ML20236M944

Amended Western Massachusetts Electric 1997 Annual Rept

ML20236M944
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Site:	Millstone, Seabrook
Issue date:	12/31/1997
From:	WESTERN MASSACHUSETTS ELECTRIC CO.
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ML20236M923	List: ML20236M920 ML20236M927 ML20236M944 ML20236M956
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'\ Western Massachusens g{f Electric h Nonheast Utilities Systern

!R ADO K O O 45 I PDR 1 l - J

4 Directors .

Officers -

Michael G. Morris Dennis E. Welch John 11. Forsgren Vice President-Environmental, Executive Vice President and Chairman Safety and Ethics Chief Financial Officer llugh C. MacKenzie Bruce D. Kenyon President Roger C. Zaklukiewicz President-Nuclear Group Vice President-Bruce D. Kenyon Transmission and Distribution liuEh C. MacKenzie President-Nuclear Group

"id* "' Patricia A. Wood J hn H. Forsgren g,,g Michael G. Morris Executive Vice President and Chairman Chief Financial Officer Theresa 11. Allsop

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Cheryl W. Grise Senior Vice President O. Kay Comendul

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Robert P. Wax Senior Vice President. Deborah L Canyock Secretary, Assistant Clerk Assistant Controller-and General Counsel Management Information and 8' "8 # ##'

Robert G. Abair Vice President and Chief Imri A. Mahler Administrative Officer Assistant Controller-

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David H. Boguslawski Vice President-Energy Delivery Michaei J. Mahoney

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Ronald G. Chevalier Rate Regulation Vice President-Fossil / Hydro Engineering and Operations Thomas V. Foley Assistant Secretary John B. Keane Vice President and Treasurer Margaret L Morton Assistant Secretary John T. Muro Vice President-Retail Marketing Robert C. Aronson Assistant Treasurer-John J. Roman Treasury operations Vice President and Controller David R. McHale Frank P. Sabatino Assistant Treasurer-Pinance Vice President-Wholesale Marketing Lisa J. Thibdaue Vice President-Rates. Regulatory Affairs and Compliance february 28.1998 l

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Western Massachusetts Electric Company and Subsidiary Amended 1997 Annual Report Index Contents FaQe Consolidated Balance Sheets (Restated)...................... 2-3 Consolidated Statements of Income (Restated)................ 4 Consolidated Statements of Cash Flows (Restated)............ 5 Consolidated Statements of Common Stockholder's Equity (Restated)........................................... 6 Notes to Consolidated Financial Statements (Rest &ted)....... 7 Report of Independent Public Accountants.................... 39 l Management's Discussion and Analysis of Financial l Condition and Results of Operations (Restated)............ 40 Selected Financial Data (Restated).......................... 51 Statements of Quarterly Financial Data (Restated)........... 51 ,

Statistics.................................................. 52 I Preferred Stockholder and Bondholder Information............ Back Cover 1

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PART I. FINANCIAL INFORMATION ifESTERN MASSACHUSETTS ELECTRIC COMPANY AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS At December 31, 1997 1996 )

(Restated) (Restated) i (Thousands of Dollars)

ASSETS' Utility Plant, at original cost:

Electric................ ................................. $ 1,284,288 $ 1,257,097 Less: Accumulated provision for depreciation.......... 559,119 503,989 725,169 753,108

Construction work in progress............. .............. 19,038 15,968 Nuclear fuel, net......................................... 30,907 30,296 Total net utility plant.............................. 775,114 799,372 Othsr Property and Investments:

i Nuclear decommissioning trusts, at market................ 102,708 83,G11

! Investments in regional nuclear generating companies, at equity....................... ............. 15,741 15,448

.Other, at. cost........................................... 4,900 4,367 i

123,349 103,426 Current Assets:

l Cash................ .................................... 105 67 Investments in securitizable assets...................... 25,280 .

Receivables, less accumulated provision for ,

, uncollectible accounts of $50,000 in 1997 j l and of $2,121,000 in 1996.............................. 2,739 40,168  ?

Accounts receivable from affiliated companies............ 3,933 3,525 Taxes receivable......................................... 10,768 1,778 cAccrued utility revenues................................. -

12,394

' Fuel, naterials and supplies, at average cost............ 5,860 5,317 Prepayments and other................ ................... 14,945 12,262

! 63,630 75,511 l.

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. Deferred Charges:

Regulatory assets-......................................... 211,377 210,852 Unamortized. debt expense................................. 2,695 1,866 Other..................................................... 2,963 888 217,035 213,606

' Total Assets.......................................... $ 1,179,128 $ 1,191,915

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The accompanying notes are an integral part of these financial statements. I 2 l 1

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e WESTERN MASSACHUSETTS ELECTRIC COMPANY AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ,

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At December 31, 1997 1996 (Restated) (Restated)

(Thousands of Dollars)

CAPITALIZATION AND LIABILITIES

, Capitalization:

Common stock--$25 par value--authorized and outstanding 1,072,471 shares in 1997 and 1996.......... $ 26,812 $ 26,812 Ctpital surplus, paid in............. .................. 151,171 150,911 Ritnined earnings (Note 1).............................. 58,608 104,212

.....__..__.. ............ l Total common stockholder's equity.............. 236,591 281,935 l Cumulative preferred stock--

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$100 par value-- authorized 1,000,000 shares; )

outstanding 200,000 shares in 1997 and 1996;

$25 par value--authorized 3,600,000 shares; I outstanding 840,000 shares in 1997 and 19S6 Preferred stock not subject to mandatory redemption..... 20,000 20,000 i Prsferred stock subject to mandatory redemption.......... 19,500 21,000  !

Long-term debt.......................................... 386,849 334,742

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Total capitalization................. ......... 662,940 657,677 Oblig:tions Under Capital Leases............. .. ......... 217 29,269 Current Liabilities: l Notts payable to. banks.................................. 15,000 -

Notes payable to affiliated company...................., 14,350 47,400 Long-term debt and preferred stock--current portion. ....... .............< ....................... 11,300 14,700 i obligations under capital leases--current portion............................................... 32,670 2,965 Accounts payable........................................ 30,571 26,698 Accounts payable to affiliated' companies. .............. 21,209 20,256 Accrued taxes........................................ ... 522 2,659 Accrued interest......................... .............. 3,318 5,643 Other....... ........................... ................ 2,446 4,754

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131,386 125,075 Deferred Credits:

Accumulated deferred income taxes....................... 246,453 249,886 Accumulated deferred investment tax credits............. 23,364 24,833 Deferred contractual obligations........................ 93,628 84 5 598 Other... ..... .... . ........... ........... ....... . 21,140 20,577 384,585 370,894 Commitments and Contingencies (Note 12)

Total Capitalization and Liabilities........... $ 1,179,128 $ 1,191,915 Th2 cecompanying notes are an integral part of these financial statements.

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e WESTERN MASSACHUSETTS ELECTRIC COMPANY AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1997 1996 (Restated) (Restated) 1995 (Thousands of Dollarc)

Operating Revenues.... ........................ $ 426,447 $ 421,337 $ 420,434 Operating Expenses:

Operation --

Fuel, purchased and net interchange power. 140,976 115,691 86,738 Other.................. ........ ......... 153,399 136,897 143,000 Maintenance.................................. 81,466 56,201 37,447 Depreciation................................. 39,753 39,710 37,924 Amortization of regulatory assets, net....... 6,428 9,170 19,562 Federal and state income taxes.. ............ (15,142) 10,628 14,060 Taxes other than income taxes................ 19,316 19,850 18,639 Total operating expenses (Note 1)...... 426,196 388,147 357,370 Operating Income.. ............................ 251 33,190 63,064 Other Income:

Equity in earnings of regional nuclear generating companies....................... 1,524 1,800 1,771 Other, net.................. .... ...... .... (1,106) 1,153 1,232 Income taxes.................. .............. 1,026 1,068 262 Other income, net...................... 1,444 4,021 3,265 Income before interest charges......... 1,695 37,211 66,329 Interest Charges:

Interest on long-term debt.......... ........ 26,046 24,094 26,840 Other interest............... ............. . 3,109 2,028 356 Interest charges, net.... ............. 29,155 26,122 27,196 Net (Loss)/ Income (Note 1). ................... $ (27,460) $ 11,089 $ 39,133 Thi accompanying notes are an integral part of these financial statements.

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e hT. STERI [ MASSACHUSETTS ELECIRIC CCNPANY AND SUBSIDIARY CONSOLIDATED STATENENTS OF CASH FILMS For the Years Ended December 31, 1997 1996 1995 (Restated) (Restated)

(Thousands of Dollars)

Operr. ting Activities:

Net (Los s ) / Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (27,460) $ 11,089 $ 39,133 Adjustments to reconcile to net cash from operating activities:

Depreciation.............................................. 39,753 39,710 37,924 Deferred income taxes and investment tax credits, net...... (1,256) 1,195 3,418 Deferred Millstone 3 return............................... - -

7,146 Recoverable energy costs, net of amortization. . . . . . . . . . . . . (8,184) (10,517) 1,285 Amortization of nuclear refueling outage, net of deferrals 8,B19 6,188 (8,857)

Other sources of cash..................................... 27,804 21,248 32,266 Other uses of cash........................................ (21,215) (10,271) (8,039)

Changes in working capital:

Receivables and accrued utility revenues ................ 29,415 (1,853) (1,933)

Fuel, materials and supplies.............................. (543) (203) (285)

Accounts payable.......................................... 4,826 20,875 (11,669)

Sale of receivables and accrued utility revenues.......... 20,000 . -

Investment in securitizable assets........................ (25,280) - -

Acczn d taxes............................................. (2,137) (805) (3,474)

Other working capital (excludes cash) . . . . . . . . . . . . . . . . . . . . . (16,882) (8,144) 1,256 Net crh flows frun operating activities (Note 1) . . . . . . . . . . . . . 27,660 68,512 88,171 Financing Activities:

In uance of long-term debt.................................. 60,000 - -

Net (decrease)/ increase in short-term debt.................. (18,050) 23,350 24,050 Reacquisitions and retirements of long-term debt............ (14,700) - (34,550)

Reacquisitions and retirements of preferred stock.. ........ -

(36,500) (15,675)

Cr h dividends on preferred stock........................... (3,140) (5,305) (4,944)

Crh div,tdends on conmon stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (15,004) (16,494) (30,223)

Net clsh flows from/ (used for) financing activities. . . . . . . . . . . 9,106 (34,949) (61,342)

Invertment Activities: l Inyntment in plant Elcctric utility plant.................................... (26,249) (23,468) (27,084)

Nuclear fuel.............................................. (8) 541 75 Net cash flows used fcr investments in plant................ (26,257) (22,927) (27,009)

NU System Money Pool........................................ - -

8,750 Inve2tment in nuclear decommissioning trusts. . . . . . . . . . . . . . . . (9,645) (9,794) (8,503)

Other investment activities, net............................ (826) (977) 46 ,

...______.. ..._______. ........... 1 Net c= h flows used for investments........................... (36,728) (33,698) (26,716)

........... .___... ... ...... .... l Net Increase /(Decrease) In Cash For The Period................ 38 (135) 113 l Crh . beginning of period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 202 89 t Cr h - end o f pe riod . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 105 $ 67 $ 202 1 Supplemental Cash Flow Information:

l Ca h paid /(refunded) during the year for:

1 Intcrest , net of amounts capitalized. . . . . . . . . . . . . . . . . . . . . . . . $ 28,711 $ 21,725 $ 25,551 Income taxes................................................ $ (1,121) $ 7,816 $ 14,385 l

Incrc=e in obligations:

l Nianti c Bay Fuel Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 660 $ 669 $ 7,851

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The reconpanying notes are an integral part of these financial statements.

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WESTERN MASSACHUSETTS ELECTRIC COMPANY AND SUBSIDIARY .

CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY Capital Retained Common Surplus, Earnings (a)

Stock Paid In (Note 1) Total (Thousands of Dollars)

Balance at January 1, 1995............... $26,812 $149,683 $111,586 $288,081 Net income for 1995 ............. .. 39,133 39,133 Cash dividends on preferred stock........ ....... ........ .... (4,944) (4,944)

Cash dividends on common stock....... (30,223) (30,223)

Loss on the retirement of preferred stock... ............. ............ (256) (256)

Capital stock expenses, net.......... 499 499 Balance at December 31, 1995.... .. ..... 26,812 150,182 115,296 292,290 Net income for 1996 (Note 1)... ... 11,089 11,089 Cash dividends on preferred stock. . ....... .... ..... ....... (5,305) (5,305)

Cash dividends on common stock....... (16,494) (16,494)

Loss on the retirement of preferred stock. . ..... .......... .. (374) (374)

Capital stock expenses, net.......... 729 729 Balance at December 31, 1996 (Restated).. 26,812 150,911 104,212 281,935 Net loss for 1997 (Note 1) . . . . . . . . . . . (27,460) (27,460)

Cash dividends on preferred stock.. ... ........ . .. . .. . (3,140) (3,140)

Cash dividends on common stock....... (15,004) (15,004)

Capital stock expenses, net. .. ..... 260 260 Balance at December 31, 1597 (Restated). $26,812 $151,171 $ 58,608 $236,591 (a) The company has dividend restrictions imposed by its long-term debt agreements.

