Annual Reports

 
Quarterly Reports

  • 10-Q (Oct 31, 2017)
  • 10-Q (Jul 28, 2017)
  • 10-Q (Apr 28, 2017)
  • 10-Q (Oct 31, 2016)
  • 10-Q (Jul 29, 2016)
  • 10-Q (May 2, 2016)

 
8-K

 
Other

Public Service Enterprise Group 10-Q 2006


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

(Mark One)

S   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

OR

£  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                  TO                 

Commission
File Number

Registrants, State of Incorporation,
Address, and Telephone Number

I.R.S. Employer
Identification No.

 

001-09120

  PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
(A New Jersey Corporation)
80 Park Plaza, P.O. Box 1171
Newark, New Jersey 07101-1171
973 430-7000
http://www.pseg.com
  22-2625848  
 

001-00973

  PUBLIC SERVICE ELECTRIC AND GAS COMPANY
(A New Jersey Corporation)
80 Park Plaza, P.O. Box 570
Newark, New Jersey 07101-0570
973 430-7000
http://www.pseg.com
  22-1212800  
 

000-49614

  PSEG POWER LLC
(A Delaware Limited Liability Company)
80 Park Plaza—T25
Newark, New Jersey 07102-4194
973 430-7000
http://www.pseg.com
  22-3663480  
 

000-32503

  PSEG ENERGY HOLDINGS L.L.C.
(A New Jersey Limited Liability Company)
80 Park Plaza—T20
Newark, New Jersey 07102-4194
973 456-3581
http://www.pseg.com
  42-1544079  


      Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes S    No £

      Indicate by check mark whether each registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Public Service Enterprise Group Incorporated

        Large accelerated filer S         Accelerated filer £         Non-accelerated filer £

Public Service Electric and Gas Company

        Large accelerated filer £         Accelerated filer £         Non-accelerated filer S

PSEG Power LLC

        Large accelerated filer £         Accelerated filer £         Non-accelerated filer S

PSEG Energy Holdings L.L.C.

        Large accelerated filer £         Accelerated filer £         Non-accelerated filer S

      Indicate by check mark whether any of the registrants is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £    No S

      As of April 30, 2006, Public Service Enterprise Group Incorporated had outstanding 251,469,431 shares of its sole class of Common Stock, without par value.

      As of April 30, 2006, Public Service Electric and Gas Company had issued and outstanding 132,450,344 shares of Common Stock, without nominal or par value, all of which were privately held, beneficially and of record by Public Service Enterprise Group Incorporated.

      PSEG Power LLC and PSEG Energy Holdings L.L.C. are wholly owned subsidiaries of Public Service Enterprise Group Incorporated and meet the conditions set forth in General Instruction H(1) (a) and (b) of Form 10-Q and are filing their respective Quarterly Reports on Form 10-Q with the reduced disclosure format authorized by General Instruction H.




TABLE OF CONTENTS

        Page

FORWARD-LOOKING STATEMENTS        ii  
PART I. FINANCIAL INFORMATION        

Item 1.

     Financial Statements        

          

           Public Service Enterprise Group Incorporated        1  

          

           Public Service Electric and Gas Company        5  

          

           PSEG Power LLC        9  

          

           PSEG Energy Holdings L.L.C.        12  

          

     Notes to Condensed Consolidated Financial Statements        

          

           Note 1. Organization and Basis of Presentation        16  

          

           Note 2. Recent Accounting Standards        18  

          

           Note 3. Discontinued Operations and Dispositions        21  

          

           Note 4. Earnings Per Share        22  

          

           Note 5. Commitments and Contingent Liabilities        23  

          

           Note 6. Risk Management        36  

          

           Note 7. Comprehensive Income, Net of Tax        40  

          

           Note 8. Changes in Capitalization        40  

          

           Note 9. Other Income and Deductions        41  

          

           Note 10. Income Taxes        42  

          

           Note 11. Financial Information by Business Segments        43  

          

           Note 12. Stock-Based Compensation        43  

          

           Note 13. Related-Party Transactions        47  

          

           Note 14. Guarantees of Debt        50  

Item 2.

     Management's Discussion and Analysis of Financial Condition and
      Results of Operations
       

          

     Pending Merger        52  

          

     Overview of 2006 and Future Outlook        53  

          

     Results of Operations        58  

          

     Liquidity and Capital Resources        65  

          

     Capital Requirements        70  

          

     Accounting Matters        70  

Item 3.

     Qualitative and Quantitative Disclosures About Market Risk        71  

Item 4.

     Controls and Procedures        76  
PART II. OTHER INFORMATION        

Item 1.

     Legal Proceedings        77  

Item 5.

     Other Information        78  

Item 6.

     Exhibits        83  
Signatures        84  

i


FORWARD-LOOKING STATEMENTS

      Certain of the matters discussed in this report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those anticipated. Such statements are based on management's beliefs as well as assumptions made by and information currently available to management. When used herein, the words “anticipate,” “intend,” “estimate,” “believe,” “expect,” “plan,” “hypothetical,” “potential,” “forecast,” “project,” variations of such words and similar expressions are intended to identify forward-looking statements. Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power) and PSEG Energy Holdings L.L.C. (Energy Holdings) undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following review should not be construed as a complete list of factors that could affect forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements discussed above, factors that could cause actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following:

business conditions, financial market, credit rating, regulatory and other risks resulting from the pending merger with Exelon Corporation;
 
regulatory issues that significantly impact operations;
 
operating performance or cash flow from investments falling below projected levels;
 
credit, commodity, interest rate, counterparty and other financial market risks;
 
liquidity and the ability to access capital and maintain adequate credit ratings;
 
adverse or unanticipated weather conditions that significantly impact costs and/or operations, including generation;
 
changes in the electric industry, including changes to power pools;
 
changes in demand resulting from changes in prices;
 
changes in the number of market participants and the risk profiles of such participants;
 
changes in technology that make generation, transmission and/or distribution assets less competitive;
 
availability of power transmission facilities that impact the ability to deliver output to customers;
 
growth in costs and expenses;
 
environmental regulations that significantly impact operations;
 
changes in rates of return on overall debt and equity markets that could adversely impact the value of pension and other postretirement benefits assets and liabilities and the Nuclear Decommissioning Trust Funds;
 
ability to maintain satisfactory regulatory results;
 
changes in political conditions, recession, acts of war or terrorism;
 
continued availability of insurance coverage at commercially reasonable rates;
 
involvement in lawsuits, including liability claims and commercial disputes;
 
inability to attract and retain management and other key employees, particularly in view of the pending merger with Exelon Corporation;
 
acquisitions, divestitures, mergers, restructurings or strategic initiatives that change PSEG's, PSE&G's, Power's and Energy Holdings' strategy or structure;
 
business combinations among competitors and major customers;
 
general economic conditions, including inflation or deflation;
 
changes in tax laws and regulations;

ii


changes to accounting standards or accounting principles generally accepted in the U.S., which may require adjustments to financial statements;
 
ability to recover investments or service debt as a result of any of the risks or uncertainties mentioned herein;

PSEG, PSE&G and Energy Holdings

ability to obtain adequate and timely rate relief;

PSEG, Power and Energy Holdings

inability to effectively manage portfolios of electric generation assets, gas supply contracts and electric and gas supply obligations;
 
inability to meet generation operating performance expectations;
 
energy transmission constraints or lack thereof;
 
adverse changes in the market for energy, capacity, natural gas, emissions credits, congestion credits and other commodity prices, especially during significant price movements for natural gas and power;
 
surplus of energy capacity and excess supply;
 
substantial competition in the worldwide energy markets;
 
margin posting requirements, especially during significant price movements for natural gas and power;
 
availability of fuel and timely transportation at reasonable prices;
 
effects on competitive position of actions involving competitors or major customers;
 
changes in product or sourcing mix;
 
delays, cost escalations or unsuccessful construction and development;

PSEG and Power

changes in regulation and safety and security measures at nuclear facilities;

PSEG and Energy Holdings

changes in foreign currency exchange rates;
 
deterioration in the credit of lessees and their ability to adequately service lease rentals;
 
ability to realize tax benefits;
 
changes in political regimes in foreign countries; and
 
international developments negatively impacting business.

      Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and PSEG, PSE&G, Power and Energy Holdings cannot assure you that the results or developments anticipated by management will be realized, or even if realized, will have the expected consequences to, or effects on, PSEG, PSE&G, Power and Energy Holdings or their respective business prospects, financial condition or results of operations. Undue reliance should not be placed on these forward-looking statements in making any investment decision. Each of PSEG, PSE&G, Power and Energy Holdings expressly disclaims any obligation or undertaking to release publicly any updates or revisions to these forward-looking statements to reflect events or circumstances that occur or arise or are anticipated to occur or arise after the date hereof. In making any investment decision regarding PSEG's, PSE&G's, Power's and Energy Holdings' securities, PSEG, PSE&G, Power and Energy Holdings are not making, and you should not infer, any representation about the likely existence of any particular future set of facts or circumstances. The forward-looking statements contained in this report are intended to qualify for the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

iii


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For the Quarters Ended
March 31,

    2006

  2005

    (Millions)
(Unaudited)

OPERATING REVENUES

     $ 3,521        $ 3,244  

OPERATING EXPENSES

               

Energy Costs

       2,204          1,849  

Operation and Maintenance

       584          576  

Depreciation and Amortization

       204          184  

Taxes Other Than Income Taxes

       41          43  
        
        
 

Total Operating Expenses

       3,033          2,652  
        
        
 

Income from Equity Method Investments

       33          31  
        
        
 

OPERATING INCOME

       521          623  

Other Income

       49          43  

Other Deductions

       (26 )        (14 )

Interest Expense

       (201 )        (200 )

Preferred Stock Dividends

       (1 )        (1 )
        
        
 

INCOME FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES

       342          451  

Income Tax Expense

       (143 )        (171 )
        
        
 

INCOME FROM CONTINUING OPERATIONS

       199          280  

Income from Discontinued Operations, net of tax expense (benefit)
of $1 and ($3)

       4          5  
        
        
 

NET INCOME

     $ 203        $ 285  
        
        
 

WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (THOUSANDS):

               

BASIC

       251,187          238,314  
        
        
 

DILUTED

       252,065          242,190  
        
        
 

EARNINGS PER SHARE:

               

BASIC

               

INCOME FROM CONTINUING OPERATIONS

     $ 0.79        $ 1.18  

NET INCOME

     $ 0.81        $ 1.20  
        
        
 

DILUTED

               

INCOME FROM CONTINUING OPERATIONS

     $ 0.79        $ 1.16  

NET INCOME

     $ 0.81        $ 1.18  
        
        
 

DIVIDENDS PAID PER SHARE OF COMMON STOCK

     $ 0.57        $ 0.56  
        
        
 

               

See Notes to Condensed Consolidated Financial Statements.

1


PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS

    March 31,
2006

  December 31,
2005

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 218        $ 288  

Accounts Receivable, net of allowances of $54 and $44 in 2006
and 2005, respectively

       1,818          1,938  

Unbilled Revenues

       246          394  

Fuel

       400          812  

Materials and Supplies

       275          277  

Energy Trading Contracts

       94          327  

Prepayments

       90          129  

Restricted Funds

       82          76  

Derivative Contracts

       11          50  

Assets of Discontinued Operations

       522          498  

Other

       45          41  
        
        
 

Total Current Assets

       3,801          4,830  
        
        
 

      

               

PROPERTY, PLANT AND EQUIPMENT

       19,111          18,896  

Less: Accumulated Depreciation and Amortization

       (5,700 )        (5,560 )
        
        
 

Net Property, Plant and Equipment

       13,411          13,336  
        
        
 

NONCURRENT ASSETS

               

Regulatory Assets

       5,000          5,053  

Long-Term Investments

       4,117          4,077  

Nuclear Decommissioning Trust (NDT) Funds

       1,184          1,133  

Other Special Funds

       559          559  

Goodwill and Other Intangibles

       595          608  

Energy Trading Contracts

       16          42  

Derivative Contracts

       2           

Other

       171          177  
        
        
 

Total Noncurrent Assets

       11,644          11,649  
        
        
 

TOTAL ASSETS

     $ 28,856        $ 29,815  
        
        
 

               

See Notes to Condensed Consolidated Financial Statements.

2


PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS

    March 31,
2006

  December 31,
2005

    (Millions)
(Unaudited)

LIABILITIES AND CAPITALIZATION

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 1,041        $ 1,536  

Commercial Paper and Loans

       154          100  

Accounts Payable

       785          1,154  

Derivative Contracts

       364          425  

Energy Trading Contracts

       134          200  

Accrued Interest

       205          152  

Accrued Taxes

       241          141  

Clean Energy Program

       103          96  

Liabilities of Discontinued Operations

       441          436  

Other

       470          517  
        
        
 

Total Current Liabilities

       3,938          4,757  
        
        
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and Investment Tax Credits (ITC)

       4,344          4,248  

Regulatory Liabilities

       614          720  

Asset Retirement Obligations

       596          585  

Other Postretirement Benefit (OPEB) Costs

       613          597  

Clean Energy Program

       210          233  

Environmental Costs

       414          420  

Derivative Contracts

       481          637  

Energy Trading Contracts

       13          19  

Other

       219          218  
        
        
 

Total Noncurrent Liabilities

       7,504          7,677  
        
        
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

CAPITALIZATION

               

LONG-TERM DEBT

               

Long-Term Debt

       7,732          7,849  

Securitization Debt

       1,841          1,879  

Project Level, Non-Recourse Debt

       880          891  

Debt Supporting Trust Preferred Securities

       660          660  
        
        
 

Total Long-Term Debt

       11,113          11,279  
        
        
 

SUBSIDIARIES' PREFERRED SECURITIES

               

Preferred Stock Without Mandatory Redemption,
$100 par value, 7,500,000 authorized; issued and outstanding,
2006 and 2005—795,234 shares

       80          80  
        
        
 

COMMON STOCKHOLDERS' EQUITY

               

Common Stock, no par, authorized 500,000,000 shares; issued;
2006—265,598,389 shares; 2005—265,332,746 shares

       4,620          4,618  

Treasury Stock, at cost; 2006—14,137,952 shares; 2005—14,169,560 shares

       (531 )        (532 )

Retained Earnings

       2,605          2,545  

Accumulated Other Comprehensive Loss

       (473 )        (609 )
        
        
 

Total Common Stockholders' Equity

       6,221          6,022  
        
        
 

Total Capitalization

       17,414          17,381  
        
        
 

TOTAL LIABILITIES AND CAPITALIZATION

     $ 28,856        $ 29,815  
        
        
 

               

See Notes to Condensed Consolidated Financial Statements.

