CONNECTICUT LIGHT & POWER CO - Quarter Report: 2005 September (Form 10-Q)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days:

  *SEC staff has granted Northeast Utilities a waiver from this requirement on November 1, 2005 with respect to its S-3 registration statement.

Indicate by check mark whether the registrants are accelerated filers (as defined in Rule 12b-2 of the Exchange Act):

Indicate by check mark whether the registrants are shell companies (as defined in Rule 12b-2 of the Exchange Act):

Indicate the number of share outstanding of each of the issuers’ classes of common stock, as of the latest practicable date:

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NORTHEAST UTILITIES AND SUBSIDIARIES
THE CONNECTICUT LIGHT AND POWER COMPANY AND SUBSIDIARIES
PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE AND SUBSIDIARIES
WESTERN MASSACHUSETTS ELECTRIC COMPANY AND SUBSIDIARY

TABLE OF CONTENTS

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NORTHEAST UTILITIES AND SUBSIDIARIES

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NORTHEAST UTILITIES AND SUBSIDIARIES

THE CONNECTICUT LIGHT AND POWER COMPANY AND SUBSIDIARIES

PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE AND SUBSIDIARIES

WESTERN MASSACHUSETTS ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (All Companies)

A.

Presentation

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with this complete report on Form 10-Q and the Annual Reports of Northeast Utilities (NU or the company), The Connecticut Light and Power Company (CL&P), Public Service Company of New Hampshire (PSNH), and Western Massachusetts Electric Company (WMECO), which were filed as part of the Northeast Utilities and subsidiaries combined 2004 Form 10-K as filed with the SEC (NU 2004 Form 10-K). The accompanying condensed consolidated financial statements contain, in the opinion of management, all adjustments (including normal, recurring adjustments) necessary to present fairly NU’s and the above companies’ financial position at September 30, 2005, and the results of operations for the three months and nine months ended September 30, 2005 and 2004 and cash flows for the nine months ended September 30, 2005 and 2004. The results of operations for the three and nine months ended September 30, 2005 and 2004 and statements of cash flows for the nine months ended September 30, 2005 and 2004, are not necessarily indicative of the results expected for a full year.  

The condensed consolidated financial statements of NU and of its subsidiaries, as applicable, include the accounts of all their respective subsidiaries.  Intercompany transactions have been eliminated in consolidation.

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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 condensed consolidated 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 period data included in the accompanying condensed consolidated financial statements have been made to conform with the current period presentation.  These reclassifications related to 1) the presentation of certain companies as discontinued operations, and 2) other operation expense and maintenance expense on the accompanying condensed consolidated statements of (loss)/income to conform with the December 31, 2004 presentation, which totaled $5.1 million and $13 million for the three and nine months ended September 30, 2004, respectively.  For further information regarding those companies classified as discontinued operations, see Note 4, “Assets Held for Sale and Discontinued Operations,” to the condensed consolidated financial statements.

In the company’s condensed consolidated statement of cash flows for the nine months ended September 30, 2004, the company changed the classification of the change in restricted cash – locational marginal pricing (LMP) costs balances to present that change as an investing activity.  The company previously presented that change as an operating activity which resulted in a $93.6 million decrease in net cash flows used in investing activities and a corresponding decrease in operating cash flows from the amounts previously reported.  

The NU, CL&P, PSNH and WMECO condensed consolidated statements of cash flows for the nine months ended September 30, 2004 have also been reclassified to exclude from cash flows from operations the change in accounts payable related to capital projects. These amounts totaled sources/(uses) of cash of $13.6 million, $19.2 million, $(2.2) million, and $(0.2) million for the nine months ended September 30, 2004 for NU, CL&P, PSNH, and WMECO, respectively.

B.

New Accounting Standards

Share-Based Payments:  On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), “Share-Based Payments,” (SFAS No. 123R), which amended SFAS No. 123, “Accounting for Stock-Based Compensation.”  Under the provisions of SFAS No. 123R, NU will recognize compensation expense for the unvested portion of previously granted awards outstanding on January 1, 2006, the effective date of SFAS No. 123R, and any new awards after that date.  NU is currently determining the amount of compensation expense to be recognized, but management believes that the adoption of SFAS No. 123R will not have a material impact on NU’s consolidated financial statements.  For information

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regarding current accounting for equity-based compensation, see Note 1F, “Summary of Significant Accounting Policies - Equity-Based Compensation,” to the condensed consolidated financial statements.

Asset Retirement Obligations: On January 1, 2003, NU implemented SFAS No. 143, “Accounting for Asset Retirement Obligations,” requiring legal obligations associated with the retirement of property, plant and equipment to be recognized as a liability at fair value when incurred and when a reasonable estimate of the fair value of the liability can be made. Upon adoption of SFAS No. 143, management identified certain conditional asset retirement obligations relating to transmission and distribution lines and poles, telecommunication towers, transmission cables, certain assets containing asbestos, and certain Federal Energy Regulatory Commission (FERC) or state regulatory agency re-licensing matters, and determined that no material asset retirement obligations had been incurred. In March 2005, the FASB issued Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143.” FIN 47 requires an entity to recognize a liability for the fair value of an asset retirement obligation even if it is conditional on a future event if the liability’s fair value can be reasonably estimated. FIN 47 is required to be implemented by December 31, 2005 by recording a liability for the fair value of conditional asset retirements with the impact of implementation recognized as a cumulative effect in the income statement. Management is currently evaluating NU’s conditional asset retirement obligations. Management has completed its initial identification of potential conditional retirement obligations (AROs) and has identified six potential categories of AROs. A fair value calculation, reflecting various probabilities and settlement scenarios, and a data consistency review across all operating companies, is currently being performed and will be completed in the fourth quarter of 2005. For those AROs recorded at the regulated companies, management believes the costs will be recovered from its customers; therefore, a regulatory asset would be recorded. Until this work is completed, management will not be able to determine whether implementation of FIN 47 will have a material effect on NU’s condensed consolidated financial statements.  

C.

Guarantees

NU provides credit assurances on behalf of subsidiaries in the form of guarantees and letters of credit (LOCs) in the normal course of business, primarily for the financial performance obligations of NU Enterprises, Inc. (NU Enterprises). NU would be required to perform under these guarantees in the event of non-performance by NU Enterprises, primarily Select Energy, Inc. (Select Energy). At September 30, 2005, the maximum level of exposure in accordance with FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” under guarantees by NU, primarily on behalf of NU Enterprises, totaled $894 million. A majority of these guarantees do not have established expiration dates, and some guarantees have unlimited exposure to commodity price movements. Additionally, NU had $70.9 million of LOCs issued, all of which were issued for the benefit of NU Enterprises at September 30, 2005. NU has no guarantees of the performance of third parties.  

At September 30, 2005, NU had outstanding guarantees on behalf of the Utility Group and Rocky River Realty (RRR) of $12.8 million and $10.9 million, respectively.  These amounts are included in the total outstanding NU guarantee exposure amount of $894 million.  The guarantee amount of $870.3 million for NU Enterprises includes $609.3 million for Select Energy and $261 million for the energy services businesses.  The $261 million in guarantees related to the energy services businesses is comprised of $95.8 million for Select Energy Services, Inc.’s (SESI) obligations under certain financing arrangements and $165.2 million for performance obligations of the energy services businesses.

Several underlying contracts that NU guarantees, as well as certain surety bonds, contain credit ratings triggers that would require NU to post collateral in the event that NU’s credit ratings are downgraded below investment grade.