At December 31, 1997, these restrictions totaled approximately $21.5 million.

The accompanying notes are an integral part of these financial statements.

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, W ctern Macccchuactto Electric Company and Subsidicry {

NOTES TO CONSOLIDATED FIMMCIAL STATEMENTS  :

1. SECURITIES AND EXCHANGE COMMISSION INQUIRY In a letter dated March 25, 1998, the Securities and Exchange  !

Commission (SEC) inquired into Northeast Utilities' (NU) accounting for nuclear compliance )

costs. These costs are the unavoidable incremental costs associated with the current nuclear outages required I to be incurred prior to restart of the units in accordance with correspondence received from the Nuclear Regulatory Commission (NRC) carly in 1996. The SEC's view is that these unavoidable costs ensociated with nuclear outages and procedures to be implemented at  !

nuclear power plants in response to regulatory requirements required '

prior to restart of the units should be expensed as incurred. During l 1996 and 1997, NU and its wholly owned subsidiaries, The Connecticut Light and Power Company (CL&P), Public Service Company of New i Hampshire (PSNH) and Western Massachusetts Electric Company (WMECO), '

reserved for these unavoidable incremental costs that they expected to incur to meet NRC standards. The SEC advised NU, CL&P, PSNH and WMECO to reflect these costs as they are incurred. While NU and its independent auditors, Arthur Andersen LLP, believed the accounting was l

' required by, and was in accordance with, generally accepted accounting principles, NU has agreed to adjust its accounting for nuclear compliance costs and amend its 1996 and 1997 Form 10-K filings. The financial statements in this report have been restated to reflect the change in accounting.

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SUMMARY

OF SIGNIFICANT ACCOUNTING POLICIES A. About Western Massachusetts Electric Company Western Massachusetts Electric Company and Subsidiary (WMECO or the company), CL&P, Holyoke Water Power Company (HWP), PSNH and l North Atlantic Energy Corporation (NAEC) are the' operating l

subsidiaries comprising the Northeast Utilities system (the NU system) and are wholly owned by NU.

The NU system furnishes franchised retail electric service in Connecticut, New Hampshire and western Massachusetts through CL&P, PSNH, WMECO and HWP. The fifth wholly owned subsidiary, NAEC, sells all of its entitlement to the capacity and output of the Seabrook nuclear power plant (Seabrook) to PSNH. In addition to its franchised retail service, the NU system furnishes firm and other wholesale electric services to various municipalities and other utilities, and participates in limited retail access programs, providing off-system retail electric service. The NU system serves about 30 percent of New England's electric needs i and is one of the 25 largest electric utility systems in the country as measured by revenues.

l Other wholly owned subsidiaries of NU provide support services for the NU system companies and, in some cases, for other New England utilities. Northeast Utilities Service Company (NUSCO) provides centralized accounting, administrative, information resources, engineering, financial, legal, operational, planning, purchasing and other services to the NU system companies.

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Wactcrn Macenchusotto Electric Company cnd Subsidiary HQTgS TO CONSOLIDATED FINANCIAL STATEMENTS Northeast Nuclear Energy Company (NNECO) acts as agent for the NU system companies and other New England utilities in operating the Millstone nuclear generating facilities. In addition, CL&P and WMECO each have established a special purpose subsidiary whose business consists of the purchase and resale of receivables. For information regarding WMECO's subsidiary, see Note 11, " Sale of Customer Receivables and Accrued Utility Revenues."

B. Presentation The consolidated financial statements of WMECO include the Significant accounts of its wholly owned subsidiary.

intercompany transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Certain reclassifications of prior years' data have been made to conform with the current year's presentation.

All transactions among affiliated companies are on a recovery of cost basis which may include amounts representing a return on equity and are subject to approval by various federal and state regulatory agencies.

C. Public Utility Regulation NU is registered with the Securities and Exchange Commission (SEC) as a holding company under the Public Utility Holding Company Act of 1935 (1935 Act). NU and its subsidiaries, including WMECO, are subject to the provisions of the 1935 Act.

Arrangements among the NU system companies, outside agencies and other utilities covering interconnections, interchange of electric power and sales of utility property are subject to regulation by the Federal Energy Regulatory Commission (FERC) and/or the SEC. WMECO is subject to further regulation for rates, accounting, and other matters by the FERC and/or the applicable state regulatory commissions.

For information regarding proposed changes in the nature of industry regulation, see Note 12A, " Commitments and Contingencies - Restructuring and Rate Matters."

D. New Accounting Standards The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 129,

" Disclosure of Information about Capital Structure." SFAS 129 establishes standards for disclosing information about an 8

• W tcrn Macccchuactta ElCctric Comptny and Subsidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS entity's capital structure. WMECO's current disclosures are consistent with the requirements of SFAS 129.

During June 1997, the FASB issued SFAS 130, " Reporting Comprehensive Income" and SFAS 131, " Disclosures about Segments of an Enterprise and Related Information." SFAS 130 establishes standards for the reporting and disclosure of comprehensive income. To date, WMECO has not had material transactions that would be required to be reported as comprehensive income. SFAS 131 determines the standards for reporting and disclosing qualitative and quantitative information about a company's operating segments. This information includes segment profit or loss, certain segment revenue and expense items and segment assets and a reconciliation of these segment disclosures to corresponding amounts in the company's general purpose financial statements.

WMECO currently evaluates management performance using a cost-based budget, and the information required by SFAS 131 is not available. Therefore, these disclosure requirements are not i applicable. Management believes that the implementation of SFAS 130 and SFAS 131 will not have a material impact on WMECO's current disclosures.

See Note 11, " Sale of Customer Receivables and Accrued Utility f Revenues," and Note 12C, " Commitments and Contingencies --

Environmental Matters, " for information on other newly issued accounting and reporting standards related to those specific areas.

E. Investments and Jointly Owned Electric Utility Plant Regional Nuclear Generating Companies: WMECO owns common stock of four regional nuclear generating companies (Yankee companies). WMECO's investments in the Yankee companies are accounted for on the equity basis due to WMECO's ability to exercise significant influence over their operating and financial policico. The Yankee companies, with WMECO's ownership interests, are:

Connecticut Yankee Atomic Power Company (CYAPC) ..... 9.5%

Yankee Atomic Electric Company (YAEC) ............... 7.0 Maine Yankee Atomic Power Company (MYAPC) ........... 3.O Vermont Yankee Nuclear Power Corporation (VYNPC) .... 2.5 l

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Wsstern Mazocchusetto Eloctric Comptny and Subsidicry ,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS WMECO's investments in the Yankee companies at December 31, 1997 are:

(Thousands of Dollars)

CYAPC ...................................... $10,552 YAEC ....................................... 1,465 MYAPC ...................................... 2,370 VYNPC ....................................... 1.354

$15,741 Each Yankee company owns a single nuclear generating unit.

Under the terms of the contracts with the Yankee companies, the shareholders-sponsors are responsible for their proportionate share of the costs of each unit, including decommissioning.

The energy and capacity costs from VYNPC and nuclear decommissioning costs of the Yankee companies that have been shut down are billed as purchased power to WMECO.

The electricity produced by the Vermont Yankee nuclear generating facility (VY) is committed substantially on the basis of ownership interests and is billed pursuant to contractual agreements. YAEC's, CYAPC's and MYAPC's nuclear power plants were shut down permanently on February 26, 1992, December 4, 1996, and August 6, 1997, respectively. Under ownership agreements with the Yankee companies, WMECO may be asked to provide direct or indirect financial support for one or more of the companies. For more information on the Yankee companies, see Note 3, Nuclear Decommissioning," and Note 12F,

" Commitments and Contingencies --

Long-Term Contractual Arrangements."

Millstone 2: WMECO has a 19 percent joint-ownership interest in Millstone 1, a 660-megawatt (MW) nuclear generating unit. As of December 31, 1997 and 1996, plant-in-service included approximately $91 million and $90.2 million, respectively, and the accumulated provision for depreciation included approximately $40.1 million and $37.2 million, respectively, for WMECO's share of Millstone 1. WMECO's share of Millstone 1 expenses is included in the corresponding operating expenses on the accompanying Consolidated Statements of Income.

Millstone 2: WMECO has a 19 percent joint-ownership. interest in Millstone 2, a- 870-MW nuclear generating unit. As of December 31, 1997 and 1996, plant-in-service included approximately $162.4 million and $161.4 million, respectively, and the accumulated provision for depreciation included approximately $57.6 million and $51.7 million, respectively, for WMECO's share of Millstone 2. WMECO's share of Millstone 2 expenses is included in the corresponding operating expenses on the accompanying Consolidated Statements of Income.

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WO tcrn MacOcchu3ctto Electric Comp *_ny end Subaidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Millstone 3: WMECO has a 12.24 percent joint-ownership interest in Millstone 3, a 1,154-MW nuclear generating unit. As of December 31, 1997 and 1996, plant-in-service included approximately $378.7 million and $377.7 million, respectively, and the accumulated provision for depreciation included approximately $110.1 million and $99.8 million, respectively,

-for WMECO's share of Millstone 3. WMECO's share of Millstone 3 expenses is included in the corresponding operating expenses on the accompanying Consolidated Statements of Income.

The three Millstone units are out of service. NU hopes to return Millstone 3 to service in the early spring of 1998 and Millstone 2 three to four months after Millstone 3. Millstone 1 l

has been placed in extended maintenance status. Management is reviewing its options with respect to Millstone 1, including restart, early retirement and other options. In a draft ruling issued in February 1998, the Connecticut Department of Public l Utility Control (DPUC) determined that Millstone 1 was no longer "used and useful" and ordered it removed from rate base. For  !

more information regarding the Millstone units, see Note 3,  !

" Nuclear Decommissioning," and Note 12B, " Commitments and  !

Contingencies - Nuclear Performance."

F. Depreciation The provision for depreciation is calculated using the straight-line method based on estimated remaining lives of depreciable utility plant-in-service, adjusted for salvage value and removal costs, as approved by the appropriate regulatory agency. i Except for major f acilities., depreciation rates are applied to the average plant-in-service during the period. Major facilities are depreciated from the time they are placed in service. When plant is retired from service, the original cost  ;

of plant, including costs of removal, less salvage, is charged to the accumulated provision for depreciation. The depreciation rates for the several classes of electric plant-in-service are equivalent to a composite rate of 3.2 percent in 1997 and 1996 and 3.1 percent in 1995. See Note 3, " Nuclear Decommissioning,"

for information on nuclear plant decommissioning.

WMECO's nonnuclear generating facilities have limited service lives. Plant may be retired in place or dismantled based upon expected future needs, the economics of the closure and environmental concerns. The costs of closure and removal are incremental costs and, for financial reporting purposes, are accrued over the life of the asset as part of depreciation. At December 31, 1997 and 1996, the accumulated provision for depreciation included approximately $3.2 million, respectively, accrued for the cost of removal, net of salvage for nonnuclear generation property.

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Wsstorn Maasachusotta Electric Comp ny cnd Subsidicry ,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS G. Revenues Other than revenues under fixed-rate agreements negotiated with certain wholeesle, commercial and industrial customers, utility revenues are based on authorized rates applied to each customer's use of electricity. In general, rates can be changed only through a formal proceeding before the appropriate regulatory commission. Regulatory commissions also have authority over the terms and' conditions of nontraditional rate making arrangements. At the end of each accounting period, ,

WMECO accrues an estimate for the amount of energy delivered but unbilled.

H. Regulatory Accounting and Assets The accounting policies of WMECO and the accompanying consolidated financial statements conform to generally accepted accounting principles applicable to rate-regulated enterprises and reflect the effects of the ratemaking process in accordance l with SFAS 71, " Accounting for the Effects of Certain Types of Regulation." Assuming a cost-of-service based regulatory structure, regulators may permit incurred costs, normally treated as expenses, to be deferred and recoverad through future i revenues. Through their actions, regulators also may reduce or eliminate the value of an asset, or create a liability. If any portion of WMECO's operations were no longer subject to the provisions of SFAS 71, as a result of a change in the cost-of-service based regulatory structure or the effects of l competition, WMECO would be required to write off related gulatory assets and liabilities unless there is a formal uansition plan which provides for the recovery, through I established rates, for the collection of approved stranded costs l and to maintain the cost-of-service basis for the remaining regulated operations. At the time of transition, WMECO would be required to determine any impairment to the carrying costs of deregulated plant and inventory assets.

