Item 1. Business
(a) General Development of Business
NSTAR (or the Company) is a holding company engaged through its subsidiaries in the energy delivery business serving approximately 1.4 million customers in Massachusetts, including approximately 1.1 million electric distribution customers in 81 communities and approximately 300,000 natural gas distribution customers in 51 communities. Utility operations accounted for approximately 96% of consolidated operating revenues in 2008, 2007, and 2006. The remaining revenue is generated from its unregulated operations.
NSTAR’s utility operations derive their operating revenues primarily from the sale of energy, distribution, and transmission services to customers. NSTAR’s earnings are impacted by fluctuations in unit sales of electric kWh and natural gas MMbtu, which directly determine the level of distribution and transmission revenues recognized. In accordance with the regulatory rate structure in which NSTAR operates, its recovery of energy and certain energy-related costs are fully reconciled with the level of energy revenues currently recorded and, therefore, do not have an impact on earnings. As a result of this rate structure, any variability in the cost of energy supply purchased will impact purchased power and transmission and cost of gas sold expenses and corresponding revenues, but will not affect the Company’s net income.
(b) Financial Information about Industry Segments
NSTAR’s principal operating segments are the electric and natural gas utility operations that provide energy delivery services in 107 cities and towns in Massachusetts and its unregulated operations. Refer to Note L, “Segment and Related Information” of the accompanying Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” for specific financial information related to NSTAR’s electric utility, natural gas utility, and unregulated operations segments.
(c) Narrative Description of Business
Principal Products and Services
NSTAR Electric
NSTAR Electric supplies electricity at retail to an area of 1,702 square miles. The territory served is located in Massachusetts and includes the City of Boston and 80 surrounding cities and towns, including Cambridge, New Bedford, Plymouth, and the geographic area comprising Cape Cod and Martha’s Vineyard. The population of this area is approximately 2.4 million.
NSTAR Electric’s operating revenues and energy sales percentages by customer class for the years 2008, 2007, and 2006 consisted of the following:
Electric Rates
Retail electric delivery rates are established by the DPU and are comprised of:
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a distribution charge, which includes a fixed customer charge and a demand and/or energy charge (to collect the costs of building and expanding the infrastructure to deliver power to its destination, as well as ongoing operating costs), a Pension and PBOP Rate Adjustment Mechanism (PAM) related costs adjustment and a reconciling rate adjustment mechanism for recovery of certain DPU-approved safety and reliability program costs,
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a basic service charge represents the collection of energy costs, including costs related to charge-offs of uncollected energy costs, through DPU-approved rate mechanisms. Electric distribution companies in Massachusetts are required to obtain and resell power to retail customers through Basic Service for those who choose not to buy energy from a competitive energy supplier. Basic Service rates are reset every six months (every three months for large commercial and industrial customers). The price of Basic Service is intended to reflect the average competitive market price for electric power,
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a transition charge represents the collection of costs primarily from previously held investments in generating plants and costs related to existing above-market power contracts, and contract costs related to long-term power contracts buy-outs,
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a transmission charge represents the collection of costs of moving the electricity over high voltage lines from generating plants to substations located within NSTAR’s service area including costs allocated to NSTAR Electric by ISO-NE to maintain the wholesale electric market,
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an energy conservation charge represents a legislatively-mandated charge to collect costs for demand-side management programs and energy efficiency programs, and
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a renewable energy charge represents a legislatively-mandated charge to collect the costs to support the development and promotion of renewable energy projects.
Rate Settlement Agreement
On December 30, 2005, the DPU approved a seven-year Rate Settlement Agreement (Rate Settlement Agreement) between NSTAR, the AG, and several interveners. Effective January 1, 2006 and continuing through 2012, the Rate Settlement Agreement establishes, among other things, annual inflation-adjusted distribution rate adjustments that are generally offset by an equal and corresponding reduction in transition rates. Refer to the “Rate Settlement Agreement” section of the accompanying Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for more details.
Massachusetts Regulatory Environment
The Secretary of Energy and Environmental Affairs oversees the Commonwealth Utilities Commission, consisting of three commissioners. The Commonwealth Utilities Commission leads the DPU, an agency that has jurisdiction over electric, natural gas, water, and transportation matters. Massachusetts has joined the Regional Greenhouse Gas Initiative, a multi-state group that supports implementation of programs to reduce the production of greenhouse gases by electric power plants.
In July 2008, the Massachusetts Legislature enacted the Green Communities Act (GCA) - energy policy legislation designed: (1) to substantially increase energy efficiency, (2) foster the development of renewable energy resources and (3) provide for a reduction of greenhouse gas emissions in Massachusetts. Refer to the “Massachusetts Regulatory Environment” section of the accompanying Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for more details.
Rate Decoupling
On July 16, 2008, the DPU issued an order to all Massachusetts’ electric and gas distribution utility companies that permits them to develop plans to decouple their rates/revenues from sales volumes. This action is intended to
encourage utility companies to help their customers reduce energy consumption. Decoupling of rates will allow utility companies to carry out the mandates of the GCA and at the same time collect the adequate level of revenues to maintain the quality and reliability of electric and gas services. This order allows utility companies to file for recovery of lost base revenues caused by incremental energy efficiency spending until their decoupling rate plans are approved. Once decoupled rate plans are approved, revenues will be set at a level designed to recover the utility companies’ incurred costs plus a return on their investment. This revenue level will be reconciled with actual revenues received from decoupled rates on an annual basis and any over or under collection will be refunded to or recovered from customers in the subsequent year.
Sources and Availability of Electric Power Supply
For Basic Service power supply, NSTAR Electric makes periodic market solicitations consistent with DPU regulations. NSTAR Electric enters into short-term power purchase agreements to meet its Basic Service supply obligation, ranging in term from three to twelve months. NSTAR Electric fully recovers its payments to suppliers through DPU-approved rates billed to customers.
Wholesale Market and Transmission Regulation
NSTAR Electric is a New England Transmission Owner subject to FERC regulation and is a member of ISO-New England. Refer to the “FERC Transmission ROE” section of the accompanying Item 7, MD&A, for more details.
Forward Capacity Market (FCM)
The New England FCM includes a locational price mechanism to establish separate zones for capacity when transmission constraints are found to exist. FCM allows load-serving entities such as NSTAR to self-supply through contracted resources to meet its capacity obligations without participating in the FCAs. FCAs are auctions designed to procure capacity three or more years into the future with a one-year to five-year commitment period. Transition payments applicable to all capacity began December 1, 2006 at a rate of $3.05/kWMonth and escalate to $4.10/kWMonth until May 2010 when FCM will begin on June 1, 2010. The impact to rates for NSTAR customers during the transition period will be approximately 0.8 to 1.1 cents per kilowatt hour and is billed to NSTAR Electric by its energy suppliers. To date, two FCM auctions have taken place covering the 2010-2011 and 2011-2012 time periods. The auctions were oversubscribed by 2,814 MW and 4,360 MW, respectively, and the price reached a floor of $4.50/kWMonth and $3.60/kWMonth, respectively. The next auction will take place in October 2009 for the period 2012-2013. NSTAR Electric expects these costs to be fully recoverable.
NSTAR Gas
NSTAR Gas distributes natural gas to approximately 300,000 customers in 51 communities in central and eastern Massachusetts covering 1,067 square miles and having an aggregate population of 1.2 million. Twenty-five of these communities are also served with electricity by NSTAR Electric. Some of the larger communities served by NSTAR Gas include the Hyde Park area of Boston, Cambridge, Dedham, Framingham, New Bedford, Plymouth, Somerville, and Worcester.
NSTAR Gas’ operating revenues and energy sales percentages by customer class for the years 2008, 2007, and 2006, consisted of the following:
Gas Rates
NSTAR Gas generates revenues primarily through the sale and/or transportation of natural gas. Gas sales and transportation services are divided into two categories: firm, whereby NSTAR Gas must supply gas and/or transportation services to customers on demand; and interruptible, whereby NSTAR Gas may, generally during colder months, temporarily discontinue service to high volume commercial and industrial customers. Sales and transportation of gas to interruptible customers have no impact on NSTAR Gas’ operating income because substantially the entire margin for such service is returned to its firm customers as rate reductions.
Retail gas delivery and supply rates are established by the DPU and are comprised of:
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a distribution charge consists of a fixed customer charge and a demand and/or energy charge that collects the costs of building and expanding the gas infrastructure to deliver gas supply to its customers’ destination. This also includes collection of ongoing operating costs
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a seasonal cost of gas adjustment clause (CGAC) represents the collection of gas supply costs, pipeline and storage capacity, costs related to charge-offs of uncollected energy costs and working capital related costs. The CGAC is reset every six months. In addition, NSTAR Gas is required to file interim changes to its CGAC factor when the actual costs of gas supply vary from projections by more than 5%
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a local distribution adjustment clause (LDAC) primarily represents the collection of demand-side management costs, environmental costs, PAM related costs, and costs associated with the residential assistance adjustment clause. The LDAC is reset annually and provides for the recovery of certain costs applicable to both sales and transportation customers
NSTAR Gas purchases financial contracts based on NYMEX natural gas futures in order to reduce cash flow variability associated with the purchase price for approximately one-third of its natural gas purchases. This practice attempts to minimize the impact of fluctuations in prices to NSTAR’s firm gas customers. These financial contracts do not procure gas supply. All actual costs incurred or benefits realized when these contracts are settled are included in the CGAC of NSTAR Gas.
Gas Supply, Transportation and Storage
NSTAR Gas maintains a flexible resource portfolio consisting of gas supply contracts, transportation contracts on interstate pipelines, market area storage and peaking services.
NSTAR Gas purchases transportation, storage, and balancing services from Tennessee Gas Pipeline Company and Algonquin Gas Transmission Company, as well as other upstream pipelines that bring gas from major producing regions in the U.S., Gulf of Mexico, and Canada to the final delivery points in the NSTAR Gas service area. NSTAR Gas purchases all of its gas supply from third-party vendors. Most of the supply is purchased under a firm portfolio management contract with a term of one year. NSTAR Gas has one multiple year contract, which is used for the purchase of its Canadian supplies for up to 4,500 MMbtu per day. Based on its firm pipeline transportation capacity entitlements, NSTAR Gas contracts for up to 139,214 MMbtu per day of domestic production during the winter heating season.
In addition to the firm transportation and gas supplies mentioned above, NSTAR Gas utilizes contracts for underground storage and LNG facilities to meet its winter peaking demands. The LNG facilities, described below, are located within NSTAR Gas’ distribution system and are used to liquefy and store pipeline gas during the warmer months for use during the heating season. During the summer injection season, excess pipeline capacity is used to deliver and store gas in market area storage facilities located in the New York and Pennsylvania region. Stored gas is withdrawn during the winter season to supplement pipeline supplies in order to meet firm heating demand. NSTAR Gas has firm storage contracts and total storage capacity entitlements of approximately 9.3 Bcf.
A portion of the storage of gas supply for NSTAR Gas during the winter heating season is provided by Hopkinton, a wholly-owned subsidiary of NSTAR. The facilities consist of a liquefaction and vaporization plant and three above-ground cryogenic storage tanks having an aggregate capacity of 3.5 Bcf of natural gas. NSTAR Gas believes that its present sources of gas supply are adequate to meet existing load and allow for future growth in sales.
Franchises
Through their charters, which are unlimited in time, NSTAR Electric and NSTAR Gas have the right to engage in the business of delivering and selling electricity and natural gas and have powers incidental thereto and are entitled to all the rights and privileges of and subject to the duties imposed upon electric and natural gas companies under Massachusetts laws. The locations in public ways for electric transmission and distribution lines and gas distribution pipelines are obtained from municipal and other state authorities who, in granting these locations, act as agents for the state. In some cases the actions of these authorities are subject to appeal to the DPU. The rights to these locations are not limited in time and are subject to the action of these authorities and the legislature. Under Massachusetts law, no other entity may provide electric or gas delivery service to retail customers within NSTAR’s territory without the written consent of NSTAR Electric and/or NSTAR Gas. This consent must be filed with the DPU and the municipality so affected.
Unregulated Operations
NSTAR’s unregulated operations include district energy operations, telecommunications, and liquefied natural gas service. District energy operations are provided through its AES subsidiary that sells chilled water, steam, and electricity to hospitals, teaching and research facilities located in Boston’s Longwood Medical Area. Telecommunications services are provided through NSTAR Com, which installs, owns, operates, and maintains a wholesale transport network for other telecommunications service providers in the metropolitan Boston area to deliver voice, video, data, and internet services to customers. Revenues earned from NSTAR’s unregulated operations accounted for approximately 4% of consolidated operating revenues in 2008, 2007 and 2006.
Regulation
The Energy Policy Act of 2005 established the Public Utility Holding Company Act of 2005 (PUHCA 2005) that transferred certain regulatory oversight from the SEC to the FERC. NSTAR has been granted an exemption and waiver from certain provisions of PUHCA 2005.
NSTAR Gas, NSTAR Electric and NSTAR Electric’s wholly-owned regulated subsidiary, Harbor Electric Energy Company, operate primarily under the authority of the DPU, whose jurisdiction includes supervision over retail rates for distribution of electricity, natural gas, and financing and investing activities. In addition, the FERC has jurisdiction over various phases of NSTAR Electric and NSTAR Gas utility businesses, conditions under which natural gas is sold at wholesale, facilities used for the transmission or sale of that energy, certain issuances of short-term debt, and regulation of accounting.
These companies are also subject to various other state and municipal regulations with respect to environmental, employment, and general operating matters.
Plant Expenditures and Financings
The most recent estimates of plant expenditures and long-term debt maturities for 2009 and the years 2010-2013 are as follows:
In the five-year period 2009 through 2013, plant expenditures are forecasted to be used for system reliability and performance improvements, customer service enhancements, and capacity expansion in NSTAR’s service territory. Capital expenditures increased $62 million from $360 million in 2007 to $422 million in 2008 primarily due to the completion and placement in service of the last phase of NSTAR Electric’s 345kV Transmission Project. This project ensures continued reliability of electric service and improvement of power import capability in the Northeast Massachusetts area. A substantial portion of the cost of this project will be shared by other utilities in New England based on ISO-NE’s approval and will be recovered by NSTAR through wholesale and retail transmission rates. Of the $365 million planned expenditures for 2009, approximately $100 million is for transmission system improvements.
Management continuously reviews its capital expenditure and financing programs. These programs and, therefore, the estimates included in this Form 10-K are subject to revision due to changes in regulatory requirements, operating requirements, environmental standards, availability and cost of capital, interest rates and other assumptions. Refer to the accompanying “Cautionary Statement Regarding Forward-Looking Information” preceding Item 1, “Business” and the “Liquidity, Commitments and Capital Resources” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Seasonal Nature of Business
NSTAR Electric’s kilowatt-hour sales and revenues are typically higher in the winter and summer than in the spring and fall as sales tend to vary with weather conditions. NSTAR Gas’ sales are positively impacted by colder weather because a substantial portion of its customer base uses natural gas for space heating purposes. Refer to the accompanying “Selected Quarterly Consolidated Financial Data” section in Item 6, “Selected Consolidated Financial Data” for specific financial information by quarter for 2008 and 2007.
Competitive Conditions
As a rate regulated distribution and transmission utility company, NSTAR is not subject to a significantly competitive business environment. Through its franchise charters, NSTAR Electric and NSTAR Gas have the exclusive right and privilege to engage in the business of delivering energy services within their granted territory. Under Massachusetts law, no other entity may provide electric or natural gas delivery service to retail customers within NSTAR’s service territory without the written consent of NSTAR Electric and/or NSTAR Gas. Refer to the accompanying “Franchises” section of this Item 1 and to Item 1A, “Risk Factors” for a further discussion of NSTAR’s rights and competitive pressures within its service territory.
