Nstar Electric Co: Form 10-Q for the period ended Mar 31, 2012

The accompanying MD&A focuses on factors that had a material effect on the financial condition, results of operations, and cash flows of NSTAR Electric during the periods presented and should be read in conjunction with the accompanying condensed consolidated financial statements and related notes, and with the MD&A in NSTAR Electric’s 2011 Annual Report on Form 10-K.

Business Overview

NSTAR Electric Company is a regulated public utility incorporated in 1886 under Massachusetts law. On April 10, 2012, NSTAR Electric became an indirect wholly-owned subsidiary of Northeast Utilities (NU). NSTAR Electric serves approximately 1.1 million electric distribution customers in the City of Boston and 80 surrounding communities. NU is a holding company engaged through its subsidiaries in the energy delivery business serving approximately 3.5 million customers in Connecticut, Massachusetts and New Hampshire. NSTAR Electric & Gas provides management and support services to NSTAR Electric.

Harbor Electric Energy Company (HEEC), a wholly-owned-subsidiary of NSTAR Electric, provides distribution service and ongoing support to its only customer, the Massachusetts Water Resources Authority’s wastewater treatment facility located on Deer Island in Boston, Massachusetts. NSTAR Electric consolidated two wholly-owned special purpose subsidiaries, BEC Funding II, LLC and CEC Funding, LLC. These entities were created to complete the sale of electric rate reduction certificates to a special purpose thrust created by two Massachusetts state agencies. These financing transactions securitized the costs incurred related to the divestiture of generation assets and long-term power contracts. The activities of a third special purpose subsidiary BEC Funding LLC, were substantially completed as of March 31, 2010 and the Company was dissolved on April 14, 2010.

NSTAR Electric derives its operating revenues primarily from the sale of energy, distribution, transmission, and energy efficiency services to customers. However, NSTAR Electric’s earnings are impacted by fluctuations in unit sales of electric kWh, which have an effect on the level of distribution and transmission revenues recognized. In accordance with the regulatory rate structure in which NSTAR Electric operates, its recovery of energy and certain energy-related costs are fully reconciled with the level of energy revenues currently recorded and, therefore, do not have an impact on earnings. As a result of this rate structure, any variability in the cost of energy supply purchased will have an impact on purchased power and transmission expenses, but will not affect the

Company’s net income as the Company recognizes a corresponding change in revenues as these costs are fully recovered in rates charged to its customers.

NSTAR Merger with Northeast Utilities Completed

On April 10, 2012, NSTAR merged into NSTAR LLC, a direct wholly-owned subsidiary of NU, in accordance with the Agreement and Plan of Merger (the Merger Agreement) dated October 16, 2010 as approved by shareholders of each company on March 4, 2011. NSTAR LLC is the sole shareholder of the Company. The transaction with NU was structured as a merger of equals in a tax-free exchange of shares. As part of the merger, NSTAR shareholders received 1.312 NU common shares for each NSTAR common share owned as of the acquisition date.

Regulatory Approvals

On February 15, 2012, NU and NSTAR reached comprehensive settlement agreements with both the Massachusetts Attorney General and the Massachusetts Department of Energy Resources (DOER). The settlement with the Attorney General covered a variety of rate-making and rate design issues, including a base distribution rate freeze at least through 2015 for NSTAR Electric, NSTAR Gas and WMECO and $15 million, $3 million and $3 million rate credits to their respective customers. The settlement agreement with the DOER covered the same rate-making and rate design issues, as well as a variety of matters impacting the advancement of Massachusetts clean energy goals established by the Green Communities Act (GCA) and Global Warming Solutions Act (GWSA). On April 4, 2012, the Massachusetts Department of Public Utilities (DPU) issued a decision approving the settlement agreements and the merger of NU and NSTAR. Base distribution rates for the utilities would then be frozen until January 1, 2016 and would allow for a lost base revenue mechanism that provides significant levels of revenues to NSTAR Electric and NSTAR Gas for sales not achieved due to energy efficiency programs, compared to the alternative scenario of less certain increases in revenues through rate case filings. In addition, under the agreement with the DOER, the utilities pledge further environmental commitments to solar, wind, hydro, energy efficiency and electric vehicle development, including a memorandum of understanding to purchase clean power from Cape Wind, expected to be the nation’s first operational off-shore, large-scale wind farm. These provisions provide material benefits for ratepayers, particularly in light of the goals and priorities framed by the Massachusetts Governor’s renewable energy targets, and the state’s GCA, the GWSA and the 2020 Clean Energy and Climate Plan.

The financial impacts of the settlement agreements related to NSTAR Electric will be recognized in the second quarter of 2012 in connection with the completion of the merger.

