.8 mil-in 1997 and contributed to the increase in firm tmit sales in 1996.

, lion reflecting the availability of Canal Unit I and the reduced Other Operating Expenses requirement for other more costly sources of capacity.

Other operation in 1997 increased $10.3 million or 4.8% due to Gas Operations a one-time charge related to the PRP ($17.7 million) as further in 1997, gas operating revenues decreased $7.9 million discussed below, costs associated with new business develop-(2.3%) primarily due to a 5.6% decline in finn unit sales ($11.1 ment ($3.6 million), and an increase in the provision for bad million) and lower conservation and load management debts ($1.4 million) that reflected Hgher reserve requirements.

(C&lM) costs ($1.8 million), offset by an increase in trans-The impact of these factors was offset, in part, by lower operating portation revenues of $1.8 million and revenues from sales of costs ($5 million) that resulted, in part, from the PRii lower pen-gas to third parties of $3.9 million. In 1996, operating revenues sion costs ($2.7 million) and the absence of costs related to the increased approximately $34.9 million or 11.4% due to higher 1996 labor dispute ($4.6 million).

gas costs of $28.7 million reflecting both higher prices from De system initially announced the details of the system-wide suppliers and increased unit sales to customers. He voluntary PRP in May 1997. He goal of the PRP was to achieve increased firm sales, including transportation, equated to $6.9 a reduced, more efficient and more productive workforce in million due to colder weather during 1996.

response to the signiGeant mgulatory changes facing the sys-Commonwealth Gas Company also utilizes the off-tystem tem. In 1997, approximately 13% of system employees voluntari-sales and capacity release markets as a means to sell excess ly terminated employment as a result of the PRI? De one-time resources. A margin-sharing agreement for these sales was charge of $17.7 million referred to above excludes generation-approved by the IrrE on January 15,1997 that allowed related costs, the recovery of which is being addressed as part Commonwealth Gas to retain 25% of the gross margins real-of the electric industry restructuring process. De payback peri-ized above a certain threshold amount as set from year to year od for the cost of the PRP is expected to be about one year. His with the remaining margins credited to firm customers action followed the consolidation of the system's electric and gas through the Cost of Gas Adjustment clause. As a result of this operations earlier in 1997. In furtherance of this consolidation margin-sharing agreement, Commonwealth Gas realized rev-effort, the system, in March 1998, reached agreement with IBM enues of approximately $644,000 in 1997.

Global Services, Inc. to offer employment to 40 system employ-Unit sales and transportation volume (in billions of British ees and to provide all of the system's information technology, thermal units or BBTU) were as follows:

telecommunications and network services.

in 1996, other operation increased anproximately $9 million 1997 Change 1996 Change 1995 or 4.4% and reflected the impact of hig'.er general liability insur-Residential 22,043 (3.1) 22,759 6.7 21,336 ance costs ($6.3 million), higher postretirement benefits costs Commercial 11,077 (4.2) 11,558 7.9 10,710

($4 million), and the net impact of the labor dispute. Dese Industrial and other 5.594 (16.2) 6.676 4.1 6,412 expenses were offset somewhat by lower C&lM costs ($2.4 mil-Total firm 38,714 (5.6) 40,993 6.6 38,458 lion), a $1.6 million decline in health benefits costs, a decline in Off-system 2,673 10.5 2,420 (40.1) 4,M3 the provision for bad debts ($1.1 million) that reflected improved Quasi-firm 51 (95.2) 1,066 (44.1) 1,906 collection experience, and the absence of legal fees ($800,000)

Intecruptible 1,882 (0.1) 1,883 55.0 1,215

" "**# C "

Total sales 43,320 (6.6) 46,362 1.6 45,622 tadon Maintenance declined in 1997 by $4.1 million or 10% and u

ma u

n in transmission and distribution-48

.)

5 3

49 related projects and, to a lesser extent, the PRi! Maintenance The decline in firm unit sales in 1997 was due to decreases increased in 1996 by $2.5 million or 6.5% primarily due to to all customer segments that reflected milder weather experi-ctorm damage costs related to Hurricane Edouard ($2.1 mil-enced in the region during the first quarter as compared to a lion), partially offset by reductions primarily associated with colder period in 1996. Degree days for the current year Canal Unit 1 ($1.5 million).

totaled 6,46't,3.6% 10wer than last year and 125 below the nor-Depreciation increased $1.6 million and $3.6 million in mallevel of 6,541. De significant fluctuations in non-firm 1997 and 1996, respectively, and reflected the system's sales reflected the competitive environment that exists in the additions to property, plant and equipment, that included natural gas industry. A portion of the margin realized on the costs associated with the completed conversion of Canal these sales reduced the cost of gas sold to firm customers.

Unit 2 in mid-1996 to burn natural gas as well as oil.

He increase in unit sales to firm customers during 1996 Federal and state income taxes decreased by $5.1 million (6.6%) reflected significant improvements for all customer seg-during 1997 due mainly to the lower level of pre-tax income.

ments consistent with colder than normal weather experienced local property and other taxes were higher during 1997 due 17

)

to higher property tax rates and assessments within the syrv (as further discussed below), $60.3 as ww o,a tem's service territory and an increase in payroll-related taxes million in construction expendi-Q*

y due to the 1996 labor dispute.

tures, $28.8 million for debt and ois.r king fund payments, and $15.6 im S")lh Other Income nu on related to new business In 1997, other income decreased $2.3 million due primarily to the absence of a 1996 recognition of the recoverability of development. These 1998 expendi-

& &$ gA51 costs associated with Canal's postretirement benefits ($1.8 tures will be met primarily through million) following Federal Energy Regulatory Commission a combination oflong and short-g approval, and the absence of a 1996 gain that related to the term debt issues ($186.8 million) sale of parcels ofland ($700,000). Rese two factors were also and internally-generated funds of the primary causes for the change for 1996 versus 1995.

$67.9 million.

Advanced Energy has reached Interest Charges agreement to purchase the total The $2 million decline in total interest charges for 1997 was energy plant that is owned and oper.

due to maturing long-term debt and scheduled sinking fund ated by liarvard University payments partially offset by a slightly higher arrage level of (MATEP) and provides the steam, short term borrowings. The decline of $2.2 millioa, or 5%, in cooling and eketric requirements of 1996 also reflected maturing debt and sinking fund payments.

Flarvard's professional schools and l

fl; L

~ Liquidity and Capital Resources five affili ted teaching hospitals in "g

q Boston. De closmg for this transac.

Financial Condition tion is expected to occur during the g"gh De system's cash requirements are second quarter of 1998. It is proket-

p g

a c-%

essentially met through the generation of a rotaltai ed that this new venture wdl d 'E cash flows from the sale of electricity, nat-Preferred Shares increase system revenues by ural gas (including liquefied natural gas)

{$7yM approximately $45 million in 1998 and steam. Cash requirements for current g j j j j and, on average, by approximately j" lyl operations, construction programs, debt

$65 milhon m the years 1999 am...,o o

sereice and other capital requirements are through 2002.

maintained through internal generation

%e System could also raise capital through the issuance of and short-term borrowings made available additional Common Shares, a new series of Preferred Shares, through the system's credit lines with or through its Dividend Reinvestment and Common Share banks. Long-term debt issues are used to Purchase Plan. He System's goal is to maintain a capital struc-prmanently finance short-term debt when ture that preserves an appropriate balance between debt and deemed appropriate by management.

equity. Management believes its capital resources and liquidity He system's 1997 net cash flow from are sufficient to meet i's current and projected requirements.

operating activities exceeded funds The system's capitalization structure is presented below:

required to support additions to property, 1996 1997 plant and equipment by $50 million or 0)ollars in thousands) 86.9% Plant ad 'itions continued to be long-term debt

$369,565 40.3%

$383,311 41.7%

funded entirely with internally-generated Preferred shares 13,020 1.4 12,200 1.3 funds. The year's cash requirements for Common equity 415,694 45.4 430,770 46.8 the payment of preferred and common div-l Short-term debt 118,475 12.9 94.075 10.2 idends ($35.1 million), the funding of Total capitalization $916,754 100.M

$920,356 100.0%

i ruturing long-term debt and sinking fund i

Forward-looking Statements requirements ($22.7 million), and the re-Capitellsetion his discussion contains statements which, to the extent it is payment of short-term borrowings ($24.4 not a recitation of historical fact, constitute " forward-looking million) were provided from operations and proceeds from the statements" and is intended to be subject to the safe harbor pro-issuance of long-term debt ($35 million). Other information on tection provided by the Private Securities Utigation Reform Act the sources and uses of cash for the past three years is includ-of.1995. A number ofimportant factors affecting the System's ed in the Consolidated Statements of Cash Flows.

business and financial results couki cause actual results to differ Capital Requirements and Resources materially from those reflected in the forward-k>oking state-De system's projected capital expenditures for the years ments or projected anmunts. %ose factors include develop-1998 through 2002 are $627.8 million, including $254.7 million ments in the legislative, regulatory and competitive emiron-for 1998 that consists of approximately $150 million for ment, certain emironmental matters, demands for capital and Advanced Energy Systems,1nc.'s pending purchase of a total new business development expenditures and the availability of energy plant that serves the longwod Medical Area in Boston cash from various sources.

18

Industr> Restructuring for stranded cost recovery. A request for bids from interested parties was issued during August, and an Offering Electn.c Memorandum was issued in October. Potential bidders exam-On November 25,1997, the Governor of Massachusetts ined all pertinent information related to the system's generating signed into law the &ctric Industry Restructuring Act (the facilities and purchased power agreements in order to prepare Act). Provisions of this legislation inciude, among other and submit their first round of bids in mid-December. In things, a 10 percent discount on standard offer service and January 1998, the system selected a short list of potential bid- '

retail choice of energy supplier effective March 1,1998, with ders, each of whom are expected to submit a final binding bid a subsequent increase in the discount on standard offer ser-in the second quarter of 1998. The entire process, including vice of up to 15 percent upon completion of divestiture of regulatory approvals, is expected to be completed in 1998.

non-nuclear generating assets and securitization of net non-g mitigable stranded costs (which. for the system, are primari-ly the result of above market purchased power contracts On July 18,1997, the DTE directed the ten Massachusetts with non-utility generators); and, recovery of stranded costs gas utilities, including Commonwealth Gas, to initiate a collabo.

subject to review and an audit process.

rative process that will establish guiding principles and specific

%e system filed a comprehensive ekctric restructuring procedures for unbundling rates and services for all customers.

plan with the DTE on November 19,1997 that was thorough.