Environmental Matters
NSTAR’s subsidiaries are subject to numerous federal, state and local standards with respect to the management of wastes and other environmental considerations. NSTAR subsidiaries face possible liabilities as a result of involvement in several multi-party disposal sites, state-regulated sites or third party claims associated with contamination remediation. NSTAR generally expects to have only a small percentage of the total potential liability for the majority of these sites. Noncompliance with certain standards can, in some cases, also result in the imposition of monetary civil penalties. Refer to the accompanying “Contingencies - Environmental Matters” section in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and to Notes to Consolidated Financial Statements, Note N, “Commitments and Contingencies,” for more information.
Management believes that its facilities are in substantial compliance with currently applicable statutory and regulatory environmental requirements.
Number of Employees and Employee Relations
As of December 31, 2008, NSTAR had approximately 3,250 employees, including approximately 2,250, or 69%, who are represented by three labor unions covered by separate collective bargaining contracts.
Substantially all management, engineering, finance and support services are provided to the operating subsidiaries of NSTAR by employees of NSTAR Electric & Gas. NSTAR has the following labor union contracts:
NSTAR’s contract with Local 369 of the Utility Workers Union of America, AFL-CIO, which represents approximately 59% of total NSTAR employees, was set to expire on June 1, 2009. In January 2009, management and Local 369 reached an agreement on a three-year contract extension through June 1, 2012. Management believes that it has satisfactory relations with its employees.
(d) Financial Information about Geographic Areas
NSTAR is a holding company engaged through its subsidiaries in the energy delivery business in Massachusetts. None of NSTAR’s subsidiaries have any foreign operations or export sales.
(e) Available Information
NSTAR files its Forms 10-K, 10-Q and 8-K reports, proxy statements and other information with the SEC. You may access materials NSTAR has filed with the SEC on the SEC’s website at www.sec.gov. In addition, NSTAR’s Board of Trustees has various committees, including an Audit, Finance and Risk Management Committee, an Executive Personnel Committee and a Board Governance and Nominating Committee. The Board also has a standing Executive Committee. The Board has adopted the NSTAR Board of Trustees Corporate Guidelines on Significant Corporate Governance Issues, a Code of Ethics for the Principal Executive Officer, General Counsel, and Senior Financial Officers pursuant to Section 406 of the Sarbanes-Oxley Act of 2002, and a Code of Ethics and Business Conduct for Directors, Officers and Employees (“Code of Conduct”). NSTAR intends to disclose any amendment to, and any waiver from, a provision of the Code of Ethics that applies to the Chief Executive Office or Chief Financial Officer or any other executive officer and that relates to any element of the Code of Ethics definition enumerated in Item 406(b) of Regulation S-K, on Form 8-K, within four business days following the date of such amendment or waiver. NSTAR’s SEC filings and Corporate Governance documents, including charters, guidelines and codes, and any amendments to such charters, guidelines and codes that are applicable to NSTAR’s executive officers, senior financial officers or trustees can be accessed free of charge on NSTAR’s website at: www.nstar.com: Select “Investor Relations” and “Financial Information.” Copies of NSTAR’s SEC filings may also be obtained free of charge by writing to NSTAR’s Investor Relations Department at the address on the cover of this Form 10-K or by calling 781-441-8338.
The certifications of NSTAR’s Chief Executive Officer and Chief Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 are attached to this Annual Report on Form 10-K as Exhibits 31.1, 31.2, 32.1, and 32.2. NSTAR also filed the required Annual CEO Certification of its Chief Executive Officer pursuant to Section 303A of the NYSE Listing Manual in 2008, certifying that he is not aware of any violation of the NYSE corporate governance listing standards.
Item 1A.
Item 1A. Risk Factors
Our future performance is subject to a variety of risks, including those described below. If any of the following risks actually occur, our business could be harmed and the trading price of our common shares could decline. In addition to the other information in this Annual Report on Form 10-K, shareholders or prospective investors should carefully consider the following risk factors.
Our electric and gas operations are highly regulated, and any adverse regulatory changes could have a significant impact on the Company’s results of operations and its financial position.
NSTAR’s electric and gas operations, including the rates charged, are regulated by the FERC and the DPU. In addition, NSTAR’s accounting policies are prescribed by GAAP, the FERC and the DPU. Adverse regulatory changes could have a significant impact on results of operations and financial condition.
Potential municipalization or technological developments may adversely affect our regulated electricity and natural gas businesses.
Under Massachusetts law, no other entity may provide electric or gas delivery service to retail customers within NSTAR’s service territory without the written consent of NSTAR Electric and/or NSTAR Gas. Although not a trend, NSTAR’s operating utility companies could be exposed to municipalization risk, whereby a municipality could acquire the electric or natural gas delivery assets located in that city or town and take over the customer delivery service, thereby reducing NSTAR’s revenues. Any such action would require numerous legal and regulatory consents and approvals. NSTAR expects that any municipalization would require that NSTAR be compensated for its assets assumed. In addition, there is also the risk that technological developments could lead to distributed generation among NSTAR’s customer base.
Changes in environmental laws and regulations affecting our business could increase our costs or curtail our activities.
NSTAR and its subsidiaries are subject to a number of environmental laws and regulations that are currently in effect, including those related to the handling, disposal, and treatment of hazardous materials. Changes in compliance requirements or the interpretation by governmental authorities of existing requirements may impose additional costs, all of which could have an adverse impact on NSTAR’s results of operations.
The Company may be required to conduct environmental remediation activities for power generating sites and other potentially unidentified sites.
NSTAR is subject to actual or potential claims and lawsuits involving environmental remediation activities for power generating sites previously owned and other potentially unidentified sites. NSTAR divested all of its regulated generating assets under terms that generally require the buyer to assume all responsibility for past and present environmental harm. Based on NSTAR’s current assessment of its environmental responsibilities, existing legal requirements and regulatory policies, NSTAR does not believe that its known environmental remediation responsibilities will have a material adverse effect on NSTAR’s results of operations, cash flows or financial position. However, discovery of currently unknown conditions at existing sites, identification of additional waste sites or changes in environmental regulation, could have a material adverse impact on NSTAR’s results of operations, cash flows or financial position.
NSTAR is subject to operational risk that could cause us to incur substantial costs and liabilities.
Our business, which involves the transmission and distribution of natural gas and electricity that is used as an energy source by our customers, is subject to various operational risks, including incidents that expose the Company to potential claims for property damages or personal injuries beyond the scope of NSTAR’s insurance coverage, and equipment failures that could result in performance below assumed levels. For example, operational performance below established target benchmark levels could cause NSTAR to incur penalties imposed by the DPU, up to a maximum of two and one-half percent of transmission and distribution revenues, under applicable Service Quality Indicators.
Increases in interest rates due to financial market conditions or changes in our credit ratings, could have an adverse impact on our access to capital markets at favorable rates, or at all, and could otherwise increase our costs of doing business.
NSTAR frequently accesses the capital markets to finance its working capital requirements, capital expenditures and to meet its long-term debt maturity obligations. Increased interest rates, or adverse changes in our credit
ratings or further deterioration in the credit markets, would increase our cost of borrowing and other costs that could have an adverse impact on our results of operations and cash flows and ultimately have an adverse impact on the market price of our common shares. In addition, an adverse change in our credit ratings could increase borrowing costs, trigger requirements that we obtain additional security for performance, such as a letter of credit, related to our energy procurement agreements. Refer to the accompanying Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” for a further discussion.
Our electric and gas businesses are sensitive to variations in weather and have seasonal variations. In addition, severe storm-related disasters could adversely affect the Company.
Sales of electricity and natural gas to residential and commercial customers are influenced by temperature fluctuations. Significant fluctuations in heating or cooling degree days could have a material impact on energy sales for any given period. In addition, extremely severe storms, such as hurricanes and ice storms, could cause damage to our facilities that may require additional costs to repair and have a material adverse impact on the Company’s results of operations, cash flows or financial position. To the extent possible, NSTAR’s rate regulated subsidiaries would seek recovery of these costs through the regulatory process.
An economic downturn, increased costs of energy supply, and customers’ conservation efforts could adversely affect energy consumption and could adversely affect our results of operations.
Energy consumption is significantly impacted by the general level of economic activity and cost of energy supply. Economic downturns such as the one which is currently occurring or periods of high energy supply costs typically lead to reductions in energy consumption and increased conservation measures. These conditions could adversely impact the level of energy sales and result in less demand for energy delivery. A recession or a prolonged lag of a subsequent recovery could have an adverse effect on NSTAR’s results of operations, cash flows or financial position.
The ability of NSTAR to maintain future cash dividends at the level currently paid to shareholders is dependent upon the ability of its subsidiaries to pay dividends to NSTAR.
As a holding company, NSTAR does not have any operating activity and therefore is substantially dependent on dividends from its subsidiaries and from external borrowings at variable rates of interest to provide the cash necessary for repayment of debt obligations, to pay administrative costs, to meet contractual obligations that may not be met by our subsidiaries and to pay common share dividends to NSTAR’s shareholders. Regulatory and other legal restrictions may limit our ability to transfer funds freely, either to or from our subsidiaries. These laws and regulations may hinder our ability to access funds that we may need to make payments on our obligations. As the holding company’s sources of cash are limited to dividends from its subsidiaries and external borrowings, the ability to maintain future cash dividends at the level currently paid to shareholders will be dependent upon earnings of NSTAR’s subsidiaries.
NSTAR’s subsidiaries do have certain limitations that could impact the payment of dividends to the parent company. Refer to the “Sources of Additional Capital and Financial Covenant Requirements” section of the accompanying Item 7, “Management’s Discussion and Analysis Financial Condition and Results of Operations” for more information.
Our electric and gas operations may be impacted if generation supply or its transportation or transmission availability is limited or unreliable.
Our electric and natural gas delivery businesses are reliant on transportation and transmission facilities that we do not own or control. Our ability to provide energy delivery services depends on the operations and facilities of third parties, including the independent system operator, electric generators that supply our customers’ energy requirements and natural gas pipeline operators from which we receive delivery of our natural gas supply. Should our ability to receive electric or natural gas supply be disrupted due either to operational issues or to inadequacy of transmission capacity, it could impact our ability to serve our customers. It could also force us to secure alternative supply at significantly higher costs.
Financial market performance and other changes may decrease the Company’s pension and postretirement benefit plans’ assets and could require additional funding beyond historic levels.
A sustained decline in the global financial markets, as was experienced in the second half of 2008, may have a material adverse effect on the value of our pension and postretirement benefit plans’ assets. This situation may increase our benefit plans’ funding requirements.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
NSTAR Electric properties include an integrated system of transmission and distribution lines and substations, a jointly owned administration office building and other structures such as garages and service centers that are located in eastern Massachusetts.
NSTAR Electric’s principal electric properties consist of substations, transmission and distribution lines and meters necessary to maintain reliable service to customers. In addition, it owns several service centers. NSTAR’s high-voltage transmission lines are generally located on land either owned or subject to perpetual and exclusive easements in its favor. Its low-voltage distribution lines are located principally on public property under permits granted by municipal and other state authorities. In October 2006, NSTAR Electric completed and placed in service the first approximate 18-mile transmission line of its 345 kV Transmission Project. A shorter second line of this project was placed in service in April 2007. A third and final line was placed in service in December 2008.
At December 31, 2008, NSTAR Electric’s primary and secondary transmission and distribution system consisted of approximately 21,950 circuit miles of overhead lines, approximately 12,980 circuit miles of underground lines, 255 substation facilities and approximately 1,169,300 active customer meters.
NSTAR Gas’ principal natural gas properties consist of distribution mains, services and meters necessary to maintain reliable service to customers. In addition, it owns a jointly owned administration office and service building, three district office buildings and several natural gas receiving and take stations. As of December 31, 2008, the gas system included approximately 3,086 miles of gas distribution lines, approximately 188,000 services and approximately 299,500 customer meters together with the necessary measuring and regulating equipment. In addition, Hopkinton owns a liquefaction and vaporization plant, a satellite vaporization plant and above ground cryogenic storage tanks having an aggregate storage capacity equivalent to 3.5 Bcf of natural gas.
District energy operations consist of AES’ cogeneration facility located in the Longwood Medical Area of Boston. MATEP provides steam, chilled water and electricity to over 9 million square feet of medical and teaching facilities.
NSTAR Com’s telecommunications service owns approximately 200 miles of fiber optic network which represents approximately 79,000 fiber miles of network.
Item 3.
Item 3. Legal Proceedings
In the normal course of its business, NSTAR and its subsidiaries are involved in certain legal matters, including civil litigation. Management is unable to fully determine a range of reasonably possible court-ordered damages, settlement amounts, and related litigation costs (legal liabilities) that would be in excess of amounts accrued and amounts covered by insurance. Based on the information currently available, NSTAR does not believe that it is probable that any such legal liabilities will have a material impact on its consolidated financial position. However, it is reasonably possible that additional legal liabilities that may result from changes in circumstances could have a material impact on its results of operations, financial condition and cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the fourth quarter of 2008.
Item 4A. Executive Officers of Registrant
Identification of Executive Officers
Name of Officer
Position and Business Experience
Age at
December 31, 2008
Thomas J. May
Chairman, President and Chief Executive Officer and a NSTAR Trustee
James J. Judge
Senior Vice President, Treasurer and Chief Financial Officer
Douglas S. Horan
Senior Vice President - Strategy, Law and Policy, Secretary and General Counsel
Joseph R. Nolan, Jr.
Senior Vice President - Customer & Corporate Relations
Werner J. Schweiger
Senior Vice President - Operations
Christine M. Carmody
Senior Vice President - Human Resources
Eugene J. Zimon
Senior Vice President - Information Technology
Robert J. Weafer, Jr.
Vice President, Controller and Chief Accounting Officer
PART II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Market Information and (c) Dividends
The NSTAR Common Shares, $1 par value, are listed on the New York Stock Exchange under the symbol “NST.” NSTAR’s Common Shares closing market price at December 31, 2008 was $36.49 per share.
The NSTAR Common Shares high and low sales prices as reported by the New York Stock Exchange composite transaction reporting system and dividends declared per share for each of the quarters in 2008 and 2007 were as follows:
NSTAR paid common share dividends to shareholders totaling $149.5 million and $138.9 million in 2008 and 2007, respectively.
(b) Holders
As of December 31, 2008, there were 20,276 registered holders of NSTAR Common Shares.
(d) Securities authorized for issuance under equity compensation plans
The following table provides information about NSTAR’s equity compensation plans as of December 31, 2008.
The NSTAR 2007 Long Term Incentive Plan (the 2007 Plan) permits a variety of stock and stock-based awards, including stock options, deferred stock awards and performance share units granted to key employees. The 2007 Plan replaced NSTAR’s 1997 Share Incentive Plan, which expired by its terms in January 2007. Subject to adjustment for stock-splits and similar events, the aggregate number of common shares that are available for award under the 2007 Plan is 3.5 million. The Plan limits the terms of awards to ten years and prohibits the granting of awards beyond ten years after its effective date. In general, stock options and stock awards vest over a three-year period from date of grants. The Executive Personnel Committee (EPC) of the Board of Trustees approves stock-based awards for all executives and other key employees. However, the Chief Executive Officer (CEO)’s award must also be approved by the independent members of the Board of Trustees. The EPC and Board of Trustees established that the date of grant for annual stock-based awards under the Plan is the date each year on which the Board of Trustees approves the CEO’s stock award. This date is when all participants are notified of their awards. Options are granted at the full market price of the common shares on the date of grant.
(e) Purchases of equity securities
Common Shares of NSTAR issued under the NSTAR Dividend Reinvestment and Direct Common Shares Purchase Plan, the Long Term Incentive Plan and the NSTAR Savings Plan may consist of newly issued shares from the Company or shares purchased in the open market by the Company or an independent agent. During the three-month period ended December 31, 2008, the shares listed below were acquired in the open market.