The staff of the SEC has had concerns regarding the appropriateness of the utilities' ability to continue application of SFAS 71 for the generation portion of their business in a restructured environment. The SEC referred the  !

issue to the Emerging Issues Task Force (EITF) of the FASB which reached a consensus and issued " Deregulation of the Pricing of Electricity - Issues Related to the Application of FASB Statements No. 71 and 101," (EITF 97-4). The EITF concluded: (1) the future recognition of regulatory assets for the portion of the business that no longer qualifies for ,

application of SFAS 71 depends on the regulators' treatment of the recovery of those costs and other stranded assets from cash flows of other portions of the business still considered to be regulated, and (2) a utility should discontinue the application l

of SFAS 71 when a legislative and regulatory plan has been  ;

enacted, which would include transition plans into a competitive environment, and when the stranded costs which are subject to future rate recovery are determined. EITF 97-4 became effective in August 1997.

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W tern Macachuu0tto Elcctric Company and Subsidicry FOTES TO CONSOLIDATED FINANCIAL STATEMENTS Electric utility industry restructuring within the state of Massachusetts will be effective March 1, 1998. WMECO has submitted its proposed restructuring plan to the Massachusetts Department of Telecommunications and Energy (DTE), formerly the Massachusetts, Department of Public Utilities. If the DTE approves the plan in its current form, WMECO would discontinue the application of SFAS 71. However, the restructuring legislation enacted by the state of Massachusetts specifically provides for future deferrals and the cost recovery of generation-related assets as contemplated under the plan. As such, WMECO is not expected to have to write off either its generation-related assets or related regulatory assets.

WMECO's generation-related regulatory assets were valued at approximately $188 million at December 31, 1997. The majority of WMECO's regulatory assets are related to its generation business.

For mo're information on the WMECO's regulatory environment and I the impacts of restructuring, see Note 12A, " Commitments and l Contingencies-Restructuring and Rate Matters," and Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A).

SFAS 121, " Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," requires the evaluation of long-lived assets, including regulatory assets, for impairment when certain events occur or when conditions exist that indicate the carrying amounts of assets may not be recoverable. SFAS 121 requires that any long-lived assets which are no longer probable of recovery through future revenues be revalued based on estimated future cash flows. If this revaluation is less than the book value of the asset, an impairment loss would be charged to earnings.

I Management continues to believe it is probable that WMECO will recover its investments in long-lived assets through future revenues. This conclusion may change in the future as the implementation of restructuring plans within Massachusetts will generally require the formation of a separate generation entity that will be subject to competitive market conditions. As a result, WMECO will be required to assess the carrying amounts of its long-lived assets in accordance with SFAS 121.

i I

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13

Estern M socchucotto Elsctric Comp ny cnd Subsidiary ,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of WMECO's regulatory assets are as follows:

At December 31, 1997 1996 (Thousands of Dollars)

Income taxes, net (Note 2I) ........... $ 63,716 $ 71,519 Unrecovered contractual obligations (Note 3) ............................ 93,628 84,598 Recoverable energy costs (Note 2J) .... 26,270 17,510 Other ................................. 27,763 37,225

$211,377 $210,852 I. ' Income Taxes The tax effect of temporary differences (differences between the periods in which transactions affect income in the financial statements and the periods in which they affect the determination of taxable income) is accounted for in accordance with the ratemaking treatment of the applicable regulatory commissions. See Note 8, " Income Tax Expense" for the components of income tax expense.

The tax effect of temporary differences, including timing differences accrued under previously approved accounting standards, which give rise to the accumulated deferred tax obligation is as follows:

At December 31, 1997 1996 (Restated) (Restated)

(Thousands of Dollars)

Accelerated depreciation and other plant-related differences ....... $223,038 $218,389 Regulatory assets - income tax gross up 30,175 29,457 Other ................................. (6.760) 2,040

$246,453 $249,886 J. Recoverable Energy Costs Under the Energy Policy Act of 1992 (Energy Act), WMECO is assessed for its proportionate share of the costs of decontaminating and decommissioning uranium enrichment plants owned by the United States Department of Energy (D&D assessment). The Energy Act requires that regulators treat D&D assessments as a reasonable and necessary current cost of fuel, to be fully recovered in rates, like any other fuel cost.

WMECO is currently recovering these costs through rates. As of December 31, 1997, WMECO's total D&D deferrals were approximately $11.3 million.

14

W: torn Ma3ccchnOctto Electric Company and Suboidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

'WMECO has a fuel adjustment clause (FAC) which includes energy costs along with capacity and transmission charges and credits that result from short-term transactions with other utilities and from certain FERC-approve.d contracts among the NU system's operating companies. The Massachusetts restructuring legislation will effectively eliminate the FAC,- effective March 1, 1998.

On August 20, 1997, WMECO filed with the DTE a joint motion for approval of a settlement agreement with the Massachusetts Attorney General which allowed WMECO to recover approximately

$15.3 million of fuel costs for the period September 1997 through February 1998. Under the current FAC rate, WMECO continues to defer significant costs for future recovery.

At December 31, 1997, WMECO's net recoverable energy costs were approximately $26.3 million, which includes approximately $11.3 million of costs related to WMECO's share of the D&D assessment. I For additional information regarding recoverable energy costs see the MD&A.

K. Spent Nuclear Fuel Disposal Costs Under the Nuclear Waste Policy Act of 1982, WMECO must pay the United States Department of Energy (DOE) for the disposal of spent nuclear fuel and high-level radioactive waste. The DOE is responsible for the selection and development of repositories for,'and the disposal of, spent nuclear fuel and high-level radioactive waste. Fees for nuclear fuel burned on or after April 7, 1983, are billed currently to customers and paid to the DOE on a quarterly basis. For nuclear fuel used to generate electricity prior to April 7, 1983 (prior-period fuel), payment must be made prior to the first delivery of spent fuel to the DOE. Until such payment is made, the outstanding balance will continue to accrue interest at the three-month Treasury Bill Yield Rate. At December 31, 1997, fees due to the DOE for the disposal of prior-period fuel were approximately $39.0 million, including interest costs of $23.4 million.

The DOE was originally scheduled to begin accepting delivery of spent fuel in 1998. However, delays in identifying a permanent storage site have continually postponed plans for the DOE's long-term storage and disposal site. Extended delays or a default by the DOE could lead to consideration of costly alternatives. The company has primary responsibility for the interim storage of its spent nuclear fuel. Current capability to store spent fuel at Millstone 1 and 2 are estimated to be adequate until 2004. Storage facilities for Millstone 3 are expected to be adequate for the projected life of the unit. i Meeting spent fuel storage requirements beyond these periods i could require new and separate storage facilities, the costa j i for which have not been determined.

I 15 ,

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Wastern Masocchusetto Electric Compcny cnd Subsidiary ,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In November 1997, the U.S. District Court of Appeals for the D.C. Circuit ruled that the lack of an interim storage facility does not excuse- the DOE from meeting its contractual obligation to begin accepting spent nuclear fuel no later than January 31, 1998. Currently, the DOE has not taken the spent nuclear fuel as scheduled and, as a result, may have to pay contract damages. The ultimate outcome of this legal i proceeding is uncertain at this time.

-3. NUCLEAR DECOMMISSIONING Millstone: WMECO's nuclear power plants have service lives that are expected to end during the years 2010 through 2025. Upon retirement, these units must be decommissioned. Current decommissioning studies concluded that complete and immediate dismantlement at retirement continues to be the most viable and economic method of decommissioning the three Millstone units.

Decommissioning studies are reviewed and updated periodically to reflect changes in decommissioning requirements, costs, technology and inflation.

The estimated cost of decommissioning WMECO's ownership share of Millstone 1, 2 and 3, in year-end 1997 dollars, is $91.7 million,

$82.1 million and $67.8 million, respectively. The Millstone units decommissioning costs will be increased annually by their respective escalation rates. Nuclear decommissioning costy are accrued over the expected service life of the units and are included in depreciation expense on the Consolidated Statements of Income. Nuclear decommissioning costs amounted to $6.2 million in 1997 and 1996 and

$5.0 million in 1995. Nuclear decommissioning, as a cost of removal, is included in the accumulated provision for depreciation on the Consolidated Balance Sheets. At December 31, 1997 and 1996, the balance in the accumulated reserve for depreciation amounted to

$102.7 million and $83.6 million, respectively.

WMECO has established external decommissioning trusts through a trustee for its portion of the costs of decommissioning Millstone 1, 2 and 3. Funding of the estimated decommissioning costs assumes levelized collections for the Millstone units and after-tax earnings on the Millstone decommissioning funds of approximately 5.5 percent.

As of December 31, 1997, WMECO has collected, through rates, $59.7 million toward the future decommissioning costs of its share of the Millstone units, all of which has been transferred to external decommissioning trusts. Earnings on the decommissioning trusts increase the decommissioning trust balance and the accumulated reserve for depreciation. Unrealized gains and losses associated l with the decommissioning trusts also impact the balance of the trust L and the accumulated reserve for depreciation.

Changes in requirements or technology, the timing of funding or dismantling, or adoption of a decommissioning method other than immediate dismantlement would change decommissioning cost estimates

-and the amounts required to be recovered. WMECO attempts to recover 16

_ _ _ _ _ _ _ _ _ = _ - _ _ . L

l

', W20 torn Mnecochuscotto Electric Comptny cnd Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and assuming its nuclear units operate to the end of their l respective license periods, WMECO expects that the decommissioning trusts will be substantially funded when the units are retired from service.

Millstone 1 has been placed in extended maintenance status while management is reviewing its options with respect to the unit.

These include restart, early retirement and other options.

Relating to management's consideration of the option to immediately retire Millstone 1 are certain Connecticut state law issues which relate to WMECO as minority owner. In its four-year rate review proceeding, the DPUC noted that CL&P may not be able to obtain its remaining investment in Millstone 1 if it were to determine that the unit had been prematurely shut down due to

! management imprudence. Additionally, there is a Connecticut l statute which may limit CL&P's ability to collect future decommissioning charges related to Millstone 1 if Millstone 1 were to be terminated before the end of its expected life.

l At December 31, 1997, WMECO's net unrecovered Millstone 1 plant costs were $50.9 million and the remaining unrecovered decommissioning costs were approximately $44 million.

Yankee Companies: VYNPC owns and operates a nuclear generating unit with a service life that is expected to end in 2012.

WMECO's ownership share of estimated costs, in year-end 1997 dollars, of decommissioning this unit is $12.6 million.

On August 6, 1997, the board of directors of MYAPC voted {

unanimously to cease permanently the production of power at its l nuclear generating facility (MY). The NU system companies had relied on MY for approximately one percent of their capacity.

During November 1997, MYAPC filed an amendment to its power contracts clarifying the obligations of its purchasing utilities l following the decision to cease power production. During January 1998, the FERC accepted the amendments and proposed rates, subject to refund. At December 31, 1997, the remaining estimated l obligation, including decommissioning, amounted to approximately

$867.2 million, of which WMECO's share was approximately $26.0 million.

l On December 4, 1996, the board of directors of CYAPC voted  ;

unanimously to cease permanently the production of power at its '

nuclear generating plant (CY). During 1996, the NU system companies had relied on CY for approximately three percent of their capacity. During late December 1996, CYAPC filed an ,

amendment to its power contracts clarifying the obligations of its I purchasing utilities following the decision to cease power '

production. On February 27, 1997, the FERC approved an order for hearing which, among other things, accepted CYAPC's contract amendment. The new rates became effective March 1, 1997, subject l to refund. At December 31, 1997, the remaining estimated I obligation, including decommissioning, amounted to $619.9 million,  !

of which WMECO's share was approximately $58.9 million. i 17

WOctern MSoccchu30tto Electric Company cnd Subcidie.ry .

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The new rates became effective March 1, 1997, subject amendment.

refund. At December 31, 1997, the remaining estimated to obligation, including decommissioning, amounted to $619.9 million, of which WMECO's share was approximately $58.9 million.

YAEC is in the process of decommissioning its nuclear facility. At including December 31, 1997, the estimated remaining costs, decommissioning, amounted to $124.4 million, of which WMECO's share was approximately $8.7 million.

Under the terms of the contracts with MYAPC, CYAPC and YAEC, the shareholder-sponsor companies, including WMECO, are responsible for their proportionate share of the costs of the units, including decommissioning. Management expects that WMECO will continue to be allowed to recover these costs from its customers.

Accordingly, WMECO has recognized these costs as regulatory assets, with corresponding obligations.