The DTE listed six principles that it considers important to ly reviewed in five separate hearings that solicited public the success of a competitive natural gas market that will pro-conunent, and seven days of evidentiary hearings that were vide safe and reliable service at the lowest possible cost to cus-completed in February 1998, t meni. De natural gas market would: (1) provide the broad-Consistent with the Act, the system's plan provides, as of est possible choice; (2) provide all customers with an opportu-March 1,1998, a rate reduction of 10 percent for customers nity to share in the benefits of increased competition; (3) choosing the standard service transition rate from the aver, ensure full and fair competition in the gas supply market; (4) age of undiscounted rates in effect during August 1997, functionally separate supply from local distribution services; divestiture of non-nuclear generating assets and a restrue.

(5) support and further the goals of environmental regtdation; tured ehrtric generation market that is able to offer retail and lastly (6) rely on incentive regulation where a fully compet-ecess to all customers. He sys,em's plan also includes the itive market cannot or presently does not exist.

following provisions 1) an estimate and detaled accounting of In addition, the DTE outlined several specific issues that it total twnsition costs eligible for recovery through a non, expects the collaborative to address: (1) services that can be bypassable access or transition charge; 2) a description of the Hered on a competitive basis; (2) terms and conditions of ser.

system's strategies to raitigate tmnsition costs: 3) unbundled vice-; (3) consumer protections and social programs; (4) mitiga-rates for generation, distribution, transmission and other ser.

tion of gas related and non-gas related transition costs; (5) third-vices; 4) proposed charges for the recovery of transition costs party supplier qualifications; and (6) curtailment principles.

through the non-by' passable transition charge; 5) propmed E* DTE also suggested that the collaborative reconsider the programs to provide universal service to all customers; 6) pro.

pncmg and provision of interruptible transportation sersices.

posed programs and mandatory charges to promote energy On August 18,1997, the DTE noted that the development of conservation and demand-side management; 7) procedures unbundling principles and procedures constitutes only a part of for ensuring direct retail access to all electric generation sup.

Ge enort necessary to develop full customer choice for gas ser-

. pliers; 8) discussions of the impact of the plan on the system's vice. He DTE recognized that each local distribution company employees and the communities served by the system; and wih be filing a comprehensive unbundling proposal at some later (9) a mandatory charge per kwh for all consumers to support date, in the interim, the ITIE directed those companies that do the development and promotion of renewable energy projects.

n t currently have unbundled rates, including Commonwealth On February 27,1998, the DTE approved the system's Gas, to have such rates in effect no later than November 1,1998.

restructuring plan stating that the plan complies with the Commonwealth Gas and eight other gas utilities initiated

'Act. While the system is encouraged with the treatment the Massachusetts Gas Unbundling Collaborat:ye (the

. afforded stranded or transition cost recovery by the legis'.a.

Collaborative) on Se, - nber 15,1997, to explore and devel-tion and the DTE, the mandated customer discount could p generic principles to achieve the goals set forth by the have a significant impact on future cash tiows.

DTE, Collaborative participar2ts represented a broad array of stakeholder intererts including the utilities, natural gas

' Auction Process marketers, interstate pipelines, producers, energy consul-On March 31,1997, the system submitted a report to the tants, unions, consumer advocates and representatives for i

DTE that detailed the proposed auction process for selling its the DTE, the Massachusetts Attorney General, and the electric generation assets and entitlements. De process includ-Massachusetts Division of Energy Resources.

ed a standard, seak d bid auction for generation assets and pur.

On November 15,1997, the CoPaborative filed a status report chased power contracts. De auction proceso provides a mar-with the DTE that outlined its progress in moving the gas indus-j ket based approach to maximizing stranded cost mitigation and try to a more competitive structure that provides all customers

^

minimizing the access charges that ratepayers will have to pay with meaningful access to competitive markets consistent with l

19 L

1 1

public-policy objectives. De status report sununarized the sub-to an increase ia the site clean-up cost estimate for an MGP stantive issues that had been the subject of Collaborative thscus site for which Commonwealth Gas was previous'y cited as a sion, including- (1) the disposition ofinterstate pipeline capacity; Potendally Responsible Party. De DTE has approved recov-(2) the unbundling of rates; (3) customer enrollment, billing, ter-ery of costs associated with MGP sites.

mination, and information exchange procedures; and, (4) con-Commonwealth Gas and certain other system subsidiaries sumer protections, low-income discounts, and competitive sup are also involved in other known or potentially contaminated plier registration. Le status report also established a schedule sites where the associated costs may not be recovemble in to implement a final unbundling plan by November 1,1998.

rates and have recorded in prior years an estimated liability in accordance with that schedule, the Collaborative submit-(and a charge to operations) of $2 million to cover the expected ted with the DTE a Rate Unbundling Status Report on January costs associated with assessment and remediation activities.

16,1998. %e report detailed an overall process for develop-Rese estimates are reviewed and adjusted periodically as fur-ing unbundled rates consistent with the DTE's rate structure ther investigation and assignment of responsibility occurs. The goals of efficiency, fairness, simplicity, continuity and earnings system is unable to estimate its ultimate liability for future envi-stability. In response to the Collaborative's proposal, the DTE ronmental remediation costs. However,in view of the system's ordered Commonwealth Gas to submit, no later than April 15, current assessment of its environmental responsibilities, exist-1998, a consensus-based settlement, or partial settlement, of ing legal requirements and regulatory policies, mariagement i

unbundled rate tariffs designed accordmg to the general con-doca not believe that these matters will have a material advers -

I cepts set forth 2n the report.

effect on the system's results of operations or financial position.

Provisions ofStatement ofFinancial Accounting On January 1,1997, the system adopted the provisions of I

Standards No. D Statement of Position (SOP) %1, " Environmental Remediation Da es pmvides authoritative guidance for As described in Note 2(b) of the Notes to Comolidated Financial Statements, the system follows the provisions of mmgnidon, meammment, Splay anq Momm of envimn-mental remediation liabilities in financial statements. %e sysr Statement of F' ancial Accounting Standards (SFAS) No. 71, m

tem has recorded environmental remediatwn liabilities net of

" Accounting for the Effects of Certain Types of Regulation." In amounts paid of $2.3 muhon at December'll,1997. %e adop the event the system is somehow unable to meet ths: aiteria for twn of SOP %1 did not have a material adverse effect on the following bFAS No. 71, the accounting impact would be an extra-sys m's msu s f pennons r financi 1 p sitmn.

ordinary, non cash charge to operations in an amount that could be material. Conditions that could cive rise to the discontinuance Year 2000 of SFAS No. 71 include: 1) increasing competition restricting the system's ability to establish prices to recover specific costs, and The system has been involved in the Year 2000 complian-

2) a significant change in the current manner in which rates are cy since 1996. A complete inventory and review of software, set by regulators. De system monitors these criteria to ensure inf rmation processing and delivery systems has been com-that the continuing application of SFAS No. 71 is appropriate.

pleted, and work continues on computer systems wherever Based on the current evaluation of the various factors and condi-necessary. While some computer systems have already been tions that are expected to impact future cost recovery, the system updated, tested and placed in production, the system expects believes that its retail electric utility operations, excludbig genera-to complete the balance of the modifications by early 1999.

tion-related assets, remain subject to SFAS No. 71 and its regula-Expenditures incurred by the system through 1997 to review tory assets, including those related to elwtric generation, remain exisung mmputer systems and to modify existing software and probable of future recovery.

appheadons amounted to nearly $900,000, and it is estimated that As a result of ek c*ric industry restructuring, the system's retail appmxim tely $2E inEon wG k incurred in 1998 and 1999.

ekctric companies discontinued application of accounting princi-Management believes that, with appropriate modifications.

. pies applied to their investment in ek ctric generation facilities the system will be fully compUant regarding all Year 2000 effective March 1,1998. %e system will not be required to write issues and will continue to provide its products and services off any of its generation-related assets, including regulatory uninterrupted through the millennium change. Failure to assets. Desc assets will be retained on the Consolidated become fully compliant could have a sigmficant impact on the Balance Sheets because the hgislation and the IYTE's plan for a system's results of operations.

restructured electric industry specifically provide for their recov-cry through the non-bypassable transition charge.

New Accountm, g I,n.nciples During 1997, the Financial Accounting Standards Board issued Environmental Matters two new accounting standards that the system will adopt in 1998.

Commonwealth Gas is participating in the assessment of a SFAS No.130, " Reporting Comprehensive income" will require number of former manufactured gas plant (MGP) sites and disclosure on comprehensive income and its components. SFAS alleged MGP waste disposallocations to determine if and to No.131, " Disclosures about Segments of an Enterprise and what extent such sites have been contaminated and whether Related Information" will require disclosure of financial and Commonwealth Gas may be responsible for remedial actions.

descriptive information on reportable operating segments. %e in April 1997, Commonwealth Gas recorded an additional lia.

adoption of these standards is not expected to have a material bility and corresponding regulatory asset of $1.2 million due impact on the system's results e operations or financial position.

r 20

Management's Report Commontcealth Energy System andSubsidiary Companies The consolidated f'mancial statements presented statements presented. The independent auditors are herein are representations of the management of selected by the Beard of Trustees and report their Commonwealth Energy System. Management findings thereto through the Audit Committee, which recognizes its responsibility for the preparation is comprised of three outside Trustees. The Board of and presentation of financial statements in Trustees is responsible for ensuring that both the conformity with generally accepted accounting independent auditors and management fulfill their principles. To fulfill this responsibility, management respective responsibilities as they pertain to these

. maintains a system of internal accounting controls, consolidated financial statements.

including established policies and procedures and a comprehensive internal auditing program to evaluate the adequacy and effectiveness of accounting and operating controls, compliance with system policies James D. Rappoli, and procedures and the safeguarding of system assets.

FinancialVice President The responsibility of our independent auditors' and Treasurer

' examination is limited to the expression of an opinion as to the fairness of the consolidated financial March 2,1998.