(f) Stock Performance Graphs
The following Stock Performance Graphs and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.
The stock performance graph presentations set forth below compare cumulative five-year and ten-year shareholder returns with the Standard & Poor’s 500 Index (S&P 500) and the Edison Electric Industry Index (EEI Index), a recognized industry index of 59 investor-owned utility companies. Pursuant to the SEC’s regulations, the graphs below depict the investment of $100 at the commencement of the measurement periods, with dividends reinvested.
Five-Year Performance Graph
Ten-Year Performance Graph
Item 6.
Item 6. Selected Consolidated Financial Data
The following table summarizes five years of selected consolidated financial data.
(a) As a result of a change in NSTAR’s Board of Trustees’ meetings schedule in 2005, the fourth quarter dividend that typically would have been declared in December 2005, was approved on January 26, 2006 at $0.3025 per share, and therefore dividends declared during 2006 include the fourth quarter of 2005. The dividend payment schedule remained unchanged.
(b) Excludes the current portion.
Selected Quarterly Consolidated Financial Data (Unaudited) (a)
(a) This information has been provided in accordance with Regulation S-K, Item 302(a)
(b) The sum of the quarters may not equal basic and diluted annual earnings per share due to rounding.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
Overview
NSTAR (or the Company) is a holding company engaged through its subsidiaries in the energy delivery business serving approximately 1.4 million customers in Massachusetts, including approximately 1.1 million electric distribution customers in 81 communities and approximately 300,000 natural gas distribution customers in 51 communities. NSTAR’s retail electric transmission and distribution utility subsidiaries are NSTAR Electric and NSTAR Gas, respectively. NSTAR’s nonutility, unregulated operations include district energy operations primarily through its AES subsidiary, telecommunications operations (NSTAR Com) and a liquefied natural gas
service company (Hopkinton). Harbor Electric Energy Company, a wholly-owned subsidiary of NSTAR Electric, provides distribution service and ongoing support to its only customer, the Massachusetts Water Resources Authority. Utility operations accounted for approximately 96% of consolidated operating revenues in 2008, 2007 and 2006.
NSTAR consolidates three wholly-owned special purpose subsidiaries, BEC Funding LLC, established in 1999, BEC Funding II, LLC and CEC Funding, LLC, both established in 2004. These entities were created to complete the sale of electric rate reduction certificates to a special purpose trust created by two Massachusetts state agencies. These financing transactions securitized the costs incurred related to the divestiture of generation assets and long-term power contracts.
NSTAR derives its operating revenues primarily from the sale of energy, distribution and transmission services to customers and from its unregulated businesses. NSTAR’s earnings are impacted by fluctuations in unit sales of electric kWh and natural gas MMbtu, which directly determine the level of distribution and transmission revenues recognized. In accordance with the regulatory rate structure in which NSTAR operates, its recovery of energy costs are fully reconciled with the level of energy revenues currently recorded and, therefore, do not have an impact on earnings. As a result of this rate structure, any variability in the cost of energy supply purchased will impact purchased power and transmission and cost of gas sold expenses and corresponding revenues but will not affect the Company’s net income.
Critical Accounting Policies and Estimates
NSTAR’s discussion and analysis of its financial condition, results of operations and cash flows are based on the accompanying Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these Consolidated Financial Statements required management to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies and estimates are defined as those that require significant judgment and uncertainties, and potentially may result in materially different outcomes under different assumptions and conditions. The accounting policies and estimates that are most critical to the reported results of operations, cash flows and financial position are described below.
a. Revenue Recognition
Utility revenues are based on authorized rates approved by the DPU and the FERC. Revenues related to the sale, transmission and distribution of energy delivery service are generally recorded when service is rendered or energy is delivered to customers. However, the determination of the energy sales to individual customers is based on systematic meter readings throughout a month. Meters that are not read during a given month are estimated and trued-up to actual use in a future period. At the end of each month, amounts of energy delivered to customers since the date of their last meter reading are estimated and the corresponding unbilled revenue is recorded. Unbilled electric revenue is estimated each month based on daily territory load (customer energy requirements), estimated line losses and applicable customer rates. Unbilled natural gas revenues are estimated based on estimated purchased gas volumes, estimated gas losses and tariffed rates in effect. Accrued unbilled revenues recorded in the accompanying Consolidated Balance Sheets as of December 31, 2008 and 2007 were $62 million and $60 million, respectively.
The level of revenues is subject to seasonal weather conditions. Electric sales volumes are typically higher in the winter and summer than in the spring or fall. Gas sales volumes are impacted by colder weather since a substantial portion of NSTAR’s customer base uses natural gas for heating purposes. As a result, NSTAR records a higher level of revenue during the seasonal periods mentioned above.
NSTAR’s nonutility revenues are recognized when services are rendered or when the energy is delivered. Revenues are based, for the most part, on long-term contractual rates.
b. Regulatory Accounting
NSTAR follows accounting policies prescribed by GAAP, the FERC and the DPU. As a rate-regulated company, NSTAR’s utility subsidiaries are subject to SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation” (SFAS 71). The application of SFAS 71 results in differences in the timing of recognition of certain revenues and expenses from those of other businesses and industries. NSTAR’s energy delivery businesses remain subject to rate-regulation and continue to meet the criteria for application of SFAS 71. This ratemaking process results in the recording of regulatory assets or a regulatory liability (including cost of removal) based on the probability of current and future cash flows. Regulatory assets represent incurred or accrued costs that have been deferred because they are probable of future recovery from customers. Regulatory liabilities may represent collections from customers that have been deferred because they will be expended in the future or they may relate to the future cost of removal of assets. (Refer to the accompanying Asset Retirement Obligations section of Item 7.) As of December 31, 2008 and 2007, NSTAR has recorded regulatory assets of $2.9 billion and $2.6 billion, and regulatory liabilities of $265 million and $258.9 million, respectively. NSTAR continuously reviews these regulatory assets to assess their ultimate recoverability within the approved regulatory guidelines. NSTAR expects to fully recover these regulatory assets in its rates. If future recovery of any deferred costs ceases to be probable, NSTAR would be required to charge such deferred amounts to current earnings. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future.
c. Pension and Other Postretirement Benefits
NSTAR’s annual pension and other postretirement benefits costs are dependent upon several factors and assumptions, such as but not limited to, employee demographics, plan design, the level of cash contributions made to the plans, the discount rate, the expected long-term rate of return on the plans’ assets and health care cost trends.
In accordance with SFAS No. 87, “Employers’ Accounting for Pensions” (SFAS 87) and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other than Pensions” (SFAS 106), changes in pension and PBOP liabilities associated with these factors are not immediately recognized as pension and PBOP costs in the statements of income, but generally are recognized in future years over the remaining average service period of the plans’ participants. As a result of the requirements of SFAS No. 158, “Employers’ Accounting for Deferred Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements Nos. 87, 88, 106, and 132(R)” (SFAS 158), these factors could have a significant impact on pension and postretirement assets or liabilities recognized.
NSTAR’s Pension Plan and PBOP Plan assets, which partially consist of equity investments, have been affected by recent declines in the overall global equity markets. Fluctuations in the fair value of the Pension Plan and PBOP Plan assets impact the funded status, accounting costs, and cash funding requirements of these Plans. The earnings impact of increased Pension and PBOP costs is mitigated as a result of NSTAR’s DPU-approved pension and PBOP rate adjustment mechanism (PAM). Under the PAM, NSTAR is authorized to recover its pension and PBOP expense through this reconciling rate mechanism. The PAM removes the volatility in earnings that could result from fluctuations in market conditions and plan assumptions.
There were no significant changes to NSTAR’s pension and PBOP benefits in 2008, 2007 and 2006 that had a material impact on recorded pension and PBOP costs. As further described in Note G, “Pension and Other Postretirement Benefits,” to the accompanying Consolidated Financial Statements, NSTAR’s discount rate for the Pension Plan was 6.25% at both December 31, 2008 and 2007, respectively. NSTAR’s discount rate for the PBOP obligation was 6.10% and 6.25% at December 31, 2008 and 2007, respectively. These discount rates align with market conditions and the characteristics of NSTAR’s pension and PBOP obligations. The expected long-term rate of return on both pension plan and PBOP assets for 2008 remained at 9.0%, the same as 2007 and 2006.
Changes in these assumptions will have an impact on reported pension and PBOP costs in future years in accordance with the cost recognition approaches of SFAS 87 and SFAS 106, respectively. In determining pension obligation and cost amounts, these assumptions may change from period to period, and such changes could result in material changes to recorded pension and PBOP costs and funding requirements.
The following table reflects the projected benefit obligation and cost sensitivities associated with a change in certain actuarial assumptions by the indicated percentage. Each sensitivity below reflects an evaluation of the change based solely on a change in that assumption.
Management evaluates the appropriateness of the discount rate through the modeling of a bond portfolio that approximates the Plan liabilities. Management further considers rates of high quality corporate bonds of appropriate maturities as published by nationally recognized rating agencies consistent with the duration of the Company’s plans. In determining the expected long-term rate of return on plan assets, NSTAR considers past performance and economic forecasts for the types of investments held by the Plan as well as the target allocation for the investments over a long-term period. In 2008, NSTAR kept the expected long-term rate of return on plan assets at 9.0% as a result of the prevailing outlook for investment returns. Actuarial assumptions also include an assumed rate for administrative and investment expenses, which have averaged approximately 0.6% for 2008, 2007 and 2006.
The expected long-term rate of return on Plan assets could vary from actual returns as well as the target allocation for investments over time. As such, these fluctuations could impact NSTAR’s capital resources to meet its plan contributions. During 2008, NSTAR contributed $72.6 million to the Pension Plans and $15 million to the PBOP Plan. In 2009 NSTAR expects to contribute $25 million to the Pension Plan and $30 million to the PBOP Plan.
The Pension Protection Act of 2006 (the PPA) requires employers with defined-benefit pension plans to make minimum contributions to fund any shortfall between the assets and liabilities of the plan over a period of seven years. On December 23, 2008, the Worker, Retiree and Employer Recovery Act of 2008 (WRERA) was enacted. WRERA provides relief to single employer pension plans with respect to contribution requirements for the 2008, 2009, and 2010 plan years. Specifically, WRERA reduces the required shortfall to the difference between plan assets and 94% of the plan liabilities for the 2009 plan year (increasing to 96% in 2010). The relief effectively reduces the required amount NSTAR will need to contribute to the pension plan for the 2009 plan year. The Company is in compliance with PPA and WRERA as of December 31, 2008.
d. Uncertain Tax Positions
Effective January 1, 2007, NSTAR adopted the provisions of FASB Interpretation No. 48 (FIN 48) “Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109, Accounting for Income Taxes” relating to uncertain tax positions. FIN 48 requires management to use judgment in assessing the potential exposure from tax positions taken that may be challenged by taxing authorities. Management is required to assess the possibility of alternative outcomes based upon all facts available at the reporting date, including in some cases the opinion of independent tax consultants. These estimates could differ significantly from the ultimate outcome. For additional information on uncertain tax positions and estimates used therein, refer to “Income Tax Matters” included in this section of this MD&A.
Investments in Yankee Companies
NSTAR Electric has an equity ownership of 14% in CY, 14% in YA, and 4% in MY, (collectively, the Yankee Companies). CY, YA and MY plant sites have been decommissioned in accordance with NRC procedures. Amended licenses continue to apply to the ISFSI’s where spent nuclear fuel is stored at these sites. CY, YA and MY remain responsible for the security and protection of the ISFSI and are required to maintain radiation monitoring programs at the sites.
Yankee Companies Spent Fuel Litigation
In October, 2006, the U.S. Court of Federal Claims issued a judgment in a spent nuclear fuel litigation, in the amounts of $34.2 million, $32.9 million and $75.8 million for CY, YA and MY, respectively. This judgment in favor of these Yankee companies relates to the alleged failure of the DOE to provide for a permanent facility to store spent nuclear fuel for years prior to 2001 for CY and YA, and prior to 2002 for MY. NSTAR Electric’s portion of the judgment amounts to $4.8 million, $4.6 million and $3 million, respectively. On December 4, 2006, the DOE filed its notice of appeal of the trial court’s decision. As a result, the Yankee Companies have not recognized the damage awards on their books, and therefore, NSTAR Electric has not recognized its portion. On December 14, 2007, the Yankee companies filed complaints against the DOE seeking damages from 2001 for CY and YA, and from 2002 for MY, through a future trial date. On August 7, 2008, a federal appeals court reversed and remanded the U.S. Court of Federal Claims judgment based on an error in the measurement of the award calculation. NSTAR cannot predict the ultimate outcome of this decision on appeal or the subsequent complaints. However, should NSTAR Electric ultimately prevail, proceeds received would be refunded to customers and would not have an earnings impact.
The accounting for decommissioning costs of nuclear power plants involves significant estimates related to costs to be incurred many years in the future. Changes in these estimates will not affect NSTAR’s results of operations or cash flows because these costs will be collected from customers through NSTAR Electric’s transition charge filings with the DPU.
Derivative Instruments
Energy Contracts
NSTAR accounts for its energy contracts in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) and SFAS No. 149, “Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities” (SFAS 149). NSTAR has determined that its electricity supply contracts qualify for, and NSTAR has elected, the normal purchases and sales exception. As a result, these agreements are not reflected on the accompanying Consolidated Balance Sheets. NSTAR has only one significant gas supply contract. This contract is an all-requirements portfolio asset management contract that expires in October 2009. This contract contains market based pricing terms and, therefore, no financial statement adjustments would be required. Gas supply costs incurred related to this contract were $259 million, $224 million
and $237 million for the years ended December 31, 2008, 2007 and 2006, respectively, and have been recorded to Cost of gas sold on the accompanying Consolidated Statements of Income. Refer to the accompanying Item 7A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Risk Management
NSTAR’s Energy Procurement Policy governs all energy-related transactions for its regulated electric and gas subsidiaries. This Policy is reviewed annually and is administered by NSTAR’s Risk Committee. The Committee is chaired by NSTAR’s chief executive officer and includes other senior officers. Items covered by this Policy and approved by the Committee are all new energy supply transactions, authorization limits, energy related derivative and hedging transactions, and counter-party credit profiles.
Commodity and Credit Risk
Although NSTAR has material energy commodity purchase contracts, any potential market risk, including counter-party credit risk, should not have an adverse impact on NSTAR’s results of operations, cash flows, or financial position. NSTAR’s electric and gas distribution subsidiaries have rate-making mechanisms that allow for the recovery of energy supply costs from those customers who make commodity purchases from NSTAR’s electric and gas subsidiaries rather than from the competitive market supplier. All energy supply costs incurred by NSTAR Electric and NSTAR Gas in providing energy to their retail customers are recovered on a fully reconciling basis.
In addition, NSTAR has minimal cash flow risk due to the short-term nature of these contracts and the rate-making mechanics that permit recovery of these costs in a timely manner. The majority of NSTAR’s electric and gas commodity purchase contracts range in term from three to twelve months. NSTAR Electric has the ability to seek cost recovery and adjust its rates as frequently as every three months for its large commercial and industrial customers and every six months for its residential customers. NSTAR Gas has the ability to seek cost recovery as required if costs exceed 5% of the current projected cost recovery level. Both NSTAR Electric and NSTAR Gas earn a carrying charge on under-collected commodity balances that would mitigate any incremental short-term borrowings costs. NSTAR believes it is unlikely that it would be exposed to a liquidity risk resulting from significant market price increases based on the recovery mechanisms currently in place.
