**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**Form 10-Q**

| [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                                          |

| Commission File Number: |      **1-14768** |
|-------------------------|-------------------------------------------|
|                         |                                           |

**NSTAR**

*(Exact name of registrant as specified in its charter)*

**Massachusetts**

**04-3466300**

*(State or other jurisdiction of incorporation or organization)*

*(IRS Employer Identification Number)*

**800 Boylston Street, Boston, Massachusetts**

**02199**

*(Address of principal executive offices)*

*(Zip code)*

**(617) 424-2000**

*(Registrant's telephone number, including area code)*

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 registrantwas required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

[X]

Yes

 

[  ]

No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

[X]

Yes

 

[  ]

No

The number of shares outstanding of the registrant's class of common stock was 53,118,873 Common Shares, par value $1, as of July 30, 2004.

**NSTARForm 10-Q - Quarterly Period Ended June 30, 2004**

**Table of Contents**

**Part I.  Financial Information:**

**Page No**.

**Item 1.**

Financial Statements

Condensed Consolidated Statements of Income

2

Condensed Consolidated Statements of Comprehensive Income

3

Condensed Consolidated Statements of Retained Earnings

3

Condensed Consolidated Balance Sheets

4 - 5

Condensed Consolidated Statements of Cash Flows

6

Notes to Condensed Consolidated Financial Statements

7 - 16

**Item 2.**

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

16 - 32

**Item 3.**

Quantitative and Qualitative Disclosures about Market Risk

32

**Item 4.**

Controls and Procedures

32

**Part II.  Other Information:**

**Item 1.**

Legal Proceedings

33

**Item 2.**

Changes in Securities and Use of Proceeds

33

**Item 6.**

Exhibits and Reports on Form 8-K

34

Signature

35

Important Shareholder Information

NSTAR files its Forms 10-K, 10-Q and 8-K reports, proxy statements and other information with the Securities and Exchange Commission (SEC).  You may access materials NSTAR has filed with the SEC on the SEC’s website atwww.sec.gov.  In addition, NSTAR’s Board of Trustees has various committees, including an Audit, Finance and Risk Management Committee, an Executive Personnel Committee, a Board Governance and Nominating Committee and an Executive Committee.  In 2003,the Board adopted the NSTAR Board of Trustees Corporate Guidelines on Significant Corporate Governance Issues, a Code of Ethics for the Principal Executive Officer, General Counsel, and Senior Financial Officers, and a Code of Ethics and Business Conduct forDirectors, Officers and Employees.  NSTAR’s SEC filings and Corporate Governance documents, including charters, guidelines and codes, and any amendments to such codes which are applicable to NSTAR’s executive officers, senior financial officers ortrustees can be accessed free of charge on NSTAR’s website at www.nstaronline.com.  Copies of NSTAR’s SEC filings may also be obtained by writing or calling NSTAR’s Investor Relations Department at the address or phone number on the cover ofthis Form 10-Q.

Table of Contents

**Part I.  Financial InformationItem 1.  Financial Statements**

NSTARCondensed Consolidated Statements of Income(Unaudited)(in thousands, except earnings and dividends declared per share data)

Three Months Ended

Six Months Ended

June 30,

June 30,

2004

2003

2004

2003

Operating revenues

$

649,787

$

647,029

$

1,459,695

$

1,409,961

Operating expenses:

  Purchased power and cost of gas sold

346,721

349,275

817,791

783,855

  Operations and maintenance

103,156

104,958

209,651

214,794

  Depreciation and amortization

61,057

57,459

126,596

119,603

  Demand side management and renewable energy programs

15,598

15,404

33,068

32,274

  Property and other taxes

25,016

22,755

53,773

49,134

  Income taxes

24,832

23,917

57,902

52,439

    Total operating expenses

576,380

573,768

1,298,781

1,252,099

Operating income

73,407

73,261

160,914

157,862

Other income (deductions):

  Other income, net

3,211

6,614

4,174

7,670

  Other deductions, net

(273

)