Report of Independent Public Accountants To the Board of Trustees of disclosures in the financial st:tements. An audit also Commonwealth Energy System:

includes assessing the accounting principles used and significent estimates made by management, as We have audited the accompanying consolidated well as evaluating the overall financial statement

~ balance sheets and consolidated statements of presentation. We believe that our audits provide a capitalization of COMMONWEALTH ENERGY reasonable basis for our opinion.

SYSTEM (the System) (a Massachusetts tmst) and In our opinion, the consolidated financial statements subsidiary companies as of December 31,1997 and referred to above present fairly, in all material

' 1996, and the related consolidated statements of respects, the financial position of Commonwealth income, cash flows, changes in common shareholders' Energy System and subsidiary companies as of

- investment and changes in redeemable preferred December 31,1997 and 1996, and the results of their shares for each of the three years in the period operations and their cash flows for each of the three ended December 31,1997. These consolidated years in the period ended December 31,1997,in financial statements are the responsibility of the conformity with generally accepted account:ng System and subsidiary companies' management.

principles.

'Our responsibility is to express an opinion on these

. consolidated financial statements based on ow audits.

' We conducted our audits in accordance with Arthur Andersen LLP generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether Boston, Massachusetts the financial statements are free of material.

February 19,1998 (except with respeci to certa'm misstatement. An audit includes examining, on a matters discussed in Note 2, as to which the date is test basis, evidence supporting the amounts and March 2,1998).

21 I

o

Consolidated Statements of Income Commontrealth Energy System andStdsidiary Companies For the Years Ended December 31, 1997 1996 1995 (Dollars in thousands except per share amounts)

Operating Revenues l

Electric S 688,508

$ 649,678 - $ 604,980 i

Gas 333,977 341,867 306,953 Steam and other 19,259 19,360 17,355 1,041,744 1,010,905 929,288 Operating Expenses Fuel used in electric producnon, principally oil 129,021 91,690 57,820 Electricity purchased for resale 265,805 265,019 274,795 Cost of gas sold 184,122 187,530 158,835 Other operation 225,658 215,319 206,280 Maintenance 36,838 40,913 38,414 Depreciation 53,405 51,782 48,170 Taxes-local property 19,130 18,049 17,573 Income 31,040 36,099 24,574 Payroll and other 9,075 7,839 8,284 954,094 914,240 834,745 Operating Income 87,650 v6,665 94,543 Other Income 2,601 4,878 1,461 Income Before Interest Charges 90,251 101,543 96.004 Interest Charges limg-term debt 33,572 35,586 38,581 Otherinterest charges 6,778 6,782 6,027 40,350 42,368 44,608 Net Income 49,901 59,175 51,396 Dividends on preferred shares 988 1,050 1,110 Earnings Applicable to Common Shares 8 48,913 S 58.125 S 50.286 Average Number of Common Shares Outstanding 21,531,433 21,529,676 21,311,836 Earnings Per Common Share 82.27 S2.70 82.36 1he accompanying notes are an integral part of these consolidatedfnoncial statements.

22

Consolidated Statements of Cash Flows Commonwealth Energy Sptem andSubsidiary Companies For the Years Ended December 31, 1997 1996 1995 (Dollars in thousands)

Operating Activities Net income S 49,901 S 59,175 S 51,396 Effects of noncash items-Depreciation and amortization 65,646 63,331 60,555 Deferred income taxes, net 2,542 3,515 4,182 Investment tax credits, net (1,278)

(1,285)

(1,401)

Earnings from corporate joint ventures (1,348)

(1,557)

(1,633)

Dividends from corporate joint ventures 1,272 1,376 2,067 Change in working capital, exclusive of cash-Accot.ts receivable and unbilled revenues (12,269)

(9,446)

(13,626)

Income taxes 6,500 (14,097) 14,353 local property and other taxes 532 (555)

(950)

Accounts payable and other 20,756 (33,956) 25,199 Power contract buy-out (25,500)

Fuel charge stabilization deferral, net (5,543) 2,372 (3,447)

Deferred postretirement benefits costs (2,126)

(2,157)

(4,479)

FERC Order 636 transition costs, net 11,390 All other operating items (17,034)

(3,391) 6,565_

Net cash provided by operating activities 107,551 63,325 124,671 Investing Activities Additions to property, plant and equipment (inclusive of AFUDC).

Electric (34,524)

(38,844)

(61,643)

Gas (18,230)

(11,611)

(16,198)

Other (4,804)

(2,730)

(3,659)

Net cash used for investing activities (57,558)

(53,185)

(81.500)

Financing Activities Sale of common shares 32 9,534 Payment of dividends (35,056)

(34,205)

(33,142)

Proceeds from (payment of) short-term borrowings, net (24,400) 62,875 10,750 T ong-term debt issues 35,000 Retirement oflong-term debt an:1 preferred shares through sinking funds (8,473)

(8,436)

(8,716) long-term debt issues refunded (14,260)

(33,230)

(25,000)

Net cash used for fimmeing activities (47,189)

(12,964)

(46,574)

Net increase (decrease) in cash 2,804 (2,824)

(3,403)

Cash at beginning of period 1,495 4,319 7,722 Cash at end of period 8 4,299 S 1,495 S 4,319 Supplemental Disclosures of Cash Flow Information Cash paid during the period for:

Interest (net of capitalized amounts)

S 38,201

$ 41,294

$ 42,051 Income taxes S 24,436

$ 46,563 S 12,918 7he accompanying notes are an integralpart ofthese consolidatedpnancialstatements.

23

Consolidated Balance Sheets Commonwealth Energy System and Subsidiary Companies December 31, 1997 1996 (Dollars in thousands)

Assets Property, Plant and Equipment, at original cost Electric

$ 1,173,797

$1,150,818 Gas 373,541 357,403 Other 72,475 66,365 1,619,813 1,574,586 Irss-Accumulated depreciation and amortization 577,962 536,041 1,041,851 1,038,545 Construction work in progress 7,864 5,485 Nuclear fuelin process 193 1,597 1,049,908 1,045,627 Equity in Corporate Joint Ventures Nuclear electric power companies (2.5% to 4.5%)

10,368 10,046 Otherinvestments 3,399 3,349 13,767 13,395 Current Assets Cash 4,299.

1,495 Accountt gn hw,less reserves of $9,408 in 1997 aiu 66,624 in 1996 128,940 117,008 Unbilled revenues 32,029 31,698 Ir ; ntories, at average cost-Electric production fuel oil 1,902 2,221 Natural gas 23,301 23,084 Materials and supplies 7,441 6,220 Prepaid taxes 9,282 9,079 Other 5,786 5,686 212,986 196,491 Deferred Charges Regulatory assets 178,864 154,291 Other 29,525 19,151 208,389 173,442

$ 1,485,050

$1,428,955 The accompanying notes are an integral part of these consolidatedfinancial statements.

l 24

Consolidated Balance Sheets Commonwealth Energy Splem and Subsidiary Companies l

December 31, 1997 1996 (Dollars in thousands)

. Capitalization and Liabilities

' Capitalization (see separa.e statement)

Common share investment :

$ 430,770

$ 415,694

. Redeemable preferred shares, less current sinking fund requirements 12,200 13,020 long-term debt, less current sinking fund requirements and maturing debt 364,311 355,305 807,281 784,019

' Capital Lease, Obligations 12,272 12,346 Current Liabilities Interim Fmancing-

' Notes payable to banks 94,075 118,475 Maturing long-term debt 19,000 14,260 113,075 132,735

. Other Current Liabilities-Current sinking fund requirements 8,473 8,473 Accounts payable 107,157 90,269 Accrued taxes-i local property and other 9,795 9,060 Income 14,410 7,910 Accrued interest 6,778 6,267 Dividends declared 8,517 8,289 Other 43,627 39,279 198,757 169,547 311,832 302,282 Deferred Credits Accumulated deferred income taxes 176,354 174,877

. Nuclear units' purchased power contracts 69,659 43,677,

Unamortized investment tax credits 25,340 26,618

- Other 82,312 85,136 353,f>65 330,308 Commitments and Contingencies 81.485,050

$1,428,955 The accompanying notes are an integralpart of these consolidated 5nancial statements.

25

Consolidated Statements of Capitalization Commontcealth Enemy System and Subsidiary Cowpanies December 31,

~1997 1996 (Dollars in thousands)

- Common Share Investment Common shares, $2 par value-Authorized-50,000,000 shares Outstanding-21,531,784 shares in 1997 and

$ 43,059 21,529,676 shares in 1996

$ 43,063

. Amounts paid in excess of par value.

111,912 111,685 Retained earnings -

275,795 260,950 Total common share investment 430,770 415,694 Redeemable Preferred Shares,

. Cumulative, $100 Par Value Series A,4.80%

2,520 2,640 Series B,8.10%

3,840 4,000 Series C,7.75%

6,660 7,200 Irss-Current sinking fund requirements (820)

(820)

Total redeemable preferred shares 12,200 13,020 long-term Debt System Senior Notes due-1997, 10.48%

10,000 1998, 10.45%

10,000 10,000 1999, 10.58%

10,000 10,000 ~

. less-Maturing long-term debt (10,000)

(10,000)

Total System long-term debt 10,000 20,000 Subsidiary companies Mortgage Bonds, collateralized by property of operating subsidiaries, due.

2001, 8.99%

14,450 18,100 2006, 8.85%

34,300 34,650 2007, 6.54% -

10,000 2017, 7.04%

25,000 2020,7%%

10,000 10,000 2020,9%%

40,000 40,000 2020, 9.95%

25,000 25,000 2033, 7,11%

35,000 35,000 i

Notes due.-

1997,6%%

4,260 1998, variable rate (6.391% in 1997 and 6.125% in 1996) 9,000 9,000 1999, 8.04%

10,000 10,000

-2002,7%%

2,500 2,600

-2002, 9.30%

30,000 30,000 2003, 7.43%

15,000 15,000 2004, 9.50%

10,000 12,500

)

2007, 8.70%

5,000 5,000 2007, 9.55%

10,000 10,000 2008, 7.70%

10,000 10,000 2012,9.37%

15,789 16,842 2013, 7.98%

25,000 25,000

2014, 9.53%

10,000 10,000 2019, 9.60%.