To mitigate the cash flow and cost variability related to the commodity price risk on approximately one-third of its natural gas purchases, NSTAR Gas purchases financial futures contracts on behalf of its customers. NSTAR Gas has a rate-making mechanism that provides for recovery of the actual settlement value of these contracts on a fully reconciling basis. Refer to the accompanying Notes to Consolidated Financial Statements, Note E, “Derivative Instruments - Hedging Agreements,” for a further discussion.
Interest Rate Risk
NSTAR believes its interest risk primarily relates to short-term debt obligations and anticipated future long-term debt financing requirements to fund its capital programs. These short-term debt obligations are typically refinanced with fixed-rate long-term notes as needed and when market interest rates are favorable. The Company is exposed to changes in interest rates primarily based on levels of short-term commercial paper outstanding. The weighted average interest rates, including fees for short-term indebtedness, were 2.4% and 5.3% for 2008 and 2007, respectively. On a long-term basis, NSTAR mitigates its interest rate risk through the issuance of mostly fixed rate debt of various maturities.
Item 8.
Item 8. Financial Statements and Supplementary Data
NSTAR
Consolidated Statements of Income
The accompanying notes are an integral part of the consolidated financial statements.
NSTAR
Consolidated Statements of Comprehensive Income
The accompanying notes are an integral part of the consolidated financial statements.
NSTAR
Consolidated Statements of Retained Earnings
The accompanying notes are an integral part of the consolidated financial statements.
NSTAR
Consolidated Balance Sheets
The accompanying notes are an integral part of the consolidated financial statements.
NSTAR
Consolidated Balance Sheets
The accompanying notes are an integral part of the consolidated financial statements.
NSTAR
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of the consolidated financial statements.
Notes to Consolidated Financial Statements
Note A. Business Organization and Summary of Significant Accounting Policies
1. About NSTAR
NSTAR (or the Company) is a holding company engaged through its subsidiaries in the energy delivery business serving approximately 1.4 million customers in Massachusetts, including approximately 1.1 million electric distribution customers in 81 communities and approximately 300,000 natural gas distribution customers in 51 communities. NSTAR’s retail electric transmission and distribution utility subsidiaries are NSTAR Electric and NSTAR Gas, respectively. NSTAR’s nonutility, unregulated operations include district energy operations primarily through its AES subsidiary, telecommunications operations (NSTAR Com) and a liquefied natural gas service company (Hopkinton). Harbor Electric Energy Company, a wholly-owned subsidiary of NSTAR Electric, provides distribution service and ongoing support to its only customer, the Massachusetts Water Resources Authority. Utility operations accounted for approximately 96% of consolidated operating revenues in 2008, 2007 and 2006.
NSTAR consolidates three-wholly owned special purpose subsidiaries, BEC Funding LLC, established in 1999, BEC Funding II, LLC and CEC Funding, LLC, both established in 2004. These entities were created to complete the sale of electric rate reduction certificates to a special purpose trust created by two Massachusetts state agencies. These financing transactions securitized the costs incurred related to the divestiture of generation assets and long-term power contracts.
2. Basis of Consolidation and Accounting
The accompanying Consolidated Financial Statements reflect the results of operations, comprehensive income, retained earnings, financial position and cash flows of NSTAR and its subsidiaries. All significant intercompany transactions have been eliminated in consolidation. Certain immaterial reclassifications have been made to prior year amounts to conform to the current year’s presentation. These include the classification of a portion of regulatory assets as of December 31, 2007 from current to non-current on the accompanying Consolidated Balance Sheets.
NSTAR’s utility subsidiaries follow accounting policies prescribed by the FERC and the DPU. In addition, NSTAR and its subsidiaries are subject to the accounting and reporting requirements of the SEC. The accompanying Consolidated Financial Statements conform to accounting principles in conformity with GAAP. The utility subsidiaries are subject to SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation” (SFAS 71). The application of SFAS 71 results in differences in the timing of recognition of certain revenues and expenses from those of other businesses and industries. The distribution and transmission businesses are subject to rate-regulation that is based on cost recovery and meets the criteria for application of SFAS 71. Refer to Note D, “Regulatory Assets,” for more information.
3. Use of Estimates
The preparation of financial statements in conformity with GAAP requires management of NSTAR and its subsidiaries to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and 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 these estimates.
4. Revenues
Utility revenues are based on authorized rates approved by the DPU and the FERC. Estimates of distribution and transition revenues for electricity and natural gas delivered to customers but not yet billed are accrued at the end of each accounting period.
Revenues for NSTAR’s nonutility subsidiaries are recognized when services are rendered or when the energy is delivered. Revenues are based, for the most part, on long-term contractual rates.
NSTAR records sales taxes collected from its customers on a net basis (excluded from operating revenues).
5. Utility Plant
Utility plant is stated at original cost. The cost of replacements of property units is capitalized. Maintenance, repairs and replacements of certain items are expensed as incurred. The original cost of property retired, net of salvage value, is charged to accumulated depreciation. The incurred related cost of removal is charged against the Regulatory liability - cost of removal in the accompanying Consolidated Balance Sheets. The following is a summary of utility property and equipment, at cost, at December 31:
6. Nonutility Property
Nonutility property is stated at cost or its net realizable value. The following is a summary of nonutility property, plant and equipment, at cost less accumulated depreciation, at December 31:
7. Depreciation and Amortization
Depreciation of utility plant is computed on a straight-line basis using composite rates based on the estimated useful lives of the various classes of property. The composite rates are subject to the approval of the DPU and the FERC. The overall composite depreciation rates for utility property were 3.03%, 3.03% and 3.02% in 2008, 2007 and 2006, respectively. The rates include a cost of removal component, which is collected from customers during the service life of the property. Depreciation and amortization expense on utility plant for 2008, 2007 and 2006 was $168.8 million, $159.3 million, and $149.9 million, respectively.
Depreciation and amortization of nonutility property is computed on a straight-line basis over the estimated life of the asset. The estimated depreciable service lives (in years) of the major components of nonutility property and equipment are as follows:
Depreciation and amortization expense on nonutility property and equipment was $12.3 million, $11.5 million, and $12.8 million for 2008, 2007 and 2006, respectively.
8. Allowance for Borrowed Funds Used During Construction (AFUDC)
AFUDC represents the estimated costs to finance utility plant construction. In accordance with regulatory accounting, AFUDC is included as a cost of utility plant and a reduction of current interest charges. Although AFUDC is not a current source of cash income, the costs are recovered from customers over the service life of the related plant in the form of increased revenues collected as a result of higher depreciation expense. Average AFUDC rates in 2008, 2007 and 2006 were 2.38%, 5.27%, and 5.26%, respectively, and represented only the costs of short-term debt. The 2008 rate decrease is directly related to decreases in short-term borrowing rates.
9. Cash, Cash Equivalents and Restricted Cash
Cash, cash equivalents and restricted cash at December 31, 2008 and 2007 are comprised of liquid securities with maturities of 90 days or less when purchased. Restricted cash represents the funds held by a trustee in connection with Advanced Energy System’s Note Agreement.
NSTAR’s banking arrangements provide for daily cash transfers to its disbursement accounts as vendor checks are presented for payment. These banking arrangements do not permit the right of offset amongst subsidiaries’ cash accounts. As a result, credit balances of certain subsidiary disbursement accounts in the amounts of $19.7 million and $21.7 million, respectively, at December 31, 2008 and 2007 are included in Accounts payable on the accompanying Consolidated Balance Sheets. Changes in the balances of the disbursement accounts are reflected in financing activities in the accompanying Consolidated Statements of Cash Flows.
10. Use of Fair Value
NSTAR uses the fair value hierarchy of SFAS No. 157, “Fair-Value Measurements,” which gives the highest priority to quoted prices in active markets, and is applicable to fair value measurements of derivative contracts and other instruments that are subject to mark-to-market accounting. Refer to Note K, “Fair Value,” for more information.
The fair value of financial instruments is estimated based on market trading information, where available. Absent published market values for an instrument or other assets, management uses observable market data to arrive at its estimates of fair value. For its long-term debt, management estimates are based in part on quotations from broker/dealers or interest rate information for similar instruments. The carrying amount of cash and temporary investments, accounts receivable, accounts payable, short-term borrowings and other current liabilities approximates fair value because of the short maturity and/or frequent repricing of those instruments.
In addition, the Company applies the fair value recognition provisions of SFAS No. 123(R), “Share Based Payment,” to estimate the fair value of its stock-based compensation.
11. Income Taxes
Income taxes are accounted for in accordance with SFAS No. 109 (SFAS 109), “Accounting for Income Taxes.” Income tax expense includes the current tax obligation or benefit and the change in deferred income tax liability for the period. Deferred income taxes result from temporary differences between financial and tax bases of certain assets and liabilities. Uncertain tax positions are accounted for in accordance with FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109, Accounting for Income Taxes.” Refer to Note F, “Income Taxes,” for more information.
12. Equity Method of Accounting
NSTAR uses the equity method of accounting for investments in corporate joint ventures in which it does not have a controlling interest. Under this method, it records as income or loss the proportionate share of the net earnings or losses of the joint ventures with a corresponding increase or decrease in the carrying value of the investment. The investment is reduced as cash dividends are received. NSTAR participates in several corporate joint ventures in which it has investments, principally its 14.5% equity investment in two companies that own and operate transmission facilities to import electricity from the Hydro-Quebec System in Canada, and its equity investments ranging from 4% to 14% in three regional nuclear facilities (CY, MY and YA), all of which have been decommissioned in accordance with the federal NRC procedures.
13. Other Income (Deductions), net of income taxes
Major components of other income, net were as follows:
14. Short-Term Debt Interest Charges (Income), net
Major components of interest charges (income) related to short-term debt and other, net were as follows:
15. Purchase and Sales Transactions with ISO-NE
During 2004 and 2005, NSTAR Electric successfully completed several buy-out and restructuring agreements for substantially all of its long-term purchase power contracts. For the remaining long-term power contract, NSTAR Electric sells its power entitlement through ISO-NE at daily market prices and the contract is not used to satisfy its Basic Service energy requirements. NSTAR Electric is prohibited by the DPU from executing new long-term energy supply agreements without prior approval of the DPU. During 2008, 2007, and 2006, NSTAR recorded an offset for these sales revenues as a reduction to Purchased power and transmission expense of $251.9 million, $212.8 million, and $175.1 million, respectively, on the accompanying Consolidated Statements of Income.
16. New Accounting Standard
SFAS No. 161
On March 19, 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” (SFAS 161) which is intended to improve financial reporting about derivatives and hedging activities by requiring enhanced disclosures. This standard became effective on January 1, 2009. NSTAR anticipates that SFAS 161 will not have a significant impact on its current disclosures.
Note B. Earnings Per Common Share
Basic EPS is calculated by dividing net income, which includes a deduction for preferred dividends of a subsidiary, by the weighted average common shares outstanding during the respective period. Diluted EPS is similar to the computation of basic EPS except that the weighted average common shares are increased to include the impact of potential (nonvested) shares and stock options granted, such as stock-based compensation, in accordance with NSTAR’s Long Term Incentive Plan.
The following table summarizes the reconciling amounts between basic and diluted EPS:
The following table summarizes potential common shares that are excluded from the calculation of diluted EPS as their effect would be anti-dilutive:
Note C. Asset Retirement Obligations
The FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of SFAS No. 143” (FIN 47), “Accounting for Asset Retirement Obligations” (SFAS 143), requires entities to record the fair value of a liability for an ARO in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement.
The recognition of an ARO within NSTAR’s regulated utility businesses has no impact on its earnings. For its rate-regulated utilities, NSTAR establishes a regulatory asset to recognize future recoveries through depreciation rates for the recorded ARO. NSTAR has certain plant assets in which this condition exists and is related to both plant assets containing hazardous materials and legal requirements to undertake remediation efforts upon retirement.
For NSTAR’s regulated utility businesses, the ultimate cost to remove utility plant from service (cost of removal) is recognized as a component of depreciation expense in accordance with approved regulatory treatment. As of December 31, 2008 and 2007, the estimated amount of the cost of removal included in regulatory liabilities was approximately $265 million and $259 million, respectively, based on the estimated cost of removal component in current depreciation rates. At December 31, 2008, NSTAR has an asset retirement cost in utility plant of $3 million, an asset retirement liability of $26 million and a regulatory asset of $21 million.
Note D. Regulatory Assets
Regulatory assets represent costs incurred that are expected to be collected from customers through future rates in accordance with agreements with regulators. These costs are expensed when the corresponding revenues are received in order to appropriately match revenues and expenses.
Regulatory assets consisted of the following:
Under the traditional revenue requirements model, electric and gas rates are based on the cost of providing energy delivery service. Under this model, NSTAR Electric and NSTAR Gas are subject to certain accounting standards that are not applicable to other businesses and industries in general. The application of SFAS 71 requires companies to defer the recognition of certain costs when incurred if future rate recovery of these costs is probable. This is applicable to NSTAR’s electric and gas distribution and transmission operations.
Amortization expense recorded to Depreciation and amortization on the accompanying Consolidated Statements of Income on certain regulatory assets for 2008, 2007 and 2006 was $198.7 million, $198.8 million, and $199.5 million, respectively. The amortization of other regulatory assets is recorded to Purchased power and transmission expense on the accompanying Consolidated Statements of Income.
Energy contracts
At December 31, 2008 and 2007, respectively, $412.7 million and $540.8 million represent the recognition of certain purchase power contract buy-out agreements that NSTAR Electric executed in 2004 and their future recovery through NSTAR Electric’s transition charges. Refer to Note M, “Contracts for the Purchase of Energy,” for further details. Since no cash outlay was incurred by NSTAR to create the regulatory asset, NSTAR does not earn a return on this regulatory asset. NSTAR recognized this regulatory asset as a result of recording the contract termination liability in accordance with SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The contracts’ termination payments will occur over time and will be collected from customers through NSTAR’s transition charge over the same time period. The cost recovery period of these terminated contracts is through September, 2016.
In addition, the unamortized balance of the costs to decommission the CY, YA and MY nuclear power plants was $56.2 million and $64.5 million at December 31, 2008 and 2007, respectively. All three nuclear units were notified by the NRC that their respective former plant sites were decommissioned in accordance with NRC procedures and regulations. NSTAR’s liability for CY decommissioning and its recovery ends at the earliest in 2015, for YA in 2014 and for MY in 2013. However, should the actual costs exceed current estimates, NSTAR could have an obligation beyond these periods that would be fully recoverable. These costs are recovered through NSTAR Electric’s transition charge. NSTAR does not earn a return on decommissioning costs, but a return is included in rates charged to NSTAR by these plants. Refer to Note N, “Commitments and Contingencies,” for further discussion.
The remaining balances at December 31, 2008 and 2007 of $32.9 million and $10.5 million, respectively, represent the recognition of the future recoverability of a derivative liability recorded related to contracts structured to hedge a portion of NSTAR Gas’ future supply purchases. NSTAR Gas does not earn a return on these balances. Refer to Note E, “Derivative Instruments,” for further details. Settled amounts would be refunded or collected from customers no later than 18 months from the settlement date.
Goodwill
The Company’s goodwill originated from the merger that created NSTAR in 1999. As a result of a rate order from the DPU approving the merger, the Company is recovering goodwill from its customers and, therefore, NSTAR has determined that this rate structure allows for amortization of goodwill over the collection period. Goodwill along with related deferred income taxes is being amortized over 40 years, through 2039, without a carrying charge.
Securitized and other energy-related costs
A portion of these energy-related regulatory assets are collateralized with the Transition Property Securitization Certificates held by NSTAR Electric’s subsidiaries, BEC Funding LLC, BEC Funding II, LLC and CEC Funding, LLC. The collateralized amounts at December 31, 2008 and 2007 were $434 million and $586.9 million, respectively. The certificates are non-recourse to NSTAR Electric.