NU currently has authorization from the Securities and Exchange Commission (SEC) to provide up to $750 million of guarantees for its non-utility subsidiaries through June 30, 2007.  The $12.8 million in outstanding guarantees to the Utility Group are subject to a separate $50 million SEC limitation apart from the current $750 million NU Enterprises guarantee limit.  The amount of guarantees outstanding for compliance with the SEC limit for NU Enterprises at September 30, 2005 is $511.3 million.  The amount of guarantees outstanding for compliance with the SEC limit for the Utility Group at September 30, 2005 is $0.3 million.  These amounts are calculated using different, more probabilistic and fair-value based criteria than the maximum level of exposure required to be disclosed under FIN 45.  FIN 45 includes all exposures even though they are not reasonably likely to result in exposure to NU.

On October 19, 2004, the SEC authorized NU to issue guarantees of up to an aggregate $100 million through June 30, 2007 of the debt or other obligations of two of its subsidiaries, NUSCO and RRR.  These companies provide certain specialized support and real estate services and occasionally enter into transactions that require financial backing from NU.  The amount of guarantees outstanding for compliance with the SEC limit under this category at September 30, 2005 is $0.2 million.

D.

Regulatory Accounting

The accounting policies of the Utility Group conform to accounting principles generally accepted in the United States of America applicable to rate-regulated enterprises and historically reflect the effects of the rate-making process in accordance with SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation.”

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Regulatory Assets:  The components of regulatory assets are as follows:  

Included in WMECO’s other regulatory assets/(overrecoveries) are $40.9 million and $50.7 million at September 30, 2005 and December 31, 2004, respectively, of amounts related to WMECO’s rate cap deferral.  The rate cap deferral allows WMECO to recover stranded costs, and these amounts represent the cumulative excess of transition cost revenues over transition cost expenses.

Additionally, the Utility Group had $13.5 million and $11.6 million of regulatory costs at September 30, 2005 and December 31, 2004, respectively, that are included in deferred debits and other assets - other on the accompanying condensed consolidated balance sheets.  These amounts represent regulatory costs that have not yet been approved by the applicable regulatory agency.  Management believes these assets are recoverable in future cost of service regulated rates.

As discussed in Note 7D, “Commitments and Contingencies - Deferred Contractual Obligations,” substantial portions of the unrecovered contractual obligations regulatory assets have not yet been approved for recovery.  At this time management believes that these regulatory assets are probable of recovery.

Regulatory Liabilities:  The Utility Group had $1.2 billion of regulatory liabilities at September 30, 2005 and $1.1 billion at December 31, 2004.  These amounts include revenues subject to refund which are classified as regulatory liabilities on the accompanying condensed consolidated balance sheets.  These amounts are comprised of the following:

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E.

Allowance for Funds Used During Construction

The allowance for funds used during construction (AFUDC) is a non-cash item that is included in the cost of Utility Group utility plant and represents the cost of borrowed and equity funds used to finance construction.  The portion of AFUDC attributable to borrowed funds is recorded as a reduction in other interest expense, and the cost of equity funds is recorded as other income on the condensed consolidated statements of (loss)/income, as follows:

The average AFUDC rate is based on a FERC-prescribed formula that develops an average rate using the cost of the company’s short-term financings as well as the company’s capitalization (preferred stock, long-term debt and common equity).  The average rate is applied to eligible construction work in progress amounts to calculate AFUDC.  For the three and nine months ended September 30, 2005, the average AFUDC rates increased by 2.3 percent and 1.5 percent, respectively.  The increase is primarily due to increases in short-term and long-term debt interest rates.

F.

Equity-Based Compensation

NU maintains an Employee Stock Purchase Plan and other long-term, equity-based incentive plans under the Northeast Utilities Incentive Plan.  NU accounts for these plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB No. 25) and related interpretations.  No equity-based employee compensation cost for stock options has been reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.  The following table illustrates the effect on net income and earnings per share (EPS) if NU had applied the fair value recognition provisions of SFAS No. 123 to equity-based employee compensation associated with restricted stock and restricted stock units:  

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NU accounts for restricted stock in accordance with APB No. 25 and amortizes the intrinsic value of the stock at the award date over the related service period.

NU assumes an income tax rate of 40 percent to estimate the tax effect on total equity-based employee compensation expense determined under the fair value-based method for all awards.

During the three and nine-month periods ended September 30, 2005, no stock options were awarded.

For information regarding new accounting standards issued but not yet effective associated with equity-based compensation, see Note 1B, “Summary of Significant Accounting Policies - New Accounting Standards,” to the condensed consolidated financial statements.

G.

Sale of Customer Receivables

At September 30, 2005 and December 31, 2004, CL&P had sold an undivided interest in its accounts receivable of $100 million and $90 million, respectively, to a financial institution with limited recourse through CL&P Receivables Corporation (CRC), a wholly owned subsidiary of CL&P.  CRC can sell up to $100 million of an undivided interest in its accounts receivable and unbilled revenues. At September 30, 2005 and December 31, 2004, the reserve requirements calculated in accordance with the Receivables Purchase and Sale Agreement were $27.5 million and $18.8 million, respectively.  These reserve amounts are deducted from the amount of receivables eligible for sale.  At their present levels, these reserve amounts do not limit CL&P’s ability to access the full amount of the facility.  Concentrations of credit risk to the purchaser under this agreement with respect to the receivables are limited due to CL&P’s diverse customer base.

At September 30, 2005 and December 31, 2004, amounts sold to CRC by CL&P but not sold to the financial institution totaling $220.9 million and $139.4 million, respectively, are included in investments in securitizable assets on the accompanying condensed consolidated balance sheets.  These amounts would be excluded from CL&P’s assets in the event of CL&P’s bankruptcy.  On July 6, 2005, CRC renewed its Receivables Purchase and Sale Agreement with CL&P and the financial institution through July 5, 2006. CL&P’s continuing involvement with the receivables that are sold to CRC and the financial institution is limited to servicing those receivables.  

The transfer of receivables to the financial institution under this arrangement qualifies for sale treatment under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities - A Replacement of SFAS No. 125.”

H.

Other Investments

Yankee Energy System, Inc. (Yankee) maintains a long-term note receivable from BMC Energy, LLC (BMC), an operator of renewable energy projects.  In the first quarter of 2004, based on revised information that negatively impacted undiscounted cash flow projections and fair value estimates, management determined that the fair value of the note receivable from BMC had declined and that the note was impaired.  As a result, management recorded a pre-tax investment write-down of $2.5 million ($1.5 million on an after-tax basis) in the first quarter of 2004.  In the second quarter of 2005, based upon additional revised information that negatively impacted the fair value of the BMC note receivable, management recorded an additional pre-tax investment write-down of $0.8 million ($0.5 million on an after-tax basis).  Yankee’s remaining note receivable from BMC, which is included in deferred debits and other assets – other on the accompanying condensed consolidated balance sheets, totaled $0.5 million at September 30, 2005.

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On June 30, 2004, Yankee sold virtually all of the assets and liabilities of R.M. Services, Inc. (RMS), a provider of consumer collection services, for $3 million.  In conjunction with the sale in the second quarter of 2004, an estimated gain totaling $0.6 million was included as a gain from sale of RMS.  As a result of adjustments to estimates recorded in conjunction with the sale during the third quarter of 2004, this gain was increased by $0.2 million and totaled $0.8 million at September 30, 2004.  