(571

)

(417

)

(1,188

)

    Total other income, net

2,938

6,043

3,757

6,482

Interest charges:

  Long-term debt

29,352

29,557

58,289

61,336

  Transition property securitization

7,174

8,221

14,757

16,905

  Short-term debt and other

2,100

2,741

4,028

5,778

  Allowance for borrowed funds used during

    construction (AFUDC)/capitalized interest

(296

)

(859

)

(624

)

(2,147

)

      Total interest charges

38,330

39,660

76,450

81,872

Preferred stock dividends of subsidiary

490

490

980

980

Net income

$

37,525

$

39,154

$

87,241

$

81,492

Weighted average common shares outstanding:

  Basic

53,085

53,033

53,059

53,033

  Diluted

53,583

53,404

53,533

53,358

Earnings per common share:

  Basic

$

0.71

$

0.74

$

1.64

$

1.54

  Diluted

$

0.70

$

0.73

$

1.63

$

1.53

Dividends declared per common share

$

0.555

$

0.54

$

1.11

$

1.08

The accompanying notes are an integral part of the condensed consolidated financial statements.Table of Contents

NSTAR Condensed Consolidated Statements of Comprehensive Income(Unaudited)(in thousands)

Three Months Ended

Six Months Ended

June 30,

June 30,

2004

2003

2004

2003

Net income

$

37,525

$

39,154

$

87,241

$

81,492

Other comprehensive income, net:

   Unrealized gain on investments

-

14,612

-

16,816

Comprehensive income

$

37,525

$

53,766

$

87,241

$

98,308

The accompanying notes are an integral part of the condensed consolidated financial statements.

Table of Contents

NSTARCondensed Consolidated Statements of Retained Earnings(Unaudited)(in thousands)

Three Months Ended

Six Months Ended

June 30,

June 30,

2004

2003

2004

2003

Balance at the beginning of the period

$

469,397

$

396,586

$

449,114

$

382,886

Add:

   Net income

37,525

39,154

87,241

81,492

     Subtotal

506,922

435,740

536,355

464,378

Deduct:

   Dividends declared:

   Common shares

29,481

28,637

58,914

57,275

Balance at the end of the period

$

477,441

$

407,103

$

477,441

$

407,103

The accompanying notes are an integral part of the condensed consolidated financial statements.

Table of Contents

NSTARCondensed Consolidated Balance Sheets(Unaudited)(in thousands) 

June 30,

December 31,

2004

2003

Assets

 

 

Utility plant in service, at original cost

$

4,290,476

  

$

4,254,848

 

  

Less: accumulated depreciation

1,071,892

  

1,109,248

 

3,218,584

3,145,600

 

Construction work in progress

84,843

70,500

 

  

Net utility plant

3,303,427

3,216,100

Non-utility property, net

156,151

160,556

Goodwill

432,996

439,122

Equity and other investments

72,178

68,888

Current assets:

  

Cash and cash equivalents

27,818

16,526

  

Restricted cash

10,233

13,144

  

Accounts receivable, net and accrued unbilled revenues

361,591

352,374

  

Inventory, at average cost

67,466

79,743

  

Other

65,466

39,172

  

  

Total current assets

532,574

500,959

Deferred debits:

  

Regulatory assets - power contracts

695,514

799,087

  

Regulatory assets - retiree benefit costs

341,774

340,111

  

Regulatory assets - other

720,281

715,849

  

Other

79,106

79,988

  

    Total deferred debits

1,836,675

1,935,035

    Total assets

$

6,334,001

$

6,320,660

The accompanying notes are an integral part of the condensed consolidated financial statements.