Also included are other costs related to purchase power contract divestitures and certain costs related to NSTAR Electric’s former generation business that are recovered with a return through the transition charge and amounted to $164.8 million and $94.8 million at December 31, 2008 and 2007, respectively. These cost recoveries primarily occur through September, 2016 for NSTAR Electric and are subject to adjustment by the DPU.
The remaining energy-related regulatory assets consist of other transition costs and other recoverable charges of $39 million and $49.8 million at December 31, 2008 and 2007, respectively.
Retiree benefit costs
The retiree benefit regulatory asset at December 31, 2008 and 2007 of $946.7 million and $406.8 million, respectively, is primarily related to the application of SFAS No. 158, “Employers’ Accounting for Deferred Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements Nos. 87, 88, 106, and 132(R)” (SFAS 158). (Refer to Note G, “Pension and Other Postretirement Benefits,” for further details.) During 2008, the funded status of NSTAR’s Pension and PBOP plans was significantly impacted by the declines in the over-all financial markets. This change in funded status resulted in a liability which was offset by a corresponding increase in the retiree benefit costs regulatory asset. The remaining balance reflects the deferred pension and PBOP costs and over-recoveries of these costs. In accordance with the PAM, these amounts are amortized and collected from or returned to customers over three years. At December 31, 2008 and 2007, a deferred over-recovery of costs amounted to $23.8 million and $8.0 million, respectively. NSTAR recovers its qualified pension and PBOP expenses through this reconciling rate mechanism, thereby removing the
volatility in earnings that may have resulted from requirements of existing accounting standards and provides for an annual filing and rate adjustment with the DPU. NSTAR earns a carrying charge on $324.7 million of the retiree benefit regulatory asset under the PAM regulatory mechanism.
Income taxes, net
The principal holder of this regulatory asset is NSTAR Electric. This regulatory asset balance reflects deferred tax reserve deficiencies that are currently being recovered from customers and excludes a return component. Offsetting these amounts is a regulatory liability associated with unamortized investment tax credits relating to NSTAR Electric and NSTAR Gas.
Purchased energy costs
The purchased energy costs at December 31, 2008 and 2007 relate to deferred electric Basic Service and gas supply costs. Basic Service is the electricity that is supplied by NSTAR Electric when a customer has chosen not to receive service from a competitive supplier. The market price for Basic Service and gas supply costs may fluctuate based on the average market price for energy. Amounts incurred for Basic Service and cost of gas supply are recovered on a fully reconciling basis without a return.
Redemption premiums
These amounts reflect the unamortized balance of redemption premiums on NSTAR Electric Debentures that are amortized and recovered over the life of the respective debentures pursuant to DPU approval. The decrease reflects the amortization of these redemption premiums. There is no return recognized on this balance.
Other
Amounts included consist of deferred transmission costs, other DPU costs, and merger-related costs. Deferred transmission costs represent the difference between the level of billed transmission revenues and the current period costs incurred to provide transmission-related services that will be recovered over a subsequent twelve-month period with carrying charges. The costs associated with a DPU-approved safety and reliability program and clean up costs related to former gas manufacturing sites that are recovered over a seven-year period without a return. The merger-related costs are collected from all NSTAR Electric and NSTAR Gas distribution customers as approved by DPU, and exclude a return component. Merger-costs are being amortized over a ten-year period ending in August, 2009.
Note E. Derivative Instruments
Energy Contracts
NSTAR accounts for its energy contracts in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) and SFAS No. 149, “Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities” (SFAS 149). NSTAR has determined that its electricity supply contracts qualify for, and NSTAR has elected, the normal purchases and sales exception. As a result, these agreements are not reflected on the accompanying Consolidated Balance Sheets. NSTAR has only one significant gas supply contract. This contract is an all-requirements portfolio asset management contract that expires in October, 2009. This contract contains market based pricing terms and therefore no financial statement adjustments are required. Gas supply costs incurred related to this contract were $259 million and $224 million for the years ended December 31, 2008 and 2007, respectively, and have been recorded to Cost of gas sold on the accompanying Consolidated Statements of Income. Refer to the accompanying Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” for a further discussion.
Hedging Agreements
In accordance with a DPU order, NSTAR Gas purchases financial contracts based upon NYMEX natural gas futures in order to reduce cash flow variability associated with the purchase price for approximately one-third of its natural gas purchases. This practice attempts to minimize the impact of fluctuations in prices to NSTAR’s firm gas customers. These financial contracts do not procure gas supply. These contracts qualify as derivative financial instruments under SFAS 133, as amended by SFAS 149. Accordingly, the fair value of these instruments is recognized on the accompanying Consolidated Balance Sheets as an asset or liability representing amounts due from or payable to the counter parties of NSTAR Gas, as if such contracts were settled as of the balance sheet date. All actual costs incurred or benefits realized are included in the CGAC of NSTAR Gas. As a result, NSTAR Gas records an offsetting regulatory asset or liability for the market price changes, in lieu of recording an adjustment to Other Comprehensive Income. Currently, these derivative contracts extend through April 2010. As of December 31, 2008 and 2007, NSTAR had recorded a liability and a corresponding regulatory asset of $32.9 million and $10.5 million, respectively, to reflect the fair value of these contracts. During the years ended December 31, 2008 and 2007, $16 million and $30 million, respectively, of these financial contracts were settled and were recognized as additional charges to Cost of gas sold on the accompanying Consolidated Statements of Income.
Note F. Income Taxes
Income taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS 109) and FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS 109.” SFAS 109 requires the recognition of deferred tax assets and liabilities for the future tax effects of temporary differences between the carrying amounts and the tax basis of assets and liabilities. In accordance with SFAS 71 and SFAS 109, net regulatory assets of $29.2 million and $30.2 million and corresponding net increases in accumulated deferred income taxes were recorded as of December 31, 2008 and 2007, respectively. The regulatory assets represent the additional future revenues to be collected from customers for deferred income taxes.
Accumulated deferred income taxes and unamortized investment tax credits consisted of the following:
Investment tax credits are amortized over the estimated remaining lives of the property that generated the credits.
Components of income tax expense were as follows:
The effective income tax rates reflected in the accompanying consolidated financial statements and the reasons for their differences from the statutory federal income tax rate were as follows:
Uncertain Tax Positions
FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109, “Accounting for Income Taxes” establishes criteria for the recognition of income tax benefits. FIN 48 requires the financial statement recognition of an income tax benefit when the company determines that it is more-likely-than-not that the tax position will be ultimately sustained.
NSTAR adopted FIN 48 effective January 1, 2007. NSTAR’s tax accounting policy prior to the adoption of FIN 48 was to recognize uncertain tax positions taken on its income tax returns only if the likelihood of prevailing was probable. FIN 48 establishes a recognition standard of more-likely-than-not, which is a lower threshold than NSTAR’s previous tax recognition policy.
Upon the adoption, and in accordance with FIN 48, NSTAR recognized the cumulative effect of approximately $46.6 million as an increase to its beginning retained earnings related to the deduction from the loss on the abandonment of NSTAR’s investment in the stock of RCN Corporation (RCN) and the deduction of construction-related costs. This adjustment consisted primarily of $39.6 million representing the net unrecognized benefit of the RCN share abandonment. This adjustment also included the reversal of previously accrued interest expense on the RCN deduction and interest income accrued on the deduction of construction-related costs, as discussed further in this Note, which combined netted to $7 million after tax. NSTAR’s assessment of the RCN tax position has consistently been that it is more-likely-than-not of prevailing.
The following is a reconciliation of the unrecognized tax benefits that have been recognized as FIN 48 liabilities on the accompanying Consolidated Balance Sheets included in Deferred Credits - Other:
As of December 31, 2008 and 2007, there were no unrecognized tax benefits of a permanent tax nature that if recognized would have an impact on the Company’s effective tax rate.
RCN Share Abandonment Tax Treatment
On December 24, 2003, NSTAR exited its investment in RCN by formally abandoning its 11.6 million shares of RCN common stock. NSTAR determined that the abandonment at that time was the most tax efficient, cost effective and expedient means to exit its RCN investment. NSTAR also determined that the abandonment at that time outweighed any benefit that it would likely realize from any other alternative, including the future sale of such shares in an orderly fashion consistent with all laws, rules and regulations. Based on NSTAR’s assessment and its tax accounting policy at that time, NSTAR accrued a tax reserve so as not to recognize the tax benefit of the uncertain tax position.
As of December 31, 2006, the potential tax loss contingency was approximately $39.6 million. Upon the adoption of FIN 48, as previously discussed, NSTAR recognized the entire amount as an adjustment to its January 1, 2007 retained earnings balance.
Construction-Related Costs
In 2004, NSTAR filed an amended 2002 Federal income tax return to change the method of accounting for certain construction-related overhead costs previously capitalized to plant to the Simplified Service Cost Method (SSCM). Under SSCM, certain costs which were previously capitalized for tax purposes are deducted in the year incurred. NSTAR has claimed additional deductions related to the tax accounting method change in its 2002-2004 returns of $368.9 million. In 2005, NSTAR received formal notification from the IRS that the claim on its amended income tax return would be denied. NSTAR did not receive the requested refund amount due.
In August 2005, the IRS issued Revenue Ruling 2005-53 and Treasury Regulations under Code Section 263A related to the SSCM to curtail these levels of construction-related cost deductions by utilities and others. Under this Regulation, the SSCM is not available for the majority of NSTAR’s constructed property for the years 2005 and forward. NSTAR was required to make a cash tax payment to the IRS of $129.1 million in late 2006 representing the disallowed SSCM deductions taken for 2002-2004 even though the tax refund was never received. This payment will be fully refunded with interest to NSTAR, once this tax position is resolved. As a result of recent developments, as of December 31, 2008, this refund has been recorded as a current refundable income tax on the accompanying Consolidated Balance Sheets; at December 31, 2007, it was recorded as non-current.
Prior to the adoption of FIN 48, NSTAR assessed its tax position related to this tax benefit as less than more-likely-than-not. However, in measuring the benefit in conjunction with the adoption of FIN 48 as of January 1, 2007, NSTAR recognized $2.3 million, net of tax, of interest income to its January 1, 2007 retained earnings balance.
IRS Appeals and Examinations
As of December 31, 2008, the 2001 through 2007 federal and state tax years remain open. Years 2001 through 2004 (which include the SSCM and RCN Share Abandonment matters) are at the IRS Office of Appeals and years 2005 through 2007 are under examination by the IRS. The 2008 Federal income tax return is being examined under the IRS Compliance Assurance Process (CAP). This program accelerates the examination of the return in an attempt to resolve issues before the tax return is filed. NSTAR expects that ongoing IRS audits will not have a material effect on its financial statements. However, the outcome of any audit and the timing of audit settlement are subject to significant uncertainty.
Interest on Tax Positions
NSTAR recognizes interest accrued related to uncertain tax positions in Interest charges: Short-term debt and other and related penalties, if applicable, in Other deductions, net on the accompanying Consolidated Statements of Income. This accounting policy is consistent with the recognition of these items prior to the adoption of FIN 48. For the years ended December 31, 2008 and 2007, the amount of interest income, net,
recognized on the accompanying Consolidated Statements of Income was $4.6 million and $9.1 million, respectively, and the total amount of accrued interest receivable on the accompanying Consolidated Balance Sheets was $17.8 million and $13.2 million, respectively. No penalties were recognized during 2008 and 2007.
In addition to its FIN 48 tax liability, NSTAR has unrecognized benefits associated with interest on construction-related uncertain tax positions. These unrecognized benefits were $9 million as of December 31, 2008 and 2007. It is possible that the amount of unrecognized tax benefits relating to the deduction for construction-related costs in the form of interest income could significantly change within twelve months from December 31, 2008. This would occur if NSTAR were to reach a final resolution with the IRS Office of Appeals on this issue. The estimated range of the unrecognized potential change is zero to approximately $9 million as of December 31, 2008.
Note G. Pension and Other Postretirement Benefits
NSTAR accounts for the funded status of its Pension and PBOP Plans in accordance with the provisions of SFAS 158. This standard amended SFAS Nos. 87, 88, 106 and 132(R). SFAS 158 requires an employer with a defined benefit plan or other postretirement plan to recognize an asset or liability on its balance sheet for the over funded or under funded status of the plan as defined by SFAS 158. The pension asset or liability is the difference between the fair value of the pension plan’s assets and the projected benefit obligation as of year-end. For other postretirement benefit plans, the asset or liability is the difference between the fair value of the plan’s assets and the accumulated postretirement benefit obligation as of year-end. As a result of NSTAR’s approved regulatory rate mechanism for recovery of pension and postretirement costs, NSTAR has recognized a regulatory asset for the majority of its pension and postretirement costs in lieu of taking a charge to AOCI.
1. Pension
NSTAR sponsors a defined benefit retirement plan, the NSTAR Pension Plan (the Plan), that covers substantially all employees. Retirement benefits are based on various final average pay formulae. NSTAR also maintains a non-qualified retirement plan for certain management employees.
The Plans use December 31st for the measurement date to determine their projected benefit obligation and fair value of plan assets for the purposes of determining the Plans’ funded status and the net periodic benefit costs for the following year.
The following tables for NSTAR’s Pension benefit plans present the change in benefit obligation, change in the Plans’ assets, the funded status, the components of net periodic benefit cost and key assumptions used:
Source of change in other comprehensive income:
The market-related value of NSTAR’s pension plans’ assets is determined based on the actual fair value as of the balance sheet date for all classes of assets. Therefore, the entire difference between the actual and expected return on Plan assets is reflected as a component of unrecognized actuarial net gain or loss.
Amounts recognized in the accompanying Consolidated Balance Sheets consisted of:
The estimated prior service cost and net actuarial loss that will be amortized from AOCI and regulatory assets into net periodic benefit cost in 2009 are $20,000 and $16.2 million, respectively.
The accumulated benefit obligation for the qualified pension plan as of December 31, 2008 and 2007 were $969.6 million and $962.9 million, respectively.
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the non-qualified retirement plan were $46 million, $42.1 million and $0, respectively, as of December 31, 2008 and were $45.2 million, $41.7 million and $0, respectively, as of December 31, 2007.
Weighted average assumptions were as follows:
The Plans’ discount rates are based on a rate modeling of a bond portfolio that approximates the Plan liabilities. In addition, management considers rates of high quality corporate bonds of appropriate maturities as published
by nationally recognized rating agencies consistent with the duration of the Company’s plans and through periodic bond portfolio matching. The Plans’ long-term rates of return are based on past performance and economic forecasts for the types of investments held in the Plans as well as the target allocation of the investments over a long-term period. Actuarial assumptions also include an assumed rate for administrative expenses and investment expenses, which have averaged approximately 0.6% for 2008, 2007 and 2006.
Components of net periodic benefit cost were as follows:
The following reflects the weighted average asset allocation percentage of the fair value of the Pension Plan’s assets for each major type of asset as of December 31st as well as the targeted ranges:
The alternative asset category consists of hedge funds and common/collective trusts.
The primary investment goal of the Plans is to achieve a total annualized return of 9% (before expenses) over the long-term and to minimize unsystematic risk so that no single security or class of securities will have a disproportionate impact on the Plans. Risk is regularly evaluated, compared and benchmarked to plans with a similar investment strategy. Other benchmarks are also considered. NSTAR currently uses 22 asset managers to manage its plans’ assets. Assets are diversified by several asset classes (i.e., equities, bonds) and within these classes (i.e., economic sector, industry), such that, for each asset manager:
•
No more than 6% of an asset manager’s equity portfolio market value may be invested in one company
•
Each equity portfolio should be invested in at least 20 different companies in different industries
•
No more than 50% of each equity portfolio’s market value may be invested in one industry sector, and
•
No more than 5% of a fixed income manager’s portfolio may be invested in the security of an issuer, except the U.S. Government and its agencies.