NU has an investment in a developer of fuel cell and power quality equipment.  Based on revised information that affected the fair value of NU’s investment, management determined that at June 30, 2004, the value of NU’s investment had declined and that decline was other than temporary.  A pre-tax investment write-down of $3.8 million ($2.4 million on an after-tax basis) was recorded to reduce the carrying value of the investment.  The balance of this investment at September 30, 2005, which is included in receivables on the accompanying condensed consolidated balance sheets, was $0.6 million.

NU owns 49 percent of the common stock of the Connecticut Yankee Atomic Power Company (CYAPC) with a carrying value of $22 million at September 30, 2005.  This amount is included in deferred debits and other assets – other on the accompanying condensed consolidated balance sheets.  CYAPC is also involved in litigation over the termination of its decommissioning contract with Bechtel Power Corporation (Bechtel).  CYAPC filed with the FERC to recover the increased estimate of decommissioning and plant closure costs.  The FERC proceeding is ongoing.  Management believes that this litigation and the FERC proceeding have not impaired the value of its investment in CYAPC at September 30, 2005 but will continue to evaluate the impacts that the litigation and the FERC proceeding have on NU’s investment.  For further information regarding the Bechtel litigation, see Note 7D, “Commitments and Contingencies - Deferred Contractual Obligations,” to the condensed consolidated financial statements.

I.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and short-term cash investments that are highly liquid in nature and have original maturities of three months or less.  At the end of each reporting period, bank overdraft amounts are reclassified from cash and cash equivalents to accounts payable.

J.

Special Deposits

Special deposits represents amounts Select Energy has on deposit with unaffiliated counterparties and brokerage firms in the amounts of $164.3 million and $46.3 million at September 30, 2005 and December 31, 2004, respectively.  Special deposits at December 31, 2004 also included $20 million in escrow for SESI that had not been spent on construction projects and $16.3 million in escrow for Yankee Gas, which represented payment for Yankee Gas’ first mortgage bonds that became due on June 1, 2005.  SESI special deposits totaling $8.7 million are included as assets held for sale on the accompanying condensed consolidated balance sheet at September 30, 2005.

K.

Counterparty Deposits

Balances collected from counterparties resulting from Select Energy’s credit management activities totaled $209.5 million at September 30, 2005 and $57.7 million at December 31, 2004.  These amounts are recorded as current liabilities and are included as counterparty deposits on the accompanying condensed consolidated balance sheets.  To the extent Select Energy requires collateral from counterparties, cash is received as a part of the total collateral required.  The right to receive such cash collateral in an unrestricted manner is determined by the terms of Select Energy’s agreements.  Key factors affecting the unrestricted status of a portion of this cash collateral include the financial standing of Select Energy and of NU as its credit supporter.

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L.

Other Income, Net

The pre-tax components of other income/(loss) items are as follows:

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Investment income for NU includes equity in earnings of regional nuclear generating and transmission companies of $0.6 million and $0.9 million of income for the three months ended September 30, 2005 and 2004, respectively, and $2.5 million and $1.8 million for the nine months ended September 30, 2005 and 2004, respectively.  Equity in earnings relates to NU’s investment in the Yankee Companies and the Hydro-Quebec system.

None of the amounts in either other income - other or other loss - other are individually significant.  

2.

WHOLESALE CONTRACT MARKET CHANGES (NU, NU Enterprises)

NU Enterprises recorded $101.2 million and $359.7 million of pre-tax wholesale contract market changes for the three months and nine months ended September 30, 2005, respectively, related to the changes in the fair value of wholesale contracts that the company is in the process of divesting.  These amounts are reported as wholesale contract market changes, net on the condensed consolidated statements of (loss)/income.  A quarterly summary of those pre-tax charges (benefits) is as follows (millions of dollars):  

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The $80.6 million in the third quarter of 2005 includes the mark-to-market of certain long-dated wholesale electricity contracts in New England and New York with municipal and other customers.  The charge reflects negative mark-to-market movements on these contracts between June 30, 2005 and September 30, 2005 as a result of rising energy prices, partially offset by positive effects of buying out certain obligations in the third quarter at prices less than the June 30, 2005 marks.  Also included in the $80.6 million charge is a pre-tax charge of $11.7 million related to a portfolio of contracts that Select Energy assigned to a third-party wholesale power marketer, obligating that marketer to assume responsibility for those contracts that Select Energy had in New England, beginning on January 1, 2006, in exchange for a $15 million payment Select Energy will make in December of 2005.  An additional $5.1 million charge from this assignment was recorded as a reduction to revenues.

The $20.6 million third quarter charge includes approximately $37 million relating to certain wholesale contracts in the PJM power pool where NU Enterprises increased its estimates of customer load above its original expectations and an additional $3.1 million charge from the assignment noted above.  Offsetting these charges is a net pre-tax benefit of $19.5 million associated with the marking-to-market of the supply contracts that previously were held to serve certain retail electric load and other mark-to-market impacts.

Included in the mark-to-market on long-term wholesale electricity contracts are $44 million and $114.2 million pre-tax mark-to-market charges for the three and nine months ended September 30, 2005, respectively, related to an intercompany contract between Select Energy and CL&P.  This contract was included in the portfolio of contracts Select Energy assigned to a third party wholesale power marketer, and Select Energy will only serve CL&P through December 31, 2005.  This contract is part of CL&P’s stranded costs, and benefits received by CL&P under this contract are provided to CL&P’s ratepayers.  A $2.8 million pre-tax mark-to-market charge for the three months ended March 31, 2005, was recorded as wholesale contract market changes by Select Energy for an intercompany contract between Select Energy and WMECO for default service from April to June of 2005.  There were no wholesale contract market changes in the second or third quarter of 2005 for this contract, as it expired on June 30, 2005.  WMECO’s benefits under this contract will be provided to ratepayers in the form of lower than market default service rates.  These charges were not eliminated in consolidation because on a consolidated basis NU retains the over-market obligation to the ratepayers of CL&P and WMECO.

For further information regarding these and other wholesale derivative assets and liabilities that are being divested, see Note 5, “Derivative Instruments,” to the condensed consolidated financial statements.

3.

RESTRUCTURING AND IMPAIRMENT CHARGES (NU, NU Enterprises)

NU Enterprises recorded $5.3 million and $53.1 million of pre-tax restructuring and impairment charges for the three and nine months ended September 30, 2005 related to the decision to exit the wholesale marketing business and to divest its energy services businesses. The amounts related to continuing operations are included as restructuring and impairment charges on the condensed consolidated statements of (loss)/income with the remainder included in discontinued operations.  A summary of those pre-tax charges is as follows (millions of dollars):  

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On March 9, 2005, NU announced that it had completed its comprehensive review of the NU Enterprises businesses.  In the first quarter of 2005, as a result of that comprehensive review, an exclusivity agreement intangible asset totaling $7.2 million related to the merchant energy business was determined to be impaired and was written off.  

NU Enterprises hired an outside firm to assist in valuing its energy services businesses and their divestiture.  Based in part on that firm’s work, the company concluded that $29.1 million of goodwill associated with those businesses and $9.2 million of intangible assets were impaired as of March 31, 2005.  An impairment charge of $38.3 million was recorded for the three months ended March 31, 2005.  In the second quarter of 2005, the energy services businesses and NU Enterprises parent recorded an additional impairment charge of $0.8 million due to the impairment of certain fixed assets.  