Table of Contents

NSTARCondensed Consolidated Balance Sheets(Unaudited)(in thousands)

  

   

  

June 30,

   

December 31,

  

2004

   

2003

Capitalization and Liabilities

  

   

  

   

Common equity:

  

 

   

  Common shares, par value $1 per share,

  

   

    100,000,000 shares authorized; issued and outstanding

  

   

        53,118,873 shares in 2004 and 53,032,546 shares in 2003

  

$

53,119

   

$

53,033

  Premium on common shares

  

864,397

   

866,221

  Retained earnings

  

477,441

   

449,114

  Accumulated other comprehensive loss

  

(6,776

)

   

(6,776

)

    Total common equity

  

1,388,181

   

1,361,592

  

   

Cumulative non-mandatory redeemable preferred

  

   

  stock of subsidiary

  

43,000

   

43,000

  

   

  

   

Long-term debt

  

1,901,305

   

1,605,381

Transition property securitization

  

342,500

   

377,150

  Total long-term debt

  

2,243,805

   

1,982,531

     Total capitalization

  

3,674,986

   

3,387,123

  

   

Current liabilities:

  

   

  Long-term debt

  

9,900

   

189,956

  Transition property securitization

  

39,410

   

40,077

  Notes payable

  

159,600

   

239,100

  Accounts payable

  

208,253

   

224,987

  Accrued expenses

  

277,968

   

231,838

  Deferred income taxes

  

36,890

   

13,961

    Total current liabilities

  

732,021

   

939,919

  

   

  

   

Deferred credits:

  

   

  Accumulated deferred income taxes and unamortized

  

   

    investment tax credits

  

785,187

   

765,507

  Power contracts

  

695,514

   

799,087

  Pension liability

  

35,302

   

46,659

  Regulatory liability - cost of removal

255,312

223,074

  Other

  

155,679

   

159,291

      Total deferred credits

  

1,926,994

   

1,993,618

  

   

Commitments and contingencies

  

   

  

   

  Total capitalization and liabilities

  

$

6,334,001

   

$

6,320,660

The accompanying notes are an integral part of the condensed consolidated financial statements.

Table of Contents

NSTARCondensed Consolidated Statements of Cash Flows(Unaudited)(in thousands)

Six Months Ended

June 30,

  

2004

  

2003

  

  

Operating activities:

  

  

  Net income

  

$

87,241

  

$

81,492

  Adjustments to reconcile net income to net cash

  

  

    provided by operating activities:

  

  

    Depreciation and amortization

  

126,983

  

120,014

    Deferred income taxes

  

51,829

  

51,691

    AFUDC/capitalized interest

  

(624

)

  

(2,147

)

  Net changes in:

  

  

    Accounts receivable and unbilled revenues

  

(9,217

)

  

5,064

    Accounts payable

  

(16,734

)

  

16,663

    Other current assets

  

(11,106

)

  

(17,063

)

    Other current liabilities

  

69,011

  

35,320

  Net change from other operating activities

  

(115,716

)

  

(121,453

)

Net cash provided by operating activities

  

181,667

  

169,581

  

  

Investing activities:

  

  

  Plant expenditures (excluding AFUDC/capitalized interest)

  

(120,304

)

  

(139,527

)

  Proceeds on sale of property

14,252

17,572

  Other investments

  

(3,290

)

  

1,008

Net cash used in investing activities

  

(109,342

)

  

(120,947

)

  

  

Financing activities:

  

  

  Long-term debt redemptions

  

(184,519

)

  

(166,854

)

  Transition property securitization

  

(35,317

)

  

(36,406

)

  Long-term debt issuance

300,000

150,000

  Debt issue costs

(1,851

)

(663

)

  Net change in notes payable

  

(79,500

)

  

25,900

  Dividends paid

  

(59,846

)

  

(58,255

)

Net cash used in financing activities

  

(61,033

)

  

(86,278

)

  

  

Net increase/(decrease) in cash and cash equivalents

  

11,292

  

(37,644

)

Cash and cash equivalents at the beginning of the year

  

16,526

  

53,438

Cash and cash equivalents at the end of the period

$

27,818

$

15,794

Supplemental disclosures of cash flow information:

  

  

  

  

Cash paid during the period for:

  

  

  Interest, net of amounts capitalized

  

$

73,460

  

$

81,342

  Income taxes

  

$

18,710

  

$

11,235

The accompanying notes are an integral part of the condensed consolidated financial statements.

