10-Q 1 a38173.txt PSE&G TRANSITION FUNDING LLC UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to _______________

Indicate by check mark whether the registrant (1) has 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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Registrant is a wholly owned subsidiary of Public Service Electric and Gas Company. Registrant meets the conditions set forth in General Instruction H(1) (a) and (b) of Form 10-Q and is filing this Form 10-Q with the reduced disclosure format authorized by General Instruction H. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes No X --- --- TABLE OF CONTENTS

i FORWARD-LOOKING STATEMENTS Except for the historical information contained herein, 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 "will", "anticipate", "intend", "estimate", "believe", "expect", "plan", "potential", variations of such words and similar expressions are intended to identify forward-looking statements. We 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 of factors should not be construed as exhaustive. In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements, factors that could cause actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following: state and federal legal or regulatory developments; national or regional economic conditions; market demand and prices for energy; customer conservation; distributed generation technology; weather variations affecting customer energy usage; the effect of continued electric industry restructuring; operating performance of Public Service Electric and Gas Company's facilities and third party suppliers; and the payment patterns of customers including the rate of delinquencies. ii PART I. FINANCIAL INFORMATION ----------------------------- ITEM 1. FINANCIAL STATEMENTS PSE&G TRANSITION FUNDING LLC CONDENSED STATEMENTS OF OPERATIONS (Thousands) (Unaudited)

See Notes to Condensed Financial Statements. 1 PSE&G TRANSITION FUNDING LLC CONDENSED BALANCE SHEETS (Thousands) (Unaudited)

See Notes to Condensed Financial Statements. 2 PSE&G TRANSITION FUNDING LLC CONDENSED STATEMENTS OF CASH FLOWS (Thousands) (Unaudited)

See Notes to Condensed Financial Statements. 3 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) Note 1. Organization and Basis of Presentation Organization Unless the context otherwise indicates, all references to "Transition Funding," "we," "us" or "our" herein mean PSE&G Transition Funding LLC, a Delaware limited liability company located at 80 Park Plaza, Newark, New Jersey 07102. We were formed under the laws of the State of Delaware on July 21, 1999 and operate pursuant to a limited liability company agreement with Public Service Electric and Gas Company (PSE&G) as our sole member. PSE&G is an operating electric and gas utility and is a wholly-owned subsidiary of Public Service Enterprise Group Incorporated (PSEG). We were organized for the sole purpose of purchasing and owning bondable transition property (BTP) of PSE&G, issuing transition bonds (Bonds), pledging our interest in BTP and other collateral to a debt/security trustee (Trustee) to collateralize the Bonds, and performing activities that are necessary, suitable or convenient to accomplish these purposes. BTP represents the irrevocable right of PSE&G, or its successor or assignee, to collect a non-bypassable transition bond charge (TBC) from electric customers pursuant to a Final Order in PSE&G's rate unbundling and restructuring proceedings (Final Order) and a bondable stranded cost rate order (Finance Order), which were issued August 24, 1999 and September 17, 1999, respectively, by the State of New Jersey Board of Public Utilities (BPU) in accordance with the New Jersey Electric Discount and Energy Competition Act enacted in February 1999. The Finance Order authorizes the TBC to recover $2.525 billion aggregate principal amount of Bonds, plus an amount to provide for any credit enhancement, to fund any reserves and to pay interest, redemption premiums, if any, servicing fees and other expenses relating to the Bonds. Our organizational documents require us to operate in a manner so that we should not be consolidated in the bankruptcy estate of PSE&G in the event PSE&G becomes subject to a bankruptcy proceeding. Basis of Presentation The condensed financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for the Quarterly Reports on Form 10-Q. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the disclosures are adequate to make the information presented not misleading. These Condensed Financial Statements and Notes to Condensed Financial Statements (Notes) should be read in conjunction with and update and supplement matters discussed in our 2003 Annual Report on Form 10-K and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. The unaudited financial information furnished reflects all adjustments, which are, in the opinion of management, necessary to fairly state the results for the interim periods presented. The year-end condensed balance sheets were derived from the audited financial statements included in our 2003 Annual Report on Form 10-K. Note 2. The Bonds On January 31, 2001, we issued $2.525 billion aggregate principal amount of Bonds in eight classes with maturities ranging from one year to fifteen years. The net proceeds of the issuance were remitted to PSE&G as consideration for the property right in the TBC. Under applicable law, the Bonds are not an obligation of PSE&G or secured by the assets of PSE&G, but rather the Bonds are only recourse to us and are collateralized on a pro rata basis by the BTP and our equity and assets. TBC collections are deposited at least monthly by PSE&G with the Trustee and are used to pay our expenses, to pay our debt service on the Bonds and to fund any credit enhancement for the Bonds. We have also pledged the capital contributed by PSE&G to secure the debt service requirements of the Bonds. The debt service requirements include 4 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) an overcollateralization subaccount, a capital subaccount and a reserve subaccount which are available to bond holders. Any amounts collateralizing the Bonds will be returned to PSE&G upon payment of the Bonds. The significant terms of the Bonds issued by Transition Funding as of June 30, 2004 are as follows:

We have entered into an interest rate swap on our sole class of floating rate Bonds (Class A-4). The interest rate swap effectively converts the existing floating rate debt into fixed rate borrowings at 6.2875%. The interest rate swap is indexed to the three-month LIBOR rate. The fair value of the interest rate swap was approximately $(37) million and $(51) million as of June 30, 2004 and December 31, 2003, respectively, and was recorded as a derivative liability, with an offsetting amount recorded as a regulatory asset on the Condensed Balance Sheets. The fair value of this swap will vary over time as a result of changes in market conditions. This amount is deferred and is expected to be recovered from or refunded to PSE&G's customers. We incurred approximately $230 million in issuance costs in connection with the securitization transaction, including $201 million of costs of a hedging arrangement as permitted by the Finance Order. Of this amount, $125 million was included with the BTP, with the balance in deferred issuance costs. Costs in excess of the $125 million of transaction costs provided for in the Finance Order were paid by PSE&G and are being recovered on a subordinated basis by us through the TBC and remitted to PSE&G with interest at a rate of 6.48%. The TBC rate became effective on February 7, 2001, in accordance with the Finance Order. Note 3. Significant Agreements and Related Party Transactions Under the servicing agreement entered into by PSE&G and us, concurrently with the issuance of the first Series of Bonds, PSE&G, as servicer, is required to manage and administer our BTP and to collect the TBC on our behalf. Under the Finance Order, PSE&G withholds from the TBC collections an annual servicing fee equal to 0.05% of the initial balance of Bonds issued. In addition we pay miscellaneous operating expenses to PSE&G up to $100 thousand per quarter, administration fees up to $31 thousand per quarter and trustee fees up to $4 thousand per quarter. Servicing and administrative fees paid to PSE&G for the quarters ended June 30, 2004 and 2003 were $368 thousand and $398 thousand, respectively. Servicing and administrative fees paid to PSE&G for the six months ended June 30, 2004 and 2003 were $757 thousand and $760 thousand, respectively. As of June 30, 2004 and December 31, 2003, we had a receivable from our member, PSE&G, of approximately $59 million and $58 million, respectively, relating to TBC billings. As of June 30, 2004 and December 31, 2003 our payable to our member was approximately $97 million and $98 million, respectively, which primarily relates to the costs in excess of the $125 million of transaction costs provided for in the Finance Order that were paid by PSE&G and billed to us. Also in 2004, we paid a cash dividend of $338 thousand to PSE&G 5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless the context otherwise indicates, all references to "Transition Funding," "we," "us" or "our" herein mean PSE&G Transition Funding LLC, a Delaware limited liability company located at 80 Park Plaza, Newark, New Jersey 07102. Following are the significant changes in or additions to information reported in our 2003 Annual Report on Form 10-K and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 affecting the financial condition and the results of operations. This discussion refers to our Condensed Financial Statements (Statements) and related Notes to Condensed Financial Statements (Notes) and should be read in conjunction with such Statements and Notes. The following analysis of the financial condition and our results of operations is in an abbreviated format pursuant to General Instruction H of Form 10-Q. On January 31, 2001, we issued $2.525 billion of transition bonds in eight classes with maturities ranging from one year to fifteen years. The net proceeds of the issuance were utilized to acquire Public Service Electric and Gas Company's (PSE&G) property right in the Transition Bond Charge (TBC). We use collections of the TBC to make scheduled principal and interest payments on the transition bonds and to cover any