Proposed Accounting: The staff of the SEC has questioned certain current accounting practices of the electric utility industry, including WMECO, regarding the recognition, measurement E.nd classification of decommissioning costs for nuclear generating units in the financial statements. In response to these questions, the FASB has agreed to review the accounting for closure and removal costs, including decommissioning. If current electric utility industry accounting practices for nuclear power plant decommissioning are changed, the annual provision for decommissioning could increase relative to 1997, and the estimated cost for decommissioning could be recorded as a liability (rather than as accumulated depreciation), with recognition of an increase in the cost of the related nuclear power plant. Management believes that WMECO will continue to be allowed to recover decommissioning costs through rates.

4. SHORT-TERM DEBT Limits: The amount of short-term debt borrowings that may be incurred by WMECO is subject to periodic approval by either the SEC under the 1935 Act or by the DTE. SEC authorization allowed WMECO, as of January 1, 1998, to incur short-term borrowings up to a maximum of $150 million. In addition, the charter of WMECO contains a provision which restricts the total amount of unsecured debt that it may borrow at any one time. As of January 1, 1998, this charter provision allowed WMECO to incur unsecured borrowings, whether j short-term or long-term, up to a maximum of approximately $114 million.

Credit Agreements: In May 1997, because of the potential for NU f and CL&P to violate their various financial ratio tests, NU amended the three-year revolving credit agreement (Credit Agreement) with a group of 12 banks. Under the amended Credit L Agreement, CL&P and WMECO are able to borrow, subject to the availability of first mortgage bond collateral, up to $313.75 18

.- W btcrn Maccachusette Electric Company cud Subcidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS million and $150 million, respectively. At December 31, 1997, CL&P and WMECO have issued first mortgage bonds to enable borrowings under this facility up to a maximum of $225 million and

$90 million, respectively. NU, which cannot issue first mortgage

' bonds, will be able to borrow up to $50 million if NU consolidated, CL&P and WMECO each meet certain interest coverage tests for two consecutive quarters. In addition, CL&P and WMECO each must meet certain minimum quarterly financial ratios to access the Credit Agreement. Both CL&P and WMECO satisfied these tests for the quarter ending December 31, 1997. The overall limit for all of the borrowing system companies under-the entire Credit Agreement is $313.75 million. The companies are obligated to pay a facility fee of .50 percent per annum of each bank's total commitment under this Credit Agreement which will expire in November 1999. At December.31, 1997 and 1996, there were $50 million and $27.5 million, respectively, in borrowings under this Credit Agreement. Of these borrowings, $15 million were borrowed by WMECO in 1997 and none were borrowed by WMECO in 1996.

In addition to the Credit Agreement, NU, CL&P, WMECO, HWP and The Rocky River Realty Company (RRR) have various revolving credit lines through separate bilateral credit agreements. Under this facility, four banks maintain commitments to the respective companies totaling $56.25 million. NU, CL&P and WMECO may borrow up to the aggregate $56.25 million, whereas HWP and RRR may borrow up to their SEC or board authorized short-term debt limit of $5 million and $22 million, respectively. Under the terms of this facility, the companies are obligated to pay a facility fee of .15 percent per annum of each bank's total commitment. These commitments will expire in December 1998. At December 31, 1997 and 1996, there were no borrowings and $11.3 million in borrowings, respectively, under this facility.

I-Under . the credit facilities discussed above, WMECO may borrow funds on a short-term revolving basis under its respective agreements, using either fixed-rate loans or standby loans. Fixed rates are set using competitive bidding. Standby loans are based upon several alternative variable rates. The weighted average annual interest rate on WMECO's notes payable to banks outstanding on December-31, 1997 was 6.95 percent. WMECO had no borrowings under these facilities at December 31, 1996.

Money. Pool: Certain subsidiaries of NU, including WMECO, are members of the Northeast Utilities System Money Pool (Pool). The Pool provides a more efficient use of the cash resources of the system, and reduces outside short-term borrowings. NUSCO administers the Pool as agent for the member companies. Short-term borrowing needs of the member companies are first met with available funds of other member companies, including funds borrowed by NU parent. NU parent may lend to the Pool but may not borrow. Funds may be withdrawn from or repaid to the Pool at any time without prior notice. Investing and borrowing subsidiaries receive or pay interest based on the average daily Federal Funds rate. However, borrowings based on loans from NU parent bear interest at NU 19

Western Massachusetts Electric Company and Subsidiary ,

I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS l parent's cost and must be repaid based upon the terms of NU parent's l original borrowing. At December 31, 1997 and 1996, WMECO had $14.4 million and $47.4 million, respectively, of borrowings outstanding f from the Pool. The interest rate on borrowings from the Pool at j

December 31, 1997 and 1996 was 5.8 percent and 6.3 percent, l

l respectively.

l Maturities of short-term debt obligations were for periods of three months or less.

For further information on short-term debt, including the ability to access these agreements, see the MD&A.

5. PREFERRED STOCK NOT SUBJECT TO MANDATORY REDEMPTION Details of preferred stock not subject to mandatory redemptions are:

December 31, Shares 1997 Outstanding

- Redemption December 31, December 31.

Description Price 1997 1997 1996 1995 (Thousands of Dollars) 7.72% Series B $20,000 $20,000 of 1971....... $103.51 200,000 $20,000 1988 Adjustable - 33,500 Rate DARTS.... -

Total preferred stock not subject to mandatory

$20,000 $20,000 $53,500 redemption....

All or any part of each outstanding series of preferred stock may be redeemed by the company at any time at established redemption prices plus accrued dividends to the date of redemption.

20

Western Massachusetts Electric Company and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION Details of preferred stock subject to mandatory redemption are:

l l December 31 Shares 1997 Outstanding Redemption December 31, December 31.

Description Price

• 1997 1997 1996 1995 (Thousands of Dollars) 7.60% Series of 1987....... $25.64 840,000 $21,000 $21,000 $24,000 Less preferred stock to be redeemed within one year, net of reacquired stock.......... 60,000 1,500 - 1,500 Total preferred stock subject to mandatory redemption..... $19,500 $21,000 $22,500

• Redemption price reduces in future years.

The minimum sinking-fund provisions of the 1987 Series subject to mandatory redemption at December 31, 1997, for the years 1998 through 2002 is $1.5 million per year. In case of default on sinking-fund payments, no payments may be made on any junior stock by way of dividends or otherwise (other than in shares of junior stock) so long as the default continues. If the company is in arrears in the payment of dividends on any outstanding shares of preferred stock, the company would be prohibited from redemption or purchase of less than all of the preferred stock outstanding. All or part of the 7.60% Series of 1987 may be redeemed by the company at any time at an established redemption price plus accrued dividends to the date of redemption subject to certain refunding limitations.

21 l

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_ _ _ _ _ 1

Wactern Maso chucetto Electric Comp 2ny and Subsidiary ,

NOTES TO CONSOLIDATED FINANCIAL S_TAIEtiERES

7. LONG-TERM DEBT Details of long-term debt outstanding are: December 31, 1997 1996 (Thousands of Dollars)

First Mortgage' Bonds:

Series F, due 1997 .......... $ - $ 14,700 5 3/4% 9,800 6 3/4% Series G, due 1998 .......... 9,800 6 1/4% Series X, due 1999 .......... 40,000 40,000 6 7/8% Series W, due 2000 .......... 60,000 60,000 7 3/8% Series B, due 2001 .......... 60,000 -

7 3/4% Series V, due 2002 .......... 85,000 85,000 Series Y, due 2024 .......... 50,000 50,000 7 3/4%

Total First Mortgage Bonds................ 304,800 259,500 Pollution Control Notes:

Tax Exempt Variable Series A, due 2028... 53,800 53,800 Fees and interest due for spent fuel disposal costs (Note 2K) ........... 39,045 37,055 Less: Amounts due within one year........ 9,800 14,700 Unamortized premium and discount, net..... (996) (913)

Long-term debt, net....................... $386,849 $334,742 Long-term debt . maturities and cash sinking-fund requirements on debt outstanding at December 31, 1997 for the years 1998 through 2002 are approximately $9.8 million, $40 million, $60 million,

$60 million and $85 million, respectively. In addition, there are annual one-percent sinking- and improvement-fund

. requirements, currently amounting to $1.5 million for 1998 and 1999 and $900 thousand for 2000 through 2002. Such sinking- and improvement-fund requirements may be satisfied by the deposit of cash or bonds by certification of property additions.

All or any part of each outstanding series of first mortgage bonds may be redeemed by WMECO at any time at established redemption - prices plus accrued interest to the date of redemption, except certain series which are subject to certain refunding limitations during their respective initial five-year redemption periods.

Essentially all of WMECO's utility plant is subject to the lien of its first mortgage bond indenture. As of December 31, 1997 and 1996, WMECO - has sec6 red $53.8 million of pollution control notes .with second mortgage liens on Millstone 1, junior to the liens of its first mortgage bond indenture. The average effective interest . rate on the variable-rate pollution control notes was 3.5 percent for 1997 and 3.3 percent for 1996.

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W$ctcrn Macccchu20tto Elcctric Company and Suboidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. INCOME TAX EXPENSE The components of the federal and state income tax provisions (credited) / charged to operations are:

For the Years Ended December 31, 1997 1996 1995 (Reetated) (Restated)

(Thousands of Dollars)

Current income taxes:

Federal..................... $ (14,277) $ 7,007 $ 7,419 State....................... (635) 1,358 2,961 Total current............. (14,912) 8,365 10,380 Deferred income taxes, net:

Federal..................... 3 2,054 4,130 State....................... 210 609 1,003 Total deferred............ 213 2,663 5,133 Investment tax credits, net... (1,469) (1,468) (1,715)

Total income tax (credit)/

expense..................... $ (16,16 8 ) $ 9,560 $13,798 The components of total income tax expense are classified as follows:

Income taxes charged to operating expenses.......... $ (15,142 ) $10,628 $14,060 Other income taxes ........... (1,026) (1,068) (262)

Total income tax (credit) /

expense..................... $ (16,16 8 ) $9,560 $13,798  ;

Deferred income taxes are comprised of the tax effects of temporary differences as follows:

For the Years Ended December 31, 1997 1996 1995 (Restated) (Restated)

(Thousands of Dollars)

Depreciation, leased nuclear fuel, settlement credits, l and disposal costs............ $ 1,407 $ 32 $9,066 Energy adjustment clause........ 3,115 4,102 (1,549) l Demand side management.......... 321 1,557 (1,184) l  ; Nuclear plant deferrals......... (3,431) (2,258) 2,468 l Pension......................... 999 (57) (482)

Bond redemptions................ (535) (502) (572)

Other........................... (1,663) (211) (2,614)

Deferred income taxes, net...... $ 213 $ 2,663 $5,133 1

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W20tcrn Macccchu5ctto Elcctric Company cnd Subaidiary .

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A reconciliation between income tax expense and the expected tax expense at the applicable statutory rate is as follows:

For the Years Ended December 31, 1997 1996 1995 (Restated) (Restated)

(Thousands of Dollars)

Expected federal income tax at 35 percent of pretax income for . . . . $ (15,270) $7,076 $18,526 Tax effect of differences:

Depreciation....................... 1,352 2,280 2,173 Amortization of regulatory assets.. 1,916 1,029 1,665 Investment tax credit amortization. (1,469) (1,468) (1,715)

State income taxes, net of federal benefit.................. (225) 1,279 2,577 Adjustment for prior years' taxes.. (967) - (7,702)

Dividends received reduction....... (408) (378) (481)

Other, net......................... (1.097) (258) (1.245)

' ntal income tax (credit) / expense . . . . $ (16,168) $9,560 $13,798 9, LEASES

'ECO and CL&P may finance up to $400 million of nuclear fuel for o i.lstone 1 and 2 and their respective shares of the nuclear fuel Millstone 3 under the Niantic Bay Fuel Trust (NBFT) capital ase agreement which is scheduled to expire July 31, 1998. The InFT capital lease agreement, which was amended in February 1998, requires CL&P and WMECO to secure their obligation to repay the NBFT with up to $90 million of first mortgage bonds. CL&P and WMECO will issue these bonds by May 1998.

WMECO and CL&P make quarterly lease payments for the cost of nuclear fuel consumed in the reactors based on a units-of-production method t

at rates which reflect estimated kilowatt hours of energy provided plus financing costs associated with the fuel in the reactors. Upon permanent discharge from the reactors, ownership of the nuclear fuel l transfers to WMECO and CL&P. WMECO has also entered into lease agreements, some of which may be capital leases, for the use of data processing and office equipment, vehicles, nuclear control room simulators and office space. The provisions of these lease agreements generally provide for renewal options. The following l

rental payments have been charged to expense:

i Year Caoital Leases Operatino Leases 1997..................... $ 1,820,000 $5,968,000 1996..................... 3,598,000 6,410,000 1995..................... 12,553-000

, 6,398,000 Interest included in capital lease rental payments was $1,820,000 in 1997, $1,858,000 in 1996, and $1,954,000 in 1995.