 Table of Contents

**Notes to Condensed Consolidated Financial Statements**

(Unaudited)

The accompanying notes should be read in conjunction with Notes to Consolidated Financial Statements included in NSTAR’s 2003 Annual Report on Form 10-K.

**Note A.  Business Organization and Summary of Significant Accounting Policies**

1.  About NSTAR

NSTAR (or the Company) is an energy delivery company serving approximately 1.4 million customers in 107 cities and towns in Massachusetts, including approximately 1.1 million electric customers in 81 communities and approximately300,000 gas customers in 51 communities.  NSTAR’s retail utility subsidiaries are Boston Edison Company (Boston Edison), Commonwealth Electric Company (ComElectric), Cambridge Electric Light Company (Cambridge Electric) (collectively operating as“NSTAR Electric”) and NSTAR Gas Company (NSTAR Gas).  Reference in this report to “NSTAR” shall mean the registrant NSTAR or one or more of its subsidiaries as the context requires.  Reference in this report to “NSTARElectric” shall mean each of Boston Edison, ComElectric and Cambridge Electric.  NSTAR also has ownership interests in and conducts non-utility, unregulated operations.

2.  Basis of Consolidation and Accounting

The financial information presented as of June 30, 2004 and for the three and six-month periods ended June 30, 2004 and 2003 have been prepared from NSTAR’s books and records without audit by an independent registered publicaccounting firm.   However, NSTAR’s independent registered public accounting firm has performed a review of these interim financial statements in accordance with standards established by the Public Company Accounting Oversight Board (United States). Financial information as of December 31, 2003 was derived from the audited consolidated financial statements of NSTAR, but does not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP).  In theopinion of NSTAR’s management, all adjustments (which are of a normal recurring nature) necessary for a fair presentation of the financial information for the periods indicated have been included.  Certain immaterial reclassifications have been made to theprior year amounts to conform with the current presentation.

The utility subsidiaries are subject to the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 71, “Accounting for the Effects of Certain Types of Regulation” (SFAS 71). The application of SFAS 71 results in differences in the timing of recognition of certain expenses from those of other businesses and industries.  The distribution and transmission businesses remain subject to rate-regulation and continue to meet the criteriafor application of SFAS 71.

The preparation of financial statements in conformity with GAAP requires management of NSTAR and its subsidiaries to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingentassets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from these estimates.

The results of operations for the three and six-month periods ended June 30, 2004 and 2003 are not indicative of the results that may be expected for an entire year.  Electric energy sales and revenues are typically higher in thewinter and summer months than in the spring and fall months, as sales tend to vary with weather conditions.  Gas energy sales and revenues are typically higher in the winter months than during other periods of the year.

  3.  Stock Option Accounting

NSTAR applies the recognition and measurement principles of Accounting Principles Board Opinion    No. 25, “Accounting for Stock Issued to Employees” and related Interpretations in accounting for its 1997Share Incentive Plan.  Currently, no stock-based employee compensation expense for option grants is reflected in net income, as all options granted under this plan had an exercise price equal to the market value of the underlying common shares on the date ofgrant.  The following table illustrates the effect on net income and earnings per common share if NSTAR had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” to stock-based employeecompensation.