10,000 10,000 2023, 8.47%

15,000

. 15,000 Irss-Maturing long-term debt

- (9,000)

(4,260)

Current sinking fund requirements (7,653)

(7,653)

Unamortized discount, net (75)

(734)

Total subsidiary companies

• long-term debt 354,311 335,305 Totallong-term debt 364,311 355,305 Total capitalization 8807,281 8784,019 lhe accompanying notes are an integral part of these consolidatedfinancial statements, I

26

Consolidated Statements of Changes in Common Shareholders' Investment Commonwealth Energy System and Subsidiary Companies For the years ended December 31,1997,1996 and 199 Amounts Par Paid in Value Excess

$2 Per of Par Retained Shares Share Value Earnings Total (Dollars in thousands)

Balance December 31,1994 21,051,794

$42,103

$103,168

$217,726

$362,997 Add (Deduct)-

Net income 51,396 51,396 Sale of shares 476,474 953 8,581 9,534 Cash dividends declared-Common shares-$1.50 per share (32,032)

(32,032)

Preferred shares (1,110)

(1,110)

Balance December 31,1995 21,528,268 43,056 111,749 235,980-390,785 Add (Deduct).

Net income 59,175 59,175 Sale of shares 1,408 3

29 32

- Cost of stock split (93)

(93)

Cash dividends declared-Common shares-$1.54 per share (33,155)

(33,155)

Preferred shares (1,050)

(1,050)

Balance December 31,1996 21.529,676 43,059 111,685 260,950 415,694 Add (Deduct)-

Netincome 49,901 49,901 Shares issued pursuant to leng-Term Incentive Compensation Plan 3,108 4

43 47 Amortization of deferred cor'pensation 184 184 Cash dividends declared-

- Common shares-81.58 per share (34,068)

(34,068)

Preferred shares (988)

(988)

Balance December 31,1997 21,531,784 843,063

$111,912 S275,795

$430,770

. Consolidated Statements of Changes in Redeemable Preferred Shares Commonwealth Energy System andSubsidiary Companies For the years ended December 31,1997,1996 and 1995 Authorized and Outstanding.

Cumulative Preferred Shares-$100 Par Value Series A Series B Series C Total 4.80%

8.10%

7,75%

Shares Balance December 31,1994 -

28,800 43,200 82,800 154,800 Irss Sinking fund redemptions '

1,200 1,600 5,400 8,200 Balance December 31, IJ95 27,600 41,600 77,400 146,600 less-Sinking fund redemptions 1.200 1,600 5,400 8,200 Balance December 31,1996 26,400 40,000 72,000 138,400 Irss-Sinking fund redemptions 1,200 1,600 5.400 8.200 t

Balance December 31,1997 25,200 38,400 66,600 130,200 The accompanying notes are an integral part of these consolidatedfinancial statements.

27

. Notes to Consolidated Financial Statements Commontcealth Energy Syskm andSubsidiary Companies 1

(1) GeneralInformation Commonwealth Energy System (the System) is an (b) Regulatory Assets and Liabilities exempt public utility holding company with invest-The system's operating utility companies are regulated as to ments in four operating public utility companies located rates, accounting and other matters by various authorities, in central, eastern and southeastern Massachusetts, including the Federal Energy Regulatory Commission (FERC)

The System is the parent company and, together with and the Massachusetts Department of Telecommunications

-its subsidiaries, is collectively referree *o as."the and Energy (DTE), formerly the Massachusetts Department system." System electric operations are involved in the of Public Utilities.

production, distribution and sale of electricity to Based on the current regulatory framework, the system 1367,000 customers in 41 communities including New accounts for the economic effects of regulation in accor-

' Bedford, Plymouth, Cambridge and the geographic dance with the provisions of Statement of Financial area comprising Cape Cod. Gas operathns serve Accounting Standards (SFAS) No. 71, " Accounting for the 237,000 customers in 49 communities including New Effects of Certain Types of Regulation." Regulated sub-Bedford, Cambridge, Plymouth and Worcester. In addi-sidiaries of the System have established various regulato-tion to the utility companies, the system includes a ry assets in cases where the DTE and/or the FERC have steam distribution company, five real estate trusts, a

- permitted or are expected to permit recovery of specific company engaged in the operation ut LNG facilities and costs over time. Similarly, the regulatory liabilities estab-three new subsidiaries that are pursuing energy-related lished by the system are required to be refunded to cus-business opportunities.

tomers over time. In the event the criteria for applying The system has 1,727 regular employees including SFAS No. 71 are no longer met, the accounting impact 1,037 (60%) represented by various collective bargaining would be an extraordinary, non-cash charge to operations units. A contract with a collective bargaining unit repre-of an amount that could be material.

senting appr_oximately 5% of regular employees that was Criteria that give rise to the discontinuance of SFAS No.

scheduled to expire in May 1997 was ratified in April 71 include: 1) increasing competition that restricts the sys-1997 and is effective through May 31,2001; In April tem's ability to establish prices to recover specific costs, 1998, a collective bargaining contract representing and 2) a significant change in the current manner in which approximately 5% of regular employees is scheduled to rates are set by regulators from cost based regulation to expire and two additional contracts (together represent-another form of regulation. These criteria are reviewed on ing approximately 7% of regular employees) are sched.

a regular basis to ensure the continuing application of SFAS uled to expire in September 1998.

No. 71 is appropriate. Based on the current evaluation of During the second quarter of 1997, the system initiated a the various factors and conditions that are expected to voluntary personnel reduction program. As a result of this impact future cost recovery, the system believes that its program, the total number of regular employees has declined regulatory assets, including those related to generation, are by approximately 13% in 1"97.

probable of future recovery.

^ * " ' " " " I d""I" I"d "*"Y '""""'i""' 'h" *Y"'

(2) Significant Accotinting Policies tem s retail electric companies discontmued applicat. ion of (a) Principles of Consolidation and Accounting accounting principles applied to their investment in electric The consolidated financial statements include the accounts generation facilities effective March 1,1998. The system of the System and all ofits subsidiary companies. All signifi-will not be required to write off any of its generation-relat.

cant intercompany accounts and transactions have been elimi-ed assets, including regulatory assets. These assets will nated in consolidation.

be retained on the Consolidated Balance Sheets because

'1he preparation of financial statements in conformity with the legislation and the DTE's plan for a restructured elec-generally accepted accounting principles requires manage-tric industry specifically provide for their recovery ment to make estimates and assumptions that affect the through a non-bypassable transition charge.

- reported amounts of assets and liabilities and disclosure of Effective January 1,1996, the system adopted SFAS No.

contingent assets and liabilities at the date of the financial 121, " Accounting for the impairment of lamg-Lived Assets statements and the reported amounts of revenues and expens-and for long-Lived Assets to be Disposed Of" SFAS No.

es during the reporting period. Actual results could differ 121 imposes stricter criteria for regulatory assets by frm those estimates.

requiring that such assets be probable of future recovery Certain prior year amounts are reclassified from time to at each balance sheet date. SFAS No.121 did not have an time to conform with the presentation used in the current impact on the system's financial position or results of oper-year's financial statements.

ations upon adoption.

i 28

The principal regulatory assets included in deferred the system will be allowed to recover and the market price of eke charges at December 31,1997 and 1996 were as foPows:

tricity. Management believes that the system will recover its 1997 1996 stranded costs. A change in any of the above listed factors or in (Dollars in thousands) the current k gislation could affeet the recovery of stranded costs and may result in a loss to the system. For additionalinformation Postretirement benefit costs S 25,475

$ 25.051 Power contract buy-out 17,609 20,794 relating to industry restructuring, see the " Industry I& structuring Fuel charge stabilization 29,655 21,5m

- Flectric" section unckr Management's Discussion and Analysis Deferred income taxes 13,089 13,597 of Rnancial Condition and Results of Operations.

FERC Order 636 transition costs 7,336 9,680 (c) Equity Method of Accounting e system uses fe equity method (

ments m corporate jo t ventures due, mlf accounti dd i s 34,908 m

part, to its ability to Connecticut Yankee unrecovered plant and decommissioning costs 28,566 35,879 exercise signiGeant influence over operating and financial poli-Yankee Atomic unrecovered plant cies of these entities. Under this method,it records as and decommissioning costs 6,184 7,798 income the proportionate share of the net earnings of the joint Seabrook related costs 4.324 6,262 ventures with a corresp mding increase in the carrying value Other 11,718 13,726 of the investment. The investment is reduced as cash divi-

$178,864

$154,291 dends are received. The system conducts business with the The regulatory liabilities, reflected in the accompanying corporate joint ventures in which it has investments, principal-Consolidated Balance Sheets and related primarily to deferred ly four nuclear generating facilities located in New England income taxes, were $14.1 million and $17.7 million at and a 3E4 interest in flydro-Quebec Phase II.

December 31,1997 and 1996, respectively.

(d) Operating Rerenties As of December 31,1997, $143.1 million of the system's regu-Customers are billed for their use of electricity and gas on a latory assets, including the costs associated with existing power cycle basis throughout the month. To reflect revenues in the j

contracts with three Yankee nuclear power plants that have shut proper period, the estimated amount of unbilled sales revenue down permanently (see Note 3(d)), and all of its regulatory lia-is recorded each month.

bilities are reflected in rau s charged to customers. Regulatory System utility companies are generally permitted to bill cus-assets are currently being ecovered over a weighted average tomers for costs associated with purchased power and trans-priod of approximately 11 years. The fuel charge stabilization mission, fuel used in electric production, gas, conservation deferral was expected to be recovered over a six-year period and load management and environmental costs. The amount irginning in April 1998, pursuant to a yet to be determined of such costs incurred but not yet reflected in customers' bills recovery schedule and subject to final D'lls approval.

is recorded as unbilled revenues.

In November 1997, the Commonwealth of Massachusetts (e) Depreciation enacted a comprehensive eketric utility industry restructuring Depreciation is provided using the straightline method at rates bill. On November 19,1997, the System's eketric subsidiaries intended to amortize the original cost and the estimak<l cost of filed a restructuring plan with the DTE. The plan, approved by removal k ss salvage of proprties over their estiman d economic the DTE on February 27,1998, describes the process by which lives. The average composite depreciation rak s werv as follows:

the System's retail electric subsidiaries will, beginning March 1997 1996 1995 1,1998, initiate a 10 percent rate reduction for all customer Electric 3.66%

3.65%

3.52%

classes and allow customers to choose their energy suppher.