Employer contributions in 2008 of $70 million were made to the qualified plan and $2.6 million of contributions in the form of funding benefit payments from the non-qualified plan. NSTAR anticipates making contributions to its qualified Pension Plan in 2009 of approximately $25 million.
The estimated benefit payments for the next 10 years are as follows:
2. Other Postretirement Benefits
NSTAR also provides health care and other benefits to retired employees who meet certain age and years of service eligibility requirements. These benefits include health and life insurance coverage. Under certain circumstances, eligible retirees are required to contribute to the cost of postretirement benefits.
NSTAR’s other postretirement benefits are not vested and the Company has the right to modify any benefit provision, including contribution requirements, with respect to any current or former employee, dependent or beneficiary, subject to applicable laws at that time.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) was adopted by NSTAR assuming continuation of prescription drug benefits to retirees that are at least actuarially equivalent to the benefits provided under Medicare Part D. For employers like NSTAR that continue to provide prescription drug programs for eligible former employees age 65 and over, there are subsidies available that are contained in the Act in the form of direct tax-exempt cash payments. The subsidy reduces service cost when it is recognized as a component of net periodic postretirement benefits cost, and it reduced NSTAR’s net periodic postretirement benefit cost by approximately $12 million and $12.1 million in 2008 and 2007, respectively. However, as a result of the PAM, these reductions do not have a material impact on reported earnings.
NSTAR’s other postretirement plans use December 31st for the measurement date to determine its benefit obligation and fair value of plan assets for the purposes of determining the plans’ funded status and the net periodic benefit costs for the following year.
The following tables for NSTAR’s postretirement plans present the change in benefit obligation, change in the plans’ assets, the funded status, the components of net periodic benefit cost and key assumptions used:
The plans’ funded status was as follows:
Source of change in other comprehensive income:
The estimated transition obligation, prior service credit and net actuarial loss that will be amortized from AOCI and regulatory assets into net periodic benefit costs in 2008 are $0.8 million, $1.4 million and $20.6 million, respectively.
Weighted average assumptions were as follows:
For measurement purposes, a 9.0% weighted annual rate increase in per capita cost of covered medical claims was assumed for 2008. This rate is assumed to decrease gradually to 5% in 2015 and remain at that level thereafter. Dental claims are assumed to increase at a weighted annual rate of 4%.
A 1% change in the assumed health care cost trend rate would have the following effects:
Components of net periodic benefit cost were as follows:
NSTAR anticipates making an estimated contribution of approximately $30 million to its other postretirement benefit plans in 2009.
The estimated future cash flows for the years after 2008 are as follows:
The following reflects the weighted average asset allocation percentages of the fair value of the PBOP Plan assets for each major type of assets as of December 31st as well as the targeted ranges:
The alternative asset category consists primarily of hedge funds.
The assets of NSTAR’s PBOP Plan are held in voluntary employees’ beneficiary association trusts and in the Pension Plan 401(h) account which is a subset of the Pension Plan assets and are not reflected as a component of the Pension Plan assets.
The Plan’s primary investment goal is to outperform the return of the composite benchmark. The portfolio also seeks a level of volatility, which approximates that of the composite benchmark returns. Other benchmarks are also considered.
3. Savings Plan
NSTAR also provides a defined contribution 401(k) plan for substantially all employees. Matching contributions (which are equal to 50% of the employees’ deferral up to 8% of eligible base and cash incentive compensation subject to statutory limits) included in the accompanying Consolidated Statements of Income amounted to $9.4 million, $8.9 million and $9 million in 2008, 2007 and 2006, respectively. The election available to participants to reinvest dividends paid on the NSTAR Common Share Fund or receive the dividends in cash is subject to a freeze period beginning seven days prior to the date any dividend is paid. During this period, participants cannot change their election. NSTAR dividends are paid to this plan four times a year in February, May, August and November.
Note H. Stock-Based Compensation
NSTAR accounts for its equity-based compensation in accordance with the provisions of SFAS 123(R), “Stock-Based Compensation.”
The NSTAR 2007 Long Term Incentive Plan (the 2007 Plan) permits a variety of stock and stock-based awards, including stock options, deferred stock awards and performance share units granted to key employees. Subject to adjustment for stock-splits and similar events, the aggregate number of common shares that are available for award under the 2007 Plan is 3.5 million. The Plan limits the terms of awards to ten years and prohibits the granting of awards beyond ten years after its effective date. In general, stock options and deferred shares vest over a three-year period from date of grants. Performance share units vest only at the end of a three year performance period if performance conditions are met. The Executive Personnel Committee (EPC) of the Board of Trustees approves stock-based awards for all executives and other key employees. However, the Chief Executive Officer (CEO)’s award must also be approved by the independent members of the Board of Trustees. The EPC and Board of Trustees established that the date of grant for annual stock-based awards under the Plan is the date each year on which the Board of Trustees approves the CEO’s stock award. This date is when all participants are notified of their awards. Options are granted at the full market price of the common shares on the date of grant. The aggregate remaining number of common shares available for award under the Plan as of December 31, 2008 is 3,597,703 unissued shares and includes unvested shares from NSTAR’s 1997 Share Incentive Plan.
Stock-based compensation activities of the Plans were as follows:
Stock Options:
Summarized information regarding stock options outstanding at December 31, 2008:
There were 1,567,304, 1,287,092, and 1,175,393 stock options exercisable as of December 31, 2008, 2007 and 2006, respectively. As of December 31, 2008, 2007 and 2006, the associated weighted average exercise price of these exercisable options is $26.59, $22.38, and $23.75, respectively. The total intrinsic value (the market price of the common shares on the date exercised, less the option exercise prices) of options exercised during the years ended December 31, 2008, 2007 and 2006 was $1.4 million, $5.3 million, and $9.7 million, respectively.
The stock options granted in 2008, 2007 and 2006 have a grant date fair value of $3.76, $4.79, and $3.86, respectively. The fair value was estimated using the Black-Scholes option-pricing model that uses the assumptions in the table below. The expected option lives are based on the average historical time frame that options are expected to remain unexercised. Expected volatilities are based on the historical performance of NSTAR’s stock price. The risk-free interest rate is based on the U.S. Treasury Strip in effect on grant date. The fair values were computed using the following range of assumptions for NSTAR’s stock options for the years ended December 31:
Deferred Shares:
The fair value of deferred shares vested during 2008 and 2007 was $6.2 million and $7.2 million, respectively.
Performance Share Units:
Performance share unit awards under the 2007 Plan contain performance criteria that affect the number of shares that ultimately vest. Restrictions on performance share unit awards lapse after a three-year period contingent on achievement of certain earnings growth performance measures. These awards grant the right to receive, at the
end of the performance period, a variable number of shares based on the level of NSTAR’s earnings growth and a total shareholder return that is compared to companies in the EEI Index. This variable range extends from 0% to 170% of the granted awards. The 2008 performance awards grant date fair value was estimated to be $32.70 for the targeted performance level using a binomial option-pricing model. No performance share awards were granted during 2007 or 2006.
Management evaluates the probability of meeting the performance criteria at each balance sheet date and related compensation cost is amortized over the performance period on a straight-line basis. If the performance is not achieved, no compensation cost is recognized and any previously recognized compensation cost is reversed. No performance share units vested during 2008.
Total Stock-Based Compensation
As of December 31, 2008, the total stock-based compensation cost related to nonvested stock options, deferred share awards and performance share units not yet recognized was $9.6 million. The remaining weighted average period over which total stock-based compensation will be recognized is 1.61 years.
Total stock-based compensation cost recognized in the accompanying Consolidated Statements of Income in 2008, 2007 and 2006 was $9.7 million, $8.9 million, and $8.2 million, respectively. Approximately $1.9 million, $1.7 million and $1.5 million of costs related to stock options are included in the 2008, 2007 and 2006 stock-based compensation totals, respectively.
2009 Awards
On January 22, 2009, NSTAR granted awards, under the terms of the 2007 Plan, of 352,000 stock options, 134,050 deferred shares and 78,750 performance based share units to executives and senior managers.
Stock options, deferred shares and performance share units granted on January 22, 2009 have a grant date fair value of $3.64, $34.02 and $33.85, respectively. The grant date fair value of deferred shares and the exercise price of stock options are equal to the closing price of the Company’s common shares on January 22, 2009.
Note I. Capital Stock and Accumulated Other Comprehensive Income
NSTAR’s Board of Trustees declared dividends per common share of $1.425, $1.325, and $1.535 in 2008, 2007, and 2006, respectively. As a result of a change in NSTAR’s Board of Trustees’ meetings schedule in 2005, the fourth quarter dividend that typically would have been declared in December 2005, was approved on January 26, 2006 at $0.3025 per share, and therefore dividends declared during 2006 include the fourth quarter of 2005. The dividend payment schedule remained unchanged.
1. Common Shares
Common share and accumulated other comprehensive income activity in 2008 and 2007 was as follows:
2. Cumulative Preferred Stock of Subsidiary
Non-mandatory redeemable series:
Par value $100 per share, 2,890,000 shares authorized and 430,000 shares issued and outstanding:
NSTAR Electric has two outstanding series of non-mandatory redeemable preferred stock. Both series are part of a class of NSTAR Electric’s Cumulative Preferred Stock. Upon any liquidation of NSTAR Electric, holders of the Cumulative Preferred stock are entitled to receive the liquidation preference for their shares before any distribution to the holder of the common stock. The liquidation preference for each outstanding series of Cumulative Preferred Stock is equal to the par value ($100.00 per share), plus accrued and unpaid dividends.
Note J. Indebtedness
1. Long-Term Debt
NSTAR’s long-term debt consisted of the following:
Consistent with the recovery in utility rates, discounts, redemption premiums and related costs associated with the issuance and redemption of long-term debt are deferred and amortized as an addition to interest expense over the life of the original or replacement debt.
On May 18, 2007, NSTAR Electric filed with the DPU for approval to issue up to $400 million of long-term debt securities from time to time through December 31, 2008. On May 18, 2007, in connection with this filing, NSTAR Electric filed a registration statement on Form S-3 with the SEC to issue up to $400 million in debt securities. This registration statement became effective on June 1, 2007. The DPU approved this financing plan on August 9, 2007. On November 19, 2007, NSTAR Electric sold $300 million of ten-year fixed rate (5.625%) Debentures. NSTAR Electric used the proceeds from the issuance of these securities to finance its capital expenditures, for repayment of short-term debt, and for general working capital purposes. On November 25, 2008, the DPU allowed NSTAR Electric to extend the period of its financing plan with additional time to issue the remaining $100 million in long-term debt securities to no later than December 31, 2009.
Sewage facility revenue bonds are tax-exempt, subject to annual mandatory sinking fund redemption requirements and mature through 2015. Scheduled redemptions of $1.65 million were made in 2008 and 2007. The interest rate of the bonds was 7.375% for both 2008 and 2007.
The 5.75% tax-exempt unsecured MIFA bonds due 2014 are currently redeemable at par.
The aggregate principal amounts of NSTAR is long-term debt (including securitization certificates and sinking fund requirements) due in the five years subsequent to 2008 are approximately $98 million in 2009, $751 million in 2010, $91 million in 2011, $492 million in 2012, $52 million in 2013 and $966 million thereafter.
The Transition Property Securitization Certificates held by NSTAR Electric’s subsidiaries, BEC Funding LLC, BEC Funding II, LLC and CEC Funding, LLC (Funding companies), are each collaterized with separate securitized regulatory assets with combined balances of $434 million and $586.9 million as of December 31, 2008 and 2007, respectively. NSTAR Electric, as servicing agent for the Funding companies, collected $179.9 million and $185.1 million in 2008 and 2007, respectively. Funds collected from the companies’ respective customers are transferred to each Funding companies’ Trust on a daily basis. These Certificates are non-recourse to NSTAR Electric.
On March 16, 2006, NSTAR Electric sold $200 million of thirty-year fixed rate (5.75%) Debentures. The net proceeds were primarily used to repay outstanding short-term debt balances.
2. Financial Covenant Requirements and Lines of Credit
NSTAR and NSTAR Electric have no financial covenant requirements under their respective long-term debt arrangements. NSTAR Gas has financial covenant requirements including a minimum equity requirement under its long-term debt arrangements and was in compliance at December 31, 2008 and 2007. NSTAR’s long-term debt other than the secured debt of NSTAR Gas and MATEP, is unsecured.
NSTAR currently has a $175 million revolving credit agreement that expires December 31, 2012. At December 31, 2008 and 2007, there were no amounts outstanding under the revolving credit agreement. This credit facility serves as a backup to NSTAR’s $175 million commercial paper program that, at December 31, 2008 and 2007, had $175 million and $4 million outstanding, respectively. Under the terms of the credit agreement, NSTAR is required to maintain a maximum total consolidated debt to total capitalization ratio of not greater than 65% at all times, excluding Transition Property Securitization Certificates, and excluding accumulated other comprehensive income (loss) from common equity. Commitment fees must be paid on the total agreement amount. At December 31, 2008 and 2007, NSTAR was in full compliance with the aforementioned covenant as the ratios were 60.2% and 58.2%, respectively.
NSTAR Electric has approval from the FERC to issue short-term debt securities from time to time on or before October 22, 2010, with maturity dates no later than October 21, 2011, in amounts such that the aggregate principal does not exceed $655 million at any one time. NSTAR Electric has a five-year, $450 million revolving credit agreement that expires December 31, 2012. However, unless NSTAR Electric receives necessary approvals from the DPU, the credit agreement will expire 364 days from the date of the first draw under the agreement. At December 31, 2008 and 2007, there were no amounts outstanding under the revolving credit agreement. This credit facility serves as backup to NSTAR Electric’s $450 million commercial paper program that had $354.6 million and $257 million outstanding balances at December 31, 2008 and 2007, respectively. Under the terms of the revolving credit agreement, NSTAR Electric is required to maintain a consolidated maximum total debt to capitalization ratio of not greater than 65% at all times, excluding Transition Property Securitization Certificates, and excluding accumulated other comprehensive income (loss) from common equity. At December 31, 2008 and 2007, NSTAR Electric was in full compliance with its covenants in connection with its short-term credit facilities, as the ratios were 47.6% and 46.2%, respectively.
As of December 31, 2008, NSTAR Gas had a $100 million line of credit ($200 million as of December 31, 2007). This line of credit is due to expire on December 11, 2009. As of December 31, 2008 and 2007, NSTAR Gas had $53.3 million and $142.4 million outstanding, respectively.
Historically, NSTAR and its subsidiaries have had a variety of external sources of financing available, as indicated above, at favorable rates and terms to finance its external cash requirements. However, the availability of such financing at favorable rates and terms depends heavily upon prevailing market conditions and NSTAR’s or its subsidiaries’ financial condition and credit ratings.
NSTAR’s goal is to maintain a capital structure that preserves an appropriate balance between debt and equity. Based on NSTAR’s key cash resources available as discussed above, management believes its liquidity and capital resources are sufficient to meet its current and projected requirements.
Interest rates on the outstanding short-term borrowings generally are money market rates and averaged 2.31% and 5.24% in 2008 and 2007, respectively. In aggregate, short-term borrowings totaled $582.9 million and $403.4 million at December 31, 2008 and 2007, respectively.
On December 2, 2008, NSTAR Electric filed a two-year financing plan with the DPU to issue an additional $500 million in long-term debt securities, and awaits approval of this filing.
Note K. Fair Value
Fair Value Measurements - FAS 157
SFAS No. 157, as amended, “Fair Value Measurements” (SFAS 157), defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. While the standard does not expand the use of fair value, it has applicability to several current accounting standards that require or permit measurement of assets and liabilities at fair value. The Company prospectively adopted SFAS 157 on January 1, 2008, with no impact to its results of operations, financial position, or cash flows.