Earnings

NSTAR Electric’s earnings are impacted by its customers’ requirements for energy in the form of unit sales of electricity, which have an effect on the level of retail distribution and transmission revenues recognized. In accordance with the regulatory rate structure in which NSTAR Electric operates, its recovery of energy costs are fully reconciled with the level of energy revenues currently recorded and, therefore, do not have an impact on earnings.

Net income for the three-month period ended March 31, 2012 was $3.9 million, as compared to $42.9 million for the same period in 2011, as further explained below.

Critical Accounting Policies and Estimates

For a complete discussion of critical accounting policies, refer to “Critical Accounting Policies and Estimates” in Item 7 of NSTAR Electric’s 2011 Form 10-K. There have been no substantive changes to those policies and estimates.

Rate and Regulatory Proceedings

Rate Structure

a. Rate Settlement Agreements

NSTAR Electric is operating under a DPU-approved Rate Settlement Agreement (2005 Rate Settlement Agreement) that expires December 31, 2012. From 2007 through 2012, the 2005 Rate Settlement Agreement establishes for NSTAR Electric, among other things, annual inflation-adjusted distribution rates that are generally offset by an equal and corresponding reduction in transition rates. The rates as of January 1 were as follows:

On February 15, 2012, NSTAR Electric reached a comprehensive settlement agreement with both the Massachusetts Attorney General and the DOER. On April 4, 2012, the DPU issued a decision approving the settlement agreements. NSTAR Electric’s base distribution rates in effect on January 1, 2012 will be frozen until January 1, 2016 (Base Rate Freeze Period). During this period, NSTAR Electric will not seek general increases to base distribution rates, unless specifically mandated by DPU statutes enacted in future periods. NSTAR Electric may pursue increases due to exogenous factors as defined in the settlement agreement. The rate freeze applies only to base distribution rates so that existing rate reconciling mechanisms and other formula rates will remain in effect.

During the Base Rate Freeze Period, NSTAR Electric will be allowed a lost base revenue mechanism that provides revenues related to sales not achieved due to energy efficiency programs implemented on or after January 1, 2012. This recovery mechanism will be based on energy efficiency savings verified through annual reports to the DPU made during the Base Rate Freeze Period.

b. Regulated Electric Distribution Rates

Retail electric delivery rates are established by the DPU and are comprised of:

• a distribution charge, which includes a fixed customer charge and a demand and/or energy charge to collect the costs of building and expanding the infrastructure to deliver power to its destination, as well as ongoing operating costs. The distribution charge also includes the recovery, on a fully reconciling basis, of certain DPU-approved safety and reliability programs costs, a Pension and PBOP Rate Adjustment Mechanism (PAM) to recover incremental pension and pension benefit costs, a reconciling rate adjustment mechanism to recover costs associated with the residential assistance adjustment clause, a net-metering reconciliation surcharge to collect the lost revenues and credits associated with net-metering facilities installed by customers, and an Energy Efficiency Reconciling Factor (EERF) to recover energy efficiency program costs and lost base revenues in addition to those charges recovered in the energy conservation charge;
• a basic service charge, which represents the collection of energy costs, including costs related to charge-offs of uncollected energy costs, through DPU-approved rate mechanisms. Electric distribution companies in Massachusetts are required to obtain and resell power to retail customers through Basic Service for those who choose not to buy energy from a competitive energy supplier. Basic Service rates are reset every six months (every three months for large commercial and industrial customers). The price of Basic Service is intended to reflect the average competitive market price for electric power. Additionally, the DPU has authorized the Company to recover the cost of its Dynamic Pricing Smart Grid Pilot Program through the Basic Service charge;
• a transition charge, which represents the collection of costs to be collected primarily from previously held investments in generating plants and costs related to existing above-market power contracts, and contract costs related to long-term power contracts buy-outs;
• a transmission charge, which represents the collection of annual costs of moving the electricity over high voltage lines from generating plants to substations located within NSTAR Electric’s service area including costs allocated to NSTAR Electric by ISO-NE to maintain the wholesale electric market;
• an energy conservation charge, which represents a legislatively-mandated charge to collect costs for energy efficiency programs; and
• a renewable energy charge, which represents a legislatively-mandated charge to collect the costs to support the development and promotion of renewable energy projects.

c. Regulatory Matters

DPU Safety and Reliability Programs (CPSL)

NSTAR Electric recovers incremental costs related to the double pole inspection, replacement/restoration and transfer program and the underground electric safety program, which includes stray-voltage remediation and manhole inspections, repairs, and upgrades. Recovery of these Capital Program Scheduling List (CPSL) billed costs is subject to DPU review and approval. From 2006 through 2011, NSTAR Electric has incurred a cumulative incremental revenue requirement of approximately $83 million. These amounts include incremental operations and maintenance and revenue requirements on capital investments.