In the second quarter of 2005, pre-tax restructuring costs totaling $1 million and $0.5 million were recorded by merchant energy and energy services business, respectively, related to professional fees, employee-related and other costs. Similar amounts were recorded in the third quarter of 2005 totaling $4.2 million and $1.1 million for merchant energy and energy services businesses, respectively. Additional restructuring charges will be recognized as incurred and may include professional fees and employee-related and other costs.

4.

ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS (NU, NU Enterprises)

Assets Held for Sale:  On March 9, 2005, NU concluded that NU Enterprises’ energy services businesses are not central to NU’s long-term strategy and do not meet the company’s expectations of profitability, and as a result, the company concluded that it would explore ways to divest those businesses in a manner that maximizes their value.  During the third quarter of 2005, management determined that it expects to divest four of these businesses within the next year.  Accordingly, at September 30, 2005, certain assets and liabilities of the following four energy services businesses are being accounted for as held for sale, at the lower of carrying amount or fair value less cost to sell:  SESI, a performance contracting subsidiary that specializes in upgrading the energy efficiency of large governmental and institutional facilities, Select Energy Contracting, Inc. - New Hampshire (SECI-NH), a division of Select Ener gy Contracting, Inc. (SECI) that provides mechanical contracting services, Woods Network Services, Inc. (Woods Network), a subsidiary of NU Enterprises that is a network products and services company, and Woods Electrical Co., Inc. (Woods Electrical), a subsidiary of Northeast Generation Services Company (NGS) which provides third-party electrical services.   Prior to September 30, 2005, SESI, SECI-NH, Woods Network, and Woods Electrical are reported as part of the services and other segment of NU Enterprises.  

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The major classes of assets and liabilities that are held for sale at September 30, 2005 are as follows:

Discontinued Operations:  NU’s condensed consolidated statements of (loss)/income for the three and nine months ended September 30, 2005 and 2004 present the operations for SESI, SECI-NH, Woods Network, and Woods Electrical as discontinued operations as a result of meeting certain criteria requiring this presentation.  Under this presentation, revenues and expenses of these businesses are classified net of tax in (loss)/income from discontinued operations, on the condensed consolidated statements of (loss)/income and all prior periods have been reclassified.  Summarized financial information for the discontinued operations is as follows:  

Included in discontinued operations for the three months ended September 30, 2005 and 2004 are $1.4 million and $2.6 million, respectively, of intercompany revenue that are not eliminated in consolidation due to the separate presentation of discontinued operations.  For the nine months ended September 30, 2005 and 2004 these amounts were $9.8 million and $5.8 million, respectively. At September 30, 2005, NU does not expect that after the disposal it will have significant ongoing involvement or continuing cash flows with the entities presented in discontinued operations.

5.

DERIVATIVE INSTRUMENTS (NU, CL&P, Select Energy, Yankee Gas)

Contracts that are derivatives and do not meet the definition of a cash flow hedge and are not elected as normal purchases or normal sales are recorded at fair value with changes in fair value included in earnings.  For those contracts that meet the definition of a derivative and meet the cash flow hedge requirements, the changes in the fair value of the effective portion of those contracts are generally recognized in accumulated other comprehensive income until the underlying transactions occur.  The ineffective portion of contracts that meet the cash flow hedge requirements is recognized currently in earnings.  Derivative contracts designated as fair value hedges and the item they are hedging are both recorded at fair value with changes in fair value of both items recognized currently in earnings.  Derivative contracts that are elected and meet the requirements of a normal purchase or sale are recognized in revenues and expenses, as applicable, when the quantity of the contract is delivered.  

For the nine months ended September 30, 2005, a negative $0.9 million, net of tax, was reclassified as expense from other comprehensive income in connection with the consummation of the underlying hedged transactions and recognized in earnings, and a positive $2.4 million, net of tax, was reclassified as expense from other comprehensive income related to the mark-to-market changes for wholesale contracts that NU Enterprises is in the process of divesting.  Also during the nine months of 2005, new cash flow hedge transactions were entered into that hedge cash flows through 2010.  As a result of the consummation of the transactions, these new transactions and market value changes since January 1, 2005, accumulated other comprehensive income increased by $22.4 million, net of tax.  Accumulated other comprehensive income at September 30, 2005 was a positive $18.9 million, net of tax (increase to equity), relating to hedged transactions, and it is estimated that a positive $11.6 million included in this net of tax balance will be reclassified as an increase to earnings within the next twelve months.  Cash flows from hedge contracts are reported in the same category as cash flows from the underlying hedged transaction.  

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There was a positive pre-tax impact of $0.8 million recognized in earnings in the third quarter 2005 for the ineffective portion of cash flow hedges.  A negative pre-tax $8.4 million was recognized in earnings in the third quarter 2005 for the ineffective portion of fair value hedges; at the same time a positive $9.2 million was recorded in earnings for the change in fair value of the hedged natural gas inventory.  The changes in the fair value of both the fair value hedges and the natural gas inventory being hedged totaling a positive $0.8 million above are recorded in fuel, purchased, and net interchange power on the accompanying condensed consolidated statements of (loss)/income.  

The table below summarizes current and long-term derivative assets and liabilities at September 30, 2005.  At September 30, 2005, derivative assets and liabilities have been segregated between wholesale, retail, generation and hedging amounts.  Management is in the process of divesting the contracts included in the wholesale category as a result of the March 9, 2005 decision to exit this portion of the business.  

The table below summarizes current and long-term derivative assets and liabilities at December 31, 2004.  Prior to the decision to exit the wholesale marketing business, these current and long-term derivative assets and liabilities were classified as trading, non-trading and hedging derivative assets and liabilities.  For NU Enterprises, current and long-term derivative assets totaled $55.6 million and $31.7 million, respectively, while current and long-term derivative liabilities totaled $125.8 million and $15.9 million, respectively, at December 31, 2004.  

The business activities of NU Enterprises that result in the recognition of derivative assets include concentrations of credit risk to energy marketing and trading counterparties.  At September 30, 2005, Select Energy had $1.0 billion of derivative assets from retail, wholesale, generation, and hedging activities.  These assets are exposed to counterparty credit risk.  However, a significant portion of these assets is contracted with investment grade rated counterparties or collateralized with cash.  

The amounts above do not include option premiums paid, which are recorded as prepayments and amounted to $6.3 million and $29.3 million related to wholesale activities at September 30, 2005 and December 31, 2004, respectively.  These amounts also do not include option premiums received, which are recorded as other current liabilities and amounted to $6.6 million and $27.1 million related to wholesale activities at September 30, 2005 and December 31, 2004, respectively.  

NU Enterprises - Wholesale:  Certain electricity and natural gas derivative contracts are part of Select Energy’s wholesale marketing business that the company is in the process of exiting.  These contracts also include other wholesale and retail short-term and long-

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term electricity supply and sales contracts, which include contracts to sell electricity to utilities under full requirements contracts and contracts to sell electricity to municipalities with terms up to eight remaining years.  The fair value of electricity contracts was determined by prices from external sources for years through 2008 and by models based on natural gas prices and a heat-rate conversion factor to electricity for subsequent periods.  The fair value of the natural gas contracts was primarily determined by prices provided by external sources and actively quoted markets.  In addition, to gather market intelligence and utilize this information in risk management activities for the wholesale marketing activities, Select Energy conducted limited energy trading activities in electricity, natural gas, and oil.  Select Energy manages open trading positions with strict policies that limit its exposure t o market risk and require daily reporting to management of potential financial exposures.   