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4

, Wactorn Macocchucotto Elcctric Comp 2ny cnd Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Future minimum rental payments, excluding executory costs such as property taxes, state use taxes, insurance and maintenance, under long-term noncancellable leases, as of December 31, 1997, are:

Year Caoital Leases Operatino Leases (Thousands of Dollars) 1998.................... $32,700 $ 3,700 1999.................... 36 3,400 2000.................... 36 3,100 2001.................... 36 2,800 2002.................... 36 2,500 After 2002.............. 70 18.600 Future minimum lease payments.............. 32,914 $34.100 Less amount representing l interest.............. 14 Present value of future minimum lease payments........ $32,900

10. EMPLOYEE BENEFITS A. Pension Benefits The NU system's subsidiaries participate in a uniform noncontributory defined benefit retirement plan covering all I regular NU system employees. Benefits are based on years of service and the employees' highest eligible compensation during 60 consecutive months of employment. WMECO's direct portion of the NU system's pension credit, part of which was i credited to utility plant, approximated $ (5.7) million in 1997, $ (2. 0) million in 1996 and $ (2. 7) million in 1995.

WMECO's pension (credits)/ costs for 1997, 1996 and 1995 included approximately $(529) thousand, $1.0 million and

$0.0 million, respectively, related to workforce reduction programs.

Currently, WMECO funds annually an amount at least equal to that which will satisfy the requirements of the Employee Retirement Income Security Act and the Internal Revenue Code. Pension costs are determined using market-related values of pension assets. Pension assets are invested primarily in domestic and international equity securities and bonds.

25

Wcatern Macccchucotto Elcctric Company and Suboidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of net pension credit for WMECO are: f i

For the Years Ended December 31, 1997 1996 1995 (Thousand of Dollars)

Service cost.................. $ 1,346 $ 2,932 $ 1,645 Interest cost................. 7,858 7,786 7,757 Return on plan assets......... (31,874) (22,174) (29,798) 16,944 9,458 17,669 Net amortization..............

Net pension (credit) .......... $(5,726) $ (1,998) $ (2,727)

For calculating pension cost, the following assumptions were used:

For the Years Ended December 31, 1997 1996 1995 Discount rate.................. 7.75% 7.50% 8.25%

Expected long-term rate of return.................... 9.25 8.75 8.50 Compensation / progression rate.. 4.75 4.75 5.00 The following table represents the plan's funded status reconciled to the Consolidated Balance Sheets:

At December 31, 1997 1996 (Thousands of Dollars)

Accumulated benefit obligation, including vested benefits at December 31, 1997 and 1996 of

$(87,278,000) and $ (85,094,000) ,

respectively .................. $( 93,555) $( 91,170)

Projected benefit obligation..... $ (109,536) $(107,816)

Market value of plan assets...... _J81,028 157,863 Market value in excess of projected benefit obligation... 71,492 50,047 Unrecognized transition amount... (1,727) (1,963)

Unrecognized prior service costs. 1,142 1,213 Unrecognized net gain............ (62,370) (46,486)

Prepaid pension asset ........... $ 8,537 $ 2,811 1

26

• W$0ternMacccchucOttoElcctricCompanyandSubidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following actuarial assumptions were used in calculating the plan's year-end funded status:

At December 31. 1997 1996 Discount rate........................... 7.25% 7.75%

Compensation / progression rate........... 4.25 4.75 B. Postratirement Benefits Other Than Pensions I

The NU system's subsidiaries provide certain health care benefits, primarily medical and dental, and life insurance benefits through a benefit plan to retired employees (referred to as SFAS 106 benefits). These benefits are available for employees retiring from the company who have met specified service requirements. For current employees i and certain retirees, the total SFAS 106 benefit is limited to two times the 1993 per-retiree health care cost. The SFAS )

106 obligation has been calculated based on this assumption. i WMECO's direct portion of SFAS 106 benefits, part of which I were deferred or charged to utility plant, approximated $2.8 million in 1997, $3.8 million in 1996, and $4.4 million in 1995. WMECO is funding SFAS 106 postretirement costs through external trusts. WMECO is funding, on an annual basis, amounts that have been rate-recovered and which also are tax deductible under the Internal Revenue Code. The trust assets are invested primarily in equity securities and bonds.

The components of health care and life insurance costs are:

For the Years Ended December 31, 1997 1996 1995 (Thousands of Dollars) i

! Service cost................... $ 355 $ 490 $ 490 Interest cost.................. 2,011 2,236 2,544 Return on plan assets.......... (2,088) (883) (718)

Amortization of unrecognized transition obligation........ 1,641 1,641 1,641 l Other amortization, net........ 868 353 473

Net health care and life insurance cost............... $2,787 $3,837 $4,430 l

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i m uu upi Wsstorn Massachucotts Electric Comptny cnd Subsidicry ,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For calculating WMECO's SFAS 106 benefit costs, the following assumptions were used:

For the Years Ended December 31, 1997 1996 1995 Discount rate.................. 7.75% 7.50% 8.00%

Long-term rate of return -

Health assets, net of tax.... 6.00 5.25 5.00 Life assets.................. 9.25 8.75 8.50 The following table represents the plan's funded status reconciled to the Consolidated Balance Sheets:

At December 31, 1997 1996 (Thousands of Dollars)

Accumulated postretirement benefit obligation of:

Retirees............................... $ (23,123) $ (24,614)

Fully eligible active employees........ (84) (28)

Active employees not eligible to retire (4.619) (5.449)

Total accumulated postretirement benefit obligation.................... (27,826) (30,091)

Market value of plan assets............. __12.838 10.215 Accumulated postretirement benefit obligation in excess of plan assets... (14,988) (19,876)

Unrecognized transition amount.......... 24,618 26,259 Unrecognized net gain................... (9,630) (6.765)

Accrued postretirement benefit liability 9 -

$ (382) l The following actuarial assumptions were used in calculating the plan's year-end funded status:

At December 31. 1997 1996 Discount rate........................... 7.25% 7.75%

Health care cost trend rate (a) ......... 5.76 7.23 (a) The annual growth in per capita cost of covered health care benefits was assumed to decrease to 4.40 percent by 2001.

28  ;

\

, W20tcrn Mucochucetto Electric Company nnd Subsidiary '

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The effect of increasing the assumed health care cost trend rate by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997, by $1.7 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by $131 thousand. The trust holding the health plan assets is subject to federal income taxes at a 39.6 percent tax rate.

WMECO currently is recovering SFAS 106 costs through rates.

11. SALE OF CUSTOMER RECEIVABLES AND ACCRUED UTILITY REVENUES During 1996, WMECO entered into an agreement to sell up to $40 l million of undivided ownership interests in eligible customer receivables and accrued utility revenues (receivables).

The FASB issued SFAS 125, " Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," in June, 1996. SFAS 125 became effective on January 1, 1997, and establishes, in part, criteria for concluding whether a transfer of financial assets in exchange for consideration should be accounted for as a sale or as a secured borrowing. During May 1997, WMECO had restructured its sales agreement to comply with the conditions of SFAS 125 and account for transactions occurring under this program as a sale of assets. WMECO established a special purpose, wholly owned subsidiary whose business consists of the purchase and resale of receivables. For receivables sold, WMECO has retained collection responsibilities as agent for the purchaser under WMECO's agreement. As collections reduce previously sold receivables, new receivables may be sold. At December 31, 1997, approximately $20 million of receivables had been sold to a third-party purchaser by WMECO, through the use of its special purpose, wholly owned subsidiary, WMECO Receivables Corporation (WRC). All receivables transferred to WRC are assets owned by WRC and are not available to pay WMECO's creditors.

For WRC's sales agreement with the third-party purchaser, the receivables were sold with limited recourse. WRC's sales agreement provides for a formula-based loss reserve in which additional receivables may be assigned to the third-party purchaser for costs such as bad debt. The third-party purchaser absorbs the excess amount in the event that actual loss experience exceeds the loss reserve. At December 31, 1997 approximately $3.0 million of assets had been designated as collateral by WRC. This amount represents the formula-based amount of credit exposure at December 31, 1997. Historical losses for bad debt for WMECO have been substantially less.

During December 1997, Moody's Investors Service downgraded the rating on WMECO's first mortgage bonds. This downgrade brought WMECO's bond ratings to a level at which the sponsor of WMECO's accounts receivable program can take various actions, in its 29

Wootorn Mncacchucatta Electric Comptny cnd Subsidiary -

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS discretion, which would have the practical effect of limiting WMECO's ability to utilize the facility. To date, the sponsor has not notified WMECO that it will elect to exercise those The rights, and the program is functioning in its normal mode.

WMECO accounts receivable program is terminable if WMECO's first mortgage bond credit ratings experience one more level of downgrade. CL&P's accounts receivable program could be terminated if its senior secured debt is downgraded two more steps from its current ratings.

Concentrations of credit risk to the purchaser under WMECO's agreement with respect to the receivables are limited due to WMECO's diverse customer base within its service territory.

For additional information on the accounts receivable program and WMECO's ability to utilize this program, see the MD&A.

12. COMMITMENTS AND CONTINGENCIES A. Restructuring and Rate Matters During November 1997, the state of Massachusetts enacted a comprehensive electric utility industry restructuring bill (legislation). On December 31, 1997, WMECO filed its restructuring plan with the DTE, as required by the legislation. The WMECO restructuring plan describes the process by which WMECO will, beginning March 1, 1998, initiate a ten percent rate reduction for all customer rate classes and allow customers to choose their energy supplier.

As part of the plan, the DTE authorized recovery of certain strandable above-market costs (strandable costs). The legislation gives the DTE the authority to determine the amount of strandable costs that will be eligible for recovery by utilities. Costs which will qualify as strandable costs and be eligible for recovery include, but are not limited to, certain above-market costs associated with generating facilities, costs associated with long-term commitments to purchase power at above-market prices from small power producers and nonutility generators, and regulatory assets and associated liabilities related to the generation portion of WMECO's business.

Under the statute, if a distribution company claims that it is unable to meet a price reduction of ten percent initially and 15 percent by September 1, 1999, the distribution company may so state to the DTE and the DTE is provided with the authority to " explore all possible mechanisms and options within the limits of the constitution" to achieve the mandated rate reductions. The statute indicates that allowing a substitute company to provide standard offer service is one option that can be considered by the DTE.

The costs of transitioning to competition will be mitigated through several steps, including divesting WMECO's non-  ;

nuclear generating assets at an auction to be held as soon I 30

, Wastern M:.ssachucstto Elsctric Compnny cnd Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS as June 1998, and securitization of approximately $500 million in strandable costs by September 30, 1998. NU presently expects to participate, through a competitive affiliate, in the competitive bid process for WMECO's generation resources. Any net proceeds in excess of book value received from the divestiture of these units will be used to mitigate strandable costs. As required by the legislation, WMECO will continue to operate and maintain its transmission and local distribution network and deliver electricity to all customers.

As noted above, the legislation has authorized Massachusetts utilities to finance a portion of the strandable costs through securitization, using rate reduction bonds. A separate transition charge will be collected over the life of the bonds to recover principal, interest and issuance costs.

WMECO's ability to recover its strandable costs will depend on several factors, which include, but are not limited to, continuous recovery cf the costs over the transitional period supported by the legislation, the aggregate amount of strandable costs which the company will be allowed to recover and the market price of electricity. Management believes that the company will recover its strandable costs.

.However, a change in one or more of these factors could affect the recovery of strandable costs and may result in a loss to the company.

FERC Rate Proceedings: For information regarding the FERC rate proceedings for CYAPC and MYAPC, see Note 3, " Nuclear Decommissioning."

B. Nuclear Performance Millstone: The three Millstone units are managed by NNECO.

Millstone 1, 2 and 3 have been out of service since November 4, 1995, February 21, 1996, and March 30, 1996, respectively, and are on the Nuclear Regulatory Commission's (NRC) watch list. NU has restructured its nuclear organization and is currently implementing comprehensive plans to restart the units.

Subsequent to its January 31, 1996 announcement that Millstone had been placed on its watch list, the NRC stated that the units cannot return to service until independent, third-party verification teams have reviewed the actions taken to improve the design, configuration and employee concerns issues that prompted the NRC to place the units on its watch list. The actual date of the return to service for each of the units is dependent upon the completion of independent inspections and reviews by the NRC and a vote by the NRC commissioners. NU hopes to return Millstone 3 to service in the early spring of 1998 and Millstone 2 three to 31

Wactorn Masacchucotts Electric Company cnd Subsidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS four months after Millstone 3. Millstone 1 is currently in extended maintenance status.