Gas 2.95 2.94 2.90 As part of the plan, the DTE authorized the recovery of cer-Steam 3.80 3.89 3.91 tain strandable costs. the legislation gives the DTE the I.NG 3.65 3.59 3.20 authority to determine the amount of strandable costs that will he eligible for recovery Costs that will qualify as strandab'e (f) Alloteancefor Funds Used During Construction costs and be eligible for recovery include, but are not limited Under applicable rate-making practices, system companies to, certain above market costs associated with generating facili.

are permitted to include an allowance for funds used during ties, costs associated with long-tenn commitments to purchase construction (AFUDC) as an element of their depreciable power at above market prices from independent power produc-property costs. This allowance is based on the amount of con-ers and regulatory assets and associated liabilities related to struction work in progress that is not included in the rate base the generation portion of the ekrtric business.

oa which utility companies earn a return. An amount equal to

'1he cost of transitioning to competition will be mitigated,in the AFUDC capitalized in the current period is reflected in part, through the divestiture of die system's non-nuclear gen-other interest charges in the accompanying Consolidated erating assets in an auction process that is expected to be Statements of Income and amounted to $368,000, $257,000 completed in 1998. Any net proceeds.in excess of book value and 8857,000 in 1997,1996 and 1995, respectively.

received from the divestiture of these assets will be used to While AFUDC does not pmvide funds currently, these amounts mitigate stranded costs.

are recoverable in revenues over the service life of the constructed lhe system's ability to recover its stranded costs will depend on property. The amount of AFUDC reconk d was at a weighted i

i several factors, including the aggregate amount of stranded costs average rate of 6.1% in 1997,6.2% in 1996 and 7.1% in 1995.

i 29

(g) Earnings Per Share Canal Ekctric and the otherjoint owners have established a

%e System adopted SFAS No.128 " Earnings Per Share" for decommissioning fund to cover decommissioning costs. The the year ended December 31,1997. SFAS No.128 rectires the estimated cost to decommission the phmt is $469.1 million -in presentation of both basic and diluted earnings per share current dollars. Canal Ekctric's swre of this liability (approxi-(EIS). Diluted EIS reflect the possible impact on EIS that mately $16.5 million),less its share of the market value of the could occur if securities or other contracts to issue common assets held in a decommissioning trust (approximately $2.5 mil-r.tock were exercised or converkd into common stock or result-tion), is approximately $14 million at December 31,1997.

ed in the issuance of common stock that then shared in the (c) Price-Anderson Act earnings of the entity. The System granted potential awards in Under the Price-Anderson Act (the Act), owners of the form of common shares to certain key employ &s pursuant nuclear power plants have the benefit of appmximately $8.9 to its long Term Incentive Compensation Plan (see Note 5(d))

billion of public liability coverage which would compensate during the first quarter of 1997. The adoption of SFAS No.128 the public for valid bodily injury and property loss on a no did not have a material impact on the System's EIS.

fault basis in the event of an accident at a commercial nuclear power plant. Under the provisions of the Act, each (3) Comm.tments and Contingencies nuclear reactor with an operating license can be assessed i

(a) Capital Expenditures up to $79.3 million per nuclear incident with a maximum

%e system is engaged in a continuous construction program assessment of $10 million per incident within one calendar presentlyestimated at $248 6 million for the five-year period 1998 year. Nuclear plant owners have initiated insurance pro-through 2002. Of that amount, $60.7 million is estimated for grams designed to help coven liability claims relating to 1998. We program is subject to pedodic review and revision.

property damage, decontamination, replacement power and De system, through its Advanced Energy Systems, Inc.

business interruption costs for participating utilities arising subsidiary, tentatively agreed to pmthase a total energy plant from a nuclear incident.

lerated in the lengwood Medical Area of Boston for $146.3 The system has an equity ownership interest in four million. His transaction is expected to be closed in the see-nuclear generating facilities as well as a 3.52% joint own-ond quartr r of 1998. Revenues for fiscal years ended June 30, ership interest in Seabrook 1. The operators of these 1997 and 1996 were $58 million and $53.9 million, respectively, units maintain nuclear insurance coverage (on behalf of (b) Seabrook Nuclear Power Plant the owners of the facilities) with Nuclear Electric

%e system's 3.52% interest in the Seabrook nuclear power Insurance Limited (NEIL II) and the combined plant is owned by Canal Electric Company (Canal Electric), a American Nuclear Insurers / Mutual Atomic Energy whok sale electric generating subsidiary, to provide for a por.

Liability Underwriters (ANI) NEIL 11 provides $2.25 tion of the capacity and energy needs of affiliates Cambridge billion of property, boiler, machinery and decontamina-Electric Light Company (Cambridge Electric) and tion insurance coverage, including accidental premature Commonwealth Electric Company (Commonwealth Ek ctric).

decommissioning insurance in the amount of the short-Canal Ek ctric is recovering 10% ofits Seabrook 1 investment fall in the Decommissioning Trust Fund, in excess of through a power contract with Cambridge Eketric and the underlying $500 million policy. All companies Commonwealth Ekstric pursuant to FERC and DTE approval.

insured with NEIL 11 are subject to retroactive assess-Pertinent information with respect to Canal Ek ctric's joint-ments iflosses exceed the accumulated funds available.

ownership interest in Seabrook 1 and information relating to ANI provides $500 million of "all risk" property damage, operating expenses that are included in the accompanying boiler, machinery and decontamination insurance. An financial statements are as follows:

additional $200 million of primary financial protection 1997 1996 coverage is provided (Dollars in thousands) for off-site bodily Utility plant-in-service

$232,471

$232,183 Plant capacity (MW) 1,150 injury or property Nuclear fuel 22,207 21,613 Canal Electric's share:

damage caused by a Accumulated depreciation Percent interest 3 52% nuclear incident.

l and amortization (64,379)

(57,359)

Entitlement (MW) 40.5 ANI also provides Construction work in progress 1,036 844 In-service date 1990 secondary financial

$191.335

$197,281 Operating license expiration date 2026 protection liability insurance which cur-g rently provides $8.7 bilhon of retrospective ini,urance H

n housande premium benefits in accordance with the provisions of Operating expenses:

Fuel

$ 1,471

$ 1,727

$ 2,353 the Act. Additional coverage ($200 million) provided by

}

Other operation 4,206 4,091 4,292 ANI includes tort liability protection arising out of radia-i Maintenance 2,3 64 990 1,376 tion injury claims by nuclear workers and injury or E"

""*E orti ati n

,1

,31 3

$15.674

$14.671

$15.882 Based on its various ownerslu.p mterests.m the five nuclear 30 1

-l

generating facilities, the systi m's retrospective premium lect from power purchasers (including system companies) could be as high as $1.9 miEion annually or a cumulative total decommissioning costs, unrecovered plant investment and of $15.1 million, exclusive of the effect of inflation indexing (at other costs associated with the permanent closure of these five year intervals) and a 5% surcharge ($4 million) in the plants over the remaining period of each plant's operating event that totid public hability claims from a nuclear incident license. 'lhe system does not believe that the ultimate out-exceed the funds ava3able to pay such claims.

come of the early closing of these plants will have a material (d) Poteer Contracts adverse effect on its operations and believes that recovery of The system has long-term contracts to purchase capacity from these FERC-approved costs would continue to be allowed in earious generating facilities. Generally, these contracts are for its rates at the retaillevel.

fixed periods and require payment of a demand charge for the Costs pursuant to these power contracts are included in eke-capacity entitlement and an energy charge to cover the cost of tricity purchased for resale in the accompanying Consolidated fuel. Information relative to these contracts is as follows:

Statements of Income and are recoverable in revenues.

Range of

'Ihe estimated aggregate obligations for capacity under the Contract leng-term purchased power contracts and a life-of-the-unit con-Type of Unit Dates

% MW 1997 1996 1995_

tract from the one remaining operating Yankee nuclear unit Expiration Entitlement Cost (Vermont Yankee) in effeet for the five years subsequent to (Dollars in thousands) 1997 is as follows:

Efg$fs[$ EquityOwned Natural gas 2008-2017 (a) 208.6 8127,580 $120,842 $121,636 Nuclear 2012 (b) 85.1 41,058 41,280 44,379 Power Nuclear Unit Total Waste-to energy 2015 100 67.0 43,038 39,622 37,52G (Dollars in thousands)

Hydro 2014-2023 100 23.9 10.952 12,537 9.933

)

Total 384.6 $222,628 $214.281 S213.474 1998

$219,909

$4,957

$224,866 1999 223,490 5.001 228,491 (a) includes contracts to purchase power from various non-utility 2000 225,513 4,311 229,824 f

f[0 generators with capacity entitlements ranging from 11 ;% to 100%

(b) The system has an 11% entitlement in the pilgr'.m nuclear power plant and a 2.5% ownership interest in the Vermont ' ankee nuclear Due to changing conditions within the nuclear industry, pwer phuit.1he estimated cost to decommission I te Vermont Yankee it is possible that the remaining operating nuclear plant in plant is $385.9 million in current dollars. The syste n's share of this lia.

which the system has an equity ownership interest could bility (approximately $8.7 million),less its share of t'ie market value of be shut down prior to the expiration of that unit's operat-the assets hekt in a decommissioning trust (approxit. ately $4.4 mil-ing license.

lion),is approximately $4.3 million at December 31,1997.

The costs associated with these power contract obligations are a significant component of the system's stranded costs Pertinent information with respect to life.of-the-unit contracts that are included in the system's restructuring plan approved with nuclear units that are no longer operating in which the sys-by the DTE.

1 tem has an equity ownership is as follows:

(e) Environmental Matters The system is subject t-laws and regulations adminis-Connecticut Maine Yankee tered by federal, state and local authorities relating to the Yankee Yankee Atoms-quality of the environment. These laws and regulations (Dollars in thousands) affect, among other things, the siting and operation of elec.