Derivatives used in wholesale activities are recorded at fair value and included in the condensed consolidated balance sheets as derivative assets or liabilities.  Changes in fair value are recognized in the condensed consolidated statements of (loss)/income in the period of change.  The net fair value position of the wholesale portfolio at September 30, 2005 was a liability of $239.9 million.    

NU Enterprises - Retail:  Select Energy manages its portfolio of retail marketing contracts to maximize value while operating within NU’s corporate risk tolerances.  Select Energy generally acquires retail customers in smaller increments than it acquired wholesale customers, which while requiring careful sourcing, allows energy purchases to be acquired in smaller increments with lower risk. However, fluctuations in prices, fuel costs, competitive conditions, regulations, weather, transmission costs, lack of market liquidity, plant outages and other factors can all impact the retail business adversely from time to time.

From time to time, the retail marketing business enters into contracts that do not immediately meet the criteria for the normal election and accrual accounting.  Therefore, changes in fair value are required to be marked-to-market in earnings.  Derivatives used in retail activities that do not follow accrual accounting under the normal election are recorded at fair value and included in the condensed consolidated balance sheets as derivative assets or liabilities.  Changes in fair value are recognized in fuel, purchased and net interchange power in the condensed consolidated statements of (loss)/income in the period of change.  The net fair value position of the retail portfolio at September 30, 2005 was an asset of $25.7 million.

Select Energy’s retail portfolio also includes New York Mercantile Exchange (NYMEX) futures, financial swaps, and physical power transactions, the fair value of which is based on closing exchange prices; over-the-counter forwards, and financial swaps, the fair value of which is based on the mid-point of bid and ask market prices; and bilateral contracts for the purchase or sale of electricity or natural gas, the fair value of which is determined using available information from external sources, financial transmission rights and transmission congestion contracts, the fair value of which is based on historical settlement prices as well as external sources.

NU Enterprises – Generation:  Select Energy manages its portfolio of derivative contracts relating to generation activities in order to maximize value while operating within NU’s corporate risk tolerances.  These derivative contracts include generation-asset-specific sales and forward sales of electricity at hub trading points.  The fair value of the generation contracts was determined by prices from external sources and actively quoted markets for the life of the contracts, which extend to the end of 2006.  Certain derivatives related to generation activities that do not follow accrual accounting under the normal election are recorded at fair value and included in the condensed consolidated balance sheets as derivative assets or liabilities.  Changes in fair value are recognized in revenues in the condensed consolidated statements of (loss)/income in the period of change.  The net fair value position of the generation derivative contract portfolio at September 30, 2005 was a liability of $7.3 million.  

NU Enterprises - Hedging:  Select Energy utilizes derivative financial and commodity instruments, including futures and forward contracts, to reduce market risk associated with fluctuations in the price of electricity and natural gas purchased to meet firm sales and purchase commitments to certain retail customers.  Select Energy also utilizes derivatives, including price swap agreements, call and put option contracts, and futures and forward contracts to manage the market risk associated with a portion of its anticipated supply and delivery requirements.  These derivatives have been designated as cash flow hedging instruments and are used to reduce the market risk associated with fluctuations in the price of electricity or natural gas.  A derivative that hedges exposure to the variable cash flows of a forecasted transaction (a cash flow hedge) is initially recorded at fair value with changes in fair value recorded in accumulated other comprehensive income.  Cash flow hedges impact net income when the forecasted transaction being hedged occurs, when hedge ineffectiveness is measured and recorded, when the forecasted transaction being hedged is no longer probable of occurring, or when there is accumulated other comprehensive loss and the hedge and the forecasted transaction being hedged are in a loss position on a combined basis.   

Select Energy maintains natural gas service agreements with certain retail customers to supply gas at fixed prices for terms extending through 2010.  Select Energy has hedged its gas supply risk under these agreements through NYMEX futures contracts.  Under these contracts, which also extend through 2010, the purchase price of a specified quantity of gas is effectively fixed over the term of the gas service agreements.  At September 30, 2005 the NYMEX futures contracts had notional values of $69.7 million and were recorded at fair value as derivative assets totaling $25.6 million and derivative liabilities of $4.4 million.   

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Select Energy also maintains various physical and financial instruments to hedge its electric and gas purchases and sales through 2006. These instruments include forwards, futures, financial transmission rights and swaps.  These hedging contracts, which are valued at the mid-point of bid and ask market prices, were recorded as derivative assets of $26.5 million and derivative liabilities of $25.1 million at September 30, 2005.   

Select Energy hedges certain amounts of natural gas inventory with gas futures and swaps, some of which are accounted for as fair value hedges.  Changes in the fair value of hedging instruments and natural gas inventory are recorded in earnings. The change in fair value of the futures, options and swaps were included in derivative liabilities and amounted to $8.4 million at September 30, 2005. The change in fair value of the hedged natural gas inventory was recorded as a increase to fuel, materials and supplies of $9.2 at September 30, 2005.   

Utility Group - Gas- Non-Trading: Yankee Gas’ non-trading derivatives consist of peaking supply arrangements to serve winter load obligations and firm sales contracts with options to curtail delivery.  These contracts are subject to fair value accounting because these contracts are derivatives that cannot be designated as normal purchase or sales, as defined, because of the optionality in the contract terms.  Non-trading derivatives at September 30, 2005 included assets of $0.7 million.  At December 31, 2004, non-trading derivatives included assets of $0.2 million and liabilities of $0.1 million.  

Utility Group - Electric - Non-Trading:  CL&P has two independent power producer (IPP) contracts to purchase power that contain pricing provisions that are not clearly and closely related to the price of power and therefore do not qualify for the normal purchases and sales exception.  The fair values of these IPP non-trading derivatives at September 30, 2005 include a derivative asset with a fair value of $403.7 million and a derivative liability with a fair value of $32.2 million.  An offsetting regulatory liability and an offsetting regulatory asset were recorded, as these contracts are part of the stranded costs, and management believes that these costs will continue to be recovered or refunded in rates.   At December 31, 2004, the fair values of these IPP non-trading derivatives included a derivative asset with a fair value of $191.3 million and a derivative liability with a fair value of $47.2 million.

NU Parent - Hedging:  In March of 2003, NU parent entered into a fixed to floating interest rate swap on its $263 million, 7.25 percent fixed rate note that matures on April 1, 2012.  As a fair value hedge, the changes in fair value of the swap and the hedged debt instrument are recorded on the condensed consolidated balance sheets but are offsetting in the condensed consolidated statements of (loss)/income.  At September 30, 2005, the cumulative change in the fair value of the hedged debt of $3 million is included as a decrease to long-term debt on the condensed consolidated balance sheets.  The hedge is recorded as a derivative liability of $3 million at September 30, 2005, and as a derivative asset of $0.1 million at December 31, 2004.  The resulting changes in interest payments made are recorded as adjustments to interest expense.

6.

GOODWILL AND OTHER INTANGIBLE ASSETS (Yankee Gas, NU Enterprises)

SFAS No. 142, “Goodwill and Other Intangible Assets,” requires that goodwill and intangible assets deemed to have indefinite useful lives be reviewed for impairment at least annually by applying a fair value-based test.  NU uses October 1st as the annual goodwill impairment testing date.  Goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value and if the implied fair value of goodwill based on the estimated fair value of the reporting unit is less than the carrying amount.