Management cannot predict when the NRC will allow any of the Millstone units to return to service and thus cannot precisely estimate the total replacement power costs WMECO will ultimately incur. Replacement power coats incurred by WMECO attributable to the Millstone outages averaged approximately $5 million per month during 1997, and for 1998 are projected to average approximately $2 million per i month for Millstone 3, $2 million per month for Millstone 2 ,

and $1 million per month for Millstone 1 while the plants remain out of service. WMECO will continue to expense its l replacement power costs in 1998.

Based on the current estimates of expenditures and restart dates, management believes the NU system has sufficient resources to fund the' restoration of the Millstone units and related replacement power costs. If the return to service of Millstone 3 or 2 is delayed substantially beyond the present restart estimates, if some financing facilities become unavailable because of difficulties in meeting borrowing conditions or renegotiating extensions, if CL&P and WMECO encounter additional significant costs or if any other significant deviations from management's assumptions occur, CL&P and WMECO could be unable to meet their cash requirements. In those circumstances, management would take even more stringent actions to reduce costs and cash outflows and attempt to obtain additional sources of funds. The availability of these funds would be dependent upon general market conditions and CL&P's and WMECO's respective credit and financial conditions at that time.

For information regarding Millstone restart costs, see the MD&A.

For information concerning the ability of WMECO to access its borrowing facilities, see the MD&A.

Litigation: CL&P and WMECO, through NNECO as agent, operate Millstone 3 at cost, and without profit, under a sharing agreement that obligates them to utilize good utility operating practice and requires the joint owners to share . the risk of employee negligence and other risks of operation and maintenance pro-rata in accordance with their ownership shares. This agreement also provides that CL&P and WMECO would be liable only for damages to the non-NU owners for a deliberate violation of the agreement pursuant to authorized corporate action.

On August 7, 1997, the non-NU owners of Millstone 3 filed demands for arbitration with CL&P and WMECO as well as lawsuits in Massachusetts Superior Court against NU and its current and former trustees. The non-NU owners raise a 32

( .

. Wsstorn Massachusetts Electric Company end Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS number of contract, tort and statutory claims arising out of the operation of Millstone 3. The arbitrations and lawsuits seek to recover compensatory damages, punitive damages, treble damages and attorneys' fees. Owners representing approximately two-thirds of the non-NU interests in

' Millstone 3 claimed compensatory damages in excess of $200 million. In addition, one of the lawsuits seeks to restrain NU from disposing of its shares of the stock of WMECO and HWP, pending the outcome of the lawsuit. Management cannot estimate the potential outcome of these suits but believes there is no legal basis.for the claims and intends to defend against them vigorously. To date, no reserves have been established for this litigation. At December 31, 1997, the costs related to this litigation for the NU system were estimated to be approximately $100 million for incremental O&M costs and approximately $100 million for replacement

, power costs. These' costs are likely to increase as long as i

Millstone 3 remains out of service.

C. Environmental Matters l The NU system is subject to regulation by federal, state and local authorities with respect to air and water quality, the handling _and disposal of toxic substances and hazardous and solid wastes,-and the handling and use of chemical products.

The NU system has an active environmental auditing and training _ program and believes that it is in substantial compliance with; current environmental laws and regulations.

However, the NU system is subject to certain enforcement actions and governmental investigations in the environmental area. Management cannot predict the outcome of these enforcement acts and investigations.

i Environmental requirements could hinder the construction of new generating units, transmission and distribution lines, substations, and other facilities. Changing environmental requirements could also require extensive and costly modifications to WMECO's existing generating units, and transmission and distribution systems, and could raise operating costs significantly. As a result, WMECO may' incur significant additional environmental costs, greater than amounts included in cost of removal and 'other reserves, in connection with the generation and transmission of electricity and the storage, transportation and disposal of by-products and wastes. WMECO may also encounter significantly increased costs to remedy the environmental effects _ of prior waste handling activities, The cumulative long-term cost impact of increasingly stringent environmental requirements cannot'be estimated accurately.

WMECO has recorded a liability based upon currently available information for what it believes are its estimated

. environmental remediation costs that it expects to incur for waste disposal sites. In most cases, additional future environmental cleanup costs are not reasonably estimable due 33

Wactcrn M Occchucotto Elcctric Company and Subcidicry NOTES TO CONSOLIDATED FINANCIAL STATEMENTS to a number of factors, including the unknown magnitude of possible contamination, the appropriate remediation methods, the possible effects of future legislation or regulation and the possible effects of technological changes. At December 31, 1997, the net liability recorded by WMECO for its estimated environmental remediation costs, excluding any possible insurance recoveries or recoveries from third parties, amounted to approximately $1.6 million, which management has determined to be the most probable amount within the range of $1.6 million to $2.6 million.

During 1997, WMECO adopted Statement of Position 96-1,

" Environmental Remediation Liabilities" (SOP). The principal objective of the SOP is to improve the manner in which existing authoritative accounting literature is applied by entities to specific situations of recognizing, measuring and disclosing environmental remediation liabilities. The adoption of the SOP resulted in an increase of approximately

$370 thousand to WMECO's environmental reserve in 1997.

WMECO cannot estimate the potential liability for future claims, including environmental remediatic.n costs, that may be brought against it. However, considering known facts, existing laws and regulatory practices, management does not believe the matters disclosed above will have a material effect on WMECO's financial position or future results of operations.

D. Nuclear Insurance Contingencies Under certain circumstances, in the event of a nuclear incident at one of the nuclear facilities in the country covered by the federal government's third-party liability indemnification program, an owner of a nuclear unit could be assessed in proportion to its ownership interest in each of its nuclear units up to $75.5 million. Payments of this ansessment would be limited to $10.0 million in any one year per nuclear incident based upon the owner's pro rata ownership interest in each of its nuclear units. In addition, the owner would be subject to an additional five percent or $3.8 million, in proportion to its ownership interests in each of its nuclear units, if the sum of all claims and costs from any one nuclear incident exceeds the maximum amount of financial protection. Based upon its ownership interests in Millstone 1, 2 and 3, WMECO's maximum liability, including any additional assessments, would be $39.8 million per incident, of which payments would be limited to $5 million per year. In addition, through power purchase contracts with MYAPC, VYNPC, and

. CYAPC, WMECO would be responsible for up to an additional l $11.9 million per incident, of which payments would be limited to $1.5 million per year.

Insurance has been purchased to cover the primary cost of i repair, replacement or decontamination of utility property )

34

_ _ - __ _ ________ ____ _ _ ___ _ - _ __ _ ___ _ _ - _-_______-___- - ____ a

WOctern Macccchuoctta Electric Comp:ny cud Subsidiary liGiES TO CONSOLIDA1mu FmWCm STArmaGGUS resulting from insured occurrences. WMECO is subject to retroactive assessments if losses exceed the accumulated funds available to the insurer. The maximum potential assessment against WMECO with respect to losses arising during the current policy year is approximately $2.7 million under the primary property insurance program.

Insurance has . been purchased to cover certain extra costs incurred in obtaining replacement power during prolonged accidental. outages and the excess cost of repair,

. replacement, or decontamination or premature decommissioning of utility property resulting from insured occurrences.

WMECO is subject to retroactive assessments if losses exceed 7 the accumulated funds available to the. insurer. The maximum potential assessments against WMECO with respect to losses arising during current policy _ years are approximately $2.2 million under the replacement power policies and $3.8 million under the excess property damage, decontamination and decommissioning policies. The cost of a nuclear incident could exceed available insurance proceeds.

Insurance has been purchased aggregating $200 million on an industry basis for coverage of worker claims. All participating reactor operators insured under this coverage are subject to retrospective assessments of $3 million per reactor. The . maximum potential assessment against WMEC3 with respect to losses arising during the current policy period is approximately $2.2 million. Effective January 1, 1998, a new worker policy was purchased which is not subject to retrospective assessments.

E. Construction Program The construction program is subject to periodic review and revision by management. WMECO' currently forecasts construction expenditures of approximately $185 million for '

the years 1998-2002, including $27 million for 1998. In addition, WMECO estimates that nuclear fuel requirements, including nuclear fuel financed through the NBFT, will be approximately $56.4 million for the years 1998-2002, including $8.4 million for 1998. See Note 9, " Leases" for  !

additional information about the financing of nuclear fuel.  !

F. Long-Term Contractual Arrangements l

Yankee Companies: The NU system companies rely on VY for

-approximately 1.7 percent of their capacity under long-term ,

contracts. Under the terms of their agreements, the NU '

system companies pay their ownership (or entitlement) shares of costs, which include depreciation, O&M expenses, taxes, ,

the estimated cost of decommissioning and a return on  !

invested capital. These costs are recorded as purchased power expense and are recovered through the companies' rates. WMECO's total cost of purchases under contracts with 35

Wactcrn Mnocachusotte Elcctric Company cnd Subsidiary ,

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS VYNPC amounted to $3.9 million in 1997, $4.1 million in 1996 and 1995.

The other Yankee generating facilities, MY, CY and Yankee l Rowe, were permanently shut down as of August 6, 1997, l December 4, 1996 and February 26, 1992, respectively. See Note 2E, " Summary of Significant Accounting Folicies--

Investments and Jointly Owned Electric Utility Plant," for further information on the Yankee companies, and Note 3,

" Nuclear Decommissioning," regarding the related decommissioning obligations.

Nonu tility Generators: WMECO has entered into various arrangements for the purchase of capacity and energy from nonutility generators (NUGs). These arrangements have terms from 15 to 25 years, currently expiring in the years 2008 through 2013, and requires WMECO to purchase energy at specified prices or formula rates. For the 12 months ending December 31, 1997, approximately 14 percent of NU system electricity requirements were met by NUGs. WMECO's total cost of purchases under these arrangements amounted to $31.2 million in 1997, $29.5 million in 1996, and $28.6 million in 1995. These costs may be deferred for eventual recovery through rates.

Hydro-Quebec: Along with other New England utilities, WMECO, CL&P, PSNH and HWP have entered into agreements to support transmission and terminal facilities to import electricity from the Hydro-Quebec system in Canada. WMECO is obligated to pay, over a 30-year period ending in 2020, its proportionate share of the annual O&M and capital costs of these facilities.

Estimated Annual Costs: The estimated annual costs of WMECO's significant long-term contractual arrangements are as follows:

1998 1999 2000 2001 2002 (Millions of Dollars)

VYNPC................. $ 4.9 $ 4.9 $ 4.8 $ 5.2 $ 5.4 NUGs.................. 35.1 36.8 39.5 41.6 43.8 Hydro-Quebec.......... 3.8 3.6 3.6 3.5 3.4 For additional information regarding the recovery of purchased power costs, see Note 2J, " Summary of Significant Accounting Policies - Recoverable Energy Costs."

36

, .Wzotern Macccchucotta Elcctric Compnny cnd Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each of the following financial instruments:

Cash and nuclear decommissioning trusts: The carrying amounts approximate fair value.

SFAS 115, " Accounting for Certain Investments in Debt and Equity Securi ties, " requires investments in debt and equity securities to be presented at fair value. As a result of this requirement, the investments held in WMECO's nuclear decommissioning trust were adjusted to market by approximately $17.9 million as of December 31, 1997, and $8.4 million as of December 31, 1996, with a corresponding offset to the accumulated provision for depreciation. The amounts adjusted in 1997 and 1996 represent cumulative gross unrealized holding gains. The cumulative gross unrealized holding losses were immaterial for both 1997 and 1996.

Preferred stock and long-term debt: The fair value of WHECO's fixed-rate securities is based upon the quoted market price for those issues or similar issues. Adjustable rate securities are assumed to have a fair value equal to their carrying value.

The carrying amount of WMECO's financial instruments and the estimated fair values are as follows:

Carrying Fair At December 31. 1997 Amount Value (Thousands of Dollars)

Preferred stock not subject to mandatory redemption................. $ 20,000 $ 16,252 Preferred stock subject to mandatory redemption.................. 21,000 20,580.

Long-term debt - First Mortgage Bonds.. 304,800 302,627 t .Other long-term debt................... 92,845 92,845 l l

i 1

l l

37 i

- _ _ . _..____.u ._m.___.m- . _ . _ _ _ _ _ _ _ _

WOctorn Macocchucotts Electric Company and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Carrying Fair At December 31. 1996 Amount Value (Thousands of Dollars)

Preferred stock not subject to mandatory redemption................. S 20,000 $ 15,200 Preferred stock subject to mandatory redemption.................. 21,000 18,404 Long-term debt - First Mortgage Bonds.. 259,500 260,440 Other long-term debt................... 90,855 90,855 The fair values shown above have been reported to meet the disclosure requirements and do not purport to represent the amounts at which those obligations would be settled.