Equity Ownership (%)

4.50 4.00 4.50 tric generating and transmission facilities and can require l'iant Entitlement (%)

4.50 3.59 4.50 the installation of expensive air and water pollution control Contract Expiration Date 2007 2008 2000 equipment. These regulations have had an impact on the Year of Shutdown 1996 1997 1992 system's operations in the past and would continue to have 1995 Actual Cost ($)

9,498 7,376 2,023 an impact on future operations, capital costs and construc-1996 Actual Cost ($)

9,259 6,511 2,260 tion schedules of major facilities; however, the electric gen-IS37 Actual Cost ($)

5,760 8,928 2,238 erating facilities are likely to be sold at auction in 1998 pur-Decommissioning cost suant to the restructuring plan filed with the DTE. For estimate (10%) ($)

437,270 386,046 137,428 additional environmental information, see " Environmental System's decommis-Matters"in Management's Discussion and Analysis of sioning cost ($)

19,677 13,859 6,1M Financial Condition and Results of Operations.

Market value of assets (10%) ($)

209,448 199,457 134,143 (4) Income Taxes System's market value of assets ($)

9,425 7,161 6,036 The system files a consolidated federal income tax return.

For financial reporting <

oses, the System and its subsidiaries Based upon regulatory precedent, the operators of the provide taxes on a separate return basis.

Yankee units believe they will be permitted to continue to col-The folkming is a summary of the consolidated provisions for 31

incorr3 taxes for the yean; ended December 31,1!7J/,1W6 and 1995:

such taxes. ne following table reconciles the statutory feder-al income tax rate to these percentages:

1997 1996 1995 1997 1996 1995 (Dollars in thousands)

(Dollars in thousands)

Federal Current

$24,396 S28,375 $15,9M Federal statutory rate 35%

35%

35%

Deferred 2,612 2,784 8,231 Investment tax credits, net (1,278)

(1,285)

(1,401)

Federalincome tax 25,730 29,874 22.784 expense at statutory State levels

$28,332 $33,363 $26,007 Current 5,389 5,M2 4,176 Increase (Decrease) from Deferred 316 890 1,115 statutory levels:

5,705 6,432 5.291 State tax net of federal 31,435 36,306 28,075 tax benefit 3,708 4,181 3,439 Amortization of regulatory Tax versus book depreciation 1,714 1,553 1,369 liability relating to deferred Amortization ofinvestment income taxes (386)

(159)

(5,1M) tax credits (1,278)

(1,285)

(1,368)

$31,049

$36,147 $22,911 Reversals of capitalized Federal and state expenses (654)

(654)

(652) income taxes charged to:

Dividend received deduction (366)

(381)

(389)

Operating expense

$31,040 S36,099 $24,574 Amortization of excess Other (income) expense 9

48 (1,663) deferred reserves (386)

(159)

(5,164)

S31,049 S36,147 $22,911 Other (21)

(471)

(331)'

$31,049 S36,147 $22,911 Deferred tax liabilities and assets are determined based

- on the difference between the financial statement and tax Effective federalincome tax rate 38%

38%

31%

bases of assets and liabilities using enacted tax rates in effect in the year in which the differences are expected t (5) Employee Benefit Plans

reverse, in May 1995, Canal Electric refunded certain unprotected (a) Pension excess deferred taxes to Commonwealth Electric and Cambridge The system has a noncontributory pension plan cov-Electric resulting in a reduction to the 1995 tax provision.

ering substantially all regular employees who have Accumulated deferred income taxes consisted of the follow-attained the age of 21 and have completed a year of ser-ing in 1997 and 1996; vice, Pension benefits are based on an employee's years 1997 1996 of service and compensation. The system makes (Dollars in thousands) monthly contributions to the plan consistent with the Liabilities funding requirements of the Er,mloyee Retirement Property-related

$198,183

$195,810 Income Security Act of 1974.

Power contract buy-out 6,853 10,002 Fuel charge stabilization 12,241 8,124 Components of pension expense and related asump-l Postretirement benefits plan 7,742 7,442 tions to develop pension expense were as follows:

Seabrook nonconstruction 707 1,183 1997 1996 1995 All other 16,140 20.018 (Dollars in thousand4 241,866 242,579 Assets Service cost S 7,565 S 7,663 8 6,386 Investment tax credits 16,058 17,205 Interest cost 24,824 24,462 23,949 Pension plan 6,409 8,528 Return on plan assets-Regulatory 11 ability 6,103 6,352 (gain)/ loss (61,094) (45,961) (62,933)

Personnel reduction program 1,540 Net amortization All other 20,960 22,239 and deferral 37,M0 24,520 42,928 51,070 54,324 Total pension expense 8,835 10,684 10,330 Accumulated deferred income taxes, net

$190,796 8188.255 less: Amounts capitalized and deferred 3,017 2,203 1,842 The net year-end deferred income tax lir.bility above Net pension expense S 5.818 $ 8,481 8 8,488 includes a current deferred tax liability of $14,442,000 and Discount rate 7,50%

7.25%

8.50%

S13,378,000 in 1997 and 1996, respectively, which are includ-Assumed rate of return 8.75 8.75 9.00 ed in accrued income taxes in the accompanying Rate ofincrease in future Consolidated Balance Sheets.

compensation 4.25 4.25 5.00 The total income tax provision set forth previously repre-Pension expense reflects the use of the projected unit sents 38% in 1997 and 1996 and 31% in 1995 of income before credit method which is also the actuarial cost method used in 32

{

l

determining future funding of the plan. Commonwealth 1997 1996 1995 Electric and Cambridge Elec*ric,in accordance with current (Dollars in thousands) ratemaking, are deferring the differeuce between pension con-Service cost

$ 1,919 $ 2,211 $ 1,774 tribution which is reflected in base rates, and pension expense.

Interest c st 9,223 9,352 9,022 De funded status of the system's pension plan (using a mea-

} (

surement date of December 31) is as follows:

Amortizat.E "" "**" ".t.

ion of transi ion obligation over 20 years 5,336 5,336 5,336 1997 1996 Net amortization and deferral 5,236 2,038 3.692 (Dollars in thousands)

Total postretirement benefit cost 12,231 13,761 14,028 Accumulated benefit obligation:

Irss: Amounts capitalized Vested

$(331,170) $(254,888) and deferred 466 1,614 5,898 Nonvested (40,822)

(30.604)

Net postretirement

$(371,992) $(285,492) benefit cost

$11,765 $12,147 $ 8.130 Projected benefit obligation

$(409,039) $(340,850)

Discount rate 7.50%

7.25% 8.50%

Plan assets at fair market value 390,625 343,884 Assumed rate of return 8.75 8.75 9.00 Projected benefit obligation less Rate of increase in or (greater) than plan assets (18,414) 3.034 future compensation 4.25 4.25 5.00 Unamortized transition obligation 6,429 8,036 Unrecognized prior service cost 11,922 13,357 Unrecognized gain (20,480)

(43,918)

The funded status of the system's postretirement benefit Accrued pension liability S (20.543)

$ (19,491) plan using a measurement date of December 31,1997 and 1996 is as follows:

1997 1996 he following actuarial assumptions were used in determin' (Dollars in thousands) ing the plan's year-end funoed status:

Accumulated postretirement 1997 1996 benefit obligation:

Retirees S (102,485) $ (72,827)

Fully eligible active plan Discount rate 7.00%

4.50's participants (18,123)

(11,468)

Rate of increase in future compensation 3.75 4.25 Other active plan participants (28,756)

(41,352)

(149,3M)

(125,647)

Plan assets consist primarily of fixed-income and equity secu-Plan assets at fair market value 61,632 45,967 rities. Fluctuations in the fair market value of plan assets will Accumulated postretirement affect pension expense in future years.

benefit obligation greater than plan assets (87,732)

(79,680)

Unamortized transition obligation 80,033 85,368 Unrecognized (gain) loss (7,699)

(5,688)

(b) Other Postretirement Benefits S

S Certain employees are eligible for postretirement benefits if they meet specific requirements. %ese benefits could include health and life insurance coverage and reimbursement ne foilowing actuarial assumptions were used in determin-of Medicare Part B premiums. Under certain circumstances, ing the plan's estimated accumulated postretirement benefit eligible employees are required to make contributions for obligation (APBO) and funded status for 1997 and 1996:

postretirement benefits.

To fund its postretirement benefits, the system makes contributions to various voluntary employees' beneficiary 1997 1996 association trusts that were established pursuant to sec-Discount rate 7.00%

7.50%

tion 501(c)(9) of the Internal Revenue Code (the Code),

Rate oiincrease in future The system also makes contributions to a subaccount of compensation 3.75 4.25 its pension plan pursuant to section 401(h) of the Code to d a e Part Il premiums 3

fund a portion of its postretirement benefit obligation.

, j, Dental care 4.50 5.00 The system contributed approximately $12.2 million, $13.7 million and $14 million to these trusts during 1997,1996 and 1995, respectively.

De above dental rate remains constant through the year 2007, De net periodic postretirement benefit cost for the years Rates for Medicare Part B premiums and medical care decrease to

- ended December 31,1997,1996 and 1995 includes the follow-3.1% and 4.5%, respectively, by 2007 and remain at that kwel there-ing components and related assumptions:

after. A one percent change in the medical trend rate would have a 33 l

$1.5 million impact on the system's annual expense and would uncommitted lines of credit for the short-term financing change the APB0 by approximately $18.2 million.

of their construction programs and other corporate pur.

Plan assets consist primarily of fixed-income and equity poses. As of December 31,1997, system companies had securities. Muctuations in the fair market value of plan assets

$145 million of committed lines of credit that will expire will affect postretirement benefit expense in future years.

at varying intervals in 1998. These lines are normally Effective hiay 1,1995 the DTE approved a settlement pro-renewed upon expiration and require annual fees of up to posal sponsored jointly by Commonwealth Electric and the

.1875% of the individualline. At December 31,1997, the Attorney General of Massachusetts that allows uncommitted lines of credit totaled $10 million. Interest Commonwealth Ekctric to fully recover costs relating to rates on the outstanding borrowings generally are at an postretirement benefits and to amortize its $8.6 million adjusted money market rate and averaged 5.8% and 5.6%

deferred balance over a ten-year period. In February 1996, in 1997 and 1996, respectively. Notes payable to banks FERC accepted for filing rate schedules that provided for the totaled $94,075,000 arv' 4118,475,000 at December 31, recovery of Canal Ekrtric's expense effective with its March 1997 and 1996, respectively.