3


PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

    For The Quarters Ended
March 31,

    2006

  2005

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 203        $ 285  

Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:

               

Depreciation and Amortization

       205          190  

Amortization of Nuclear Fuel

       25          22  

Provision for Deferred Income Taxes (Other than Leases) and ITC

       3          4  

Non-Cash Employee Benefit Plan Costs

       57          57  

Leveraged Lease Income, Adjusted for Rents Received and Deferred Taxes

       (22 )        (26 )

Gain on Sale of Investments

                (45 )

Undistributed Earnings from Affiliates

       (29 )        (19 )

Foreign Currency Transaction Gain

       (1 )        (3 )

Unrealized Losses (Gains) on Energy Contracts and Other Derivatives

       21          (14 )

Over Recovery of Electric Energy Costs (BGS and NTC) and Gas Costs

       49          29  

Under Recovery of Societal Benefits Charge (SBC)

       (8 )        (8 )

Net Realized Gains and Income from NDT Funds

       (18 )        (21 )

Other Non-Cash Charges

       3          13  

Net Change in Certain Current Assets and Liabilities

       524          203  

Employee Benefit Plan Funding and Related Payments

       (35 )        (105 )

Proceeds from the Withdrawal of Partnership Interests and Other Distributions

       1          61  

Other

       (63 )        34  
        
        
 

Net Cash Provided By Operating Activities

       915          657  
        
        
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (240 )        (197 )

Proceeds from the Sale of Investments and Return of Capital from Partnerships

       2          1  

Proceeds from NDT Funds Sales

       300          1,378  

Investment in NDT Funds

       (305 )        (1,383 )

Restricted Funds

       (22 )        (5 )

NDT Funds Interest and Dividends

       10          7  

Other

       17          39  
        
        
 

Net Cash Used In Investing Activities

       (238 )        (160 )
        
        
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net Change in Commercial Paper and Loans

       54          (268 )

Issuance of Non-Recourse Debt

                11  

Issuance of Common Stock

       17          18  

Redemptions of Long-Term Debt

       (493 )        (34 )

Repayment of Non-Recourse Debt

       (12 )        (4 )

Redemption of Debt Underlying Trust Securities

       (154 )         

Cash Dividends Paid on Common Stock

       (143 )        (134 )

Other

       (15 )        (24 )
        
        
 

Net Cash Used In Financing Activities

       (746 )        (435 )
        
        
 

Effect of Exchange Rate Change

       (1 )        (1 )
        
        
 

Net (Decrease) Increase in Cash and Cash Equivalents

       (70 )        61  

Cash and Cash Equivalents at Beginning of Period

       288          263  
        
        
 

Cash and Cash Equivalents at End of Period

     $ 218        $ 324  
        
        
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes Paid

     $ 25        $ 1  

Interest Paid, Net of Amounts Capitalized

     $ 134        $ 172  

               

See Notes to Condensed Consolidated Financial Statements.

4


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For the Quarters Ended
March 31,

    2006

  2005

    (Millions)
(Unaudited)

OPERATING REVENUES

     $ 2,350        $ 2,184  

OPERATING EXPENSES

               

Energy Costs

       1,631          1,424  

Operation and Maintenance

       301          295  

Depreciation and Amortization

       152          135  

Taxes Other Than Income Taxes

       41          43  
        
        
 

Total Operating Expenses

       2,125          1,897  
        
        
 

OPERATING INCOME

       225          287  

Other Income

       4          2  

Other Deductions

       (1 )        (1 )

Interest Expense

       (85 )        (84 )
        
        
 

INCOME BEFORE INCOME TAXES

       143          204  

Income Tax Expense

       (65 )        (86 )
        
        
 

NET INCOME

       78          118  

Preferred Stock Dividends

       (1 )        (1 )
        
        
 

EARNINGS AVAILABLE TO PUBLIC SERVICE
ENTERPRISE GROUP INCORPORATED

     $ 77        $ 117  
        
        
 

               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

5


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS

    March 31,
2006

  December 31,
2005

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 133        $ 159  

Accounts Receivable, net of allowances of $50 in 2006 and $41 in 2005

       1,025          959  

Unbilled Revenues

       246          394  

Materials and Supplies

       49          49  

Prepayments

       13          49  

Restricted Cash

       18          14  

Other

       37          32  
        
        
 

Total Current Assets

       1,521          1,656  
        
        
 

PROPERTY, PLANT AND EQUIPMENT

       10,743          10,636  

Less: Accumulated Depreciation and Amortization

       (3,695 )        (3,627 )
        
        
 

Net Property, Plant and Equipment

       7,048          7,009  
        
        
 

NONCURRENT ASSETS

               

Regulatory Assets

       5,000          5,053  

Long-Term Investments

       145          144  

Other Special Funds

       304          315  

Other

       114          114  
        
        
 

Total Noncurrent Assets

       5,563          5,626  
        
        
 

TOTAL ASSETS

     $ 14,132        $ 14,291  
        
        
 

               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

6


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS

    March 31,
2006

  December 31,
2005

    (Millions)
(Unaudited)

LIABILITIES AND CAPITALIZATION

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 452        $ 485  

Accounts Payable

       252          286  

Accounts Payable—Affiliated Companies, net

       512          388  

Accrued Interest

       43          59  

Clean Energy Program

       103          96  

Derivative Contracts

       12          6  

Other

       375          373  
        
        
 

Total Current Liabilities

       1,749          1,693  
        
        
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and ITC

       2,581          2,608  

Other Postretirement Benefit (OPEB) Costs

       573          561  

Regulatory Liabilities

       614          720  

Clean Energy Program

       210          233  

Environmental Costs

       359          365  

Asset Retirement Obligations

       213          210  

Derivative Contracts

       12          6  

Other

       27          27  
        
        
 

Total Noncurrent Liabilities

       4,589          4,730  
        
        
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

CAPITALIZATION

               

LONG-TERM DEBT

               

Long-Term Debt

       2,753          2,866  

Securitization Debt

       1,841          1,879  
        
        
 

Total Long-Term Debt

       4,594          4,745  
        
        
 

PREFERRED SECURITIES

               

Preferred Stock Without Mandatory Redemption, $100 par value, 7,500,000 authorized; issued and outstanding, 2006 and 2005—795,234 shares

       80          80  
        
        
 

COMMON STOCKHOLDER'S EQUITY

               

Common Stock; 150,000,000 shares authorized, 132,450,344 shares
issued and outstanding

       892          892  

Contributed Capital

       170          170  

Basis Adjustment

       986          986  

Retained Earnings

       1,077          1,000  

Accumulated Other Comprehensive Loss

       (5 )        (5 )
        
        
 

Total Common Stockholder's Equity

       3,120          3,043  
        
        
 

Total Capitalization

       7,794          7,868  
        
        
 

TOTAL LIABILITIES AND CAPITALIZATION

     $ 14,132        $ 14,291  
        
        
 

               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

7


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

    For the Quarters Ended
March 31,

    2006

  2005

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 78        $ 118  

Adjustments to Reconcile Net Income to Net Cash Flows from
Operating Activities:

               

Depreciation and Amortization

       152          135  

Provision for Deferred Income Taxes and ITC

       (25 )        (29 )

Non-Cash Employee Benefit Plan Costs

       41          40  

Non-Cash Interest Expense

                2  

Employee Benefit Plan Funding and Related Payments

       (13 )        (60 )

Over Recovery of Electric Energy Costs (BGS and NTC)

       19          16  

Over Recovery of Gas Costs

       30          13  

Under Recovery of SBC

       (8 )        (8 )

Other Non-Cash Charges

       2          1  

Net Changes in Certain Current Assets and Liabilities:

               

Accounts Receivable and Unbilled Revenues

       82          (144 )

Materials and Supplies

                (8 )

Prepayments

       36          46  

Accrued Taxes

       22          37  

Accrued Interest

       (16 )        (10 )

Accounts Payable

       (34 )        (41 )

Accounts Receivable/Payable—Affiliated Companies, net

       (52 )        8  

Other Current Assets and Liabilities

       (21 )        48  

Other

       (21 )        62  
        
        
 

Net Cash Provided By Operating Activities

       272          226  
        
        
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (108 )        (93 )

Restricted Funds

       (5 )         
        
        
 

Net Cash Used In Investing Activities

       (113 )        (93 )
        
        
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net Change in Short-Term Debt

                (32 )

Redemption of Securitization Debt

       (36 )        (34 )

Redemption of Long-Term Debt

       (148 )         

Preferred Stock Dividends

       (1 )        (1 )
        
        
 

Net Cash Used In Financing Activities

       (185 )        (67 )
        
        
 

Net (Decrease) Increase In Cash and Cash Equivalents

       (26 )        66  

Cash and Cash Equivalents at Beginning of Period

       159          6  
        
        
 

Cash and Cash Equivalents at End of Period

     $ 133        $ 72  
        
        
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes (Received) Paid

     $ (4 )      $ 5  

Interest Paid, Net of Amounts Capitalized

     $ 92        $ 87  

               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

8


PSEG POWER LLC
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For the Quarters
Ended
March 31,

    2006

  2005

    (Millions)
(Unaudited)

OPERATING REVENUES

     $ 1,967            $ 1,730  

OPERATING EXPENSES

               

Energy Costs

       1,487              1,270  

Operation and Maintenance

       235              227  

Depreciation and Amortization

       35              30  
        
            
 

Total Operating Expenses

       1,757              1,527  
        
            
 

OPERATING INCOME

       210              203  

Other Income

       41              31  

Other Deductions

       (19 )            (8 )

Interest Expense

       (40 )            (28 )
        
            
 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

       192              198  

Income Tax Expense

       (80 )            (83 )
        
            
 

INCOME FROM CONTINUING OPERATIONS

       112              115  

Loss from Discontinued Operations, net of tax benefit of $5

                    (7 )
        
            
 

EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED

     $ 112            $ 108  
        
            
 

               

See disclosures regarding PSEG Power LLC
included in the Notes to Condensed Consolidated Financial Statements.

9


PSEG POWER LLC
CONDENSED CONSOLIDATED BALANCE SHEETS

    March 31,
2006

  December 31,
2005

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 5        $ 8  

Accounts Receivable

       675          862  

Accounts Receivable—Affiliated Companies, net

       319          288  

Short-Term Loan to Affiliate

       380           

Fuel

       400          812  

Materials and Supplies

       200          201  

Energy Trading Contracts

       94          327  

Derivative Contracts

       8          50  

Other

       30          27  
        
        
 

Total Current Assets

       2,111          2,575  
        
        
 

PROPERTY, PLANT AND EQUIPMENT

       6,557          6,457  

Less: Accumulated Depreciation and Amortization

       (1,637 )        (1,577 )
        
        
 

Net Property, Plant and Equipment

       4,920          4,880  
        
        
 

NONCURRENT ASSETS

               

Deferred Income Taxes and Investment Tax Credits (ITC)

                70  

Nuclear Decommissioning Trust (NDT) Funds

       1,184          1,133  

Goodwill and Other Intangibles

       62          63  

Other Special Funds

       153          143  

Energy Trading Contracts

       16          42  

Other

       42          39  
        
        
 

Total Noncurrent Assets

       1,457          1,490  
        
        
 

TOTAL ASSETS

     $ 8,488        $ 8,945  
        
        
 

LIABILITIES AND MEMBER'S EQUITY

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 500        $ 500  

Accounts Payable

       428          745  

Short-Term Loan from Affiliate

                202  

Energy Trading Contracts

       134          200  

Derivative Contracts

       336          403  

Accrued Interest

       96          41  

Other

       90          86  
        
        
 

Total Current Liabilities

       1,584          2,177  
        
        
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and Investment Tax Credits (ITC)

       53           

Asset Retirement Obligations

       381          373  

Energy Trading Contracts

       13          19  

Derivative Contracts

       431          597  

Environmental Costs

       55          55  

Other

       72          70  
        
        
 

Total Noncurrent Liabilities

       1,005          1,114  
        
        
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

LONG-TERM DEBT

               

Total Long-Term Debt

       2,817          2,817  
        
        
 

MEMBER'S EQUITY

               

Contributed Capital

       2,000          2,000  

Basis Adjustment

       (986 )        (986 )

Retained Earnings

       2,422          2,310  

Accumulated Other Comprehensive Loss

       (354 )        (487 )
        
        
 

Total Member's Equity

       3,082          2,837  
        
        
 

TOTAL LIABILITIES AND MEMBER'S EQUITY

     $ 8,488        $ 8,945  
        
        
 

               

See disclosures regarding PSEG Power LLC
included in the Notes to Condensed Consolidated Financial Statements.