38

, W ctorn M20ccchuactto Electric Company cud Sub0idicry EEPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Western Massachusetts Electric Company:

We have audited the accompanying consolidated balance sheets, as restated - see Note 1, of Western Massachusetts Electric Company (a Massachusetts corporation and a wholly owned subsidiary of Northeast Utilities) and subsidiary as of December 31, 1997 and 1996, and the related consolidated statements of income, common stockholder's equity and cash flows, as restated - see Note 1, for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform l the audit to obtain reasonable assurance about whether the financial I

statements are free of material misstatement. An audit includes I examining, on a test basis, evidence supporting the amounts and I

disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a l reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Western l Massachusetts Electric Company and subsidiary as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.

As explained in Note 1 to the consolidated financial statements, the l company has given retroactive effect to the change in accounting for nuclear compliance costs.

/s/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP Hartford, Connecticut j February 20, 1998 (except with respect to the matter discussed in l Note 1, as to which the date is June 10, 1998) i l

l 39

WO3 tern Massachusetts Electric Company MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 1 This section contains management's assessment of WMECO's (the company) financial condition and the principal factors having an impact on the results of operations. The company is a wholly-owned subsidiary of Northeast Utilities (NU). This discussion should be read in conjunction with the company's consolidated financial statements and footnotes.

FINANCIAL CONDITION Ov0rview The length of the ongoing outages at the three Millstone nuclear plants (Millstone) and the high costs of the recovery efforts weakened NMECO's 1997 net income, balance sheet and cash flows and will continue to have an adverse impact on the company's financial condition until the units are returned to service.

WMECO had a net loss of approximately $27 million in 1997, compared to net income of approximately $11 million in 1996. The poorer financial results in 1997 were due primarily to the fact that all three Millstone units were off line for the entire year in 1997 and spending associated with the recovery efforts was significantly higher in 1997 than it was in 1996. Millstone 3 operated for nearly three months in 1996 and Millstone 2 for nearly two months. As a result, the cost of replacing power ordinarily generated by the Millstone units rose by approximately $15 million in 1997. The total operation and maintenance (O&M) costs at Millstone were approximately $40 million higher in 1997.

The higher Millstone costs have caused WMECO to focus closely on maintaining adequate liquidity and reducing non nuclear O&M costs. In July 1997, WMECO successfully sold $60 million of first mortgage bonds. WMECO's access to $90 million of revolving credit lines was renegotiated in the first half of 1997. Also helping to maintain liquidity was the renegotiation in early 1998 of a $100 million credit

-line used by Niantic Bay Fuel Trust (NBFT) to purchase nuclear fuel for Millstone. Additionally, non nuclear O&M expenses in 1997 were reduced by about $5 million from 1996.

The SEC has advised WMECO to adjust for certain costs associated with the ongoing Millstone outages as they are incurred. For the past two years, WMECO. has been reserving for the unavoidable costs they expected to incur to meet NRC requirements. These annual statements have been adjusted in accordance with the SEC's directive. Management r does not expect implementation of this accounting change to affect the l

ability of The Connecticut Light and Power Company (CL&P) and WMECO 40 l

and to meet their financial covenants contained in their $313.75 million revolving credit arrangement.

In 1998, management expects Millstone-related expenses to fall significantly, assuming Millstone 3 and Millstone 2 are returned to service at dates close to current estimates, although the O&M expenses at Millstone 3 and 2 will be considerably higher than before the station was placed on the Nuclear Regulatory Commission's (NRC's) watch list. The actual level of 1998 nuclear spending at Millstone will depend on when the- units return to operation and the cost of restoring them to service. The company hopes to restart Millstone 3, the newest and largest unit at the site, in early spring of 1998 and Millstone 2 three to four months after Millstone 3. The company cannot restart the Millstone units until it receives formal approval from the NRC. As part of an effort to reduce spending in 1998, Millstone 1 has been placed in extended maintenance status. Management will review its options with respect to Millstone 1 in 1998, including restart, early retirement and other options.

Rate reductions to customers served by the company are likely to offset a portion of the benefit of lower Millstone-related costs. On l March 1, 1998, WMECO reduced retail rates by 10 percent in compliance with industry restructuring legislation passed in November 1997 by the Massachusetts Legislature.

The 1997 Massachusetts legislation allowed full retail choice on March 1, 1998. WMECO expects to recover fully its stranded costs through a combination of securitization and divestiture of its non-nuclear generating assets.

Millstone Outages 1

I WMECO has a 19-percent ownership interest in Millstone units 1 and 2 and a 12.24-percent ownership interest in Millstone unit 3. Millstone 1, 2 and 3 have been out of service since November 4, 1995, February 21, 1996, and March 30, 1996, respectively.

Subsequent to its January 31, 1996, announcement that Millstone had been placed on its watch list, the NRC has stated that the units cannot return to service until independent, third-party verification teams have reviewed the actions taken to improve the design, configuration and employee concern issues that prompted the NRC to place the units on its watch list. The actual date of the return to l service for each of the units is dependent upon the completion of I independent inspections, reviews by the NRC and a vote by the NRC Commissioners.

In January 1998, NU declared Millstone 3 physically ready for restart, which meant that almost all of the restart-required physical work had I

been completed in the plant. The NRC currently is conducting a series of inspections to determine, among other things, whether the plant has effective leadership and corrective action and employee concerns programs. The Independent Corrective Action Verification Program, an 41

NRC-ordered independent review of the plant's design and licensing bases, is expected to be completed in March 1998.

In 1997, WMECO's share of nonfuel O&M costs expensed for Millstone increased to approximately $104 million, compared to approximately $64 million in 1996.

Replacement power costs attributable to the Millstone outages totaled approximately $56 million in 1997 compared to $41 million expensed in 1996. These costs for 1998 are forecasted to average approximately $2 million per month for Millstone 3, $2 million per month for Millstone 2 and $1 million per month for Millstone 1 while the plants are out of service.

The company has been, and will continue to be, expensing all of the costs to restart the units including replacement power and nonfuel O&M expenses.

NU and its subsidiaries are involved in several class action lawsuits and other litigation in connection with their nuclear operations. See the " Notes to Consolidated Financial Statements," Note 12B, for further information on this litigation.

Millstone 1 Management will review its options with respect to Millstone 1 during 1998. The issues that management will consider in evaluating its options include the costs to restart the unit and the economic benefits of the unit's continued operation.

Ccpacity During 1996 and continuing into 1997, WMECO took measures to improve its capacity position, including obtaining additional generating capacity, improving the availability of the company's generating units and improving the company transmission capability. During 1997, WMECO spent approximately $10 million to ensure availability of adequate generating capacity, of which $6 million was expensed. In 1998, WMECO does not anticipate the need to take additional measures to ensure adequate generating capacity.

Liquidity and Capital Resources cash provided from operations decreased approximately $41 million in 1997, compared to 1996, primarily due to higher cash expenditures related to the Millstone outages, and the pay down in 1997 of the 1996 year end accounts payable balance. The 1996 year end accounts payable balance was relatively high due to costs related to a severe December storm and costs associated with the Millstone outages that had been incurred but not yet paid by the end of 1996. Net cash from financing activities increased approximately $44 million, primarily due to the issuance of long-term debt in 1997 and lower reacquisitions and retirements of long-term debt and preferred stock, partially offset by {

the repayment of short-term debt. i j

42 U

WMECO established facilities in 1996 under which they may sell, from time to time, up to $40 million, of its accounts receivable and accrued utility revenues. As of December 31, 1997, WMECO sold approximately $20 million of receivables to third-party purchasers.

NU's, WMECO's and CL&P's three-year revolving credit agreement was amended in May 1997 (the Credit Agreement). Under the credit Agreement, CL&P and WMECO are able to borrow up to approximately $225 million and $90 million, respectively, subject to a total borrowing limit of $313.75 million for all three borrowers. NU will be able to borrow up to $50 million when NU, CL&P and WMECO have each maintained a consolidated operating income to consolidated interest expense ratio of at least 2.50 to 1 for two consecutive fiscal quarters. Currently, the companies cannot meet this requirement. At December 31, 1997, WMECO had $15 million outstanding under the Credit Agreement.

Each major subsidiary of NU finances its own needs. Neither CL&P nor WMECO has any financing agreements containing cross defaults based on financial defaults by NU, Public Service Company of New Hampshire (PSNH) or North Atlantic Energy Corporation (NAEC). Nevertheless, it is possible that investors will take negative operating results or regulatory developments for one subsidiary of NU into account when evaluating the other NU subsidiaries. That could, as a practical matter and despite the contractual and legal separations among NU and its subsidiaries, negatively affect the company's access to financial markets.

In December 1997 and January 1998, Moody's Investors Service (Moody's) and Standard & Poor's (S&P), respectively, downgraded the senior secured debt of CL&P, WMECO and NU, as well as the preferred stock of CL&P and WMECO. This was the fourth time Moody's and S&P have downgraded CL&P and WMECO securities since the Millstone units went on the NRC watch list in 1996. All of the NU system's securities are rated below investment grade and remain under review for further downgrade. Although WMECO does not have any plans to issue debt in the near term, rating agency downgrades generally increase the future cost of borrowing funds because lenders will want to b: compensated for increased risk. Additionally, this could also affect the terms and ability of the company to extend existing agreements.

The downgrade by Moody's of WMECO's first mortgage bonds to Ba2 in December 1997 brought those ratings to a level at which the sponsor of WMECO's accounts receivable program can take various actions, in its j discretion, which would have the practical effect of limiting WMECO's q ability to utilize the facility. The WMECO accounts receivable program could be terminated if WMECO's first mortgage bond credit ratings experience one more level of downgrade.

WMECO's ability to borrow under the financing arrangements is dependent on the satisfaction of contractual borrowing conditions.

The financial covenants that must be satisfied to permit WMECO to borrow under the Credit Agreement are particularly restrictive and i become more restrictive throughout 1998. Spending levels in 1998, particularly for the first half of the year while the Millstone units 43 i

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w_______-______-_________ __ .__ _ -

are expected to be out of service, have been, and will be constrained to levels intended to assure that the financial covenants in WMECO's Credit Agreement are satisfied. However, there is no assurance that these financial covenants will be met as the system may encounter additional unexpected costs from such areas as storms, reduced revenues from regulatory actions or the effect of weather on sales levels.

If the return to service of Millstone 3 or Millstone 2 is delayed substantially beyond the present restart estimates, if some borrowing facilities become unavailable because of difficulties in meeting borrowing conditions or renegotiating extensions, if the system encounters additional significant costs, or any other significant deviations from management's current assumptions, the currently available borrowing facilities could be insufficient to meet all of WMECO's cash requirements. In those circumstances, management would take even more stringent actions to reduce costs and cash outflows and would attempt to take other actions to obtain additional sources of i funds. The availability of these funds would be dependent upon the general market conditions and WMECO's credit and financial condition at that time.

Restructuring On November 25, 1997, Massachusetts enacted a comprehensive electric utility industry restructuring bill. The bill provides that each Massachusetts electric company, including WMECO, will decrease its rates by 10 percent and allow all its customers to choose their retail electric supplier on March 1, 1998. The statute requires a further 5 percent rate reduction, adjusted for inflation, by September 1, 1999.

In addition, the legislation provides, among other things, for: (i) recovery of stranded costs through a " transition charge" to customers, subject to review by the Department of Telecommunications and Energy (DTE), formerly the Department of Public Utilities (DPU, collectively the DTE), (ii) a possible limitation on WMECO's return on equity should its transition cost charge go above a certain level, (iii) securitization of allowed strandable costs, and (iv) divestiture of nonnuclear generation. WMECO hopes it will be able to complete securitization in 1998.

The statute also provides that an electric company must transfer or separate ownership of generation, transmission and distribution facilities into independent affiliates or functionally separate such facilities within 30 business days after federal approval.

Additionally, marketing companies formed by an electric company are to be separate from the electric company and separate from generation, 1 transmission or distribution affiliates.

On December 31, 1997, WMECO filed its restructuring plan with the DTE consistent with the Massachusetts restructuring legislation. The plan sets out the process by which WMECO, as of March 1, 1998, initiated a 10 percent rate reduction for all customer rate classes and allowed customers to choose their energy supplier. WMECO intends to mitigate its strandable costs through several steps, including divesting 44 l

WMECO's nonnuclear generating plants at an auction to be held as soon as June 30, 1998, and securitization of approximately $500 million of stranded costs. NU intends to participate through a nonregulated affiliate in the competitive bid process for WMECO's generation resources. Any proceeds in excess of book value received from the divestiture of these units will be used to mitigate stranded costs. As l required by the legislation, WMECO will continue to operate and (

maintain the transmission and local distribution network and deliver i electricity to all customers. On February 20, 1998, the DTE issued an {

order approving, in all material respects, WMECO's restructuring plan 1 on an interim basis. A final decision is expected in 1998.