SFAS 157 establishes a fair value hierarchy that prioritizes the inputs used to determine fair value and requires the Company to classify assets and liabilities carried at fair value based on the observability of these inputs. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The three levels of the fair value hierarchy defined by SFAS 157 are:
Level 1 - Unadjusted quoted prices available in active markets for identical assets or liabilities as of the reporting date. Financial assets utilizing Level 1 inputs include active exchange-traded equity securities.
Level 2 - Quoted prices available in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are directly observable, and inputs derived principally from market data.
Level 3 - Unobservable inputs from objective sources. These inputs may be based on entity-specific inputs. Level 3 inputs include all inputs that do not meet the requirements of Level 1 or Level 2.
The following represents the fair value hierarchy of NSTAR’s financial assets and liabilities that were recognized at fair value on a recurring basis as of December 31, 2008. As required by SFAS 157, financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.
Recurring Fair Value Measures
(a) - Included in “Cash and cash equivalents” on the accompanying Consolidated Balance Sheets
(b) - Included in “Other investments” on the accompanying Consolidated Balance Sheets
(c) - Included in “Current liabilities: Other” on the accompanying Consolidated Balance Sheets
Financial Instruments - FAS 107
The carrying amounts for cash and cash equivalents, net accounts receivable, other current assets, certain current liabilities, and notes payable as of December 31, 2008 and 2007, respectively, approximate fair value due to the short-term nature of these securities.
The fair values of long-term indebtedness (excluding notes payable) are based on the quoted market prices of similar issues. Carrying amounts and fair values as of December 31, 2008 and 2007 were as follows:
Note L. Segment and Related Information
For the purpose of providing segment information, NSTAR’s principal operating segments, are its traditional core businesses of electric and natural gas retail transmission and distribution utilities that provide energy delivery services in 107 cities and towns in Massachusetts. The unregulated operating segment engages in business activities that include district energy operations, telecommunications, and a liquefied natural gas service. Amounts shown on the following table for 2008, 2007 and 2006 include the allocation of NSTAR’s (Holding Company) results of operations (primarily interest costs) and assets to each business segment, net of inter-company transactions that primarily consist of interest charges and investment assets, respectively. The allocation of Holding Company charges is based on an indirect allocation of the Holding Company’s investment relating to these various business segments.
Financial data for the operating segments were as follows:
(a) The equity income from equity investments is included in other income, net on the accompanying Consolidated Statements of Income.
Note M. Contracts for the Purchase of Energy
1. NSTAR Electric Purchase Power Agreements
As a Massachusetts distribution company, NSTAR Electric is required to obtain and resell power to retail customers through Basic Service for those who choose not to buy energy from a competitive energy supplier. Basic Service rates are reset every six months (every three months for large commercial and industrial customers). The price of Basic Service is intended to reflect the average competitive market price for power. For basic service power supply, NSTAR Electric makes periodic market solicitations consistent with DPU
regulations. NSTAR Electric enters into short-term power purchase agreements to meet its Basic Service supply obligation, ranging in term from three to twelve months. NSTAR Electric fully recovers its payments to suppliers through DPU-approved rates billed to customers.
The Rate Settlement Agreement required NSTAR Electric to design a policy for the procurement of Basic Service supply for residential customers effective July 1, 2006, permitting NSTAR Electric to execute energy supply contracts for one, two and three-years procuring fifty, twenty-five and twenty-five percent, respectively, of its total energy load requirements for residential customers. NSTAR Electric, after working with the AG and a low-income support organization, developed a schedule to implement this provision. In 2007, NSTAR Electric entered into two longer-term renewable energy supply contracts with 10-year terms, which were filed with the DPU for approval. In April 2008, the DPU approved the contracts and the recovery of costs through Basic Service rates.
2. NSTAR Gas Firm Transportation and Storage Agreements
NSTAR Gas purchases transportation, storage, and balancing services from Tennessee Gas Pipeline Company and Algonquin Gas Transmission Company, as well as other upstream pipelines that bring gas from major producing regions in the U.S., Gulf of Mexico, and Canada to the final delivery points in the NSTAR Gas service area. NSTAR Gas purchases all of its gas supply from third-party vendors. Most of the supplies are purchased under a firm portfolio management contract with a term of one year. NSTAR Gas has one multiple year contract, which is used for the purchase of its Canadian supplies for up to 4,500 MMbtu per day. Based on its firm pipeline transportation capacity entitlements, NSTAR Gas contracts for up to 139,214 MMbtu per day of domestic production.
NSTAR Gas has various contractual agreements covering the transportation of natural gas and underground natural gas storage facilities, which are recoverable from customers under the DPU-approved rates, through its CGAC. The contracts expire at various times from 2009 to 2016. NSTAR Gas’ firm contract demand charges associated with firm pipeline transportation and storage capacity contracts in 2008, 2007, and 2006 were approximately $51.5 million, $51.8 million, and $50.6 million, respectively. Refer to Note N, “Commitments and Contingencies,” “Energy Supply” section for NSTAR Gas’ firm contract demand charges at current rates under these contracts for the years after 2008.
Note N. Commitments and Contingencies
1. Service Quality Indicators
SQI are established performance benchmarks for certain identified measures of service quality relating to customer service and billing performance, safety and reliability and consumer division statistics performance for all Massachusetts utilities. NSTAR Electric and NSTAR Gas are required to report annually to the DPU concerning their performance as to each measure and are subject to maximum penalties of up to two percent (two and a half percent beginning in 2009) of total transmission and distribution revenues should performance fail to meet the applicable benchmarks.
NSTAR monitors its service quality continuously to determine if a liability has been triggered. If it is probable that a liability has been incurred and is estimable, a liability is accrued. Annually, each NSTAR utility subsidiary makes a service quality performance filing with the DPU. Any settlement or rate order that would result in a different liability level from what has been accrued would be adjusted in the period that the DPU issues an order determining the amount of any such liability.
On March 1, 2007, NSTAR Electric and NSTAR Gas filed their 2006 Service Quality Reports with the DPU that demonstrated the Companies achieved sufficient levels of performance. The reports indicate that no penalty was assessable for 2006. The DPU approved both filings but did not approve NSTAR Electric’s benchmarks due to
outstanding DPU decisions relating to changes in the calculation of reliability measures for the duration and frequency of service interruptions. On September 25, 2008, the DPU issued an order clarifying these requirements, and NSTAR Electric will file recalculated benchmarks in 2009.
On February 29, 2008, NSTAR Electric and NSTAR Gas filed their 2007 Service Quality Reports with the DPU that demonstrated the Companies achieved sufficient levels of performance. The NSTAR Electric report did not include 2007 results for reliability measures for the duration and frequency of service interruptions due to the outstanding DPU decisions. The filed reports indicate that no penalty was assessable for 2007 for non-reliability measurements. On May 16, 2008, the DPU issued an order that approved the NSTAR Gas 2007 Service Quality Report, as filed. The September 2008 order clarified the outstanding issues pertaining to calculating reliability measures for the duration and frequency of service interruptions. NSTAR Electric will now file its 2007 Service Quality Report for reliability performance information in 2009.
In addition, the May and September 2008 DPU orders established new requirements for NSTAR Electric performance metrics related to poor performing circuits. These new performance metrics measure circuit performance over a three-year period that commenced on January 1, 2007. NSTAR Electric’s performance level has not been in a penalty position as of December 31, 2008. NSTAR Electric will not be able to determine its final performance related to SQI circuit performance measurements until the end of 2009.
On July 2, 2008, the Massachusetts Legislature passed the “Green Communities Act” (GCA), an energy policy legislation. Among other things, the GCA increased the potential maximum service quality performance penalties provision from 2% to 2.5% of total transmission and distribution revenues effective for the 2009 performance year.
2. Contractual Commitments
Leases
NSTAR has leases for facilities and equipment, including agreements for use of transmission facilities of other providers. The estimated minimum rental commitments under non-cancellable operating leases for the years after 2008 are as follows:
NSTAR was notified by one of its lessors of vehicle fleet operating leases that the agreement will terminate on November 13, 2009. As a result, a $28 million one-time payment is anticipated to be made by November 13, 2009 to buyout of this agreement. This obligation is not included in the above schedule.
The total expense for both leases and transmission agreements was $26.7 million in 2008, $24.7 million in 2007, and $26.8 million in 2006, net of capitalized expenses of $2.6 million in 2008, $2.4 million in 2007, and $2.3 million in 2006.
Transmission
As a member of ISO-NE, NSTAR Electric is subject to the terms and conditions of the ISO-NE tariff through February 2010, as NSTAR Electric is obligated to remain a member through this period. NSTAR Electric is
obligated to pay for regional network services through that period to support the pooled transmission facilities requirements of other New England transmission owners whose facilities are used by NSTAR Electric. These payments amounted to $134.6 million, $130.2 million, and $89.4 million in 2008, 2007 and 2006, respectively. This membership also obligates NSTAR Electric, along with other transmission owners and market participants, to fund a proportionate share of the RTO’s operating and capital expenditures.
Energy Commitments
NSTAR is currently recovering payments it is making to suppliers from its customers and has financial and performance assurances and financial guarantees in place with those suppliers to protect NSTAR from risk in the unlikely event any of its suppliers encounter financial difficulties or fail to maintain an investment grade credit rating. This condition principally relates to NSTAR Electric’s energy supply contract to provide Basic Service to its customers. In connection with certain of these agreements, in the event NSTAR Electric should receive a credit rating below investment grade, it would be required to obtain certain financial commitments, including but not limited to, letters of credit. Refer to Note M, “Contracts for the Purchase of Energy” for a further discussion.
The following represents NSTAR’s long-term energy related contractual commitments:
Electric capacity obligations represent remaining capacity costs of long-term contracts that reflect NSTAR Electric’s proportionate share of capital and fixed operating costs of certain generating units. These contracts expire in 2012 and 2019. In 2008 and 2007, these costs were attributed to 47.9 MW of capacity purchased. Energy costs are paid to generators based on a price per kWh actually received into NSTAR Electric’s distribution system and are in addition to the costs above.
Gas transportation and storage obligations represent agreements covering the transportation of natural gas and underground natural gas storage facilities that are recoverable from customers under the DPU-approved CGAC. These contracts expire at various times from 2009 through 2016.
Purchase power buy-out obligations represent the buy-out/restructuring agreements for contract termination costs that reduce the amount of above-market costs that NSTAR Electric will collect from its customers through its transition charges. These agreements require NSTAR Electric to make monthly payments through September, 2016.
The electric interconnection agreement relates to a single interconnection with a municipal utility for additional capacity into NSTAR Electric’s service territory.
3. Electric Equity Investments and Joint Ownership Interest
NSTAR has an equity investment of approximately 14.5% in two companies that own and operate transmission facilities to import electricity from the Hydro-Quebec system in Canada. As an equity participant, NSTAR Electric is required to guarantee, in addition to its own share, the obligations of those participants who do not meet certain credit criteria. NEH and NHH have agreed to use their best efforts to limit their equity investment to 40% of their total capital during the time NEH and NHH have outstanding debt in their capital structure.
NSTAR Electric collectively has an equity ownership of 14% in CY, 14% in YA, and 4% in MY, (collectively, the “Yankee Companies”). CY, YA and MY plant sites have been decommissioned in accordance with NRC procedures. Amended licenses continue to apply to the ISFSI’s where spent nuclear fuel is stored at these sites. CY, YA and MY remain responsible for the security and protection of the ISFSI and are required to maintain radiation monitoring programs at the sites.
The accounting for decommissioning and/or security or protection costs of these three decommissioned nuclear power plants involves estimates from Yankee Companies’ management and reflect total remaining costs of approximately $56 million to be incurred for CY, YA and MY. Changes in these estimates will not affect NSTAR’s results of operations or cash flows because these costs will be collected from customers through NSTAR Electric’s transition charge filings with the DPU.
Yankee Companies Spent Fuel Litigation
In October, 2006, the U.S. Court of Federal Claims issued a judgment in a spent nuclear fuel litigation, in the amounts of $34.2 million, $32.9 million and $75.8 million for CY, YA and MY, respectively. This judgment in favor of these Yankee companies relates to the alleged failure of the DOE to provide for a permanent facility to store spent nuclear fuel for years prior to 2001 for CY and YA, and prior to 2002 for MY. NSTAR Electric’s portion of the judgment amounts to $4.8 million, $4.6 million and $3 million, respectively. On December 4, 2006, the DOE filed its notice of appeal of the trial court’s decision. As a result, the Yankee Companies have not recognized the damage awards on their books, and therefore, NSTAR Electric has not recognized its portion. On December 14, 2007, the Yankee companies filed complaints against the DOE seeking damages from 2001 for CY and YA, and from 2002 for MY, through a future trial date. On August 7, 2008, a federal appeals court reversed and remanded the U.S. Court of Federal Claims judgment based on an error in the measurement of the award calculation. NSTAR cannot predict the ultimate outcome of this decision on appeal or the subsequent complaints. However, should NSTAR Electric ultimately prevail, proceeds received would be refunded to customers.
4. Financial and Performance Guarantees
On a limited basis, NSTAR and certain of its subsidiaries may enter into agreements providing financial assurance to third parties. Such agreements include letters of credit, surety bonds, and other guarantees.
At December 31, 2008, outstanding guarantees totaled $29.3 million as follows:
Letter of Credit
NSTAR has issued a $5.6 million letter of credit for the benefit of a third party, as trustee in connection with Advanced Energy System’s 6.924% Notes. The letter of credit is available if the subsidiary has insufficient funds to pay the debt service requirements. As of December 31, 2008, there have been no amounts drawn under its letter of credit.
Surety Bonds
As of December 31, 2008, certain of NSTAR’s subsidiaries have purchased a total of $1.4 million of performance surety bonds for the purpose of obtaining licenses, permits and rights-of-way in various municipalities. In addition, NSTAR and certain of its subsidiaries have purchased approximately $16.2 million in
workers’ compensation self-insurer bonds. These bonds support the guarantee by NSTAR and certain of its subsidiaries to the Commonwealth of Massachusetts, required as part of the Company’s workers’ compensation self-insurance program. NSTAR and certain of its subsidiaries have indemnity agreements to provide additional financial security to its bond company in the form of a contingent letter of credit to be triggered in the event of a downgrade in the future of NSTAR’s Senior Note rating to below BBB by S&P and/or to below Baa1 by Moody’s. These Indemnity Agreements cover both the performance surety bonds and workers’ compensation bonds.
Hydro-Quebec Guarantees
NSTAR and its subsidiaries have also issued approximately $6.1 million of residual value guarantees related to its equity interest in the Hydro-Quebec transmission companies.
5. Environmental Matters
NSTAR subsidiaries face possible liabilities as a result of involvement in several multi-party disposal sites, state-regulated sites or third party claims associated with contamination remediation. NSTAR generally expects to have only a small percentage of the total potential liability for the majority of these sites. As of December 31, 2008 and 2007, NSTAR had a liability of approximately $0.8 million for these environmental sites. This estimated recorded liability is based on an evaluation of all currently available facts with respect to these sites.
NSTAR Gas is participating in the assessment or remediation of certain former MGP sites and alleged MGP waste disposal sites to determine if and to what extent such sites have been contaminated and whether NSTAR Gas may be responsible to undertake remedial action. The DPU permits recovery of costs associated with MGP sites over a 7-year period, without carrying costs. As of December 31, 2008 and 2007, NSTAR had a liability of approximately $13.3 million and $10.1 million, respectively, as an estimate for site cleanup costs for several MGP sites for which NSTAR Gas was identified as a potentially responsible party. A corresponding regulatory asset was recorded that reflects the future rate recovery for these costs.