10


PSEG POWER LLC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

    For The Quarters
Ended March 31,

    2006

  2005

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 112            $ 108  

Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:

               

Depreciation and Amortization

       35              34  

Amortization of Nuclear Fuel

       25              22  

Interest Accretion on Asset Retirement Obligations

       8              7  

Provision for Deferred Income Taxes and ITC

       24              39  

Unrealized Losses (Gains) on Energy Contracts and Other Derivatives

       21              (13 )

Non-Cash Employee Benefit Plan Costs

       11              11  

Net Realized Gains and Income from NDT Funds

       (18 )            (21 )

Net Change in Certain Current Assets and Liabilities:

               

Fuel, Materials and Supplies

       413              404  

Accounts Receivable

       187              171  

Accrued Interest

       55              54  

Accounts Payable

       (292 )            (385 )

Accounts Receivable/Payable—Affiliated Companies, net

       145              13  

Other Current Assets and Liabilities

       18              (10 )

Employee Benefit Plan Funding and Related Payments

       (16 )            (30 )

Other

       (46 )            (40 )
        
            
 

Net Cash Provided By Operating Activities

       682              364  
        
            
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (118 )            (89 )

Proceeds from NDT Funds Sales

       300              1,378  

NDT Funds Interest and Dividends

       10              7  

Investment in NDT Funds

       (305 )            (1,383 )

Short-Term Loan—Affiliated Company, net

       (380 )            (185 )

Other

       10              10  
        
            
 

Net Cash Used In Investing Activities

       (483 )            (262 )
        
            
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Short-Term Loan—Affiliated Company, net

       (202 )            (98 )
        
            
 

Net Cash Used In Financing Activities

       (202 )            (98 )
        
            
 

Net (Decrease) Increase in Cash and Cash Equivalents

       (3 )            4  

Cash and Cash Equivalents at Beginning of Period

       8              10  
        
            
 

Cash and Cash Equivalents at End of Period

     $ 5            $ 14  
        
            
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes Paid

     $ 18            $ 13  

Interest Paid, Net of Amounts Capitalized

     $ 2            $ 2  

               

See disclosures regarding PSEG Power LLC
included in the Notes to Condensed Consolidated Financial Statements.

11


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For The Quarters Ended
March 31,

    2006

  2005

    (Millions)
(Unaudited)

OPERATING REVENUES

               

Electric Generation and Distribution Revenues

     $ 263        $ 213  

Income from Leveraged and Operating Leases

       39          47  

Other

       10          53  
        
        
 

Total Operating Revenues

       312          313  
        
        
 

OPERATING EXPENSES

               

Energy Costs

       194          138  

Operation and Maintenance

       49          57  

Depreciation and Amortization

       12          14  
        
        
 

Total Operating Expenses

       255          209  
        
        
 

Income from Equity Method Investments

       33          31  
        
        
 

OPERATING INCOME

       90          135  

Other Income

       5          9  

Other Deductions

       (5 )        (5 )

Interest Expense

       (50 )        (58 )
        
        
 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

       40          81  

Income Tax Expense

       (12 )        (14 )
        
        
 

INCOME FROM CONTINUING OPERATIONS

       28          67  

Income from Discontinued Operations, net of tax expense of $1 and $2

       4          12  
        
        
 

NET INCOME

       32          79  

Preference Units Distributions

                (2 )
        
        
 

EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED

     $ 32        $ 77  
        
        
 

               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

12


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED BALANCE SHEETS

    March 31,
2006

  December 31,
2005

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 70          $ 68  

Accounts Receivable:

               

Trade—net of allowances of $4 and $3 in 2006 and 2005, respectively

       99            103  

Other Accounts Receivable

       18            14  

Notes Receivable:

               

Affiliated Companies

       58            409  

Other

       5            5  

Inventory

       25            27  

Restricted Funds

       64            62  

Assets of Discontinued Operations

       522            498  

Derivative Contracts

       2             

Other

       8            7  
        
          
 

Total Current Assets

       871            1,193  
        
          
 

PROPERTY, PLANT AND EQUIPMENT

       1,570            1,560  

Less: Accumulated Depreciation and Amortization

       (243 )          (237 )
        
          
 

Net Property, Plant and Equipment

       1,327            1,323  
        
          
 

NONCURRENT ASSETS

               

Leveraged Leases, net

       2,719            2,720  

Corporate Joint Ventures

       1,012            976  

Partnership Interests

       207            204  

Goodwill and Other Intangibles

       530            540  

Derivative Contracts

       2            3  

Other

       93            98  
        
          
 

Total Noncurrent Assets

       4,563            4,541  
        
          
 

TOTAL ASSETS

     $ 6,761          $ 7,057  
        
          
 

               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

13


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED BALANCE SHEETS

    March 31,
2006

  December 31,
2005

    (Millions)
(Unaudited)

LIABILITIES AND MEMBER'S EQUITY

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 40          $ 348  

Accounts Payable:

               

Trade

       47            50  

Affiliated Companies

       23            13  

Derivative Contracts

       11            13  

Accrued Interest

       48            42  

Liabilities of Discontinued Operations

       441            436  

Other

       54            83  
        
          
 

Total Current Liabilities

       664            985  
        
          
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and Investment and Energy Tax Credits

       1,704            1,705  

Derivative Contracts

       30            27  

Other

       66            66  
        
          
 

Total Noncurrent Liabilities

       1,800            1,798  
        
          
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

MINORITY INTERESTS

       15            15  
        
          
 

LONG-TERM DEBT

               

Project Level, Non-Recourse Debt

       880            891  

Senior Notes

       1,448            1,448  
        
          
 

Total Long-Term Debt

       2,328            2,339  
        
          
 

MEMBER'S EQUITY

               

Ordinary Unit

       1,713            1,713  

Retained Earnings

       349            317  

Accumulated Other Comprehensive Loss

       (108 )          (110 )
        
          
 

Total Member's Equity

       1,954            1,920  
        
          
 

TOTAL LIABILITIES AND MEMBER'S EQUITY

     $ 6,761          $ 7,057  
        
          
 

               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

14


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

    For The Quarters Ended
March 31,

    2006

  2005

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 32        $ 79  

Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:

               

Depreciation and Amortization

       13          17  

Demand Side Management Amortization

       1          2  

Deferred Income Taxes (Other than Leases)

       4          (6 )

Leveraged Lease Income, Adjusted for Rents Received and Deferred Income Taxes

       (22 )        (26 )

Undistributed Earnings from Affiliates

       (29 )        (19 )

Gain on Sale of Investments

       (2 )        (45 )

Unrealized Gain on Investments

       (1 )        (2 )

Foreign Currency Transaction Gain

       (1 )        (3 )

Change in Fair Value of Derivative Financial Instruments

       1          (1 )

Other Non-Cash Charges

                3  

Net Changes in Certain Current Assets and Liabilities:

               

Accounts Receivable

       25          2  

Inventory

       3          8  

Accounts Payable

       (29 )        11  

Other Current Assets and Liabilities

       4          11  

Proceeds from Withdrawal of Partnership Interests and Other Distributions

       1          61  

Other

       1           
        
        
 

Net Cash Provided By Operating Activities

       1          92  
        
        
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (14 )        (13 )

Proceeds from Sale of Property

       1           

Proceeds from the Sale of Investments and Return of Capital from Partnerships

       2          1  

Short-Term Loan Receivable—Affiliated Company, net

       351          13  

Restricted Funds

       (17 )        (5 )

Proceeds from Collection of Notes Receivable

                34  

Other

       1          (5 )
        
        
 

Net Cash Provided By Investing Activities

       324          25  
        
        
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Proceeds from Non-Recourse Long-Term Debt

                11  

Repayment of Non-Recourse Long-Term Debt

       (12 )        (4 )

Repayment of Senior Notes

       (309 )         

Return of Capital Contributed

                (100 )

Cash Distributions Paid on Preference Units

                (2 )

Other

       (1 )         
        
        
 

Net Cash Used In Financing Activities

       (322 )        (95 )
        
        
 

Effect of Exchange Rate Change

       (1 )        (1 )
        
        
 

Net Increase In Cash and Cash Equivalents

       2          21  

Cash and Cash Equivalents at Beginning of Period

       68          183  
        
        
 

Cash and Cash Equivalents at End of Period

     $ 70        $ 204  
        
        
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes Paid

     $ 2        $ 1  

Interest Paid, Net of Amounts Capitalized

     $ 26        $ 52  

               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

15


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      This combined Form 10-Q is separately filed by Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power) and PSEG Energy Holdings L.L.C. (Energy Holdings). Information contained herein relating to any individual company is filed by such company on its own behalf. PSE&G, Power and Energy Holdings each make representations only as to itself and make no representations as to any other company.

Note 1. Organization and Basis of Presentation

Organization

      PSEG

      PSEG has four principal direct wholly owned subsidiaries: PSE&G, Power, Energy Holdings and PSEG Services Corporation (Services).

      As previously disclosed, on December 20, 2004, PSEG entered into an agreement and plan of merger (Merger Agreement) with Exelon Corporation (Exelon), a public utility holding company headquartered in Chicago, Illinois, whereby PSEG will be merged with and into Exelon (Merger). Under the Merger Agreement, each share of PSEG Common Stock will be converted into 1.225 shares of Exelon Common Stock.

      The Merger Agreement has been unanimously approved by both companies' Boards of Directors. On July 19, 2005, shareholders of PSEG voted to approve the Merger and on July 22, 2005, shareholders of Exelon voted to approve the issuance of common shares to PSEG shareholders to effect the Merger.

      The Merger Agreement provides that if the Merger is not consummated by June 20, 2006, either party may terminate the Merger Agreement.

      PSE&G

      PSE&G is an operating public utility engaged principally in the transmission of electric energy and distribution of electric energy and natural gas in certain areas of New Jersey. PSE&G is subject to regulation by the New Jersey Board of Public Utilities (BPU) and the Federal Energy Regulatory Commission (FERC).

      PSE&G also owns PSE&G Transition Funding LLC (Transition Funding) and PSE&G Transition Funding II LLC (Transition Funding II), bankruptcy-remote entities that purchased certain transition property from PSE&G and issued transition bonds secured by such property. The transition property consists principally of the right to receive electricity consumption-based per kilowatt-hour (kWh) charges from PSE&G electric distribution customers, which represents the irrevocable right to receive amounts sufficient to recover certain of PSE&G's transition costs related to deregulation, as approved by the BPU.

      Power

      Power is a multi-regional, wholesale energy supply company that integrates its generating asset operations and gas supply commitments with its wholesale energy, fuel supply, energy trading and marketing and risk management function through three principal direct wholly owned subsidiaries: PSEG Nuclear LLC (Nuclear), PSEG Fossil LLC (Fossil) and PSEG Energy Resources & Trade LLC (ER&T). Nuclear and Fossil own and operate generation and generation-related facilities. ER&T is responsible for the day-to-day management of Power's portfolio. Fossil, Nuclear and ER&T are subject to regulation by FERC and Nuclear is also subject to regulation by the Nuclear Regulatory Commission (NRC).

16


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Energy Holdings

      Energy Holdings has two principal direct wholly owned subsidiaries: PSEG Global L.L.C. (Global), which owns and operates international and domestic projects engaged in the generation and distribution of energy, including power production facilities and electric distribution companies, and PSEG Resources L.L.C. (Resources), which has invested primarily in energy-related leveraged leases. Energy Holdings also owns Enterprise Group Development Corporation (EGDC), a commercial real estate property management business.

      Services

      Services provides management and administrative services to PSEG and its subsidiaries. These include accounting, legal, communications, human resources, information technology, treasury and financial services, investor relations, stockholder services, real estate, environmental, health and safety, insurance, risk management, tax, library, records and information services, security, corporate secretarial and certain planning, budgeting and forecasting services. Services charges PSEG and its subsidiaries for the cost of work performed and services provided pursuant to the terms and conditions of intercompany service agreements.

Basis of Presentation

      PSEG, PSE&G, Power and Energy Holdings

      The respective financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for Quarterly Reports on Form 10-Q. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed or omitted pursuant to such rules and regulations. These Condensed Consolidated Financial Statements and Notes to Condensed Consolidated Financial Statements (Notes) should be read in conjunction with, and update and supplement matters discussed in PSEG's, PSE&G's, Power's and Energy Holdings' respective Annual Reports on Form 10-K for the year ended December 31, 2005.

      The unaudited condensed consolidated financial information furnished herein reflects all adjustments which are, in the opinion of management, necessary to fairly state the results for the interim periods presented. All such adjustments are of a normal recurring nature. The year-end Condensed Consolidated Balance Sheets were derived from the audited Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2005. Certain reclassifications of prior period data have been made to conform with the current presentation.

Pension and Other Postretirement Benefits (OPEB)

      PSEG

      PSEG sponsors several qualified and nonqualified pension plans and OPEB plans covering PSEG's and its participating affiliates' current and former employees who meet certain eligibility criteria. The following table provides the components of net periodic benefit costs relating to all qualified and nonqualified pension and OPEB plans on an aggregate basis. OPEB costs are presented net of the

17


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

federal subsidy expected for prescription drugs under the Medicare Prescription Drug Improvement and Modernization Act of 2003.

      Pension Benefits

  OPEB

      Quarters Ended
March 31,

  Quarters Ended
March 31,

      2006

  2005

  2006

  2005

      (Millions)
      

Components of Net Periodic Benefit Costs:

                               
      

Service Cost

     $ 21        $ 23        $ 5        $ 5  
      

Interest Cost

       53          52          17          14  
      

Expected Return on Plan Assets

       (67 )        (63 )        (3 )        (2 )
      

Amortization of Net

                               
      

Transition Obligation

                         7          7  
      

Prior Service Cost

       3          4          3           
      

Loss

       13          11          2          1  
          
        
        
        
 
      

Net Periodic Benefit Cost

       23          27          31          25  
      

Effect of Regulatory Asset

                         5          5  
          
        
        
        
 
      

Total Benefit Costs

     $ 23        $ 27        $ 36        $ 30  
          
        
        
        
 
      

                               

      PSE&G, Power, Energy Holdings and Services

      Pension costs and OPEB costs for PSE&G, Power, Energy Holdings and Services are detailed as follows:

      Pension Benefits

  OPEB

      Quarters Ended
March 31,

  Quarters Ended
March 31,

      2006

  2005

  2006

  2005

      (Millions)
      

PSE&G

     $ 12        $ 14        $ 30        $ 26  
      

Power

       7          8          4          3  
      

Energy Holdings

                                   
      

Services

       4          5          2          1  
          
        
        
        
 
      

Total Benefit Costs

     $ 23        $ 27        $ 36        $ 30  
          
        
        
        
 
      

                               

Note 2. Recent Accounting Standards

The following accounting standard was issued, but has not yet been adopted by PSEG as of March 31, 2006.