On May 28, 2010, the DPU issued an order on NSTAR Electric’s 2006 CPSL costs recovery filing. The expected recovery amount did not vary materially from the revenue previously recognized. On October 8, 2010, NSTAR Electric submitted a Compliance Filing with the DPU reconciling the recoverable CPSL Program revenue requirement for each year 2006 through 2009 with the revenues already collected to determine the proposed adjustment effective on January 1, 2011. The DPU allowed the proposed rates to go into effect on that date, subject to reconciliation of program costs. NSTAR Electric cannot predict the timing of subsequent DPU orders related to this filing. Should an adverse DPU decision be issued, it could have a material adverse impact on NSTAR Electric’s result of operations, financial position, and cash flows.

The comprehensive settlement agreement with the Massachusetts Attorney General stipulates a revenue stream of up to $15 million per annum for 2012 through 2015 in order to continue these programs. CPSL revenues will end once NSTAR Electric has recovered its 2015-related CPSL revenues. Realization of these revenues is subject to maintenance of certain performance metrics and DPU approval.

Basic Service Bad Debt Adder

On July 1, 2005, in response to a generic DPU order that required electric utilities in Massachusetts to recover the energy-related portion of bad debt costs in their Basic Service rates, NSTAR Electric increased its Basic Service rates and reduced its distribution rates for those bad debt costs. In furtherance of this generic DPU order, NSTAR Electric included a bad debt cost recovery mechanism as a component of its 2005 Rate Settlement Agreement. This recovery mechanism (bad debt adder) allows NSTAR Electric to recover its Basic Service bad debt costs on a fully reconciling basis. These rates were implemented, effective January 1, 2006, as part of the 2005 Rate Settlement Agreement.

On February 7, 2007, NSTAR Electric filed its 2006 Basic Service reconciliation with the DPU proposing an adjustment related to the increase of its Basic Service bad debt charge-offs. This proposed rate adjustment was anticipated to be implemented effective July 1, 2007. On June 28, 2007, the DPU issued an order approving the implementation of a revised Basic Service rate. However, the DPU instructed NSTAR Electric to reduce distribution rates by the increase in its Basic Service bad debt charge-offs. Such action would result in a further reduction to distribution rates from the adjustment NSTAR Electric made when it implemented the Settlement Agreement. This adjustment to NSTAR Electric’s distribution rates would eliminate the fully reconciling nature of the Basic Service bad debt adder.

As of December 31, 2011, NSTAR Electric had not implemented the directives of the June 28, 2007 DPU order. NSTAR Electric filed a Motion for Reconsideration of the DPU’s order on July 18, 2007. On May 28, 2010, the DPU issued an order and reaffirmed that NSTAR Electric should reduce its distribution rates by the increase in its Basic Service bad debt charge-offs. On June 18, 2010, NSTAR Electric filed an appeal of the DPU’s order with the Massachusetts Supreme Judicial Court (SJC). On October 10, 2010, the SJC allowed a stay of the DPU’s order pending appeal. Briefs were filed during the summer of 2011 and oral arguments were held on December 8, 2011. On April 11, 2012, the SJC issued a procedural order waiving its standing 130-day rule for issuance of an opinion on the matter. NSTAR Electric continues to believe that its position is appropriate. However, the delay by the SJC has caused management to reassess its position as to the outcome. As such, NSTAR Electric has concluded that a final ruling on the SJC matter in the company’s favor can no longer be determined as “probable”, but rather would be “more likely than not.” A decision by the SJC is expected in the second quarter of 2012.

Therefore, as of March 31, 2012, NSTAR Electric has recognized a change from a probable outcome of recovery to one of more likely than not of the previously recorded regulatory asset related to its Basic Service bad debt costs. This results in a $28 million charge ($17 million after-tax) to operations in the first quarter of 2012.

Other

In the fourth quarter of each year, NSTAR Electric files proposed distribution rate adjustments for effect on the following January 1. These rate adjustments include a SIP rate factor and several other fully reconciling cost recovery items. Consistent with previous filings, the 2011 filings include a combination of actual and forecasted data for 2011 that NSTAR Electric will update during 2012 with year-end data to allow a final investigation and reconciliation. There are several case years that remain outstanding at the DPU. These cases are pending decisions at the DPU and NSTAR Electric cannot predict the timing or the ultimate outcome of these filings.