Estimates related to environmental remediation costs are reviewed and adjusted as further investigation and assignment of responsibility occurs and as either additional sites are identified or NSTAR’s responsibilities for such sites evolve or are resolved. NSTAR’s ultimate liability for future environmental remediation costs may vary from these estimates. Based on NSTAR’s current assessment of its environmental responsibilities, existing legal requirements, and regulatory policies, NSTAR does not believe that these environmental remediation costs will have a material adverse effect on NSTAR’s consolidated results of operations, financial position, or cash flows.
6. Regulatory and Legal Proceedings
DPU Rate Settlement Agreement
The DPU approved a seven-year Rate Settlement Agreement (Rate Settlement Agreement) between NSTAR, the AG, and several interveners. For 2006, the Rate Settlement Agreement required NSTAR Electric to lower its transition rates by $20 million, effective January 1, 2006, and by an additional $30 million, effective May 1, 2006, from what would otherwise have been billed in 2006. Effective May 1, 2006, NSTAR Electric increased its distribution rates by $30 million. Beginning January 1, 2007 and continuing through 2012, the Rate Settlement Agreement establishes annual inflation-adjusted distribution rate increases (SIP of 1.74%, 2.68%, and 2.64% effective January 1, 2009, 2008, and 2007, respectively). These increases are generally offset by an equal and corresponding reduction in transition rates. Uncollected transition charges as a result of the reductions in transition rates are deferred and collected through future rates with a carrying charge. The Rate Settlement Agreement implemented a 50%/50% earnings sharing mechanism based on NSTAR Electric’s distribution return on equity (excluding incentives) should it exceed 12.5% or fall below 8.5%. Should the return on equity fall below 7.5%, NSTAR Electric may file a request for a general rate increase.
Wholesale Power Cost Savings Initiatives
The Rate Settlement Agreement encourages NSTAR Electric to continue its efforts to advocate on behalf of customers at the FERC to mitigate wholesale electricity cost inefficiencies that would be borne by regional customers. If NSTAR Electric’s efforts to reduce customers’ costs are successful, it is allowed to retain a portion of those savings as an incentive, as well as recover related litigation costs. Under the terms of the Rate Settlement Agreement, NSTAR Electric was to share in 25% of the savings applicable to its customers. The recovery of NSTAR Electric’s share of benefits is to be collected over three years. As a result of its role in two RMR cases, NSTAR Electric had sought to collect $9.8 million annually for three years and began recognizing and collecting some of these incentive revenues from its customers effective January 1, 2007, subject to final DPU approval. Public hearings were held by the DPU in early 2007 to investigate the basis and support for the incentive payments. After these hearings, NSTAR Electric began discussions with the staff of the newly elected AG and a revised Settlement Agreement was executed on July 23, 2007. This revised Settlement Agreement allowed NSTAR Electric to collect $6.3 million of the savings annually for three years effective January 1, 2007 and it stipulated that NSTAR Electric would share 12.5% of the savings applicable to its customers in its future efforts related to new wholesale energy cost savings cases. On February 29, 2008, the DPU issued an order that did not approve the revised Settlement Agreement. The DPU re-established a procedural schedule and final briefs were filed in early May 2008. Through December 31, 2008, $12.6 million has been collected from customers for the Wholesale Power Cost Savings Initiatives.
NSTAR is unable to predict the timing or ultimate outcome of this proceeding. In the event an adverse decision is issued, it would not have a material impact on the Company’s results of operations. However, such a decision could have an impact on future results of operations and cash flows.
DPU Safety and Reliability programs (CPSL)
As part of the 2005 rate settlement, NSTAR Electric is allowed to recover incremental spending for the double pole inspection, replacement/restoration and transfer program and the underground electric safety program, which includes stray-voltage remediation and manhole inspections, repairs, and upgrades. Recovery of these CPSL costs is subject to DPU review and approval. NSTAR Electric incurred incremental costs of $11.1 million and $13.1 million in 2006 and 2007, respectively. This includes incremental operations and maintenance and revenue requirements on capital investments. The final reconciliation of 2006 and 2007 CPSL costs recovery is currently under review by the DPU. The incremental costs for the year 2008 are currently under review by the Company and are estimated to be approximately $15 million. NSTAR anticipates filing with the DPU its final 2008 CPSL cost recovery reconciliation in the second quarter of 2009. NSTAR cannot predict the timing of these pending filings. Should an adverse decision be issued that would disallow CPSL cost recovery, it could have a material adverse impact to NSTAR’s results of operations, financial position, and cash flows.
Basic Service Bad Debt Adder
On July 1, 2005, in response to a generic DPU order that required electric utilities in Massachusetts to recover the energy-related portion of bad debt costs in their Basic Service rates, NSTAR Electric increased its Basic Service rates and reduced its distribution rates for those bad debt costs. In furtherance of this generic DPU order, NSTAR Electric included a bad debt cost recovery mechanism as a component of its Rate Settlement Agreement. This recovery mechanism (bad debt adder) allowed NSTAR Electric to recover its Basic Service bad debt costs on a fully reconciling basis. These rates were implemented, effective January 1, 2006, as part of NSTAR Electric’s Rate Settlement Agreement.
On February 7, 2007, NSTAR Electric filed its 2006 Basic Service reconciliation with the DPU proposing an adjustment related to the increase of its Basic Service bad debt charge-offs. This proposed rate adjustment was anticipated to be implemented effective July 1, 2007. On June 28, 2007, the DPU issued an order approving the implementation of a revised Basic Service rate. However, the DPU required NSTAR Electric to reduce distribution rates by the increase in its Basic Service bad debt charge-offs. Such action would result in a further
reduction to distribution rates from the adjustment NSTAR Electric made when it implemented the Settlement Agreement. This adjustment to NSTAR Electric’s distribution rates would eliminate the fully reconciling nature of the Basic Service bad debt adder.
NSTAR Electric has not implemented the components of the June 28, 2007 DPU order. Implementation of this order would require NSTAR Electric to write-off a previously recorded regulatory asset related to its Basic Service bad debt costs. NSTAR Electric filed a Motion for Reconsideration of the DPU’s order on July 18, 2007. On December 14, 2007, the Motion for Reconsideration was granted and the DPU reopened the case to hear additional evidence. NSTAR Electric filed additional testimony in April 2008, an evidentiary hearing was held, and briefs were filed in June and early July 2008. NSTAR Electric believes its position is appropriate and that it is probable that it will ultimately prevail. However, in the event that it does not, NSTAR Electric intends to pursue all legal options. As of December 31, 2008, the potential impact to earnings of eliminating the bad debt adder would be approximately $17 million, pre-tax. NSTAR cannot predict the timing of this proceeding.
Other
Annually, in the fourth quarter of each year, NSTAR Electric files proposed distribution rate adjustments for effect on January 1 of the following year. These rate adjustments include a SIP rate factor and several other fully reconciling cost recovery items. Consistent with previous reconciliation filings, the 2008 filings include part actual/part forecast data for 2008 that NSTAR Electric will update early in 2009 with year-end data to allow a final investigation and reconciliation. There are several case years that remain outstanding at the DPU. These cases are pending decisions at the DPU and NSTAR cannot predict the timing or the ultimate outcome of these filings.
Wholesale Market and Transmission Changes
Regulatory Proceeding - FERC
On July 9, 2007, FERC approved NSTAR Electric’s 2007 proposed consolidated transmission rates as filed on February 14, 2007, subject to refund, pending the conclusion of subsequent proceedings. As a result of these proceedings, NSTAR Electric reached an agreement with the FERC staff, the AG, and a wholesale customer. A final Settlement Agreement was filed on March 12, 2008 and approved by the FERC on June 19, 2008. The implementation of this Settlement Agreement did not have an impact on the Company’s results of operations, financial position, or cash flows.
FERC Transmission ROE
Local Transmission Facilities
Effective retroactive to February 1, 2005, the FERC authorized, for the participating New England Transmission Owners, including NSTAR Electric, a base ROE on transmission facilities of 10.4%. This was increased to 11.14% effective on November 1, 2006. NSTAR earns this ROE on all local transmission facility investments.
Regional Transmission Facilities
The FERC also authorized a 50 basis point adder on regional facilities for joining a RTO effective February 1, 2005 (the RTO effective date). NSTAR joined ISO-New England on the RTO effective date, thereby qualifying for the adder. This brings the ROE on NSTAR’s regional transmission facilities to 10.9% for the period from February 1, 2005 to October 31, 2006, and 11.64% thereafter. Customers of the ISO-NE participants benefit from this order because it responds to the need to enhance the New England transmission grid to alleviate congestion costs and reliability concerns.
Additional Incentive Adders
Additional incentive adders are decided on a case by case basis according to FERC’s most recent national transmission incentive rules. The FERC may grant a variety of financial incentives, including ROE basis point incentive adders for qualified investments made in new regional transmission facilities. New England projects that were included in ISO-NE’s regional system plan and went into service prior to December 31, 2008 qualified for a 100 basis point ROE adder. This 100 basis point adder, when combined with the FERC’s approved ROEs described above, results in a 12.64% ROE for qualified regional investments. The incentive is intended to promote and accelerate investment in transmission projects that can significantly reduce congestion costs and enhance reliability in the region. NSTAR’s 345 kV Transmission Project, among others, has received this additional incentive adder.
Legal Matters
In the normal course of its business, NSTAR and its subsidiaries are involved in certain legal matters, including civil litigation. Management is unable to fully determine a range of reasonably possible court-ordered damages, settlement amounts, and related litigation costs (legal liabilities) that would be in excess of amounts accrued and amounts covered by insurance. Based on the information currently available, NSTAR does not believe that it is probable that any such legal liabilities will have a material impact on its consolidated financial position. However, it is reasonably possible that additional legal liabilities that may result from changes in circumstances could have a material impact on its results of operations, cash flows or financial condition.
Report of Independent Registered Public Accounting Firm
To Shareholders and Trustees of NSTAR:
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of NSTAR and its subsidiaries (the “Company”) at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note F to the consolidated financial statements, the Company changed the manner in which it accounts for uncertain tax positions in 2007.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
February 9, 2009
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
No event that would be described in response to this item 9 has occurred with respect to NSTAR or its subsidiaries.
Item 9A.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.
NSTAR is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal controls. This results in modifications to its processes throughout the Company. However, there has been no change in its internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f). A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, NSTAR management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2008 based on the criteria established in a report entitled “Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission” and the Interpretive Guidance issued by the SEC in Release 34-55929. Based on this evaluation, NSTAR management has evaluated and concluded that NSTAR’s internal control over financial reporting was effective as of December 31, 2008.
PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report on Form 10-K, has also audited the effectiveness of our internal control over financial reporting as of December 31, 2008, as stated in their report which appears on page 89.
Item 9B.
Item 9B. Other Information
None
Part III
The information required by Part III (Items 10(a), 11, 12, 13, and 14) will be included in NSTAR’s 2009 Proxy Statement (as specified below) to be filed in connection with the Annual Meeting of Shareholders to be held on April 30, 2009 and is incorporated herein by reference. NSTAR’s Proxy Statement will be filed with the Securities and Exchange Commission on or about March 13, 2009.
Item 10.
Item 10. Trustees, Executive Officers and Corporate Governance
The information with respect to Trustees of NSTAR, information with respect to compliance with the reporting obligations under Section 16(a) of the Exchange Act, information concerning NSTAR’s code of ethics applicable to senior management, information on NSTAR’s compliance with corporate governance regulations, and information on NSTAR’s Board of Trustees’ Audit Committee, is incorporated herein by reference from disclosures contained in NSTAR’s Definitive Proxy Statement for the 2009 Annual Meeting of Shareholders to be held on April 30, 2009 under the captions “Information about the NSTAR Board, Nominees and Incumbent Trustees,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Governance of the Company.” Information regarding NSTAR’s executive officers found in the section captioned “Executive Officers of the Registrant” in Item 4A of Part 1 of this Report is also incorporated herein by reference into this Item 10.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference from disclosures contained in NSTAR’s Definitive Proxy Statement for the 2009 Annual Meeting of Shareholders under the caption “Executive Compensation,” including NSTAR’s “Compensation Discussion and Analysis” and “Executive Personnel Committee Report.”
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding securities authorized for issuance under equity compensation plans located in Item 5, Section (d) of Part II hereof is also incorporated by reference into this Item 12. Other information required by this Item is incorporated herein by reference from disclosures contained in NSTAR’s Definitive Proxy Statement for the 2009 Annual Meeting of Shareholders under the captions “2008 Trustee Compensation,” “Beneficial Ownership Table,” and “Potential Payments Upon Termination or Change in Control.”
Item 13.
Item 13. Certain Relationships and Related Transactions, and Trustee Independence
The information required by this Item is incorporated herein by reference from disclosures contained in NSTAR’s Definitive Proxy Statement for the 2009 Annual Meeting of Shareholders under the captions “Governance of the Company - Board Independence” and “NSTAR Policy on Related Persons Transactions.”
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated herein by reference from disclosures contained in NSTAR’s Definitive Proxy Statement for the 2009 Annual Meeting of Shareholders under the caption “Audit and Related Fees.”
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this Form 10-K:
1. Financial Statements:
Incorporated herein by reference unless designated otherwise:
NSTAR and its subsidiaries
SCHEDULE I
CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
NSTAR (Holding Company)
Condensed Balance Sheets
The accompanying notes are an integral part of the condensed financial statements.
NSTAR (Holding Company)
Condensed Statements of Income and Comprehensive Income
The accompanying notes are an integral part of the condensed financial statements.
NSTAR (Holding Company)
Condensed Statements of Cash Flows
The accompanying notes are an integral part of the condensed financial statements.
NSTAR (Holding Company)
Notes to Condensed Financial Statements
1. Basis of Presentation
NSTAR (Holding Company) on a stand alone basis has accounted for its wholly-owned subsidiaries using the equity method basis of accounting. These financial statements are presented on a condensed basis. Additional disclosures relating to the Holding Company financial statements are included under the accompanying NSTAR Notes to Consolidated Financial Statements, and are incorporated herein by reference.
2. Use of Estimates
The preparation of condensed financial statements in conformity with GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the period. Actual results could differ from these estimates.
3. Notes Payable
NSTAR (Holding Company) currently has a $175 million revolving credit agreement that expires December 31, 2012. At December 31, 2008 and 2007, there were no amounts outstanding under the revolving credit agreement. This credit facility serves as a back up to NSTAR’s $175 million commercial paper program that, at December 31, 2008 and 2007, had $175 million and $4 million outstanding, respectively. Under the terms of the credit agreement, NSTAR is required to maintain a maximum total consolidated debt to total capitalization ratio and was in compliance with this ratio at December 31, 2008 and 2007. Commitment fees must be paid on the total agreement amount.
4. Long-Term Debt
NSTAR (Holding Company) had $500 million of 8% Notes outstanding as of December 31, 2008 and 2007. These Notes will mature and are due in February 2010.
Refer to Note J of the NSTAR Consolidated Financial Statements for a description and details of the Holding Company long-term debt.
5. Equity Transactions
NSTAR (Holding Company) received $85.6 million, $208.3 million, and $125.2 million of cash dividends from subsidiaries during 2008, 2007, and 2006, respectively. NSTAR also received returned capital of $5.7 million, $3.9 million, and $5.6 million from subsidiaries during 2008, 2007, and 2006, respectively.
6. Commitments, Contingencies and Guarantees
Refer to Note N of the NSTAR Consolidated Financial Statements for a description of any material commitments, contingencies or guarantees of the Holding Company.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 and 2006
(in thousands)
FORM 10-K
NSTAR
DECEMBER 31, 2008
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of the 9th day of February 2009.