Emerging Issues Task Force (EITF) Issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty” (EITF 04-13)

      PSEG, PSE&G, Power and Energy Holdings

      EITF 04-13 concludes that inventory purchases and sales transactions with the same counterparty that are entered into in contemplation of one another should be combined and treated as nonmonetary exchanges involving inventory. The consensus includes indicators that should be considered in determining whether transactions were entered into in contemplation of one another. The EITF also concludes that exchanges of finished goods for raw materials or work-in-process within the same line of business should be recognized at fair value if the transaction has commercial substance and fair value is determinable within reasonable limits. All other inventory exchanges should be recognized at carrying value. The provisions of EITF 04-13 are effective for new inventory arrangements entered into, or

18


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

modifications or renewals of existing inventory arrangements occurring in financial periods beginning after March 15, 2006. PSEG, PSE&G, Power and Energy Holdings do not believe that adoption of EITF 04-13 will have a material effect on their respective financial statements.

The following accounting standards have been proposed by the Financial Accounting Standards Board (FASB).

      PSEG and Energy Holdings

      In July 2005, the FASB issued proposed guidance concerning the accounting for uncertain tax positions and the accounting for a change in the timing of cash flows relating to income taxes generated by leveraged lease transactions.

      The proposal concerning uncertain tax positions would require that an uncertain tax position meet a more likely-than-not recognition threshold based on the merits of the position in order for the benefit to be recognized in the financial statements. The proposal also addresses the accrual of interest and penalties related to tax uncertainties and the classification of liabilities on the balance sheet. If implemented in its present form, PSEG and Energy Holdings do not believe the impact of this proposal would be material.

      The proposal concerning leveraged leases would require a lessor to perform a recalculation of leveraged lease income when there is a change in the timing of the realization of tax benefits generated by the lease. If implemented in its present form, the proposal could have an impact on earnings of PSEG and Energy Holdings, which could be material.

      PSEG, PSE&G, Power and Energy Holdings

      On March 31, 2006, the FASB issued an exposure draft that would require recognition of the overfunded or underfunded positions of defined benefit pension and OPEB plans on the balance sheet. For an underfunded plan, the incremental liability to be recorded would be equal to the difference between the projected benefit obligation and the fair value of plan assets. Statement of Financial Accounting Standard (SFAS) No. 87, “Employers' Accounting for Pensions” (SFAS 87) and SFAS No. 106, “Employers' Accounting for Postretirement Benefits Other Than Pensions” (SFAS 106) allow for deferred recognition of this liability through amortization of this difference over time. Under this exposure draft, actuarial gains and losses and prior service costs and credits that arise during the period but, pursuant to SFAS 87 and SFAS 106 are not yet recognized as components of net periodic benefit cost, would be recognized as a component of Other Comprehensive Income, net of tax. For PSE&G, management believes the amounts not yet recognized would be recorded as a Regulatory Asset because the amortization of these costs is reflected in current rates. This would represent more than 50% of PSEG's unrecognized pension and OPEB costs. Such amounts would be adjusted as they are subsequently amortized as a component of net periodic benefit cost. The exposure draft also would require an adjustment to the beginning balance of retained earnings, net of tax, for any transition obligation remaining from the initial application of SFAS 87 and 106. Such amounts would then not subsequently be amortized as a component of net periodic benefit cost.

      PSEG, PSE&G, Power and Energy Holdings are currently evaluating the potential impact on their respective financial statements, which could be material, if the exposure draft is adopted as proposed.

The following new accounting standards were adopted by PSEG during the first quarter of 2006.

SFAS No. 123R, “Share-Based Payment, revised 2004” (SFAS 123R)

      PSEG

      Effective January 1, 2006, PSEG adopted SFAS No. 123R, which replaces SFAS 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board (APB) Opinion No. 25, “

19


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Accounting for Stock Issued to Employees” (APB 25). SFAS 123R focuses primarily on accounting for share-based awards to employees in exchange for services, and it requires entities to recognize compensation expense for these awards. The cost for equity-based awards is expensed based on their grant date fair value, and liability awards are expensed based on their fair value, which is re-measured each reporting period. The pro forma disclosure previously permitted under SFAS 123 is no longer an alternative to financial statement recognition.

      Prior to January 1, 2006, PSEG accounted for stock-based awards under the intrinsic value method of APB 25. In accordance with APB 25, PSEG did not record compensation expense related to its stock option grants because the strike price was equal to the fair value of the underlying stock on the grant date; however, it did record compensation expense over the requisite service period for restricted stock grants and performance unit awards.

      SFAS 123R is applicable to all of PSEG's outstanding unvested share-based payment awards as of January 1, 2006 and all prospective awards using the modified prospective method. Accordingly, the financial results for prior periods were not retroactively adjusted to reflect the effects of SFAS 123R. The compensation expense recorded as a result of adopting SFAS 123R was not material. For additional information, see Note 12. Stock-Based Compensation.

SFAS No. 151, “Inventory Costs” (SFAS 151)

      PSEG, PSE&G, Power and Energy Holdings

      In November 2004, the FASB issued SFAS 151, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. This statement requires that abnormal amounts of idle facility expense, freight, handling costs and spoilage be recognized as current-period charges. In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 was effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 did not have a material impact on the respective financial statements of PSEG, PSE&G, Power and Energy Holdings.

      FASB Staff Position (FSP) 115-1 and 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (FSP 115-1 and 124-1)

      PSEG, PSE&G, Power and Energy Holdings

      This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of the impairment loss. It also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. This guidance applies to equity securities that have a readily determinable fair value and all debt securities. It does not apply to investments accounted for under the equity method. An investment is impaired if its fair value is less than its cost, as assessed at the individual security level. When an investment is impaired, the investor is required to evaluate whether the impairment is other-than-temporary. If other-than-temporary, the unrealized loss must be recognized. For all investments in an unrealized loss position for which other-than-temporary impairments have not been recognized, the investor should disclose by category of investment the amount of unrealized losses and the fair value of investments with unrealized losses and related narrative disclosures. FSP 115-1 and 124-1 was effective for reporting periods beginning after December 15, 2005. The adoption of this FSP did not have a material effect on PSEG's, PSE&G's, Power's or Energy Holdings' respective financial statements.

20


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 3. Discontinued Operations and Dispositions

Discontinued Operations

      Power

      Waterford Generation Facility (Waterford)

      In September 2005, Power completed the sale of its electric generation facility located in Waterford, Ohio to a subsidiary of American Electric Power Company, Inc.

      Waterford's operating results for the quarter ended March 31, 2005, which have been reclassified to Discontinued Operations, are summarized below:

      Quarter Ended
March 31,
2005

             

Operating Revenues

     $  
             

Loss Before Income Taxes

     $ 12  
             

Net Loss

     $ 7  
             

       

      Energy Holdings

      Elektrocieplownia Chorzow Elcho Sp. Z o.o. (Elcho) and Elektrownia Skawina SA (Skawina)

      On January 31, 2006, Global entered into an agreement with CEZ a.s. to sell its interest in two coal-fired plants in Poland, Elcho and Skawina, consistent with its strategy of monetizing assets on an opportunistic basis. The sale is expected to close in the second quarter of 2006 and is expected to yield cash proceeds in excess of $300 million after taxes and transaction costs, which is in excess of the book value of the facilities as of March 31, 2006. The agreement is subject to customary conditions, including government consents. The 2005 results for Global's assets in Poland have been reclassified to Discontinued Operations to reflect Energy Holdings' intention to sell these facilities.

      Elcho's and Skawina's operating results for the quarters ended March 31, 2006 and 2005 are summarized below:

      Quarters Ended March 31,

      2006

  2005

      Elcho

  Skawina

  Elcho

  Skawina

      

Operating Revenues

     $ 30        $ 33        $ 29        $ 36  
      

Income Before Income Taxes

     $ 3        $ 2        $ 11        $ 3  
      

Net Income

     $ 3        $ 1        $ 10        $ 2  
      

                               

      The carrying amounts of the assets of Elcho and Skawina as of March 31, 2006 and December 31, 2005 are summarized in the following table:

      As of
March 31,
2006

  As of
December 31,
2005

      Elcho

  Skawina

  Elcho

  Skawina

      (Millions)
      

Current Assets

     $ 55        $ 26        $ 41        $ 27  
      

Noncurrent Assets

       325          116          319          111  
          
        
        
        
 
      

Total Assets of Discontinued Operations

     $ 380        $ 142        $ 360        $ 138  
          
        
        
        
 
      

                               
      

                               
      

Current Liabilities

     $ 34        $ 22        $ 27        $ 24  
      

Noncurrent Liabilities

       335          50          336          49  
          
        
        
        
 
      

Total Liabilities of Discontinued Operations

     $ 369        $ 72        $ 363        $ 73  
          
        
        
        
 
      

                               

21


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Elcho's and Skawina's total non-recourse debt amounted to $288 million and $23 million as of March 31, 2006, respectively, and $287 million and $26 million as of December 31, 2005, respectively.

Dispositions

      Energy Holdings

      Solar Electric Generating Systems (SEGS) Projects

      In January 2005, Resources and Global sold their minority limited partner interests in three SEGS projects for proceeds of approximately $7 million, resulting in an after-tax gain of $4 million.

      Dhofar Power Company S.A.O.C. (Dhofar Power)

      In April 2005, Global sold a 35% interest in Dhofar Power through a public offering on the Omani stock exchange as required under the Concession Agreement, reducing Global's ownership in Dhofar Power from 81% to 46%. Net proceeds from the sale approximated $25 million, resulting in an after-tax gain of approximately $1 million. As a result, Global's investment in Dhofar Power has been accounted for under the equity method following the sale.

      Meiya Power Company Limited (MPC)

      In January and April 2005, Global received payments of approximately $38 million and $99 million, respectively, representing the full payment of the receivable relating to the sale of its 50% equity interest in MPC in December 2004.

      Resources

      In January 2005, a KKR Fund, in which Resources had invested, sold its investment in KinderCare Learning Centers, Inc. and Resources received proceeds of approximately $17 million, resulting in an after-tax gain of approximately $1 million.

Note 4. Earnings Per Share (EPS)

PSEG

      Diluted EPS is calculated by dividing Net Income by the weighted average number of shares of common stock outstanding, including shares issuable upon exercise of stock options outstanding under PSEG's stock option plans, upon payment of performance units and upon conversion of Participating Units. The following table shows the effect of these stock options, performance units and Participating Units on the weighted average number of shares outstanding used in calculating diluted EPS:

22


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Quarters Ended March 31,

      2006

  2005

      Basic

  Diluted

  Basic

  Diluted

      

                               
      

EPS Numerator:

                               
      

Earnings (Millions)

                               
      

Continuing Operations

     $ 199        $ 199        $ 280        $ 280  
      

Discontinued Operations

       4          4          5          5  
          
        
        
        
 
      

Net Income

     $ 203        $ 203        $ 285        $ 285  
          
        
        
        
 
      

EPS Denominator (Thousands):

                               
      

Weighted Average Common Shares Outstanding

       251,187          251,187          238,314          238,314  
      

Effect of Stock Options

                787                   1,028  
      

Effect of Stock Performance Units

                91                   111  
      

Effect of Participating Units

                                  2,737  
          
        
        
        
 
      

Total Shares

       251,187          252,065          238,314          242,190  
          
        
        
        
 
      

EPS:

                               
      

Continuing Operations

     $ 0.79        $ 0.79        $ 1.18        $ 1.16  
      

Discontinued Operations

       0.02          0.02          0.02          0.02  
          
        
        
        
 
      

Net Income

     $ 0.81        $ 0.81        $ 1.20        $ 1.18  
          
        
        
        
 
      

                               

      Dividend payments on common stock for the quarter ended March 31, 2006 were $0.57 per share and totaled approximately $143 million. Dividend payments on common stock for the quarter ended March 31, 2005 were $0.56 per share and totaled approximately $134 million.

Note 5. Commitments and Contingent Liabilities

Guaranteed Obligations

      Power

      Power has unconditionally guaranteed payments by its subsidiary, ER&T, in certain commodity-related transactions in the ordinary course of business. These payment guarantees were provided to counterparties in order to obtain credit under physical and financial agreements for gas, pipeline capacity, transportation, oil, electricity and related commodities and services. These Power payment guarantees support the current exposure, interest and other costs on sums due and payable by ER&T under these agreements. Guarantees offered for trading and marketing cover lines of credit between entities and are often reciprocal in nature. The exposure between counterparties can move in either direction. The face value of the guarantees outstanding as of March 31, 2006 and December 31, 2005 was approximately $1.6 billion. In order for Power to incur a liability for the face value of the outstanding guarantees, ER&T would have to fully utilize the credit granted to it by every counterparty to whom Power has provided a guarantee and all of ER&T's contracts would have to be “out-of-the-money” (if the contracts are terminated, Power would owe money to the counterparties). The probability of all contracts at ER&T being simultaneously “out-of-the-money” is highly unlikely due to offsetting positions within the portfolio. For this reason, the current exposure at any point in time is a more meaningful representation of the potential liability to Power under these guarantees. The current exposure consists of the net of accounts receivable and accounts payable and the forward value on open positions, less any margins posted. The current exposure from such liabilities was $536 million and $549 million as of March 31, 2006 and December 31, 2005, respectively.

      Power is subject to collateral calls related to commodity contracts that are bilateral and is subject to certain creditworthiness standards as guarantor under performance guarantees for ER&T's agreements. Changes in commodity prices, including fuel, emission allowances and electricity, can have an impact on

23


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

contract terms and conditions, as margin calls on contracts entered into in the normal course of business will change as commodity prices change. As of March 31, 2006, Power had paid cash margin of approximately $145 million and received cash margin of approximately $10 million. In addition, as of March 31, 2006, letters of credit issued by Power were outstanding in the amount of approximately $556 million (including $195 million issued to PSE&G) to satisfy trading collateral obligations and support various contractual and environmental obligations. Assuming no changes in forward energy prices and positions, Power's collateral requirements can be expected to decline over time as its contracts expire.