Three Months Ended

Six Months Ended

June 30,

June 30,

(in thousands, except earnings per common share amounts)

2004

2003

2004

2003

Net income, as reported

$

37,525

$

39,154

$

87,241

$

81,492

Add: Share grant incentive compensation

   expense included in reported net income, net

   of related tax effects

661

542

1,219

997

Deduct:  Total share grant and stock

   option compensation expense determined

   under fair value method for all awards, net

   of related tax effects

(869

)

(779

)

(1,606

)

(1,377

)

Pro forma net income

$

37,317

$

38,917

$

86,854

$

81,112

Earnings per common share:

   Basic - as reported

$

0.71

$

0.74

$

1.64

$

1.54

   Basic - pro forma

$

0.70

$

0.73

$

1.64

$

1.53

   Diluted - as reported

$

0.70

$

0.73

$

1.63

$

1.53

   Diluted - pro forma

$

0.70

$

0.73

$

1.62

$

1.52

4.  Pension and Other Postretirement Benefits

Pension

NSTAR sponsors a defined benefit retirement plan, the NSTAR Pension Plan (the Plan), that covers substantially all employees.  During the first half of 2004, NSTAR contributed approximately $40 million to the Plan.  TheCompany does not anticipate contributing any additional amounts to the Plan over the remaining six months of 2004.

Effective for the quarter ended March 31, 2004, SFAS No. 132R, “Employers’ Disclosures about Pension and Other Postretirement Benefits,” requires disclosure of the details of net periodic pension and otherpostretirement benefits cost.

Components of net periodic pension benefits cost were as follows:

Three Months Ended

Six Months Ended

June 30,

June 30,

(in millions)

2004

2003

2004

2003

Service cost

$

4.8

$

4.5

$

9.5

$

9.0

Interest cost

15.0

14.7

30.1

29.4

Expected return on Plan assets

(17.7

)

(14.7

)

(35.4

)

(29.5

)

Amortization of transition obligation

0.1

0.2

0.2

0.3

Amortization of prior service cost

-

-

0.1

0.1

Recognized actuarial loss

6.8

8.4

13.4

16.8

   Net periodic pension benefit cost

$

9.0

$

13.1

$

17.9

$

26.1

The net periodic pension costs for the six months ended June 30, 2004 have been adjusted based on the actual actuarial study results.  For the three months ended June 30, 2004, the net periodic pension benefits cost was increased(decreased) by approximately $500,000 and ($800,000), respectively, to reflect the true-up to actual results.

Other Postretirement Benefits

NSTAR also provides health care and other benefits to retired employees who meet certain age and years of service eligibility requirements.  These benefits include health and life insurance coverage and up until April 1, 2003included reimbursement of certain Medicare premiums for certain retirees.  Under certain circumstances, eligible retirees are required to make contributions for postretirement benefits.  During the first half of 2004, NSTAR contributed approximately $4.9million toward these benefits.  The Company anticipates contributing an additional $15 million for these benefits over the remaining six months of 2004. 

Components of net periodic postretirement benefits cost were as follows:

Three Months Ended

Six Months Ended

June 30,

June 30,

(in millions)

2004

2003

2004

2003

Service cost

$

1.8

$

1.8

$

3.6

$

3.5

Interest cost

9.1

8.8

18.3

17.7

Expected return on Plan assets

(6.1

)

(4.8

)

(12.3

)

(9.5

)

Amortization of transition obligation

0.5

0.5

0.9

0.9

Amortization of prior service cost

0.3

0.3

0.6

0.6

Recognized actuarial loss

3.2

3.3

6.5

6.7

   Net periodic postretirement benefit cost

$

8.8

$

9.9

$

17.6

$

19.9

The net periodic other postretirement benefits cost for the six months ended June 30, 2004 has been adjusted based on the actual actuarial study results.  For the three months ended June 30, 2004 and 2003, the net periodic otherpostretirement benefits cost was decreased by approximately $500,000 and $1,100,000, respectively, to reflect the true-up to actual results. 

In December 2003, the FASB issued Staff Position (FSP) 106-1, “Accounting and Disclosure Requirements related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the Act).  The Act providesfor prescription drug benefits for retirees over the age of 65 under a new Medicare Part D program.  For employers like NSTAR, who currently provide retiree medical programs for former employees over the age of 65, there are potential subsidies available thatare inherent in the Act.  The Act potentially entitles these employers to a direct tax-exempt federal subsidy.