NU’s reporting units that maintain goodwill are generally consistent with the operating segments underlying the reportable segments identified in Note 12, “Segment Information,” to the condensed consolidated financial statements. Consistent with the way management reviews the operating results of its reporting units, NU’s reporting unit under the NU Enterprises reportable segment that maintains goodwill is the merchant energy reporting unit. The merchant energy reporting unit is comprised of the operations of Select Energy, Northeast Generation Company (NGC), the generation operations of Holyoke Water Power Company (HWP), and NGS. As a result, NU's reporting units that maintain goodwill are as follows: the Yankee Gas reporting unit, which is classified under the Utility Group - gas reportable segment, and the merchant energy reporting unit, which is classified under the NU Enterprises - merchant energy reportable segment. The goodwill recorded related to the acquisition of Yankee Gas is not being recovered from the customers of Yankee Gas. The goodwill balances of these reporting units are included in the table herein.

A summary of NU’s goodwill balances at September 30, 2005 and December 31, 2004, by reportable segment and reporting units is as follows:

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On March 9, 2005, NU announced that it had completed its comprehensive review of the NU Enterprises businesses.  During this review, certain goodwill balances and intangible assets were deemed to be impaired, and adjustments were recorded in the first quarter of 2005 to write these assets off.  The goodwill balance in the NU Enterprises energy services reporting unit was determined to be impaired in its entirety, and a $29.1 million write-off was recorded.  Energy services intangible assets not subject to amortization were also impaired, and an $8.5 million pre-tax write-off was recorded, while an additional $0.7 million pre-tax of other intangible assets were impaired.  At September 30, 2005, NU’s remaining intangible assets totaled $2.3 million.  This amount will be amortized $0.3 million for the remainder of 2005, $1 million in 2006, and $1 million in 2007.  Additionally, NU Enterprises had an exclusivity agreement intangible asset, which was included in the merchant energy business and was also written off.  The $7.9 million balance at December 31, 2004 was amortized by $0.7 million in the first quarter of 2005 and the remaining $7.2 million was written off at March 31, 2005.  

There were no impairments or adjustments to the goodwill balances during the third quarter of 2005 or the first nine months of 2004.  

NU recorded amortization expense of $0.3 million and $0.9 million for the three months ended September 30, 2005 and 2004, respectively, and amortization expense of $1.4 million and $2.7 million for the nine months ended September 30, 2005 and 2004, respectively, related to intangible assets subject to amortization which are included in deferred debits and other assets – other on the condensed consolidated balance sheets.

7.

COMMITMENTS AND CONTINGENCIES

A.

Regulatory Issues and Rate Matters (CL&P, PSNH, WMECO, Yankee Gas)

Connecticut:

CTA and SBC Reconciliation:  The Competitive Transition Assessment (CTA) allows CL&P to recover stranded costs, such as securitization costs associated with the rate reduction bonds, amortization of regulatory assets, and IPP over market costs, while the System Benefits Charge (SBC) allows CL&P to recover certain regulatory and energy public policy costs, such as public education outreach costs, hardship protection costs, transition period property taxes, and displaced worker protection costs.

On April 1, 2005, CL&P filed its 2004 CTA and SBC reconciliation with the Connecticut Department of Public Utility Control (DPUC), which compared CTA and SBC revenues to revenue requirements.  For the year ended December 31, 2004, total CTA revenues exceeded the CTA revenue requirements by $14.1 million.  This amount was recorded as a regulatory liability on the accompanying condensed consolidated balance sheets.  For the same period, SBC revenues exceeded the SBC revenue requirement by $3.6 million which was recorded as a regulatory liability.  Management expects a decision in this docket from the DPUC by the end of 2005.   

In the 2001 CTA and SBC reconciliation filing, and subsequently in a September 10, 2002 petition to reopen related proceedings, CL&P requested that a deferred intercompany tax liability associated with the intercompany sale of generation assets be excluded from the calculation of CTA revenue requirements. This liability is currently included as a reduction in the calculation of CTA revenue requirements. On September 10, 2003, the DPUC issued a final decision denying CL&P’s request, and on October 24, 2003, CL&P appealed the DPUC’s final decision to the Connecticut Superior Court. The appeal has been fully briefed and argued. If CL&P’s request is granted and upheld through these court proceedings, there would be additional amounts due to CL&P from its customers. The amount due is contingent upon the findings of the court; however, management believes that CL&P’s pre-tax earnings would increase by a minimum of $17 million in 2005 if CL&P’s position is adopted by the court.

Unbilled Revenue Adjustment:  On September 9, 2005, the DPUC issued a draft decision regarding Yankee Gas Purchased Gas Adjustment (PGA) clause charges for the time period of September 1, 2003 through August 31, 2004.  The draft decision disallowed approximately $9 million in previously recovered PGA revenues associated with two separate Yankee Gas unbilled sales and revenue adjustments.  At the request of Yankee Gas, the DPUC reopened the PGA hearing on September 20, 2005 and requested that Yankee Gas file supplemental information regarding the two adjustments.  Yankee Gas filed the supplemental information on October 3, 2005 and is waiting for the DPUC to establish the remaining schedule.  If upheld, this disallowance would result in a $9 million pre-tax write-off.  Management believes the unbilled sales and revenue adjustments and resultant charges to customers through the PGA clause were appropriate.  Based on the facts of the case and the supplemental information provided to the DPUC, management believes the appropriateness of the PGA charges to customers for the time period under review will be allowed.

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New Hampshire:

SCRC Reconciliation Filing:  The Stranded Cost Recovery Charge (SCRC) allows PSNH to recover its stranded costs.  On an annual basis, PSNH files with the New Hampshire Public Utilities Commission (NHPUC) a SCRC reconciliation filing for the preceding calendar year.  This filing includes the reconciliation of stranded cost revenues and costs and transition energy service/default energy service (TS/DS) revenues and costs.  The NHPUC reviews the filing, including a prudence review of the operation of PSNH’s generation assets.  The cumulative deferral of SCRC revenues in excess of costs was $271.1 million at September 30, 2005.  This cumulative deferral will decrease the amount of non-securitized stranded costs that will have to be recovered from PSNH’s customers in the future from $374.1 million to $103 million.

The 2004 SCRC reconciliation filing was filed with the NHPUC on May 2, 2005.  The SCRC and TS/DS rate mechanisms currently reconcile accrued expenses with billed revenues on a monthly basis.  PSNH included a request, and supporting testimony, to include unbilled revenues as part of the reconciliation process in its annual 2004 SCRC and TS/DS reconciliation filing.  This request allows for the reconciliation of revenues on an accrual basis, including unbilled revenues, with the current accrued expenses recovered through the SCRC and TS/DS rate mechanisms, consistent with accrual accounting.  At September 30, 2005, PSNH’s unbilled revenue balance related to SCRC and TS/DS was $11.7 million and $16.7 million, respectively.  On October 19, 2005, PSNH, the NHPUC staff and the Office of Consumer Advocate reached a settlement agreement in this case, which requires no disallowances and provides for recovery of unbilled revenues. The NHPUC held a hearing on the merits of the settlement agreement on October 26, 2005, and a decision is expected later this year.  

Litigation with IPPs:  Two wood-fired IPPs that sell their output to PSNH under long-term rate orders issued by the NHPUC brought suit against PSNH in state superior court.  The IPPs and PSNH dispute the end-dates of the above-market long-term rates set forth in the respective rate orders.  Subsequent to the IPP’s court filing, PSNH petitioned the NHPUC to decide this matter, and requested that the court stay its proceeding pending the NHPUC’s decision.  By court order dated October 20, 2005, the court granted PSNH’s motion to stay indicating that the NHPUC had primary jurisdiction over this matter.  The NHPUC will determine how long each of the rate orders in question remain in effect.  PSNH recovers the over market costs of IPP contracts through the SCRC.  