      In the event of a deterioration of Power's credit rating to below investment grade, which represents at least a two level downgrade from its current ratings, many of these agreements allow the counterparty to demand that ER&T provide further performance assurance, generally in the form of a letter of credit or cash. As of March 31, 2006, if Power were to lose its investment grade rating and, assuming all counterparties to which ER&T is “out-of-the-money” were contractually entitled to demand, and demanded, performance assurance, ER&T could be required to post additional collateral in an amount equal to approximately $776 million. Power believes that it has sufficient access to liquidity to post such collateral, if necessary.

      Due to an increase in commodity prices subsequent to March 31, 2006, the amount of collateral posting requirements increased by approximately 35% as of April 28, 2006.

      Energy Holdings

      Energy Holdings and/or Global have guaranteed certain obligations of their subsidiaries or affiliates, including the successful completion, performance or other obligations related to certain projects. The guaranteed obligations as of March 31, 2006 and December 31, 2005 are as follows:

                As of

Subsidiaries/Affiliates

     Location

     Description

   Expiration
Date

  March 31,
2006

  December 31,
2005

                (Millions)

Skawina (a)

     Poland      Equity commitment    August 2007    $ 9      $ 9  

PSEG Global Funding II LLC

     Delaware      Contingent guarantee related to debt service obligations associated with Chilquinta    April 2011      25        25  

Elcho (a)

     Poland      Contingent guarantee related to debt service obligations    October 2009      32        32  

Prisma 2000 S.p.A. (Prisma)

     Italy      Leasing agreement guarantee    N/A      20        20  

PSEG Energy Technologies Asset Management Company LLC

     New Jersey      Performance guarantee    N/A      6        6  

Other

     Various      Various    N/A      35        46  

                
      
 

Total Contingent Obligations

               $ 127      $ 138  

                
      
 

                           


     
(a)     Expected to be sold in 2006. For further information, see Note 3. Discontinued Operations and Dispositions.

      In September 2003, Energy Holdings completed the sale of PSEG Energy Technologies Inc. (Energy Technologies) and nearly all of its assets. However, Energy Holdings retained certain outstanding construction and warranty obligations related to ongoing construction projects previously performed by Energy Technologies. These construction obligations have performance bonds issued by insurance companies for which exposure is adequately supported by the outstanding letters of credit shown in the table above for PSEG Energy Technologies Asset Management Company LLC. As of March 31, 2006, there were $22 million of such bonds outstanding related to uncompleted construction projects and other obligations. These performance bonds are not included in the $127 million of guaranteed obligations above.

24


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      In addition to the amounts discussed above, certain subsidiaries of Energy Holdings also have contingent obligations related to their respective projects, which are non-recourse to Energy Holdings.

Environmental Matters

      PSEG, PSE&G and Power

      Hazardous Substances

      The New Jersey Department of Environmental Protection (NJDEP) has regulations in effect concerning site investigation and remediation that require an ecological evaluation of potential damages to natural resources in connection with an environmental investigation of contaminated sites. These regulations may substantially increase the costs of environmental investigations and necessary remediation, particularly at sites situated on surface water bodies. PSE&G, Power and respective predecessor companies own or owned and/or operate or operated certain facilities situated on surface water bodies, certain of which are currently the subject of remedial activities. The financial impact of these regulations is not currently estimable. However, neither PSE&G nor Power anticipates that compliance with these regulations will have a material adverse effect on their respective financial positions, results of operations or net cash flows.

      The U.S. Environmental Protection Agency (EPA) has determined that a six-mile stretch of the Passaic River in the area of Newark, New Jersey is a ‘facility' within the meaning of that term under the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA). PSE&G and certain of its predecessors conducted industrial operations at properties adjacent to the Passaic River facility. The operations included one operating electric generating station (Essex Site), one former generating station and four former manufactured gas plants (MGPs). PSE&G's costs to clean up former MGPs are recoverable from utility customers through the societal benefits clause (SBC). PSE&G has sold the site of the former generating station and obtained releases and indemnities for liabilities arising out of the site in connection with the sale. The Essex Site was transferred to Power in August 2000. Power assumed any environmental liabilities of PSE&G associated with the electric generating stations that PSE&G transferred to it, including the Essex Site.

      In 2003, the EPA notified 41 potentially responsible parties (PRPs), including PSE&G and Power, that it was expanding its assessment of the Passaic River Study Area to the entire 17-mile tidal reach of the lower Passaic River. The EPA further indicated, with respect to PSE&G, that it believed that hazardous substances had been released from the Essex Site and a former MGP located in Harrison, New Jersey (Harrison Site), which also includes facilities for PSE&G's ongoing gas operations. The EPA estimated that its study would require five to eight years to complete and would cost approximately $20 million, of which it would seek to recover $10 million from the PRPs, including PSE&G and Power. Power is evaluating recoverability of any disbursed amounts from its insurance carriers.

      Also, in 2003, PSEG, PSE&G and 56 other PRPs received a Directive and Notice to Insurers from the NJDEP that directed the PRPs to arrange for a natural resource damage assessment and interim compensatory restoration of natural resource injuries along the lower Passaic River and its tributaries pursuant to the New Jersey Spill Compensation and Control Act. The NJDEP alleged in the Directive that it had determined that hazardous substances had been discharged from the Essex Site and the Harrison Site. The NJDEP announced that it had estimated the cost of interim natural resource injury restoration activities along the lower Passaic River to approximate $950 million.

      PSE&G and Power have indicated to both the EPA and NJDEP that they are willing to work with the agencies in an effort to resolve their respective claims and, along with approximately 43 other PRPs, have executed an agreement with the EPA that provides for sharing the costs of the study between the government organizations and the PRPs. PSEG, PSE&G and Power cannot predict what further

25


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

actions, if any, or the costs or the timing thereof, that may be required with respect to the Passaic River or natural resource damages. However, such costs could be material.

      PSE&G

      MGP Remediation Program

      PSE&G is currently working with the NJDEP under a program to assess, investigate and remediate environmental conditions at PSE&G's former MGP sites (Remediation Program). To date, 38 sites have been identified as requiring some level of remedial action. In addition, the NJDEP has announced initiatives to accelerate the investigation and subsequent remediation of the riverbeds underlying surface water bodies that have been impacted by hazardous substances from adjoining sites. Specifically, in 2005, the NJDEP initiated a program on the Delaware River aimed at identifying the ten most significant sites for cleanup. One of the sites identified is a former MGP facility located in Camden, New Jersey. The Remediation Program is periodically reviewed, and the estimated costs are revised by PSE&G based on regulatory requirements, experience with the program and available remediation technologies. Since the inception of the Remediation Program in 1988 through March 31, 2006, PSE&G had expenditures of approximately $349 million.

      During the fourth quarter of 2005, PSE&G refined the detailed site estimates. The cost of remediating all sites to completion, as well as the anticipated costs to address MGP-related material discovered in two rivers adjacent to former MGP sites, could range between $751 million and $796 million. No amount within the range was considered to be most likely. Therefore, $402 million was accrued as of March 31, 2006, which represents the difference between the low end of the total program cost estimate of $751 million and the total incurred costs through March 31, 2006 of $349 million. Of this amount, approximately $43 million was recorded in Other Current Liabilities and $359 million was reflected in Other Noncurrent Liabilities. The costs associated with the MGP Remediation Program have historically been recovered through the SBC charges to PSE&G ratepayers. As such, a $402 million Regulatory Asset was recorded. PSE&G anticipates spending $44 million in 2006, $45 million in 2007 and an average of $35 million per year through 2016 to remediate MGP-related environmental conditions.

      New Jersey Clean Energy Program

      The BPU has approved a funding requirement for each New Jersey utility applicable to its Renewable Energy and Energy Efficiency programs for the years 2005 to 2008. The liability for the funding requirement has been recorded at the discounted present value. The costs associated with this program will be recovered from PSE&G ratepayers over the four years and, therefore, a Regulatory Asset was also recorded. The liability for the funding requirement as of March 31, 2006 and December 31, 2005 was $313 million and $329 million, respectively.

      Power

      Prevention of Significant Deterioration (PSD)/New Source Review (NSR)

      The PSD/NSR regulations, promulgated under the Clean Air Act (CAA), require major sources of certain air pollutants to obtain permits, install pollution control technology and obtain offsets, in some circumstances, when those sources undergo a “major modification,” as defined in the regulations. The Federal government is seeking to order companies allegedly not in compliance with the PSD/NSR regulations to install the best available control technology at the affected plants and to pay monetary penalties of up to approximately $27,500 for each day of continued violation.

      The EPA and the NJDEP issued a demand in March 2000 under the CAA requiring information to assess whether projects completed since 1978 at the Hudson and Mercer coal-burning units were implemented in accordance with applicable PSD/NSR regulations. Power completed its response to the

26


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

requests for information and, in January 2002, reached an agreement with the NJDEP and the EPA to resolve allegations of noncompliance with PSD/NSR regulations. Under that agreement, over the course of 10 years, Power agreed to install advanced air pollution controls to reduce emissions of Sulfur Dioxide (SO2), Nitrogen Oxide (NOx), particulate matter and mercury from the coal-burning units at the Mercer and Hudson generating stations. The cost of the program was approximately $110 million for installation of selective catalytic reduction systems (SCRs) at Mercer, as well as additional expenditures of approximately $400 million to $500 million at Hudson and $150 million to $250 million at Mercer for other pollution control equipment to be installed by December 31, 2006 and December 31, 2012, respectively. Power also paid a $1.4 million civil penalty and has agreed to spend up to $6 million on supplemental environmental projects. The agreement resolving the NSR allegations concerning the Hudson and Mercer coal-fired units also resolved a dispute over Bergen 2 regarding the applicability of PSD requirements and allowed construction of the unit to be completed and operations to commence.

      Power has notified the EPA and the NJDEP that it is evaluating the continued operation of the Hudson coal unit in light of changes in the energy and capacity markets, increases in the cost of pollution control equipment and other necessary modifications to the unit. Power will be unable to complete the installation of the pollution control equipment at Hudson by the December 31, 2006 deadline. Power has proposed to the NJDEP and the EPA an alternative pollution reduction plan to permit Hudson to continue to operate on coal beyond December 31, 2006. Discussions relating to this issue are ongoing. Power believes that system reliability concerns that PJM previously identified in the area may result in the unit continuing to operate after December 31, 2006, however no assurances can be given regarding the outcome of these discussions. Power cannot accurately determine all costs, including any penalties and limitations on operations, that may be associated with the continued operation of the Hudson unit beyond December 31, 2006, but such costs could be material. The costs associated with the pollution control modifications for the Hudson unit have not been included in Power's forecasted capital expenditures.

      Mercury Legislation

      New Jersey and Connecticut have adopted standards for the reduction of emissions of mercury from coal-fired electric generating units. The Connecticut legislation requires coal-fired power plants in Connecticut to achieve either an emissions limit or a 90% mercury removal efficiency through technology installed to control mercury emissions effective in July 2008. The regulations in New Jersey require coal-fired electric generating units in New Jersey to meet certain emission limits or reduce emissions by 90% by December 15, 2007. Companies that are parties to multi-pollutant reduction agreements are permitted to postpone such reductions on half of their coal-fired electric generating capacity until December 15, 2012. Power has a multi-pollutant reduction agreement with the NJDEP as a result of a consent decree that resolved issues arising out of the PSD and the NSR air pollution control programs at the Hudson, Mercer and Bergen facilities. Substantial uncertainty exists regarding the feasibility of achieving the reductions in mercury emissions required by the New Jersey regulations and Connecticut statute; however, the estimated costs of technology believed to be capable of meeting these emissions limits at Power's coal-fired unit in Connecticut and at its Mercer Station are included in Power's capital expenditure forecast. Total estimated costs for the project are estimated between $300 million and $360 million.

      New Jersey Industrial Site Recovery Act (ISRA)

      Potential environmental liabilities related to subsurface contamination at certain generating stations have been identified. In the second quarter of 1999, in anticipation of the transfer of PSE&G's generation-related assets to Power, a study was conducted pursuant to ISRA, which applies to the sale of certain assets. Power had a $51 million liability as of March 31, 2006 and December 31, 2005 related

27


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

to these obligations, which is included in Other Noncurrent Liabilities on Power's Consolidated Balance Sheets and Environmental Costs on PSEG's Consolidated Balance Sheets.

      Permit Renewals

      In June 2001, the NJDEP issued a renewed New Jersey Pollutant Discharge Elimination System (NJPDES) permit for Salem, expiring in July 2006, allowing for the continued operation of Salem with its existing cooling water system. A renewal application prepared in accordance with the new Phase II 316(b) rule was filed with the NJDEP that allows the station to continue operating under its existing NJPDES permit until a new permit is issued. Power believes that its application to renew Salem's NJPDES permit demonstrates that the station meets the Phase II 316(b) rule's performance standards for reduction of impingement and entrainment through the station's existing cooling water intake technology and operations plus implemented restoration measures. Power believes that the application further demonstrates that the station meets the Phase II 316(b) rule's site-specific determination standards without the benefits of restoration. If NJDEP were to require the installation of structures at the Salem facility to reduce cooling water intake flow commensurate with closed-cycle cooling as a result of an unfavorable decision in the Phase II litigation or otherwise, Power's application estimates that the costs associated with cooling towers for Salem are approximately $1 billion, of which Power's share would be approximately $575 million. These costs are not included in Power's currently forecasted capital expenditures.

New Generation and Development

      Power

      Power completed construction of a natural gas-fired generation plant in Linden, New Jersey, which commenced commercial operation on May 1, 2006. Total costs, including interest capitalized during construction (IDC) of $214 million, were approximately $1.0 billion.