FERC Transmission Base ROE Complaint

On September 30, 2011, several New England state attorneys general, state regulatory commissions, consumer advocates and other parties filed a joint complaint with the FERC under Sections 206 and 306 of the Federal Power Act alleging that the base ROE used in calculating formula rates for transmission service under the ISO-NE Open Access Transmission Tariff by New England transmission owners, including NSTAR Electric, CL&P, PSNH and WMECO, is unjust and unreasonable. The complainants asserted that the current 11.14 percent rate, which became effective in 2006, is excessive due to changes in the capital markets and are seeking an order to reduce the rate to 9.2 percent, effective September 30, 2011. In response, the New England transmission owners filed testimony and analysis based on standard FERC methodology and precedent, justifying a base ROE of approximately 11.2 percent, thus demonstrating that the base ROE of 11.14 percent remained just and reasonable. On May 3, 2012, the FERC issued an order establishing hearing and settlement judge procedures for the complaint. In the order, FERC encouraged the parties to reach a settlement of the dispute before hearings commence. One of the commissioners dissented, stating that the complaint should have been rejected based on the record and FERC precedent. The FERC indicated that if a settlement was not reached, it would expect to render a decision in the third quarter of 2013, with changes, if any, effective October 1, 2011. NSTAR Electric cannot predict the outcome of this proceeding, or its impact on its financial position, results of operations or cash flows.

As of March 31, 2012, NSTAR Electric had approximately $500 million of aggregate shareholders equity invested in its transmission facilities. As a result, each 10 basis points change in the authorized base ROE would change annual consolidated earnings by an approximate $0.5 million.

Other

a. Energy Efficiency Plans

NSTAR Electric administers demand-side management energy efficiency programs. The GCA directed electric distribution companies to develop three-year energy efficiency plans. The current three-year plan covering the period 2010 through 2012 was approved by the DPU and represents a significant expansion of energy efficiency activity in Massachusetts. The current three-year plan includes financial incentives based on energy efficiency program performance. In addition, the DPU has stated that it will permit distribution companies that do not yet have rate decoupling mechanisms in place to implement Lost Base Revenue (LBR) rate adjustment mechanisms in order to partially offset reduced distribution rate revenues as a result of successful energy efficiency programs.

During the first quarter of 2012, NSTAR Electric recognized recoverable Energy Efficiency program expenses of $26.8 million. In 2012, NSTAR Electric anticipates that its separate recoverable expenses, inclusive of program administrator incentives, will be $227 million.

b. Emergency Preparation and Restoration of Service for Electric Customers

Under Massachusetts law and regulation, the DPU has established standards of performance for emergency preparation and restoration of service for electric companies. As a remedy to violation of those standards, the DPU is authorized to levy a penalty not to exceed $250,000 for each violation for each day that the violation persists up to a maximum penalty of $20 million for any related series of violations.

NSTAR Electric believes that it is not in a penalty situation with respect to its performance during declared emergency events to date.

c. Major Storm Events and Service Restoration

In late August 2011, Tropical Storm Irene (Irene) brought heavy rains and damaging winds to Massachusetts and the Eastern Seaboard. Irene caused considerable damage in NSTAR Electric’s service territory. Approximately 500,000 customer outages occurred on the NSTAR Electric system in its aftermath. This represents the most severe damage event on the NSTAR Electric system in nearly 20 years. On September 15, 2011, the DPU, on its own initiative, initiated an investigation into the efforts of NSTAR Electric and one other Massachusetts electric company to restore power to their customers in the aftermath of Irene. NSTAR Electric filed a Final Event Report with the DPU regarding Irene on October 3, 2011.

In late October 2011, an unprecedented early snow storm brought heavy, wet snow and strong winds to the region, impacting the electric service of approximately 200,000 NSTAR Electric customers. On November 8, 2011, the DPU opened an additional investigation to include NSTAR Electric and two other Massachusetts electric companies and their responses to the October snowstorm. NSTAR Electric filed a Final Event Report with the DPU regarding the October snowstorm on December 16, 2011.

On December 20, 2011, NSTAR Electric filed a Report of Emergency Response Plan Improvements with the DPU outlining steps that had been implemented prior to and also following the October snowstorm to improve restoration performance. The DPU has announced it will conduct further hearings regarding NSTAR Electric’s storm response starting on June 18, 2012.

NSTAR Electric’s DPU-approved storm accounting mechanism helps to reduce the volatility of the earnings impact of severe storm restoration events. The Company is permitted to spread the incremental costs of severe storm restoration over several periods. The incremental cost incurred for Irene was approximately $24 million and the October snowstorm was approximately $14 million.