Environmental Legislation:  The New Hampshire legislature will be considering legislation in its 2006 legislative session that would place strict limitations on the level of mercury that PSNH’s existing generation plants can emit.  Management has been reviewing the proposed legislation and assessing how PSNH might meet any required reduction in mercury emissions should such strict limitations be established.  PSNH conducted testing of one control technology at its Merrimack Station during the summer of 2005.  While state law and PSNH’s restructuring agreement provide for the recovery of its generation costs, including the cost to comply with state environmental regulations, at this time management is unable to determine the impact of any potential new legislation on PSNH’s net income or financial position.

Massachusetts:

Transition Cost Reconciliation and Other Filings:  On March 31, 2005, WMECO filed its 2004 transition cost reconciliation with the Massachusetts Department of Telecommunications and Energy (DTE).  The DTE has combined the 2003 transition cost reconciliation filing, standard offer service and default service reconciliation, the transmission cost adjustment filing, and the 2004 transition cost reconciliation filing into a single proceeding.  The timing of a decision in the combined proceeding is uncertain, but management does not expect the outcome to have a material adverse impact on WMECO’s net income or financial position.

B.

NRG Energy, Inc. Exposures (CL&P, Yankee Gas)

Certain subsidiaries of NU, including CL&P and Yankee Gas, entered into transactions with NRG Energy, Inc. (NRG) and certain of its subsidiaries. On May 14, 2003, NRG and certain of its subsidiaries filed voluntary bankruptcy petitions. On December 5, 2003, NRG emerged from bankruptcy. NU’s NRG-related exposures as a result of these transactions relate to 1) the recovery of congestion charges incurred by NRG prior to the implementation of standard market design on March 1, 2003, 2) the recovery of CL&P’s station service billings from NRG, and 3) the recovery of Yankee Gas’ and CL&P’s expenditures that were incurred related to an NRG subsidiary’s generating plant construction project that has ceased. While it is unable to determine the ultimate outcome of these issues, management does not expect that their resolution will have a material adverse effect on NU’s consolidated financial condition or results of operations.

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C.

Long-Term Contractual Arrangements (CL&P, Merchant Energy)

CL&P:  These amounts represent commitments for various services and materials primarily associated with the Bethel, Connecticut to Norwalk, Connecticut and the Middletown, Connecticut to Norwalk, Connecticut transmission projects as of September 30, 2005.  

Merchant Energy:   Select Energy maintains off-balance sheet long-term agreements to purchase energy as part of its portfolio of resources to meet its actual or expected sales commitments.  These sale commitments are accounted for on the accrual basis.  The aggregate amount of these purchase contracts was $968.2 million at September 30, 2005, as follows (millions of dollars):

Select Energy’s purchase contract amounts can exceed the amount expected to be reported in fuel, purchased and net interchange power.

Select Energy maintains certain wholesale energy commitments whose mark-to-market values have been recorded on the condensed consolidated balance sheet as derivative assets and liabilities.  The aggregate amount of these purchase contracts was $3.2 billion at September 30, 2005, the majority of which settle in 2005 and 2006.

D.

Deferred Contractual Obligations (NU, CL&P, PSNH, WMECO)

FERC Proceedings: In 2003, CYAPC increased the estimated decommissioning and plant closure costs for the period 2000 through 2023 by approximately $395 million over the April 2000 estimate of $436 million approved by the FERC in a 2000 rate case settlement. The revised estimate reflects the increases in the projected costs of spent fuel storage, increased security and liability and property insurance costs, and the fact that CYAPC is now self performing all work to complete the decommissioning of the plant due to the termination of the decommissioning contract with Bechtel in July 2003. NU’s share of CYAPC’s increase in decommissioning and plant closure costs is approximately $194 million. On July 1, 2004, CYAPC filed with the FERC for recovery of these increased costs. In the filing, CYAPC sought to increase its annual decommissioning collections from $16.7 million to $93 million for a six-year period beginning on January 1, 2005. On August 30, 2004, the FERC issued an order accepting the rates, with collection beginning on February 1, 2005, subject to refund.

Both the DPUC and Bechtel filed testimony in the FERC proceeding claiming that CYAPC was imprudent in its management of the decommissioning project. The DPUC has claimed that CYAPC did not terminate the contract with Bechtel soon enough, and Bechtel has claimed that CYAPC terminated the contract too soon. In its testimony, the DPUC recommended a disallowance of $225 million to $234 million out of CYAPC’s requested rate increase of approximately $395 million. NU’s share of the DPUC’s recommended disallowance is between $110 million to $115 million. The FERC staff also filed testimony that recommended a $36 million decrease in the requested rate increase claiming that CYAPC should have used a different gross domestic product (GDP) escalator. NU’s share of this recommended decrease is $17.6 million. Management expects that if the FERC staff’s position on the decommissioning GDP cost escalator is found by the FERC to be more appropriate than that used by CYAPC to develop its proposed rates, then CYAPC would review whether to reduce its estimated decommissioning obligation and reduce the customers’ obligation, including CL&P, PSNH and WMECO. Hearings in this proceeding began on June 1, 2005 and have concluded, and post-hearing briefs have been filed. While FERC staff did not take a position on prudence in the hearing, they have claimed in their brief that increases in decommissioning cost estimates were due to imprudent actions and were not the fault of ratepayers. A FERC administrative law judge decision in this proceeding is expected to be rendered in December 2005.

The company cannot at this time predict the timing or outcome of the FERC proceeding required for the collection of the increased CYAPC decommissioning costs.  The company believes that the costs have been prudently incurred and will ultimately be recovered from the customers of CL&P, PSNH and WMECO.  However, there is a risk that some portion of these increased costs may not be recovered, or will have to be refunded if recovered, as a result of the FERC proceedings.  

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On June 10, 2004, the DPUC and the Connecticut Office of Consumer Counsel (OCC) filed a petition seeking a declaratory order that CYAPC be allowed to recover all decommissioning costs from its wholesale purchasers, including CL&P, PSNH and WMECO, but that such purchasers may not be allowed to recover in their retail rates any costs that the FERC might determine to have been imprudently incurred.  On August 30, 2004, the FERC denied this petition.  On September 29, 2004, the DPUC and OCC asked the FERC to reconsider the petition and on October 20, 2005, the FERC denied the reconsideration, holding that the sponsor companies are only obligated to pay CYAPC for prudently incurred decommissioning costs and the FERC has no jurisdiction over the sponsors’ rates to their retail customers.  

Bechtel Litigation:  CYAPC is currently in litigation with Bechtel in Connecticut Superior Court (the Court) over the termination of its decommissioning contract.  On June 13, 2003, CYAPC gave notice of the termination of its contract with Bechtel for the decommissioning of its nuclear power plant.  CYAPC terminated the contract due to Bechtel’s incomplete and untimely performance and refusal to perform the remaining decommissioning work.  Bechtel has departed the site and the decommissioning responsibility has been transitioned to CYAPC, which has recommenced the decommissioning process.