      Power also has contracts with outside parties to purchase upgraded turbines for Salem Units 1 and 2 and to purchase upgraded turbines and complete a power uprate for Hope Creek to modestly increase its generating capacity. Phase II of the Salem Unit 2 turbine replacement is currently scheduled for 2008 concurrent with steam generator replacement and is anticipated to increase capacity by 26 MW. Phase II of the Hope Creek turbine replacement is expected to be completed in 2007 along with the thermal power uprate and is expected to add approximately 120 MW. Power's expenditures to date approximate $209 million (including IDC of $18 million) with an aggregate estimated share of total costs for these projects of $247 million (including IDC of $27 million). Timing, costs and results of these projects are dependent on timely completion of work, timely approval from the NRC and various other factors.

      Completion of the projects discussed above within the estimated time frames and cost estimates cannot be assured. Construction delays, cost increases and various other factors could result in changes in the operational dates or ultimate costs to complete.

      Energy Holdings

      Electroandes S.A. (Electroandes)

      There is a 35 MW expansion project on an existing hydro station under development at Electroandes, a generating facility in Peru. Construction is expected to be completed in 2007 at a total cost of approximately $30 million. The project is expected to be financed by a Global subsidiary with cash and non-recourse debt.

28


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Basic Generation Service (BGS) Basic Gas Supply Service (BGSS)

      Power

      Power seeks to mitigate volatility in its results by contracting in advance for its anticipated electric output as well as its anticipated fuel needs.

      As part of its objective, Power has entered into contracts to directly supply PSE&G and other New Jersey Electric Distribution Companies (EDCs) with a portion of their respective BGS requirements through the New Jersey BGS auction process, described below. In addition to the BGS-related contracts, Power has entered into firm supply contracts with EDCs in Pennsylvania and Connecticut, as well as other firm sales and trading positions and commitments.

      PSE&G and Power

      PSE&G is required to obtain all electric supply requirements for customers that do not purchase electric supply from third-party suppliers through the annual New Jersey BGS auctions. The BGS auction process is a statewide process in which all of the New Jersey EDCs participate. The BGS auctions are “declining clock” auctions, where the EDCs accept offers for the amount of electric supply bidders are willing to offer with higher prices at the beginning of the auction. The auction proceeds when the amount of supply bid exceeds what is needed. The offer price is subsequently lowered and the process continues in a series of steps. When the amount of supply bid by the prospective suppliers matches an EDC's electric supply needs, the auction ends. The BPU renders a decision whether or not to accept the auction results within two business days of its conclusion.

      PSE&G enters into the Supplier Master Agreement (SMA) with the winners of these BGS auctions within three business days of the BPU's approval. PSE&G has entered into contracts with Power, as well as with other winning BGS suppliers, to purchase BGS for PSE&G's anticipated load requirements. The winners of the auction are responsible for fulfilling all the requirements of a PJM Load Serving Entity (LSE) including capacity, energy, ancillary services, transmission and any other services required by PJM. BGS suppliers assume any migration risk and must satisfy New Jersey's renewable portfolio standards.

      Through the BGS auctions, PSE&G has contracted for its anticipated BGS-Fixed Price load, as follows:

      Term Ending

      May 2006(a)

  May 2007(b)

  May 2008(c)

  May 2009(d)

       Term

  34 months

  36 months

  36 months

  36 months

      

Load (MW)

       2,900          2,840          2,840          2,882  
      

$per kWh

     $ 0.05560        $ 0.05515        $ 0.06541        $ 0.10251  
      

                               


     
(a)     Prices set in the February 2003 BGS auction.
     
(b)     Prices set in the February 2004 BGS auction.
     
(c)     Prices set in the February 2005 BGS auction.
     
(d)     Prices set in the February 2006 BGS auction, which become effective on June 1, 2006.

      PSE&G entered into a full requirements contract through 2007 with Power to meet the supply requirements of PSE&G's gas customers. Power has entered into hedges for a portion of its anticipated BGSS obligations, as permitted by the BPU. The BPU permits recovery of the cost of gas hedging up to 115 billion cubic feet or approximately 80% of PSE&G's residential gas supply annually through the BGSS tariff. For additional information, see Note 13. Related-Party Transactions.

29


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Minimum Fuel Purchase Requirements

      Power

      Power purchases coal and oil for certain of its fossil generation stations through various long-term commitments. The total minimum purchase requirements included in these commitments amount to approximately $726 million through 2012.

      Power has various multi-year requirements-based purchase commitments that average approximately $89 million per year to meet Salem's and Hope Creek's nuclear fuel needs, of which Power's share is approximately $64 million per year through 2010. Power has been advised by the co-owner and operator of Peach Bottom, Exelon Generation LLC (Exelon Generation), that it has similar purchase contracts to satisfy the fuel requirements for Peach Bottom through 2010, of which Power's share is approximately $29 million per year.

      In addition to its fuel requirements, Power has entered into various multi-year contracts for firm transportation and storage capacity for natural gas, primarily to meet its gas supply obligations to PSE&G. As of March 31, 2006, the total minimum requirements under these contracts were approximately $1.2 billion through 2016.

      These purchase obligations are aligned with Power's strategy to enter into contracts for its fuel supply in comparable volumes to its sales contracts.

      Energy Holdings

      The Guadalupe and Odessa plants of Texas Independent Energy, L.P. (TIE) have entered into gas supply agreements for their anticipated fuel requirements to satisfy obligations under their forward energy sales contracts. As of March 31, 2006, the Guadalupe and Odessa plants, which total approximately 2,000 MW of capacity, had forward energy sales contracts in place for approximately 50% of their expected output for the balance of 2006 and the sale of approximately 18% of their aggregate capacity for 2007 through 2010. The plants had fuel purchase commitments totaling $123 million to fully support such contracts.

Operating Services Contract (OSC)

      Power

      Nuclear has entered into an OSC with Exelon Generation, which commenced on January 17, 2005, relating to the operation of the Hope Creek and Salem nuclear generating stations. The OSC requires Exelon Generation to provide a chief nuclear officer and other key personnel to oversee daily plant operations at the Hope Creek and Salem nuclear generating stations and to implement the Exelon Generation operating model, which defines practices that Exelon Generation has used to manage its own nuclear performance program. Nuclear continues as the license holder with exclusive legal authority to operate and maintain the plants, retains responsibility for management oversight and has full authority with respect to the marketing of its share of the output from the facilities. Exelon Generation is entitled to receive reimbursement of its costs in discharging its obligations, an annual operating services fee of $3 million and incentive fees up to $12 million annually based on attainment of goals relating to safety, capacity factor and operation and maintenance expenses. The OSC has a term of two years, subject to earlier termination in certain circumstances. In the event of termination, Exelon Generation will continue to provide services under the OSC for a transition period of at least 180 days and up to two years at the election of Nuclear. This period may be further extended by Nuclear for up to an additional 12 months if Nuclear determines that additional time is necessary to complete required activities during the transition period.

30


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Maintenance Agreement

      Power

      Power entered into a long-term contractual services agreement with a vendor in September 2003 to provide the outage and service needs for certain of Power's fossil generating units at market rates. The contract covers approximately 25 years and could result in annual payments ranging from approximately $10 million to $50 million for services, parts and materials rendered.

Nuclear Fuel Disposal

      Power

      Under the Nuclear Waste Policy Act of 1982, as amended (NWPA), the Federal government has entered into contracts with the operators of nuclear power plants for transportation and ultimate disposal of spent nuclear fuel. To pay for this service, nuclear plant owners are required to contribute to a Nuclear Waste Fund at a rate of one mil ($0.001) per kWh of nuclear generation, subject to such escalation as may be required to assure full cost recovery by the Federal government. Under the NWPA, the U.S. Department of Energy (DOE) was required to begin taking possession of the spent nuclear fuel by no later than 1998. The DOE has announced that it does not expect a facility for such purpose to be available earlier than 2010.

      Pursuant to NRC rules, spent nuclear fuel generated in any reactor can be stored in reactor facility storage pools or in independent spent fuel storage installations located at reactors or away-from-reactor sites for at least 30 years beyond the licensed life for reactor operation (which may include the term of a revised or renewed license). Adequate spent fuel storage capacity is estimated to be available through 2011 for Salem 1, 2015 for Salem 2 and 2007 for Hope Creek. Power has commenced construction of an on-site storage facility that will satisfy the spent fuel storage needs of both Salem and Hope Creek through the end of their current respective license lives. Exelon Generation has advised Power that it has a licensed and operational on-site storage facility at Peach Bottom that will satisfy Peach Bottom's spent fuel storage requirements until at least 2014.

      Exelon Generation had previously advised Power that it had signed an agreement with the DOE, applicable to Peach Bottom, under which Exelon Generation would be reimbursed for costs incurred resulting from the DOE's delay in accepting spent nuclear fuel for permanent storage. Under this agreement, Power's portion of Peach Bottom's Nuclear Waste Fund fees was reduced by approximately $18 million through August 31, 2002, at which point credits were fully utilized and covered the cost of Exelon Generation's on-site storage facility. In September 2002, the U.S. Court of Appeals for the Eleventh Circuit issued an opinion upholding a petition seeking to set aside the receipt of these credits by Exelon Generation. On August 14, 2003, Exelon Generation received a letter from the DOE demanding repayment of previously received credits from the Nuclear Waste Fund. The letter also demanded a total of approximately $1.5 million of accrued interest. In August 2004, Exelon Generation advised Nuclear that it reached a settlement with the U.S. Department of Justice, under which Exelon Generation would be reimbursed for costs associated with the storage of spent nuclear fuel at the Peach Bottom facility, a portion of which would be paid to Nuclear as a co-owner of Peach Bottom. Future costs incurred resulting from the DOE delays in accepting spent fuel will be reimbursed annually until the DOE fulfills its obligation to accept spent nuclear fuel. In addition, Exelon Generation and Nuclear are required to reimburse the DOE for the previously received credits from the Nuclear Waste Fund, plus lost earnings. Under this settlement, Power received approximately $27 million for its share of previously incurred storage costs for Peach Bottom, $22 million of which was used for the required reimbursement to the Nuclear Waste Fund. Exelon Generation paid Power approximately $5.4 million for its portion of the spent fuel storage costs reimbursed by DOE in 2005 for costs incurred between October 1, 2003 and June 30, 2005.

31


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      In September 2001, Power filed a complaint in the U.S. Court of Federal Claims seeking damages caused by the DOE not taking possession of spent nuclear fuel in 1998. On October 14, 2004, an order to show cause was issued regarding whether the U.S. Court of Federal Claims has jurisdiction over the matter. Power responded to this order in November 2004. On January 31, 2005, the Judge dismissed the breach-of-contract claims of Power and three other utilities. Power moved for reconsideration in the U.S. Court of Federal Claims and jointly petitioned for permission to appeal the January 31, 2005 order to the U.S. Court of Appeals for the Federal Circuit. No assurances can be given as to any damage recovery or the ultimate availability of a disposal facility.

Spent Fuel Pool

      Power

      The spent fuel pool at each Salem unit has an installed leakage collection system. This system was found to be obstructed at Salem Unit 1. Power developed a solution to maintain the design function of the leakage collection system at Salem Unit 1 and investigated the existence of any structural degradation that might have been caused by the obstruction. The concrete and reinforcing steel laboratory tests results were completed in March 2006. Test results that have been collected as part of the ongoing testing indicate that no repairs are anticipated. The NRC issued Information Notice 2004-05 in March 2004 concerning this emerging industry issue and Power cannot predict what further actions the NRC may take on this matter.

      Elevated concentrations of tritium in the shallow groundwater at Salem Unit 1 were detected in early 2003. This information was reported to the NJDEP and the NRC, as required. Power conducted a comprehensive investigation in accordance with NJDEP site remediation regulations to determine the source and extent of the tritium in the groundwater. Power is conducting remedial actions to address the contamination in accordance with a remedial action workplan approved by the NJDEP in November 2004. The remedial actions are expected to be ongoing for several years. The costs necessary to address this onsite groundwater contamination issue are not expected to be material.

Investment Tax Credits (ITC)

      PSEG and PSE&G

      As of June 1999, the Internal Revenue Service (IRS) had issued several private letter rulings (PLRs) that concluded that the refunding of excess deferred tax and ITC balances to utility customers was permitted only over the related assets' regulatory lives, which were terminated upon New Jersey's electric industry deregulation. Based on this fact, PSEG and PSE&G reversed the deferred tax and ITC liability relating to PSE&G's generation assets that were transferred to Power, and recorded a $235 million reduction of the extraordinary charge in 1999 due to the restructuring of the utility industry in New Jersey. PSE&G was directed by the BPU to seek a PLR from the IRS to determine if the ITC included in the impairment write-down of generation assets could be credited to customers without violating the tax normalization rules of the Internal Revenue Code. PSE&G filed a PLR request with the IRS in 2002, which is still pending.

      On December 21, 2005, the Treasury proposed new regulations for comment addressing the normalization of ITC replacing regulations originally proposed in 2003. The new proposed regulations, if finalized, would not permit retroactive application. Accordingly, the IRS's conclusions in the above referenced PLRs would continue to remain in effect for all industry deregulations prior to December 21, 2005.

      The BPU initiated generic proceedings on the ITC issue and requested all utilities to submit comments on the issue by February 21, 2006 with reply comments to be submitted by March 7, 2006. These comments were solicited even though the IRS has issued new proposed regulations for comment

32


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

and public hearing. PSE&G filed a letter response on February 15, 2006 requesting the BPU to take no further action until the IRS issues its final rule or PSE&G receives its PLR.

      On April 6, 2006, a conference was held between the IRS, PSEG and the BPU concerning PSE&G's private letter ruling request. At that conference, the IRS informed the participants that it had reached the tentative conclusion that no portion of the generation-related ITC in question may be passed on to utility customers without violating the normalization rules. The IRS provided a 21-day comment period in which the parties may provide additional information to be considered in the ruling process.

      On April 26, 2006, the BPU issued an order to PSE&G revoking its previous instruction and directing PSE&G to withdraw its request for a PLR by April 27, 2006. The BPU asserted that the proposed regulation project was the more appropriate authority to rely upon in deciding the ITC issue. PSE&G plans to aggressively contest the BPU's order to withdraw the request, as it is an important step in determining the appropriate application of federal tax law to PSE&G's specific facts. PSE&G cannot predict the outcome of the BPU order to withdraw the private letter ruling request.