Pursuant to the February 15, 2012 merger Settlement Agreement with the DOER and the AG, which was approved by the DPU on April 4, 2012, these storm costs will be excluded from the DPU-approved storm fund calculation. Irene and October snowstorm restoration costs instead will be deferred, to be recoverable in rates over a five-year period beginning January 1, 2014. This regulatory asset will earn a rate of return at the prime interest rate. Before these storm costs may be recovered in rates, such costs will be subject to a DPU review.

d. Transmission Capital Improvement Project – Lower SEMA

The Lower Southeastern Massachusetts (SEMA) Project consists of an expansion and upgrade of existing transmission infrastructure, and construction of a new 31 mile, 345kV transmission line that will cross the Cape Cod Canal. On December 16, 2011, ISO-NE issued formal approval for the Lower SEMA 345 kV Transmission Project to be included in the Pool Transmission Facility regional rates. At a hearing held on January 12, 2012, the Massachusetts Energy Facilities Siting Board (EFSB) voted unanimously to direct the EFSB Staff to prepare tentative decisions for public comment based on the EFSB’s approval of the project subject to the conditions of NSTAR Electric providing reports to the EFSB every six months on project costs and schedule of construction. Further conditions may be imposed. The Cape Cod Commission (CCC) unanimously approved the project on January 19, 2012. On April 27, 2012, the EFSB issued its decision approving the project. The cost estimate of this project is approximately $110 million; NSTAR Electric anticipates starting construction in the second half of 2012 and completion by early 2013.

e. Electric Service Outage in the Back Bay/Prudential Area of Boston

On March 13, 2012, a substation that supplies the Back Bay/Prudential area of the City of Boston experienced a fire causing damage to certain equipment including a 115kV transformer. The fire was contained to the structure and the station’s fire suppression systems worked as designed.

This incident resulted in the need to shut off electric service in the affected area to minimize damage and to assist fire suppression efforts. This outage impacted approximately 21,000 customers. Power was restored to approximately 17,000 customers within 28 hours, with the remaining 4,000 customers restored within 54 hours.

NSTAR Electric incurred significant costs for the temporary cables and generators that were used for the restoration of service, to provide environmental cleanup and to repair paving that was disrupted by the temporary trenches needed to bury power cables.

The total impact of this event on first quarter results was an increase of approximately $9.5 million (pre-tax) in operations and maintenance expense. NSTAR Electric will also incur capital costs to replace the transformer and to implement system design enhancements that will create additional network redundancies in this section of the city of Boston. NSTAR Electric believes that a substantial portion of the capital replacement costs will be recovered through insurance proceeds.

Results of Operations

The following section of MD&A compares the results of operations for each of the three-month periods ended March 31, 2012 and 2011 and should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and the accompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this report.

Three Months Ended March 31, 2012 compared to Three Months Ended March 31, 2011

Executive Summary of Quarterly Results

Net income was $3.9 million for the quarter ended March 31, 2012 compared to $42.9 million for the same period in 2011. Major factors on an after-tax basis during the quarter include:

• Adjustment recorded to establish a reserve against the regulatory asset related to Basic Service bad debt costs ($17 million)
• Adjustments related to changes in accounting estimates of NSTAR Electric’s allowance for doubtful accounts, workers’ compensation, employee medical benefits, and general liability claims ($11.4 million)
• Higher operations and maintenance expense, primarily related to a March incident involving a substation in the Back Bay/Prudential area of Boston ($4.1 million)
• A reserve recorded relating to lost base revenues based on recent developments during hearings in the merger proceeding ($3.7 million)
• Lower distribution revenues due to a warmer winter and the impact of NSTAR Electric’s Energy Efficiency programs, partially offset by the annual inflation rate adjustment ($3.1 million)
• Higher depreciation and property taxes ($1.5 million)

These decreases in earnings factors were partially offset by:

• Higher transmission revenues ($1.9 million)

Significant cash flow events during the quarter include the following:

• Cash flows from operating activities provided approximately $103.8 million, an increase of $55.9 million as compared to the same period in 2011. The increase primarily reflects the absence of pension contributions due to funding status and the timing of energy supply payments and customer collections related to these energy costs
• NSTAR Electric invested approximately $98.7 million in capital projects to improve system reliability and capacity
• NSTAR Electric paid $57.1 million in common share dividends to NSTAR and retired approximately $18.7 million in securitized debt.

Energy sales

The following is a summary of retail electric energy sales for the periods indicated:

NSTAR Electric’s energy sales in the three months ended March 31, 2012 decreased 4.9% compared to 2011 primarily due to unfavorable weather conditions resulting from a warmer winter during 2012 as compared to 2011. Heating degree-days in the Boston area for the three months ended March 31, 2012 were down 20.6% from the same period in 2011.