Pursuant to FSP 106-1, NSTAR has elected to defer recognition of the provisions of this Act until further accounting guidance is effective.  As a result, the provisions of the Act are not reflected in this disclosure or in theaccompanying Condensed Consolidated Financial Statements. 

In May 2004, the FASB issued FSP 106-2.  This FSP provides guidance on the accounting for the effects of the Act.  The guidance indicates that, when an employer initially accounts for the subsidy, the effect on the accumulatedpostretirement benefits obligation should be accounted for as an actuarial gain (assuming no plan amendments are made).  In addition, since the subsidy would affect the employer’s share of its plan’s costs, the subsidy is included in measuring thecosts of benefits attributable to current service.  Therefore, the subsidy should reduce service cost when it is recognized as a component of net periodic postretirement benefits cost.  This FSP will be effective for the third quarter of 2004.  NSTARis evaluating the impact that the Act and this FSP will have on its financial position.  The initial evaluation indicates that the 2004 net periodic postretirement benefits cost will be reduced by approximately $7 million.  However, due to theCompany’s pension and other postretirement benefits rate reconciliation adjustment mechanism, this reduction in cost will not have a material impact on earnings.

5.  New Accounting Standards

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” as revised in December 2003 (FIN 46R), which addresses the consolidation of variable interest entities (VIE) by businessenterprises that are the primary beneficiaries.  A VIE is an entity that does not have sufficient equity investment at risk to permit it to finance its activities without additional subordinated financial support, or whose equity investors lack thecharacteristics of a controlling financial interest.  The primary beneficiary of a VIE is the enterprise with the majority of the risks or rewards associated with the VIE.  This interpretation has two effective dates:  December 31, 2003 and March 31,2004.

NSTAR has a wholly owned special purpose subsidiary, BEC Funding LLC, established to facilitate the sale and administration of $725 million in notes to a special purpose trust created by two Massachusetts state agencies. Historically, NSTAR has consolidated this entity.  As part of NSTAR’s assessment of FIN 46R and for compliance at December 31, 2003, NSTAR reviewed the substance of this entity to determine if it is still proper to consolidate this entity.  Based onits review, NSTAR has concluded that BEC Funding LLC is a VIE and should continue to be consolidated by NSTAR.

For the March 31, 2004 effective date, NSTAR evaluated, among other entities, the companies that supply power to NSTAR through its purchase power agreements and NSTAR determined that it is possible that five of these companies may beconsidered VIEs.  These companies have power plants that have daily capacity output ranging from 20 megawatts (MW) to 330 MW.  Through March 31, 2004 and 2003, NSTAR purchased a total of approximately 1,121 MWH and 1,233 MWH, respectively, under theseagreements.  These purchases approximate 18% of the total megawatts purchased by NSTAR for the three-month periods ended March 31, 2004 and 2003 and amounted to approximately $102 million and $100 million, respectively.  In order to determine if thesecounterparties are VIEs and if NSTAR is the primary beneficiary of these counterparties, NSTAR concluded that it needed more information from the entities.  NSTAR attempted to obtain the information required and requested, in writing, these entities provide theCompany with the necessary information.  However, each of the entities has indicated that they will not provide the requested information as they are not contractually obligated to provide such confidential information.  Since NSTAR was unable to obtain thenecessary information and as allowed under a scope exception in FIN 46R, the accompanying Condensed Consolidated Financial Statements do not reflect the consolidation of any entities with which NSTAR has a purchase power agreement. 

In March 2004, the FASB issued an Exposure Draft for a Proposed Statement of Financial Accounting Standards, “Share-Based Payment.”  This proposed Statement addresses the accounting for transactions in which a companyreceives employee services in exchange for (a) equity instruments of the company or (b) liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments.  This proposedStatement would also eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally would require that such transactions be accounted for using afair-value-based method.  This Exposure Draft was open for public comment until June 30, 2004.  The final Statement, if adopted, is expected to be applied prospectively, for NSTAR, for fiscal years beginning after December 15, 2004.  NSTAR is currentlyassessing the impact of this proposed Statement on its share-based compensation programs.