1993 contract billings including the recovery of previously (b) Long-term Debt Maturities and Retirements deferred costs over a six month period. On April 15,1997, the Under terms of various indentures and loan agreements, the DTE issued an accounting ruling allowing Conunonwealth System and certain subsidiary companies are required to Gas Company to include postretirement benefits costs in cost-make periodic sinking fund payments for retirement of out-of service and to amortize the deferred balance of $10.5 mil-standing long term debt. %ese payments and balances of lion at March 31,1997 associated with these costs over a peri-maturing debt issues for the five years subsequent to od not to exceed ten years that began in April 1997.

December 31,1997 are as follows:

(c) Savings Plan The system has an Employees Savings Plan that provides Sinking Funds Maturing Debt Issues Year Subsidiaries System Eubsidiaries Total for system contributions equal to contributions by eligible (Dollars in thousands) employees of up to four percent of each employee's compen.

sation rate and up to five percent for those employees n 1998

$7,653

$10,000 S 9,000

$26,653 longer eligible for postretirement health benefits. He total 1999 7,653 10,000 10,000 27,653 system contribution was $4,173,000 in 1997, $1,053,000 in 2000 7,653 7,653 1996 and $4,393,000 in 1995.

2001 9,010 3,500 12,510 (d) Long-Term incentive Compensation Plan 2002 5.360 32,000 37,360 The I;mg Term Incentive Compensation Plan (the Plan),

(7) Redeemable I3 referred Shares approved by shareholders in 1994, was established to advance the interests of the System by providing long-term financial Each series of the System's preferred shares was issued incentives, primarily corrra m shares of the System, to select-at par value, $100 per share, and is subject to periodic, ed key employees of th< m.-m for achieving specified objeo mandatory sinking fund payments.The System can make tives. He System,ir van m 1g such share ownership, additional voluntary rederaptions, not exceeding the s

~ employees who hold posi-required redemption, at par, on a non-cumulative basis, on seeks to attract, reta e, n 3.

tions of significant rc

• s. ' -

Nible employees are cho-each sinking fund date.

sen by the Executive ( -

-nr n *. mmittee of the lloard Preferred shares may also be called for redemption,in whole of Trustees and are presen if tt si e awards which or in part,in excess of the required and voluntary sinking fund mature after a three-year e ! 3 oeriou Shares are issued to redemptions. De obligation to make mandatory redemptions is participants in March folle in; We cmse of the third plan cumulative and the System is not allowed to pay dividends to yean All shares are subject to forfeiture if specified perfor-common shareholders or make optional sinking fund paymen's mance measures are not met. During the applicable vesting if mandatory redemptions are in arrears. Details of redemptions period, participants have all the voting, dividend and other for each series are contained in the following table:

related rights of a record holder except that the shares are nontransferable. Common shares granted under the Plan can-Sinking Funds Optional not exceed 1% of the total shares issued and outstanding. In Dividend 19 5 2002 Redemption Rate Mandatory Optional Call Pdees 1997,31606 common shares, valued at approximately (Dollars in thousands)

$707,000, were granted to system officers. Compensation costs of approximately $231,000 were recorded in 1997 with Series A 4.80%

$120

$120

$102 the remainder to be recognized over the remaining vestmg Series B 8.10 160 160 101 priod of 26 months. Common shares granted pursuant to the Series C 7.75 S40 540 101 Plan had no materialimpact on earnings per share.

Prefmed sha eholdm have no vodng dghts mpt in (6) Interim Financing and Long-Term Debt the event that s{ix full quarterly dividends have not been (a) Notes Payable to Banks paid. In this circumstance, the preferred shareholders System companies maintain both committed and are entitled, voting as a class, to elect two of the nine 1

34 l

b l

I l

Trustees of the System.

He following is a breakdown, by major class, of property j

De preference of these shares in involuntary liquida-under capital lease at December 31,1997 and 1996:

tion is equal to par value. De shares are of equal rank and are entitled to cumulative dividends at the annual rate established for each series. No dividend can be declared 1997 1996

]

on any series unless proportionate dividends are concur.

0)ollars in thousands) l rently declared on the other outstanding series and in the event that dividend payments are in arrears, the System Transmissi,on facilities

$11,801

$12,454 Office furmture, computer may not redeem any shares unless all shares of all pr*

equipment and other 1,753 1,500 ferred series are redeemed' 13,554 13,954 less: Accumu>ated amortization 53 77 (8) D. losures About Fa,r Value of Financial isc i

313,301 313,377 Instruments ne fair value of certain financial instruments included in the accompanying Consolidated Balance Sheets as of Future minimum lease payments, by period and in the aggre-December 31,1997 and 1996 were as follows:

gate, of capitalleases and non cancelable operating leases con-sisted of the following at December 31,1997:

1997 1996 Carrying Fair Carrying Fair Value Value Value Value Capital Operating (Dollars in thousands)

Leases Irases (Dollars in thousands) long-term debt

$390,964 $444,970 $377,218 $417,411 Preferred shares 13,020 14,708 13,840 14,601 1998

$ 2,603

$11,000 1999 2,456 9,218 De carrying amount of cash and notes payable to banks 2000 2,159 5,012 approximates the fair value because of the short maturity of j

j'f these financialinstruments.

Beyond 2002 17,128 11,672 he estimated fair value of long-term debt and preferred stock Total future minimum lease payments 27,604

$44,064 are based on quoksi market pnces of the same or similar issues less: Estimated interest element or on the current rates offered for debt or preferred shares with included therein 14,103 the same remaining maturity. Le fair values shown above do not Estimated present value of future purport to represent the amounts at which those obligations minimum lease payments S13.501 woukl be settktl.

(9) Lease Obligations Total rent expense for all operating leases, except those with terms of a month or less, amounted to $11,181,000 in System companies lease property, transmission facilities 1997, $12,922,000 in 1996 and $13,867,000 in 1995. Dere and equipment under ayreements, some of which are capital were no contingent rentals and no sublease rentals for the leases. Seseral subsidiaries renegotiate certain lease agree years 1997,1996 and 1995.

ments annually. %ese new agreements are for a term of one year and are renewable monthly thereafter. COM/ Energy Services Company has agreements in effect for office furni-(10) Dividend Restriction ture, computer and transportation equipment. Generally, these agreements require the lessee to pay related taxes, At December 31,1997, approximately $111,729,000 of con-maintenance and other costs of operation. Irases currently in solidated retained earnings was restricted aga'mst the pay-effeu contain no provisions which prohibit system companies ment of cash dividends by terms ofindentures and note agree-from entering into future lease agreements or obligations, ments securing long-term debt.

i l

35

. (11) Segment Information Operating income of the various industry segments System companies provide electric, gas and steam ser-includes income from transactions with affiliates and is exclu-vices to retail customers in communities located in central, sive of interest expense, income taxes and equity in earnings eastern and southeastern Massachusetts and, in addition, of unconsolidated corporate joint ventures.

sell electricity at wholesale to Massachusetts customers, The amount of identifiable assets represented by the sys-Other operations of the system include the development and tem's investment in corporate joint ventures consists princi-operation of rental properties and other activities whic't do pally of a percentage ownership in the assets of four regional not presently contribute significantly to either revenues or electric generating plants and a 3.8% interest in flydro-operating income, Quebec Phase II.

1997 1996 1995 (Dollars in thousands)

Revenues from Unaffiliated Customers Electric

$ 688,508 8 649,678

$ 604,980 Gas 333,977 341,867 306,953 Steam and other 19,259 19,360 17,355 Total Revenues

$1,041,744 S 1.010,905 S 929.288 Capital Expenditures (including AFUDC)

Electric

$ 34,524

$ 38,844

$ 61,643 Gas 18.230 11,611 16,198 Other 4,804 2,730 3,659

$ 57,558

$ 53,185 S 81.500 Oprating income Before Income Taxes Elcrtric

$ 84,828

$ 92,374

$ - 78,817 Gas 34,918 36,984 36,611 Steam and other (1,056) 3,406 3,689 Total Operating Income Before income Taxes S 118,690 S 132.764 S 119.117 Identifiable Assets Electric

$1,049,094

$1,011,306 S 982,384 Gas 395,966 388,930 374,615 Steam and other 74,298 58,081 57.269 1,519,358 1,458,317 1,414,268 Intercompany eliminations (48,075)

(42,757)

(35,140)

Investment in corporate joint ventures 13,767

,13.395 13,214 TotalIdentifiable Assets

$1,485,050

$1,428,955

$1,392.342 Depreciation Expense Electric.

$ 41,103

$ 39,977

$ 36,977

Gas' 10,482 10,061 9,656 Steam and other -

1,820 1,744 1,537 Total Depreciation S 53,405 S 51,782 S 48,170 36

Selected Financial Data Commonwealth Energy System and Subsidiary Companies 1997 1996 1995 1994 1993 (Dollars in thousands except common share data)

Operating Revenues Electric S 688,508

$ 649,678

$ 604,980

$ 638,150

$ 622,039 Gas 333,977 341,867 306,953 323,568 302,644

- Steam and other 19,259 19,360 17,355 15,867 14,035 Total S1,041,744 S1,010,905

$ 929,288

'S 977,585 S 938,718 Net Income S 49,901 S 59,175 S 51.396 S 48,968

$ 45,834 Common Share Data-Earnings per share -

$2.27

$2.70

$2.36

$2.29

$2.18 Dividends declared per share

$1.58

$1.54

$1.50

$1.50

$1.46 Average shares outstanding 21,531,433 21,529,676 21,311,836 20,827,562 20,431,228 Total Assets

$1,485.050 S1,428,955

$1,392.342

$1,345.032 S1,318,940 long-term debt

' $ 364,311

$ 355,305

$ 377,181

$ 418,307

$ 448,893 Redeemable preferred shares 12,200 13,020 13,840 14,660 15,480 Common share investment 430,770 415,694 390,785 362,997 337,070 Total Capitalization S 807,281 S 784,019 S 781,806 f 795,964 S 801,443 1997 by arter 1st 2nd 3rd 4th (Dollars in thousands except per share amounts)

Operating Revenues

$316,190

$221,944

$222,115 $281,495 Operating income 35,892 7,793 16,887 27,078 Income Before Interest Charges 36,541 8,774 17,227 27,709 Net income 26,400 (1,334) 7,147 17,688 Earnings per Common Share 1.21 007)

.32

.81 Dividends Declared per Common Share

.395

.395

.395

.395 Closing Price of Common Shares-Iligh 24%

24 27 34 %

low 20%

19 23%

25 %

1996 by Quarter 1st 2nd 3rd 4th (Dollars in thousands except per share amounts)

Operating Revenues

$298,614

$222,667

$226,909 $262,715 l

Operating Income 36,131 18,608 17,601 24,325 income Before Interest Charges 38,622 19,863 18,838 24,220 Net income 27,907 9,463 8,360 13,445 Earnings per Common Share 1.28

.43

.37

.62 Dividends Declared per Common Share

.385

.385

.385

.385 Closing Price of Common Shares-liigh 25 25%

25%

24%

low 21 %

22%

21%

22%

l.