Weather and, to a lesser extent, fluctuations in fuel costs, conservation measures, and economic conditions affect sales to NSTAR Electric’s residential and small commercial customers. Economic conditions, fluctuations in fuel costs, and conservation measures affect NSTAR Electric’s large commercial and industrial customers. In terms of customer sector characteristics, industrial sales are less sensitive to weather than residential and commercial sales, which are influenced by temperature variations. Refer to the “Operating Revenues” section below for a more detailed discussion.

Weather conditions

NSTAR Electric forecasts its electric sales based on normal weather conditions. Actual results may vary from those projected due to actual weather conditions, energy conservation, and other factors. Refer to the “Cautionary Statement Regarding Forward-Looking Information” section preceding Part 1 “Financial Information” of this Form 10-Q.

The demand for electricity is affected by weather. Weather impacts electric sales primarily during the summer in NSTAR Electric’s service area. Customer heating or cooling usage may not directly correlate with historical levels or with the level of degree-days that occur (as further discussed below), particularly when weather patterns experienced are consistently colder or warmer. Also, NSTAR Electric’s business is sensitive to variations in daily weather, is highly influenced by New England’s seasonal weather variations, and is susceptible to damage from major storms and other natural events and disasters that could adversely affect the Company’s ability to provide energy.

Degree-days measure changes in daily mean temperature levels. A degree-day is a unit measuring how many degrees the outdoor daily mean temperature falls below (in the case of heating) or rises above (in the case of cooling) a base of 65 degrees. As shown in the table below, weather conditions during the three-month period ended March 31, 2012 measured by heating degree-days were 20.6% warmer for 2012 as compared to 2011. Similarly, weather conditions were warmer than the 30-year average by 20.4% during the first quarter of 2012. Refer to the “Operating Revenues” section below for a more detailed discussion.

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Operating revenues

Operating revenues for the first quarter of 2012 decreased $17.6 million, or 2.9%, from the same period in 2011 as follows:

(in millions)

NSTAR Electric’s largest earnings sources are the revenues derived from distribution and transmission rates approved by the DPU and the FERC. Electric retail distribution revenues primarily represent charges to customers for recovery of the Company’s capital investment, including a return component, and operation and maintenance costs related to its electric distribution infrastructure. The transmission revenue component represents charges to customers for the recovery of similar costs to move the electricity over high voltage lines from the generator to the Company’s distribution substations.

The decrease of $11 million, or 4.1%, in retail distribution and transmission revenues primarily reflects:

• Decreased transmission revenues primarily due to lower rates reflecting a lower under-recovered regulatory deferral balance at the beginning of the year and partially offset by the recovery of a higher transmission investment base, including higher depreciation and property taxes and recovery of higher regional network service and other costs ($5.9 million)
• Decreased distribution revenues due to decreased sales of 4.9% due to the impact of weather conditions, partially offset by a positive annual inflation rate adjustment ($5.1 million)

Energy, transition, and other revenues primarily represent charges to customers for the recovery of costs incurred by the Company in order to acquire the energy supply on behalf of its customers and a transition charge for recovery of the Company’s prior investments in generating plants and the costs related to long-term power contracts. The energy revenues relate to customers being provided energy supply under Basic Service. These revenues are fully reconciled to the costs incurred and have no impact on NSTAR Electric’s consolidated net income. Energy, transition, and other revenues also reflect revenues related to the Company’s ability to effectively reduce stranded costs (incentive entitlements), rental revenue from electric property, and annual cost reconciliation true-up adjustments. The $6.6 million, or 2.0% decrease in energy, transition, and other revenues is primarily attributable to lower Basic Service rates in effect to lower energy costs along with a lower level of sales. Uncollected transition costs as a result of the reductions in transition rates are deferred and collected through future rates with a carrying charge.

Operating expenses

Purchased power and transmission expense was $262.6 million in the first quarter of 2012 compared to $279.3 million in the same period of 2011, a decrease of $16.7 million, or 6%. The decrease in expense reflects lower Basic Service and other energy costs of $12.9 million as well as lower transmission costs of $3.8 million due to a decrease in regional network support costs. NSTAR Electric adjusts its rates to collect the costs related to energy supply from customers on a fully reconciling basis. Due to this rate adjustment mechanism, changes in the amount of energy supply expense have no impact on consolidated net income.