On June 23, 2003, Bechtel filed a complaint against CYAPC asserting a number of claims and seeking a variety of remedies, including monetary and punitive damages and rescission of the contract.  Bechtel has since amended its complaint to add claims for wrongful termination.  On August 22, 2003, CYAPC filed its answer and counterclaims, including counts for breach of contract, negligent misrepresentation and breach of duty of good faith and fair dealing.  The parties are proceeding with depositions in the case.  Bechtel filed an offer of judgment for CYAPC to pay Bechtel the amount of $20 million, which was rejected by CYAPC.  CYAPC filed an offer of judgment for Bechtel to pay the amount of $65 million to CYAPC, which was rejected by Bechtel.  If either party prevails in litigation with an award equal to or higher than its offer, then the Court will add 12 percent annual interest to the award to the prevailing party, computed from the date of the party’s claim (from June 23, 2003 for Bechtel or August 22, 2003 for CYAPC).  A trial has been scheduled for spring of 2006.  

In the prejudgment remedy proceeding before the Court, Bechtel sought garnishment of the CYAPC decommissioning trust and related payments.  In October 2004, Bechtel and CYAPC entered into an agreement under which Bechtel waived its right to seek garnishment of the decommissioning trust and related payments in return for the potential attachment of CYAPC’s real property in Connecticut and the escrowing of $41.7 million the sponsors are scheduled to pay to CYAPC through June 30, 2007 in respect to CYAPC’s common equity.  This stipulation is subject to approval of the Court and would not be implemented until the Court found that such assets were subject to attachment.  CYAPC has contested the attachability of such assets.  The DPUC is an intervenor in this proceeding.  NU cannot predict the timing and the outcome of the litigation with Bechtel.

Spent Nuclear Fuel Litigation:  CYAPC, Yankee Atomic Electric Company (YAEC) and Maine Yankee Atomic Power Company (MYAPC) (collectively, the Yankee Companies) also commenced litigation in 1998 charging that the federal government breached contracts it entered into with each company in 1983 under the Nuclear Waste Policy Act of 1982 (the Act).  Under the Act, the DOE was to begin removing spent nuclear fuel from the nuclear plants of the Yankee Companies no later than January 31, 1998 in return for payments by each company into the nuclear waste fund.  No fuel has been collected by the DOE, and spent nuclear fuel is stored on the sites of the Yankee Companies’ plants.  The Yankee Companies collected the funds for payments into the nuclear waste fund from wholesale utility customers under FERC-approved contract rates.  The wholesale utility customers in turn collect these payments from their retail electric customers.  The Yankee Companies’ individual damage claims attributed to the government’s breach totaling $548 million are specific to each plant and include incremental storage, security, construction and other costs through 2010.  The CYAPC damage claim is $197 million, the YAEC damage claim is $191 million and the MYAPC damage claim is $160 million.

The DOE trial ended on August 31, 2004 and a verdict has not been reached.  The current Yankee Companies’ rates do not include an amount for recovery of damages in this matter.  Management cannot predict either the outcome of this matter or its ultimate impact on NU.

Yankee Atomic Electric Company: During the course of carrying out decommissioning work at the unit’s site, YAEC has identified increases in the scope of soil remediation and certain other remediation required to meet environmental standards, beyond the levels assumed in its 2003 decommissioning estimate.  YAEC is continuing to evaluate the impact of the additional requirements on its decommissioning plan.  While that evaluation is not complete, YAEC has determined that the schedule for the completion of physical work will need to extend until mid-2006 and the costs of completing decommissioning will be approximately $63 million greater than the estimate that formed the basis of its 2003 FERC settlement.  Most of the cost increase relates to decommissioning expenditures that will be made during 2006.  In order to fund these additional costs, YAEC is preparing an application to the FERC for increased decommissioning charges to go into effect in early 2006, subject to FERC acceptance and approval.  The timing and amount of the FERC application and the increase in decommissioning charges are under development, but YAEC expects that it will seek rate recovery of a significant component of the increased expenditures during 2006.  NU has a 38.5 percent ownership interest in YAEC, and NU’s share of this increase would total approximately $24 million.  The company cannot at this time predict the timing or outcome of a FERC proceeding required for the collection of the increased YAEC decommissioning costs.  The company believes that

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the costs have been prudently incurred and will ultimately be recovered from the customers of CL&P, PSNH and WMECO. However, there is a risk that some portion of these increased costs may not be recovered, or will have to be refunded if recovered, as a result of the FERC proceedings.  

E.

Consolidated Edison, Inc. Merger Litigation

Certain gain and loss contingencies continue to exist with regard to the October 13, 1999 Agreement and Plan of Merger between NU and Consolidated Edison, Inc. (CEI) and the related litigation.  On October 12, 2005, a panel of three judges at the United States Court of Appeals for the Second Circuit determined that NU shareholders do not have the right to assert a claim against CEI for damages related to breach of the agreement.  The ruling left intact the remaining claims between NU and CEI for breach of contract, which include NU’s claim for recovery of costs and expenses of approximately $32 million and CEI’s claim for damages of “at least $314 million.”  NU filed for a rehearing and requested review by the full Court of Appeals on October 26, 2005.  At this stage, NU cannot predict the outcome of this matter or its ultimate effect on NU.  

8.

MARKETABLE SECURITIES

The following is a summary of NU’s available-for-sale securities related to NU’s investment in Globix Corporation (Globix), NU’s SERP assets and WMECO’s prior spent nuclear fuel trust assets, which are included in current and long-term marketable securities on the accompanying condensed consolidated balance sheets:  

(a)

At December 31, 2004, NU’s investment in NEON Communications, Inc. (NEON) was not a marketable equity security.  On March 8, 2005, NEON merged with Globix, and NU’s investment in Globix became a marketable equity security at that time.    

At September 30, 2005 and December 31, 2004, NU has evaluated the securities in an unrealized loss position and has determined that none of the related unrealized losses are deemed to be other-than-temporary in nature.

For information related to the change in net unrealized holding gains and losses included in shareholders’ equity, see Note 9, “Comprehensive Income,” to the condensed consolidated financial statements.

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For the three months and nine months ended September 30, 2005 and 2004, realized gains and losses recognized on the sale of available-for-sale securities are as follows (in millions):

For the three months ended September 30, 2005 and 2004, realized gains of $0.1 million are included in other income, net on the accompanying condensed consolidated statements of (loss)/income.  For the three months ended September 30, 2005, a realized loss of $0.2 million relating to the WMECO spent nuclear fuel trust is included in fuel, purchased and net interchange power on the accompanying condensed consolidated statements of (loss)/income.

For the nine months ended September 30, 2005 and 2004, realized gains of $0.5 million and $0.6 million, respectively, are included in other income, net on the accompanying condensed consolidated statements of (loss)/income.  For the nine months ended September 30, 2005, a realized loss of $0.2 million relating to the WMECO spent nuclear fuel trust is included in fuel, purchased and net interchange power on the accompanying condensed consolidated statements of (loss)/income.  

NU utilizes the specific identification basis method for the Globix and SERP securities and the average cost basis method for the WMECO prior spent nuclear fuel trust to compute the realized gains and losses on the sale of available-for-sale securities.

Proceeds from the sale of these securities, including proceeds from short-term investments, totaled $41.9 million and $18.4 million for the three months ended September 30, 2005 and 2004, respectively, and $96.5 million and $31.7 million for the nine months ended September 30, 2005 and 2004, respectively.

At September 30, 2005, the contractual maturities of the available-for-sale securities are as follows (in millions):

NU’s investment in Globix is included in the one to five years maturity category in the table above.  

9.

COMPREHENSIVE INCOME (NU, CL&P, PSNH, WMECO, NU Enterprises, Yankee Gas)

Total comprehensive income, which includes all comprehensive (loss)/income items by category, for the three months and nine months ended September 30, 2005 and 2004 is as follows (millions of dollars):

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