additional administrative costs. RESULTS OF OPERATIONS Operating Revenues TBC revenues increased approximately $3 million or 5% and $3 million or 2% for the quarter and six months ended June 30, 2004, respectively, as compared to the same periods in 2003 due to an increase in sales volume at PSE&G. The increase was partially offset by a decline in the TBC rate from 2003. In January 2004, as a result of the annual true-up approved by the State of New Jersey Board of Public Utilities (BPU), the TBC rate decreased to 0.6862 cents per Kilowatt-hour (kWh) from 0.7018 cents per kWh in 2003. Any increases or decreases in the TBC rate are designed to maintain the Capital Subaccount and the Overcollateralization account at appropriate levels and have adequate funds to meet our scheduled repayments of the deferred issuance costs to PSE&G, as servicer of the Bonds. Operating Expenses Amortization of Bondable Transition Property (BTP) Amortization of BTP increased approximately $5 million or 20% and $7 million or 14% for the quarter and six months ended June 30, 2004, respectively, as compared to the same periods in 2003. As a regulated entity, our amortization expense fluctuates with changes in revenue and interest expense. We defer any over or under collection of expense to match against future revenues. Servicing and Administrative Fees PSE&G withholds from the TBC collections an annual servicing fee equal to 0.05% of the initial balance of the Bonds issued and charges an additional fee for various administrative costs. Servicing and Administrative Fees decreased approximately $30 thousand or 8% and $3 thousand or less than 1% for the quarter and six months ended June 30, 2004, respectively, as compared to the same periods in 2003, due to decreases in administrative expenses billed to us by the Servicer, PSE&G. Interest Income Interest Income decreased approximately $13 thousand or 12% and $16 thousand or 7% for the quarter and six months ended June 30, 2004, respectively, as compared to the same periods in 2003 primarily due to lower interest rates in 2004. 6 Interest Expense Interest expense decreased approximately $2 million or 4% and $4 million or 5% for the quarter and six months ended June 30, 2004, respectively, as compared to the same periods in 2003 due to a reduction in the total amount of debt outstanding. LIQUIDITY AND CAPITAL RESOURCES The principal amount of the Bonds, interest, fees and funding of the overcollateralization subaccount are being recovered through the TBC payable by retail customers of electricity within PSE&G's service territory who receive electric delivery service from PSE&G. As part of PSE&G's responsibility as servicer under the Servicing Agreement, PSE&G remits the TBC collections to the Trustee to make scheduled payments on the Bonds. During 2004, payments of bond principal, interest and all related expenses were made by the Trustee on March 15, 2004 and June 15, 2004 each totaling approximately $69 million including funding of the Capital Subaccount and the Overcollateralization account to required levels. Also in 2004, we paid a cash dividend of $338 thousand to PSE&G. ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK There were no material changes from the disclosures in the Annual Report on Form 10-K for the year ended December 31, 2003 or Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. ITEM 4. CONTROLS AND PROCEDURES Not Applicable. 7 PART II. OTHER INFORMATION -------------------------- ITEM 1. LEGAL PROCEEDINGS There are no updates to information reported under Item 3 of Part I of our 2003 Annual Report on Form 10-K and March 31, 2004 Quarterly Report on Form 10-Q. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) A listing of exhibits being filed with this document is as follows:

(B) Reports on Form 8-K: None. 8 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PSE&G TRANSITION FUNDING LLC (Registrant) By: /s/ Patricia A. Rado -------------------------------------------------- Patricia A. Rado Controller (Principal Accounting Officer) Date: August 10, 2004 9

PSE&G TRANSITION FUNDING LLC 10-Q