Operations and maintenance expense was $145.4 million in the first quarter of 2012 compared to $92.8 million in the same period of 2011, an increase of $52.6 million, or 56.7%. The increase in expense primarily reflects a cumulative adjustment recorded to reduce the regulatory asset for Basic Service bad debt costs ($27 million). Also, cumulative adjustments were recognized for changes in accounting estimates of NSTAR Electric related primarily to the allowance for doubtful accounts, workers’ compensation, employee medical benefits, and general liability claims ($18.7 million). In addition, costs were incurred related to a March incident involving a substation fire in the Back Bay/Prudential area of Boston ($9.5 million). These factors are partially offset by the timing of maintenance ($0.9 million) and lower storm-related expense ($0.7 million).

Depreciation and amortization expense was $70 million in the first quarter of 2012 compared to $68.5 million in the same period of 2011, an increase of $1.5 million, or 2.2%. The increase primarily reflects a higher depreciable distribution and transmission plant in-service.

Energy efficiency programs expense was $46.9 million in the first quarter of 2012 compared to $40.1 million in the same period of 2011, an increase of $6.8 million, or 17%. These costs are in accordance with the three-year plan program guidelines established by the DPU and are collected from customers on a fully reconciling basis.

Property and other taxes expense was $30.8 million in the first quarter of 2012 compared to $29.0 million in the same period of 2011, an increase of $1.8 million, or 6.2%, reflecting higher overall property investments and higher tax rates.

Interest charges (income):

Long-term debt and transition property securitization interest charges were $23.7 million in the first quarter of 2012 compared to $25.0 million in the same period of 2011, a decrease of $1.3 million, or 5.2%. The decrease in interest charges reflects scheduled principal pay downs of transition property securitization debt.

Interest income and other, net were $5.0 million of net interest income in the first quarter of 2012 compared to $7.4 million of net interest income in the same period of 2011, a decrease of $2.4 million, or 32.4%, due to lower regulatory deferral net interest income ($2.1 million), which includes the impact of writing off the Basic Service Bad Debt Adder of $1.3 million due to the current quarter’s triggering event.

Other income (deductions):

Other income was approximately $1.4 million in the first quarter of 2012 compared to $1.0 million in the same period of 2011, an increase of $0.4 million, or 40%. The increase relates primarily to higher cash surrender values and proceeds from insurance policies.

Other deductions were $1.3 million in the first quarter 2012 compared to $0.6 million in the same period 2011, an increase of $0.7 million, or 116.7%, primarily due to write-off of software related costs.

Income tax expense:

Income tax expense was $2 million in the first quarter of 2012 compared to $28.1 million in the same period of 2011, a decrease of $26.1 million, or 93%, primarily reflecting lower pre-tax operating income.

Liquidity

NSTAR Electric had cash flows provided by operating activities in the first quarter of 2012 of $103.8 million, compared with cash flows provided by operating activities of $47.9 million in the first quarter of 2011. The increased cash flows were due primarily to the absence of pension contributions, recovery of regulatory assets and the timing of energy supply payments and customer collections related to these energy costs.

Cash capital expenditures included on the accompanying Condensed Consolidated Statements of Cash Flows in the first quarter of 2012 and 2011 reflect approximately $98.7 million and $72.8 million, respectively, in capital projects to improve system reliability and capacity.

NSTAR Electric believes that it has adequate access to short-term credit markets to facilitate its working capital needs at favorable terms. As of March 31, 2012, NSTAR Electric had $450 million in available unused revolving credit facilities in order to meet working capital needs, capital expenditures and contractual obligations.

NSTAR Electric paid $57.1 million and $50 million in common share dividends to NSTAR and retired approximately $18.7 million and $21.3 million in securitized debt in the quarters ended March 31, 2012 and 2011, respectively.

Short-Term Financing Activities

NSTAR Electric’s short-term debt increased by $71 million to $212.5 million at March 31, 2012 compared to $141.5 million at December 31, 2011. The increase resulted primarily from the higher level of CWIP, as well as a lower level of accounts payable.

NSTAR Electric has approval from the FERC to issue short-term debt securities from time to time on or before October 22, 2012, with maturity dates no later than October 21, 2013, in amounts such that the aggregate principal does not exceed $655 million at any one time. On March 26, 2012, NSTAR Electric filed to extend this authorization until October 23, 2014, with maturity dates no later than October 23, 2015. NSTAR Electric has a five-year, $450 million revolving credit agreement that expires December 31, 2012. However, unless NSTAR Electric receives necessary approvals from the DPU, the credit agreement will expire 364 days from the date of the first draw under the agreement. At March 31, 2012 and December 31, 2011, there were no amounts outstanding under the revolving credit agreement. This credit facility serves as backup to NSTAR Electric’s $450 million commercial paper program discussed above. At March 31, 2012 and December 31, 2011, NSTAR Electric was in full compliance with its covenants in connection with its short-term credit facilities, as the total debt to capitalization ratios were 46.9% and 45.4%, respectively.