**Note B.  Cost of Removal**

For NSTAR’s regulated utility businesses, the ultimate cost to remove utility plant from service (negative net salvage) is recognized as a component of depreciation expense in accordance with approved regulatory treatment. As of June 30, 2004 and December 31, 2003, the estimated amount of the cost of removal included in regulatory liabilities was approximately $255 million and $223 million, respectively.
****
**Note C.  Derivative Instruments - Power Contracts**

NSTAR accounts for its power contracts in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133).  NSTAR has six purchase power contracts that contain components withpricing mechanisms that are partly based on a pricing index, such as the Gross National Product or Consumer Price Index.   The amount recognized for the fair value of the above-market portion of these contracts at June 30, 2004 and December 31, 2003 isapproximately $572 million and $666 million, respectively, and is a component of Deferred credits - Power contracts on the accompanying Condensed Consolidated Balance Sheets.  NSTAR has recorded a corresponding regulatory asset to reflect the future recovery ofthe above-market component of these contracts through its transition charge.  Therefore, as a result of this regulatory treatment, the recording of these contracts on its accompanying Condensed Consolidated Balance Sheets does not result in an earningsimpact.

NSTAR has other purchase power contracts in which the contract value is significantly above-market.  However, these contracts have met the criteria for the normal purchases and sales exception pursuant to SFAS 133 and have not beenrecorded on the accompanying Condensed Consolidated Balance Sheets.  The above-market portion of these contracts is currently being recovered through the transition charge. 

As of the date of this filing, NSTAR has executed buyout/restructuring agreements with certain parties through which NSTAR has entitlements to approximately 620 MW of capacity.  These agreements are contingent upon approval by theMassachusetts Department of Telecommunications and Energy (MDTE).  Five of these contracts have previously been classified as derivatives and recorded at their fair value at each reporting period.  Upon the effective date of these buy-out agreements, thecontracts will no longer be accounted for as derivatives.  For more information, refer to Note I, “Commitments and Contingencies.”

**Note D.  Other Utility Matters**

1.  Sale of Property

On April 7, 2004, Boston Edison completed the sale of a parcel of land in the City of Newton, Massachusetts for $15.1 million; the net proceeds from the sale were used to reduce Boston Edison’s transition charge.  The salewas approved by the MDTE.

2.  Service Quality Indicators

Service quality indicators are established performance benchmarks for identified measures of service quality relating to customer service and billing performance, customer satisfaction, and reliability and safety performance for allMassachusetts utilities.  NSTAR Electric and NSTAR Gas are required to report annually to the MDTE concerning their performance as to each measure and are subject to maximum penalties of up to two percent of transmission and distribution revenues shouldperformance fail to meet the applicable benchmarks. 

On March 1, 2004, NSTAR Electric and NSTAR Gas filed their 2003 Service Quality Reports with the MDTE that reflected sufficient levels of reliability and performance; the reports indicate that no penalty will be assessed for 2003. The MDTE will review this filing and will likely issue an order later in 2004.  NSTAR monitors its service quality continuously to determine its contingent liability, and if it were determined that a liability has been incurred and is estimable, an appropriateliability would be accrued.  Annually, each NSTAR utility subsidiary makes a service quality performance filing with the MDTE.  Any settlement or rate order that would result in a different liability level from what has been accrued would be adjusted in theperiod that the MDTE issues an order determining the amount of any such liability.

As of June 30, 2004, NSTAR Electric’s and NSTAR Gas’ 2004 performance has exceeded the applicable established benchmarks such that no liability has been accrued for 2004.  However, these results may not be indicative ofthe results that may be expected for the remainder of the year, including the peak demand period anticipated during the summer period.