Because WMECO is obligated to reduce rates on March 1, 1998, before the means of financing for restructuring are completed, WMECO's cash flows and financial condition will be negatively affected. These impacts would become significant if there are material delays in, or significantly reduced proceeds from, the divestiture of nonnuclear generation and securitization. See the " Notes to Consolidated Financial Statements," Note 12A, for the potential accounting impacts of restructuring.

Rate Matters In April, 1996, the DTE approved a settlement (the Agreement) that included the continuation through February 1998 of a 2.4 percent rate reduction instituted in June 1994. Additionally, the Agreement terminated certain pending and potential reviews of WMECO's generating plant performance and accelerated its amortization of strandable generation assets by approximately $6 million in 1996 and $10 million in 1997.

On August 20, 1997, WMECO filed with the DTE a joint motion for approval of a settlement agreament with the Massachusetts Attorney General for a fuel adjustment clause (FAC) which would allow for a lower rate to WMECO customers for the billing months of September 1997 through February 1998. WMECO is not recovering replacement power costs during this period and has indicated that it would not seek recovery of any of replacement power costs associated with the Millstone outages. WMECO has been expensing and will continue to expense these costs. The Massachusetts restructuring legislation effectively eliminates the FAC, effective March 1, 1998.

Nuclear Decommissioning Connecticut Yankee WMECO has a 9.5 percent ownership interest in the Connecticut Yankee nuclear generating facility (CY or the plant). On December 4, 1996, the Board of Directors of Connecticut Yankee Atomic Power Company voted unanimously to cease permanently the production of power at the plant. The decision to retire CY from commercial operation was based on an economic analysis of the costs of operating it compared to the costs of closing it and incurring replacement power costs over the remaining period of the plant's operating license, which would have j 45 l

expired in 2007. The economic analysis showed that closing the plant ,

and incurring replacement power costs produced substantial savings.

CY has undertaken a number of regulatory filings intended to implement the decommissioning. In late December 1996, CY filed an amendment to its power contracts with the FERC to clarify the obligations of its purchasing utilities following the decision to cease power production.

At December 31, 1997, WMECO's share of these obligations was approximately $59 million, including the cost of decommissioning and the recovery of existing assets. Management expects that the company will continue to be allowed to recover such FERC approved costs from its customers. Accordingly, WMECO has recognized its share of the estimated costs as a regulatory asset, with a corresponding obligation, on its balance sheets.

Mnine Yankee (MY)

WMECO has a 3 percent ownership interest in the Maine Yankee (MY) l nuclear generating facility. On August 6, 1997, the Board of l Directors of Maine Yankee Atomic Power Company (MYAPC) voted  ;

unanimously to retire MY. On January 14, 1998, FERC released a draft j order on the MYAPC application to amend its power contracts with the owner / purchasers and revise its decommissioning and other charges.

FERC has accepted the proposed application for filing and made the amendments and the proposed charges under the contracts effective on January 15, 1998, subject to refund after hearings. At December 31, 1997, WMECO'S share of the estimated remaining obligation, including decommissioning, amounted to approximately $26 million. Under the terms of the contracts with MYAPC, the shareholders' sponsor companies, including WMECO, are responsible for their proportionate share of the costs of the unit, including decommissioning. Management expects that WMECO will be allowed to recover these costs from its customers. Accordingly, WMECO has recognized these costs as a regulatory asset, with a corresponding obligation on its balance sheet.

Millstone WMECO's estimated cost to decommission its share of the Millstone plants is approximately $242 million in year end 1997 dollars. These costs are being recognized over the lives of the respective units with a portion being currently recovered through rates. As of December 31, 1997, the market value of the contributions already made to the decommissioning trusts, including their investment returns, was I approximately $103 million. See the " Notes to Consolidated Financial I Statements," Note 3, for further information on nuclear decommissioning.

Environmental Matters WMECO is potentially liable for environmental cleanup costs at a number of sites inside and outside its service territory. To date, the future ' estimated environmental remediation liability has not been 46 1

l material with respect to the ehrnings or financial position of WMECO.

At December 31, 1997, WMECO had recorded an environmental reserve of approximately $1.4 million. See the " Notes to Consolidated Financial Statements," Note 12C, .for further information matters.

on environmental l Year 2000. Issue l

The Year 2000 issue exists because many computer systems and I applications currently use two-digit date fields to designate-a year.

As the change of the century occurs, date-sensitive systems may L recognize the year 2000 as 1900, or not recognize it at all. This I

' inability to recognize or properly treat the year 2000 may cause NU's systems to process - critical financial and operational information incorrectly. The NU system has assessed and continues to assess the

-impact ~ of the Year 2000 issue on.its operating and reporting systems.

The assessment of the nuclear operating systems is continuing and is expected to be completed in the summer of 1998.

The NU System will utilize both internal and external resources to reprogram or replace, and test the software for Year 2000 modifications. The total estimated remaining cost of the Year 2000 project for the NU system is $37 million and is being funded through operating cash flows. This estimate does not include any costs for the replacement or repair of equipment or devices that may be identified during the assessment process. The majority of these costs will be expensed as incurred over the next two years. To date, the NU system has incurred and expensed approximately $4 million related to the assessment of and preliminary efforts in connection with its Year 2000. project.

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I The costs of the project and the date on which the NU system plans to complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results could differ materially from those plans. If the NU system's remediation plan is not successful, there could be a significant disruption of the company's operations.

RESULTS OF OPERATIONS Income Statement Variances Millions of Dollars 1997 over/ (under) 1996 1996 over/(under) 1995 Amount Percent Amount Percent Operating revenues $ 5 1% $ 1 -%

Fuel, purchased and net interchange power 25 22 29 33 Other operation 17 12 (6) (4)

Maintenance 25 45 19 50 Amortization of regulatory assets, net (3) (30) 0)

. (53)

Federal and state income taxes (26) (a) (4) (31)

Other income, net (2) (a) - -

Interest on long-term debt 2 8 (3) (10)

Net income (39) (a) (28) (72)

(a) Percentage greater than 100 Operating Revenues Total operating revenues increased in 1997, primarily due to higher transmission and capacity revenues and higher retail revenues. Retail revenues were higher due to lower price discounts to customers, partially offset by lower retail sales. Retail kilowatt-hour sales were 1 percent lower in 1997 primarily as a result of mild winter weather.

Total operating revenues increased in 1996, primarily due to higher retail sales, partially offset by lower fuel and conservation recoveries. Retail kilowatt-hour sales increased 2.7 percent ($9 million) primarily due to modest economic growth in 1996. Fuel recoveries decreased $6 million, primarily due to the timing of the recovery of costs under the company's fuel clause. Conservation recoveries decreased approximately $6 million primarily due to lower demand side management Oosts.

48

l -

Fuel, Purchased and Net Interchange Power Fuel, purchased and net interchange power expense increased in 1997, primarily outages.

due to replacement power costs associated with the Millstone 1

l Fuel, purchased primarily and net interchange power expense increased in 1996, due to higher replacement power associated with the l Millstone outages, partially offset by the timing of the recognition j

of costs under the company's fuel clause and lower nuclear generation.

Other Opere'elon and Maintenance Other operation and maintenance expenses increased in 1997, primarily due to higher costs associated with the Millstone restart effort ($40 million), higher capacity charges from Maine Yankee ($2 million) and higher costs to ensure adequate capacity ($6 million), partially offset by lower capacity charges from Connecticut Yankee as a result of a property tax refund (S4 million) and lower administrative and general expenses ($5 million) primarily due to lower pensions and benefit costs.

Other operation and maintenance expenses increased in 1996, primarily due to higher costs associated with the Millstone restart effort

($21 million), partially offset by lower costs for demand side management programs and a 1995 work stoppage.

Amortization of Regulatory Assets, Net Amortization of regulatory assets, net decreased in 1997, primarily due to the completion of the amortization of the Millstone 3 unuseful investment in 1996.

Amortization of regulatory assets, net decreased in 1996, primarily due to the completion of the amortization of the Millstone 3 phase-in plans in 1995 and unuseful investment in June, 1996, partially offset by higher amortization as a result of the 1996 rate settlement.

Federal and State Income Taxes Federal and state income taxes decreased in 1997, primarily due to lower book taxable income.

Federal and state income taxes decreased in 1996, primarily due to lower book taxable income, partially offset by 1995 tax benefits from a favorable of limitations, tax ruling and the expiration of the 1991 federal statute l Other Income, Net Other income, net decreased in 1997, primarily due to costs associated with the accounts .eceivable facility.

49

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Interest on Long-Terna Debt  !

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. Interest'on long-term debt increased in 1997 due to the issuance of i additional long-term debt. Interest on long-term debt decreased in i 1996; primarily due to lower average interest rates as a result of l refinancing activities and lower average 1996 debt levels. l I

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W3 stern Massachusetts Electric Company and Subsidiary SELECTED FINANCIAL DATA

• 1997 1996 1995 1994 1993 (Restated) (Pestated)

(Thousands of Dollars)

l. l Op2rsting Revenues.. . ........... $426,447 $421,337 $ 420,434 $ 421,477

$ 415.055 Operating Income......... ........ 251 33,190 63,064 70,940 60,348 Nat (Loss) / Income . . . . . . . . . . . . . ... (27,460) 11,089 39,133 49,457 40,594*

Cash Dividends on i Common Stock.. .. .. .. . . 15,004 16,494 30,223 29,514 l 28,785 Total Assets. ...... ..... - . . . .. 1,179,128 1,191,915 1,142,346 1,183,618 1,204,642 Long-Term Debt '" , . .. ... ... 396,649 349,442 347,470 379,969 393,232 Preferred Stock Not Subject to Mandatory RadImption. .. . .. ... ... . 20,000 20,000 53,500 68,500 73,500 Preferred Stock Subject to HIndatory Radsmption'" .. . . ............ 21,000 21,000 24,000 24,675 27,000 Obligations under )

Cepital Leases * . ... . . . 32,887 32,234 36,011 36,797 36,902 Reclassifications of prior data have been made to conform with the current presentation.

Includes the cumulative effect of change in accounting for municipal property tax expense, which increased earnings for common shares by $3.9 million.

Includes portion due within one year.

STATEMENTS OF OUARTERIY FINANCI AL DATA (Unaudited) (Pestated)

Ouarter Ended '*'

1997 March 31 June 30 Sept. 30 Dec. 31 i Operating Revenues.... . . . .. $106,044 $104,130 $111,166 $105,097 l Operating Income /(Loss) , . . .. . . $ 675 $ (4,704) $ 1,87s $ 2,495

' Net Loss. . . ... .. .. .. . .. $ (5,033) $ (11,4 9 2 ) $ (%,301) $ (5,632) 1996 1

. Operating Revenues.. .. . . ..... . $114,797 $102,602 $ 99,P66 $104,072 l,

. Op3 rating Income ........ . .. .. .. . $ 18,004 $ 10,522 $ 1.441 $ 1,221 l NJt Income /(Loss).. .. ... .... .. . .. $ 12,421 $  %,161 $ (1,282) $ (5,211) i l

I 51 i

Western Massachusetts Electric Company and Subsidiary i

STATISTICS Gross Electric Average Utility Plant Annual December 31, Use Per Electric kWh Sales Residential Customers Employees (Thousands (Averace) (December 31) of Dollars) (Millions) Customer (kWh) 4,300 7,121 195,324 507 1997 $1,334,233 4,626 7,335 194,705 497 1996 1,303,361 4,846 7,105* 193,964 527 1995 1,285,269 4,978 7,433 193,187 617 1994 1,271,513 4,715 7,351 192,542 657 1993 1,242,927

• Effective January 1, 1996, the amounts shown reflect billed and unbilled sales. 1995 has been restated to reflect this change.

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' Western Massachusetts Electric Company First andRefunding Mortgage Bonds Trustee and interest Paying Agent State Street Bank and Trust Company Corporate Trust Department Two International Place,4th Floor Boston, Massachusetts 02110 PreferredStock Transfer Agent, Dividend Disbursing Agent and Registrar Northeast Utilities Service Company Shareholder Services P.O. Box 5006 Hartford, Connecticut 06102-5006 1998 Dividend Payment Dates 7.72% Series B January 1, April 1, July 1, and October 1 7.60% Series February 1, May 1 August 1, and November 1 l

I Address General Correspondence in Care of:

Northeast Utilities Service Company  !

investor Relations Department P.O. Box 270 Hartford, Connecticut 06141-0270 Telephone

(860) 665-50(X) l Data contained in this Anmsal Report are sutumitted 174 Brush Hill Avenue for the sole purpose ofpmnding information to present security holders alwur the Company. West Springfield, Mossochusetts 01090~0010