      On April 27, 2006, the IRS extended the comment period deadline through May 8, 2006 and the BPU stayed its order to withdraw the PLR request through the same date. While it is expected that the IRS will issue the PLR sometime after the deadline, provided the request for the ruling is not withdrawn, the exact date of issuance cannot be predicted. PSE&G and the BPU are continuing to discuss the matter.

      While PSE&G cannot predict the outcome of these matters, a requirement to refund such amounts to customers would have a material adverse impact on PSEG's and PSE&G's financial condition, results of operations and net cash flows.

BPU Deferral Audit

      PSEG and PSE&G

      The BPU Energy and Audit Division conducts audits of deferred balances. A draft Deferral Audit—Phase II report relating to the 12-month period ended July 31, 2003 was released by the consultant to the BPU in April 2005. The draft report addresses the SBC, Market Transition Charge (MTC) and Non-Utility Generation (NUG) deferred balances. The BPU released the report on May 13, 2005.

      While the consultant to the BPU found that the Phase II deferral balances complied in all material respects with the BPU Orders regarding such deferrals, the consultant noted that the BPU Staff had raised certain questions with respect to the reconciliation method PSE&G employed in calculating the overrecovery of its MTC and other charges during the Phase I and Phase II four-year transition period. The amount in dispute is approximately $118 million. PSE&G and the BPU Staff are continuing discussions to resolve these questions and, if a resolution cannot be achieved, a BPU proceeding may be instituted to consider the issues raised. While PSE&G believes the MTC methodology it used was fully litigated and resolved, without exception, by the BPU and other intervening parties in its previous electric base rate case, deferral audit and deferral proceeding that were approved by the BPU in its order on April 22, 2004, and that such order is non-appealable, PSE&G cannot predict the impact of the outcome of any such proceeding.

Leveraged Lease Investments

      PSEG and Energy Holdings

      Resources faces risks with regard to the creditworthiness of certain lessees that collectively comprise a substantial portion of Resources' investment portfolio. Resources also faces risks related to potential changes in the current accounting and tax treatment of certain investments in leveraged leases.

33


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      From 1996 through 2002, PSEG, through its indirect wholly owned subsidiary, Resources, entered into a number of leveraged lease transactions in the ordinary course of business. Certain of those transactions are similar to a type that the IRS subsequently announced its intention to challenge, and PSEG understands that similar transactions entered into by other companies have been the subject of review and challenge by the IRS. As of each of March 31, 2006 and December 31, 2005, Resources' total gross investment in such transactions was approximately $1.4 billion. The IRS is presently reviewing the tax returns of PSEG and its subsidiaries for tax years 1997 through 2000, years when Resources entered into some of these transactions.

      On September 27, 2005, the IRS proposed to disallow PSEG's deductions associated with certain of these leveraged leases which have been designated by the IRS as “listed transactions”. Other lease transactions within the audit period are still under IRS review. The IRS may propose additional disallowances in the future. If deductions associated with these lease transactions entered into by PSEG are successfully challenged by the IRS, it could have a material adverse impact on PSEG's and Energy Holdings' financial position, results of operations and net cash flows and could impact future returns on these transactions. PSEG believes that its tax position related to these transactions is proper based on applicable statutes, regulations and case law and believes that it should prevail with respect to any IRS challenge, although no assurances can be given.

      If the tax benefits associated with the above referenced lease transactions were completely disallowed by the IRS, approximately $693 million of PSEG's deferred tax liabilities that have been recorded under leveraged lease accounting through March 31, 2006 could become currently payable. In addition, interest expense of approximately $97 million, after-tax, and penalties could be assessed. Management assessed the probability of various outcomes to this matter and recorded appropriate reserves in accordance with SFAS No. 5 “Accounting for Contingencies.” Energy Holdings believes that such an outcome is unlikely. However, in the event that such a payment is required, Energy Holdings believes that, assuming certain asset monetizations of its investment portfolio, it has the financial capacity to meet this potential obligation.

      The FASB is currently considering a modification to GAAP for leveraged leases. Under present GAAP, a tax settlement with the IRS that results in a change in the timing of tax liabilities would not require an accounting repricing of the lease investment. As such, income from the lease would continue to accrue at the original economic yield computed for the lease and there would be no write-down of the lease investment. See Note 2. Recent Accounting Standards for additional information.

Restructuring Charge

      Power

      In June 2005, Power implemented a plan to reduce its Nuclear workforce by approximately 200 positions. The plan included voluntary and involuntary separations offered to both represented and non-represented employees. The major cost associated with the restructuring relates to payments to the employees who are terminated. Power's $14 million share of the estimated total cost was recorded in 2005, approximately $7 million of which had been paid as of March 31, 2006.

Retention Program

      PSEG

      The Retention Program, effective as of December 20, 2004, provides for payments to be made to certain key employees of PSEG who remain employed from the date of execution of the Merger Agreement through the date that is 90 days after the consummation of the Merger. The amount of a participant's retention payment may not be less than 40% or more than 150% of the participant's annual base salary. Retention payments under the Retention Program were not to exceed $10 million in the aggregate.

34


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      PSEG paid the first installment, equal to half of a participant's total retention payment, in December 2005, the first anniversary of the date of execution of the Merger Agreement. PSEG will pay the participants' remaining retention payments within 90 days after the consummation of the Merger. In April 2006, the Retention Program was amended to change maximum aggregate payments from $10 million to $15 million. Awards granted after March 31, 2006 are to be paid in one installment. No participant whose employment terminates for any reason other than involuntary termination without “cause” will receive any retention payment. A participant whose employment is terminated without “cause” on or prior to the payment of the final installment of the retention payment will be treated as if he or she remained employed through the date that is 90 days after consummation of the Merger for all purposes under the Retention Program.

Severance Plan

      PSEG

      The Severance Plan provides change in control severance benefits to certain elected officers of PSEG whose employment is terminated without “cause” or who resign their employment for “good reason” within two years after a change in control, which would include the consummation of the Merger. Under the Severance Plan, the majority of the participants, if they are terminated without “cause” or resign employment for “good reason”, under the terms of the plan, will receive (1) a pro rata bonus based on the participant's target annual incentive compensation, (2) two times the sum of the participant's salary and target incentive bonus, (3) accelerated vesting of equity-based awards, (4) a lump sum payment equal to the actuarial equivalent of the participant's benefits under all of PSEG's retirement plans in which the participant participates calculated as though the participant remained employed for two years beyond the date his or her employment terminates less the actuarial equivalent of such benefits on the date his or her employment terminates, (5) two years continued welfare benefits (the first 18 months of which will be provided through PSEG-paid COBRA continuation coverage), (6) one year of PSEG-paid outplacement services and (7) vesting of any compensation previously deferred. Under the Severance Plan, five participants will receive the same benefits as the other participants, except that the applicable multiplier for salary and target incentive bonus, retirement plan accruals and continuation of welfare benefits is three years instead of two.

Other

      Energy Holdings

      Rio Grande Energia S.A. (RGE)

      The governing tax authority in Brazil has claimed past due taxes from RGE plus penalties and interest for the periods 1998 to 2004 primarily related to claims that certain deductions were improper, certain changes in average depreciation rates made by RGE were not allowable and that the goodwill tax amortization period used by RGE for several years resulted in higher-than-allowed tax deductions. Global's share of the maximum claim amount related to these tax issues is approximately $27 million. RGE believes it has valid legal defenses to these claims. The court of first instance has ruled against RGE and RGE has appealed the lower court ruling, which remains pending. Although RGE believes its defenses to these claims are valid and will continue to vigorously contest this matter, no assurances can be given regarding the outcome.

      Between 1998 and September 2005, Sul Geradora Participacoes Ltda. (SGP) was a wholly owned subsidiary of RGE. Following new regulations issued by the national regulatory authority, 33.34% of SGP was sold to an indirect subsidiary of Global and the remainder was sold to a subsidiary of the majority owner of RGE in September 2005. In 2004, the Brazilian tax authority filed a tax assessment against SGP relating to a loan entered into between SGP and BankBoston N.A. denying the characterization of the loan as a withholding-free transaction for 2000, 2001 and 2002. The original

35


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

amount of the assessment is $15 million, including tax, penalty and interest. Global's indirect share of the claim is approximately $5 million. SGP believes it has valid defenses to these claims and has filed an appeal of the assessment, and it remains pending, although no assurances can be given regarding the outcome.

      Electroandes

      In July 2005, Electroandes received a notice from Superintendencia Nacional de Administracion Tributaria (SUNAT), the governing tax authority in Peru, claiming past due taxes for 2002 totaling approximately $2 million related to certain interest deductions. Electroandes has taken similar interest deductions subsequent to 2002. The total cumulative estimated potential amount for past due taxes, including associated interest and penalties, is approximately $7 million through March 31, 2006. Electroandes believes it has valid legal defenses to these claims, and has filed for an appeal with SUNAT to which it has not yet received a response; however, no assurances can be given regarding the outcome of this matter.

      Dhofar Power

      Since commencing operations in Oman in May 2003, Dhofar Power has experienced a number of unplanned service interruptions, including four in the first half of 2004, which resulted from a combination of force majeure events and breaches of general warranties of the contractors that installed equipment at Dhofar Power. Dhofar Power and the Government of Oman have been in a dispute regarding the applicability and extent of any penalties under Dhofar Power's Concession Agreement arising from these service interruptions. On July 14, 2005, the expert engaged by the parties recommended no penalties be assessed for the 2003 service interruptions and agreed with Dhofar Power's interpretation of the Concession Agreement with respect to the criteria to be utilized in assessing penalties. The Government of Oman has exercised its right to appeal the expert's determination to a full arbitration panel. While Dhofar Power believes this matter will be favorably resolved in 2006, no assurances can be given.

      Dhofar Power and the Government of Oman are also in disagreement on the basis of the calculation of certain monthly allowances to be paid to compensate Dhofar Power for the capital investment costs associated with the enhancements and extensions of the transmission and distribution system in Salalah. On August 24, 2005, the expert engaged by the parties found in favor of Dhofar Power with respect to the criteria to be used in determining the monthly allowances. The Government has failed to properly exercise its right to appeal the expert's determination to a full arbitration panel but has not yet agreed to pay the sums awarded by the expert. Dhofar Power will seek to enforce the expert's determination that it is entitled to approximately $1 million annually for 15 years retroactive to December 2003 and believes that this matter will be favorably resolved in 2006, although no assurances can be given.

Note 6. Risk Management

PSEG, PSE&G, Power and Energy Holdings

      The operations of PSEG, PSE&G, Power and Energy Holdings are exposed to market risks from changes in commodity prices, foreign currency exchange rates, interest rates and equity prices that could affect their results of operations and financial conditions. PSEG, PSE&G, Power and Energy Holdings manage exposure to these market risks through their regular operating and financing activities and, when deemed appropriate, hedge these risks through the use of derivative financial instruments. PSEG, PSE&G, Power and Energy Holdings use the term “hedge” to mean a strategy designed to manage risks of volatility in prices or rate movements on certain assets, liabilities or anticipated transactions and by creating a relationship in which gains or losses on derivative instruments are expected to counterbalance the gains or losses on the assets, liabilities or anticipated transactions exposed to such

36


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

market risks. Each of PSEG, PSE&G, Power and Energy Holdings uses derivative instruments as risk management tools consistent with its respective business plan and prudent business practices.

Derivative Instruments and Hedging Activities

      Power

      Power maintains a strategy of entering into positions to optimize the value of its portfolio and reduce earnings volatility of generation assets, gas supply contracts and its electric and gas supply obligations. Power engages in physical and financial transactions in the electricity wholesale markets and executes an overall risk management strategy seeking to mitigate the effects of adverse movements in the fuel and electricity markets. These contracts also involve financial transactions including swaps, options and futures.

      Energy Trading Contracts (ETCs)

      Power actively trades energy and energy-related products, including electricity, natural gas, electric capacity, firm transmission rights (FTRs), coal, oil and emission allowances in the spot, forward and futures markets, primarily in PJM, but also in the surrounding region, which extends from Maine to the Carolinas and the Atlantic Coast to Indiana, and natural gas in the producing region.

      Power marks to market its derivative ETCs in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended (SFAS 133), with changes in fair value charged to the Condensed Consolidated Statements of Operations. Wherever possible, fair values for these contracts are obtained from quoted market sources. For contracts where no quoted market exists, modeling techniques are employed using assumptions reflective of current market rates, yield curves and forward prices, as applicable, to interpolate certain prices. The effect of using such modeling techniques is not material to Power's financial results.

      Power routinely enters into exchange-traded futures and options transactions for electricity and natural gas as part of its operations. Generally, exchange-traded futures contracts require a deposit of margin cash, the amount of which is subject to change based on market movement and in accordance with exchange rules. As of March 31, 2006, Power had deposited margin of approximately $246 million related to such transactions.

      Commodity Contracts

      Power

      The availability and price of energy commodities are subject to fluctuations from factors such as weather, environmental policies, changes in supply and demand, state and federal regulatory policies, market conditions, transmission availability and other events. Power manages its risk of fluctuations of energy price and availability through derivative instruments, such as forward purchase or sale contracts, swaps, options, futures and FTRs.

      Cash Flow Hedges

      Power uses forward sale and purchase contracts, swaps and FTR contracts to hedge forecasted energy sales from its generation stations and to hedge related load obligations. Power also enters into swaps and futures transactions to hedge the price of fuel to meet its fuel purchase requirements. These derivative transactions are designated and effective as cash flow hedges under SFAS 133. As of March 31, 2006, the fair value of these hedges was $(759) million. These hedges resulted in a $(443) million after-tax impact on Accumulated Other Comprehensive Loss (OCL). As of December 31, 2005, the fair value of these hedges was $(951) million. These hedges, along with realized gains on hedges of $11 million retained in OCL, resulted in a $(558) million after-tax impact on OCL. During the next 12

37


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

months, $194 million (after-tax) of net unrealized and realized losses on these commodity derivatives is expected to be reclassified to earnings. Approximately $174 million of after-tax unrealized losses on these commodity derivatives in OCL is expected to be reclassified to earnings for the 12 months ended March 31, 2008. Ineffectiveness associated with these hedges, as defined in SFAS 133, was $(10) million. The expiration date of the longest-dated cash flow hedge is in 2009.