The banking arrangements in place require NSTAR Electric to make daily cash transfers to fund vendor checks that are presented for payment. These banking arrangements do not permit the right of offset among the Company’s cash accounts. In the event of a credit book balance in the Company’s cash accounts resulting from uncleared checks, the Company will adjust its disbursement cash account on the balance sheet accordingly.

Income Tax Payments

During the quarters ended March 31, 2012 and 2011, NSTAR Electric made estimated tax payments of $7.2 million and $13.1 million, respectively.

Long-Term Financing Activities

On April 19, 2012, NSTAR Electric filed an application for a new two-year financing plan with the DPU for an approval to issue long-term debt securities in an aggregate amount not to exceed $600 million prior to December 31, 2013. The Company intends to use the proceeds of such issuances for the payment of capital expenditures incurred by the Company for extensions, additions and improvements to plant and properties, for repayment of short-term debt, to refinance its existing $400 million 4.875% Debentures, due October 15, 2012, or for working capital purposes.

In connection with the merger with Northeast Utilities, NSTAR Electric received a waiver and executed an amendment to its revolving credit agreement necessary to allow NSTAR to complete the merger.

Energy Risk Management

NSTAR Electric’s Energy Procurement Policy governs all energy-related transactions. This Policy is reviewed annually and is administered by NSTAR’s Risk Committee. The Committee is chaired by NSTAR’s chief executive officer and includes other senior officers. Items covered by this Policy and approved by the Committee are all new energy supply transactions, authorization limits, energy related derivative and hedging transactions, and counter-party credit profiles.

Commodity and Credit Risk

Although NSTAR Electric has material energy commodity purchase contracts, any potential market risk, including counter-party credit risk, should not have an adverse impact on NSTAR Electric’s results of operations, cash flows, or financial position. NSTAR Electric’s has rate-making mechanisms that allow for the recovery of energy supply costs from those customers who make commodity purchases from NSTAR Electric rather than from the competitive market supplier. All energy supply costs incurred by NSTAR Electric in providing energy to its retail customers are recovered on a fully reconciling basis.

In addition, NSTAR Electric has minimal cash flow risk due to the short-term nature of these contracts and the rate-making mechanisms that permit recovery of these costs in a timely manner. The majority of NSTAR Electric’s commodity purchase contracts range in term from three to twelve months. NSTAR Electric has the ability to seek cost recovery and adjust its rates as frequently as every three months for its large commercial and industrial customers and every six months for its residential customers. NSTAR Electric earns a carrying charge on under-collected commodity balances that would mitigate any incremental short-term borrowing costs. NSTAR Electric believes it is unlikely that it would be exposed to a liquidity risk resulting from significant market price increases based on the recovery mechanisms currently in place.

Interest Rate Risk

NSTAR Electric believes its interest risk primarily relates to short-term debt obligations and anticipated future long-term debt financing requirements to fund its capital programs. These short-term debt obligations are typically refinanced with fixed-rate long-term notes as needed and when market interest rates are favorable. At March 31, 2012 and December 31, 2011, respectively, all of NSTAR Electric’s long-term debt had fixed interest rates. The Company is exposed to changes in interest rates primarily based on levels of short-term commercial paper outstanding. The weighted average interest rates, including fees for short-term indebtedness, were 0.26% and 0.30% for the three months ended March 31, 2012 and 2011, respectively. On a long-term basis, NSTAR Electric mitigates its interest rate risk through the issuance of mostly fixed rate debt of various maturities.

Management evaluated the design and operation of the disclosure controls and procedures as of March 31, 2012 to determine whether they are effective in ensuring that the disclosure of required information is made timely and in accordance with the Securities Exchange Act of 1934 and the rules and regulations of the SEC. This evaluation was made under management’s supervision and with management’s participation, including the principal executive officers and principal financial officer as of the end of the period covered by this Quarterly Report on Form 10-Q. There are inherent limitations of disclosure controls and procedures, including the possibility of human error and the circumventing or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. The principal executive officer and principal financial officer have concluded, based on their review, that the disclosure controls and procedures of NSTAR Electric are effective to ensure that information required to be disclosed by NSTAR Electric in reports filed under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized, and reported within the time periods specified in SEC rules and regulations and (ii) is accumulated and communicated to management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.

There have been no changes in internal controls over financial reporting during the quarter ended March 31, 2012, that have materially affected, or are reasonably likely to materially affect, NSTAR Electric’s internal controls over financial reporting.

Investors or prospective investors should carefully consider the risk factors that were previously disclosed in NSTAR Electric’s Annual Report on Form 10-K for the year ended December 31, 2011.