37

Comparative Statistical Data Commonwealth Energy System and Subsidiary Companies Five-Year Compound Growth Rate 1997 1996 1995 1994 1993

(%)

(Dollars in Thousands)

Operations Revenues

$1,041,744 S1,010,905

$929,288

$977,585

$938,718 2.9 Operating Expenses-Operations 804,606 759,558 697,730 750,352 718,362 2.9 Maintenance 36,838 10,913 38,414 36,522 40,574 (1.6)

Depreciation 53,405 51,782 48,170 44,188 42,480 4.4 Taxes 59,245 61,987 50,431 54,708 51,947 5.7 954,094 914.240 834,745 885.770 853,363 2.9 Operatingincome 87,650 96,665 94,543 91,815 85,355 2.4 Add-Other Income 2,601 4,878 1,461 627 4,430 (6.1) less-Interest charges 40,350 42,368 44,608 43,474 43,951 (0,5)

Net income 49,901 59,175 51,396 48,968 45,834 4.6 Preferred dividends 988 1,050 1,110 1,170 1,230 (5.2)

Earnings applicable to common shares S

48,913 S 58,125

$ 50,286 S 47,798 S 44,604 4.9 Sources of Consolidated Net Income-Electric 36,967

$ 41,299

$ 34,739

$ 36,473

$ 30,301 Gas 15,443 16,789 16,229 13,568 16,299 s*

Steam and other (2,509) 1,087 428 (1,073)

(766)

Total S

49,901 S 59,175 S 51,396 S 48,968 S 45,834 Financial Property, plant and equipment (including construction work in progress, net and nuclear fuelin process)

S1,627,870

$1,581,668 S1,540,916 $1,476,518

$1,434,951 Accumulated depreciation and amortization 577,962

.536,041 497,712 461,661 434,287 Construction Expenditures (exclusive of AFUDC) 57,190 52,928 80,643 57,833 54,385 Capitalization long-term debt 0)

$ 383,311

$ 369,565

$ 410,411 S 443,307

$ 458,893 Preferred shares 12,200 13,020 13,840 14,660 15,480 Common equity 430,770 415,694 390,785 362,997 337,070 Total S 826,281 S 798,279 S 815.036 S 820,964 S 811,443 (D includes maturinglong-term debt.

I 38

Comparative Statistical Data Commonwealth Energy System and Subsidiary Companies Five-Year Compound Growth Rate 1997 1996 1995 1994 1993

(%)

Statistics and Ratios Unit Sales -

MWil-Residential 1,830,793 1,802,973 1,752,430 1,770,095 1,744,181 1.2 Commercial 2,506,215 2,430,188 2,450,390 2,406,077 2,378,073 1.7 Industrial 434,666 425,748 421,224 421,821 411,527 0.9 Other 24,438 24,096 23,796 23.216 22,243 1.0

. Total Retail 4,796,112 4,683,005 4,647,840 4,621,209 4,556,024 1.4 Wholesale 3,916,974 2,721,623 1,973,543 3,803.786 3,689,129 0.1 Total 8,713,086 7,404.628 6.621,383 8.424.995 8,245.153 0.8 IlBTU-Residential 22,043 22,759 21,336 21,515 22,252 (0.3)

Commercial 11,077 11,558 10,710 10,728.

10,931 0.3 Industrial 3,483 4,468 4,445 4,401 4,205 (5.9)

Other 2,111 2,208 1,967 1,895 1,831 3.4 Total Firm 38,714 40,993 38,458 38,539 39,219 (0.6)

Off-system 2,673 2,420 4,043 6,401 Quasi-firm 51 1,066 1,906 487 Interruptible 1,882 1,883 1,215 1,927 1,896 (5.3)

Transportation 6,506 4,852 4,024 2,208 1,753 (43.0)

Total 49,826 51,214 49,646 49.562 42.868 2.8 Capitalization Ratios -

long-term debt 46.4 % -

46.3%

50.4 %

54.0 %

56.6 %

Preferred shares 1.5 1.6 1.7 1.8 1.9 Common equity 52.1 52.1 47.9 44.2 41.5 Total 100.0 %

100.0 %

100.0 %

100.0 %

100.0 %

Return on average common equity 11.6%

14.4 %

13.3 %

13.7 %

13.7 %

Common share dividend payout 69.2 %

56.7%

63.6 %

643%

66.8 %

Average price / earnings ratio 14.6 8.7 8.7 8.8 10.4

' Common Share Data -

1 Earnings per share 0)

$ 2.27

$ 2.70

$ 2.36

$ 2.29

$ 2.18 3.5 Dividends paid 1,57 1.53-1.50 1.49 1.46 1.5 Annual dividend rate at end of year 1.58 1.54 1.50 1.50 1.46 1.6 Ilook value 20.01 19.31 18.15 17.24 16.37 5.2 l

Closing market price -

i liigh 34 %

25%

23 %

22 %

25 Low 19 21 %

17 %

17 %

20%

Year-end 33 %

23 %

22 %

18 23 %

4 (1) Based on the..r. rage number ofshares outstanding.

i i

l 39 i

Shareholder Information Commonwealth Energy System and Subsidiary Companies Annual Meeting by the Board of Trustees. Common dividends are paid n the first day of February, May, August and All shareholders are invited to attend the next Annual November. I referred dividends are paid on the first Meeting which will be held on May 7,1998 at the System's ay Ganuary, April, July and October.

corporate headquarters at One Main Street in Kendall Square, Cambridge, Massachusetts. A formal notice of the meeting together with a proxy statement and a Shareholder Services form of proxy is enclosed for use by shareholders enti-The System has a dividend reinvestment plan tied to vote at the meeting.

which provides holders of Common Shares with an eco-l nomical and convenient method for purchasing addi-tim 1 Common Shares of the System without paying Market Price Rangefor Common brokerage fees or service charges.

Shares and Dividends Paid The System also offers direct deposit to Common 1997 High imw Dividends Shareholders so that dividends can be received faster.

1st Quarter

$24%

$20%

$.385 Dividends can be electronically credited to a checking, savings, credit union or thrift account.

2nd Quarter 24L 18%

.395 3rd Quarter 27 23 %

.395 A seasonal mailing address for your shareholder 4th Quarter 34'W 25L

.395 account (s) is also available for the period of time requested. This can help avoid lost interest on delayed 1996 High Low Dividends deposits caused by forwarded mail.

1st Quarter

$25

$21%.

$.375 -

For more information about these services or any 2nd Quarter 25%

22 %

.385 other inquiries, please contact a Shareholder Services 3rd Quarter 25%

21%

.385 representative at the appropriate toll-free number 4th Quarter 25 %

22 %

.385 listed below:

The System's Common Shares are listed on the New 1-800-336-3773 (within Afassachusetts)

York and Pacific stock exchanges:

1-800-447-1183 (outside Afassachusetts)

Ticker Symbol"CES" Bond Data Daily Newspaper Quotation "ComES" Trustees underindentures of trust are:

Citibank, N.A. -

Transfer Agents and Registrars Canal Electric Company Series B, E and F Bonds State Street Bank and Trust Company-Shareholder communiertions regarding transfer of Other Subsidiary Companies'lxmg-term Debt Common Shares or lost certificates shouki be directed to:-

Common Shares.

Req.uests for Financial Information Transfer Agent and Registrar:

The System files quarterly reports on Form 10-Q and BankBoston, N.A.

an annual report on Form 10-K each year with the P.O. Box 8040 Securities and Exchange Commission. Requests for Boston, MA 02266-8040 these and any other reports as well as questions regarding financialinformation should be directed to:

Preferred Shares-Transfer Agent:

John E Gavin Commonwealth Energy System Manager-Investor Relations

. P.O. Box 9150

' Commonwealth Energy System Cambridge, M A 02142-9150 110. Box 9150 Cambridge, MA 02142-9150 Registrar:

Certain information requirements of Form 10-K are satis-State Street Bank and Trust Company fled in the 1998 Proxy Statement. Financial and other information about the System, including Forms 10-Q and Dividend Payments 10-K, are also available on our web site:

Dividends are paid by the System subject to declaration http://www.comenergy.com.

40

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Cambridge, Manachmits 3 CORPORATE DIVISION -

• . ~3^

UDIRY OPERADONS LWilliam G. Poisti -..

• Russell D; Wright,

! President and ChiefExecutive Offcer ChiefErecutive OfRcer

, l James D. Rappoli,'.

Deborah A. Mclaughlin, J Financial Vice President and Treasurer -

. besident and ChiefOperating Offcer s

Michael P, Sullivan,.

Samy II. Ibrahim, _

[Vice IWsident; Secretary and General Counsel ;

Vice Ruldent-Gas Operations

? JohriR. Williams,i James J. Kedne, VicePresident-Corporate Services

. Vice President-Energy Supply and Engineering Services

Charles W. Kiely, G4 NON-UbbTY OPERATIONS l Via Presiden ustomerService

m. ; Energy Facilities Kevin E Roberts, e

, Iconard R. Devanna,1 Vice President-Electric Operations l Pmident and ChiefOperating Offcer-

}: Energy Services and Techkologies ~

Bobert A, Paul '

Rumt! a wright has sarn selected to sucerad William c. hist

President and ChidOperating Offcer -

as Presiaent and airtrzrcutive pfnecv of Commonweettis Enerv

. system upon Me hist's retirement on september 1,199a

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