      Other Derivatives

      Power also enters into certain other contracts that are derivatives, but do not qualify for hedge accounting under SFAS 133. Most of these contracts are used for fuel purchases for generation requirements and for electricity purchases for contractual sales obligations. Therefore, the changes in fair market value of these derivative contracts are recorded in Energy Costs or Operating Revenues, as appropriate, on the Condensed Consolidated Statements of Operations. The net fair value of these instruments as of March 31, 2006 was $(16) million. The net fair value of these instruments as of December 31, 2005 was not material.

      Energy Holdings

      Other Derivatives

      TIE, an indirect, wholly owned subsidiary of Energy Holdings and Global, enters into electricity forward and capacity sale contracts to sell up to 1,500 MW of its 2,000 MW capacity for portions of the current calendar year, with the balance sold into the daily spot market. TIE also enters into gas purchase contracts to specifically match the generation requirements to support the electricity forward sales contracts. Although these contracts fix the amount of revenue, fuel costs and cash flows, and thereby provide financial stability to TIE, these contracts are, based on their terms, derivatives that do not meet the specific accounting criteria in SFAS 133 to qualify for the normal purchases and normal sales exception, or to be designated as a hedge for accounting purposes. As a result, these contracts must be recorded at fair value. The net fair value of the open positions was approximately $(12) million and $(7) million as of March 31, 2006 and December 31, 2005, respectively.

      Certain fixed price contracts that hedge a portion of TIE's output resulted in an unrealized loss, or opportunity cost for the quarter ended March 31, 2006, relative to current market prices. Such contracts can lead to significant earnings volatility in the future as these fixed price contracts that are supported by TIE's physical plant capacity are marked to market each period against current prices.

Interest Rates

      PSEG, PSE&G, Power and Energy Holdings

      PSEG, PSE&G, Power and Energy Holdings are subject to the risk of fluctuating interest rates in the normal course of business. PSEG's policy is to manage interest rate risk through the use of fixed and floating rate debt and interest rate derivatives.

      Fair Value Hedges

      PSEG and Power

      In March 2004, Power issued $250 million of 3.75% Senior Notes due April 2009. PSEG used an interest rate swap to convert Power's fixed-rate debt into variable-rate debt. The interest rate swap is designated and effective as a fair value hedge. The fair value changes of the interest rate swap are fully offset by the fair value changes in the underlying debt. As of March 31, 2006 and December 31, 2005, the fair value of the hedge was $(12) million and $(10) million, respectively.

38


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Cash Flow Hedges

      PSEG, PSE&G and Energy Holdings

      PSEG, PSE&G and Energy Holdings use interest rate swaps and other interest rate derivatives to manage their exposures to the variability of cash flows, primarily related to variable-rate debt instruments. The interest rate derivatives used are designated and effective as cash flow hedges. Except for PSE&G's cash flow hedges, the fair value changes of these derivatives are initially recorded in OCL. As of March 31, 2006, the fair value of these cash flow hedges was $(8) million, including $(6) million and $(2) million at PSE&G and Energy Holdings, respectively. As of December 31, 2005, the fair value of these cash flow hedges was $(17) million, including $(11) million and $(6) million at PSE&G and Energy Holdings, respectively. The $(6) million and $(11) million at PSE&G as of March 31, 2006 and December 31, 2005, respectively, is not included in OCL, as it is deferred as a Regulatory Asset and is expected to be recovered from PSE&G's customers. During the next 12 months, $(18) million of unrealized losses (net of taxes) on interest rate derivatives in OCL is expected to be reclassified to earnings, including $(1) million and $(17) million at PSEG and Energy Holdings, respectively. As of March 31, 2006, hedge ineffectiveness associated with these hedges was $(3) million. The fair value amounts above do not include approximately $(56) million and $(60) million as of March 31, 2006 and December 31, 2005, respectively, for the cash flow hedges at Elcho, which have been reclassified into Discontinued Operations.

      Other Derivatives

      Energy Holdings

      Energy Holdings has cross currency interest rate swaps whose changes in fair value were recorded in Income from Equity Method Investments on the Condensed Consolidated Statements of Operations. The fair value of these swaps was approximately $(2) million as of March 31, 2006 and December 31, 2005.

Foreign Currencies

      Energy Holdings

      Global is exposed to foreign currency risk and other foreign operations risk that arise from investments in foreign subsidiaries and affiliates. A key component of its risks is that some of its foreign subsidiaries and affiliates have functional currencies other than the consolidated reporting currency, the U.S. Dollar. Additionally, Global and certain of its foreign subsidiaries and affiliates have entered into monetary obligations and maintain receipts/receivables in U.S. Dollars or currencies other than their own functional currencies. Global, a U.S. Dollar functional currency entity, is primarily exposed to changes in the Brazilian Real, the Euro, the Peruvian Nuevo Sol and the Chilean Peso. Changes in valuation of these currencies can impact the value of Global's investments. Global has attempted to limit potential foreign exchange exposure by entering into revenue contracts that adjust for changes in foreign exchange rates. Global also uses foreign currency forward, swap and option agreements to manage risk related to certain foreign currency fluctuations.

      As of March 31, 2006, the net cumulative foreign currency devaluations have reduced the total amount of Global's Member's Equity by $29 million.

      In November and December 2005, Energy Holdings purchased foreign currency options in order to hedge the majority of its 2006 expected earnings denominated in Brazilian Real, Chilean Pesos and Peruvian Nuevo Soles. These options are not considered hedges for accounting purposes under SFAS 133 and, as a result, changes in their fair value are recorded directly to earnings. The fair value of these options was approximately $1 million and $2 million as of March 31, 2006 and December 31, 2005, respectively. On January 31, 2006, in connection with the sale of Elcho and Skawina, Energy Holdings

39


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

purchased options to sell Euros and receive U.S. Dollars at a rate of 1.17 Euros to the Dollar. These nine-month options will hedge more than 90% of the expected sale proceeds from a devaluation of the Euro relative to the U.S. Dollar prior to the closing of the sale. The fair value of these options, which are classified within Discontinued Operations, was approximately $4 million as of March 31, 2006.

Hedges of Net Investments in Foreign Operations

      Energy Holdings

      In March 2004 and April 2004, Energy Holdings entered into four cross currency interest rate swap agreements. The swaps are designed to hedge the net investment in a foreign subsidiary associated with the exposure to the U.S. Dollar to Chilean Peso exchange rate. The fair value of the cross currency swaps was $(29) million and $(33) million as of March 31, 2006 and December 31, 2005, respectively. The change in fair value is recorded net of tax in Cumulative Translation Adjustment within OCL. As a result, Energy Holdings' Member's Equity was reduced by $23 million as of March 31, 2006.

Note 7. Comprehensive Income, Net of Tax

    PSE&G

  Power (A)

  Energy
Holdings (B)

  Other (C)

  Consolidated
Total

    (Millions)

For the Quarter Ended March 31, 2006:

                                       

Net Income (Loss)

     $ 78        $ 112        $ 32        $ (19 )      $ 203  

Other Comprehensive Income

                133          2          1          136  
        
        
        
        
        
 

Comprehensive Income (Loss)

     $ 78        $ 245        $ 34        $ (18 )      $ 339  
        
        
        
        
        
 

For the Quarter Ended March 31, 2005:

                                       

Net Income (Loss)

     $ 118        $ 108        $ 79        $ (20 )      $ 285  

Other Comprehensive (Loss) Income

                (110 )        (51 )        2          (159 )
        
        
        
        
        
 

Comprehensive Income (Loss)

     $ 118        $ (2 )      $ 28        $ (18 )      $ 126  
        
        
        
        
        
 

                                       


     
(A)     Changes at Power primarily relate to changes in SFAS 133 unrealized losses on derivative contracts that qualify for hedge accounting and unrealized gains and losses on Nuclear Decommissioning Trust (NDT) Funds.
     
(B)     Changes at Energy Holdings primarily relate to foreign currency translation adjustments and unrealized gains and losses on various derivative transactions.
     
(C)     Other primarily consists of activity at PSEG (as parent company), Services and intercompany eliminations.

Note 8. Changes in Capitalization

PSEG

      During the quarter ended March 31, 2006, PSEG issued approximately 266,000 shares of its common stock under its Dividend Reinvestment Program and Employee Stock Purchase Program for approximately $17 million.

      In February 2006, PSEG redeemed $154 million of its Subordinated Debentures underlying $150 million of Enterprise Capital Trust II, Floating Rate Capital Securities and its common equity investment in the trust.

PSE&G

      On March 1, 2006, PSE&G repaid at maturity $148 million of its 6.75% Series UU First and Refunding Mortgage Bonds.

      In March 2006, Transition Funding repaid approximately $36 million of its transition bonds.

40


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Power

      In April 2006, Power repaid at maturity $500 million of its 6.875% Senior Notes.

Energy Holdings

      In January 2006, Energy Holdings redeemed $309 million of its 7.75% Senior Notes due in 2007.

      On February 17, 2006, the maturity of the Odessa–Ector Power Partners, L.P (Odessa) debt was extended to December 31, 2009. Interest on the debt is based on a spread (currently 2.25%) above LIBOR. As of September 29, 2006, Odessa's interest rate will be swapped to a fixed rate of 5.4275%.

Note 9. Other Income and Deductions

    PSE&G

  Power

  Energy
Holdings

  Other (A)

  Consolidated
Total

    (Millions)

Other Income:

                                       

For the Quarter Ended March 31, 2006:

                                       

Interest Income

     $ 4        $ 2        $        $        $ 6  

NDT Fund Realized Gains

                28                            28  

NDT Interest and Dividend Income

                10                            10  

Foreign Currency Gains

                         2                   2  

Other

                1          3          (1 )        3  
        
        
        
        
        
 

Total Other Income

     $ 4        $ 41        $ 5        $ (1 )      $ 49  
        
        
        
        
        
 

For the Quarter Ended March 31, 2005:

                                       

Interest Income

     $ 2        $ 1        $ 6        $        $ 9  

Gain on Disposition of Investments

                         1                   1  

NDT Fund Realized Gains

                22                            22  

NDT Interest and Dividend Income

                7                            7  

Foreign Currency Gains

                         1                   1  

Other

                1          1          1          3  
        
        
        
        
        
 

Total Other Income

     $ 2        $ 31        $ 9        $ 1        $ 43  
        
        
        
        
        
 

                                       
    PSE&G

  Power

  Energy
Holdings

  Other (A)

  Consolidated
Total

    (Millions)

Other Deductions:

                                       

For the Quarter Ended March 31, 2006:

                                       

Donations

     $ 1        $        $        $        $ 1  

NDT Fund Realized Losses

                17                            17  

Foreign Currency Losses

                         1                   1  

Change in Derivative Fair Value

                         1                   1  

Other

                2          3          1          6  
        
        
        
        
        
 

Total Other Deductions

     $ 1        $ 19        $ 5        $ 1        $ 26  
        
        
        
        
        
 

For the Quarter Ended March 31, 2005:

                                       

Donations

     $ 1        $        $        $        $ 1  

NDT Fund Realized Losses

                7                            7  

Foreign Currency Loss

                         5                   5  

Other

                1                            1  
        
        
        
        
        
 

Total Other Deductions

     $ 1        $ 8        $ 5        $        $ 14  
        
        
        
        
        
 

                                       


     
(A)     Other consists of reclassifications for minority interests in PSEG's consolidated results of operations and intercompany eliminations at PSEG (as parent company).

41


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 10. Income Taxes

      An analysis of the tax provision expense is as follows:

    PSE&G

  Power

  Energy
Holdings

  Other (A)

  Consolidated
Total

    (Millions)

For the Quarter Ended March 31, 2006:

                                       

Income (Loss) before Income Taxes

     $ 143        $ 192        $ 40        $ (33 )      $ 342  
        
        
        
        
        
 

Tax Computed at the Statutory Rate

     $ 50        $ 67        $ 14        $ (12 )      $ 119  

Increase (Decrease) Attributable to Flow Through of Certain Tax Adjustments:

                                       

State Income Taxes after Federal Benefit

       11          11          (2 )        (2 )        18  

Plant Related Items

       3                                     3  

Other

       1          2                            3  
        
        
        
        
        
 

Total Income Tax Expense (Benefit)

     $ 65        $ 80        $ 12        $ (14 )      $ 143  
        
        
        
        
        
 

Effective income tax rate

       45.5 %        41.7 %        30.0 %        42.4 %        41.8 %

For the Quarter Ended March 31, 2005:

                                       

Income (Loss) before Income Taxes

     $ 204        $ 198        $ 81        $ (32 )      $ 451  
        
        
        
        
        
 

Tax Computed at the Statutory Rate

     $ 72        $ 69        $ 28        $ (11 )      $ 158  

Increase (Decrease) Attributable to Flow Through of Certain Tax Adjustments:

                                       

State Income Taxes after Federal Benefit

       14          11          (2 )        (1 )        22  

Rate Differential of Foreign Operations

                         (14 )                 (14 )

Plant Related Items

       1                                     1  

Lease Rate Differential

                         1                   1  

Other

       (1 )        3          1                   3  
        
        
        
        
        
 

Total Income Tax Expense (Benefit)

     $ 86        $ 83        $ 14        $ (12 )      $ 171  
        
        
        
        
        
 

Effective Income Tax Rate

       42.2 %        41.9 %        17.3 %        37.5 %        37.9 %

                                       


     
(A)     PSEG's other activities include amounts applicable to PSEG (as parent corporation) that primarily relate to financing and certain administrative and general costs.

42


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 11. Financial Information by Business Segments