3.  Regulatory Proceedings

On March 24, 2004, the Federal Energy Regulatory Commission (FERC) set for hearing a joint return on equity (ROE) filing made by participating New England Transmission Owners (NETO), including NSTAR Electric.  The NETO proposalrequested an increase in the base ROE component of the regional and local transmission rates, to be provided under the Regional Transmission Organization for New England   (RTO-NE) open access transmission tariff (OATT) to a single ROE of 12.8% for allregional and local transmission rates.  Presently, transmission service in New England is provided under a two-tier structure, with the potential for the ROE for local service to be different than regional service for the same transmission provider.  Whilethe FERC set for hearing the base ROE proposal consistent with decisions in prior RTOs, FERC approved a ROE adder of 50 basis points in regional rates as an incentive for joining an RTO for regional service.  In addition, FERC set for hearing NETO’sproposal for an additional 100 basis points in regional rates applicable to all future transmission expansion.  The NETO maintain that sufficient equity returns are needed to elicit the necessary investments by the transmission owners within an RTO. Settlement negotiations in April before a FERC administrative law judge were unsuccessful.  As such, hearings on the base ROE and 100 basis point adder issues are scheduled to begin in December 2004.

The joint filing among the NETO was made in connection with the proposed formation of RTO-NE by the NETO and Independent System Operator - New England (ISO-NE), the present administrator of the New England Power Pool (NEPOOL) OATT, andis an important and integral component of the agreement to form an RTO for the New England region.

Also, on March 24, 2004, the FERC conditionally approved RTO status for ISO-NE pending the acceptance of certain conditions.  RTO-NE will act as both the regional transmission provider and the tariff administrator with the RTO-NEOATT replacing the NEPOOL OATT.  RTO-NE will also have operational authority over all transmission within the New England region’s bulk electric power system under a longer-term and more stable contractual structure than the current interim agreementbetween the ISO-NE and NEPOOL.  The NETO are seeking rehearing and clarification of certain provisions of the FERC RTO order issued on March 24, 2004.  On June 29, 2004, ISO-NE, NETO and NEPOOL agreed to a term sheet for a settlement that is intended, amongother things, to resolve NEPOOL’s interests and the terms under which those interests are transferred to RTO-NE.  This proposed settlement does not resolve the issues related to NETO’s rehearing and clarification requests.

**Note E.  Income Taxes**

Income taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS 109).  SFAS 109 requires the recognition of deferred tax assets and liabilities for the future tax effects of temporarydifferences between the carrying amounts and the tax basis of assets and liabilities.  In accordance with SFAS 109, net regulatory assets include $49.9 million and $50.2 million of deferred tax assets and corresponding amounts in accumulated deferred incometaxes that were recorded as of June 30, 2004 and December 31, 2003, respectively.  The regulatory assets represent the additional future revenues to be collected from customers for deferred income taxes.

The following table reconciles the statutory federal income tax rate to the annual estimated effective income tax rate for 2004 and the actual effective income tax rate for the year ended December 31, 2003:

2004

2003

Statutory tax rate

 

 

35.0

%

 

 

35.0

%

State income tax, net of federal income tax benefit

 

 

5.0

 

 

 

5.3

 

Investment tax credits

(0.6

)

(0.6

)

Other

1.2

1.4

  Effective tax rate before write-down and tax valuation allowance

    adjustment

40.6

41.1

Adjustment to tax valuation allowance and write-down of RCN investment

-

(2.8

)

 Effective tax rate

 

 

40.6

%

 

38.3

%

**Note F.  Earnings Per Common Share**

Basic earnings per common share (EPS) is calculated by dividing net income, which includes a deduction for preferred dividends of a subsidiary, by the weighted average common shares outstanding during the year.  SFAS No. 128,“Earnings per Share,” requires the disclosure of diluted EPS.  Diluted EPS is similar to the computation of basic EPS except that the weighted average common shares is increased to include the number of dilutive potential common shares.  DilutedEPS reflects the impact on shares outstanding of the deferred (nonvested) shares and stock options granted, adjusted for forfeitures, under the NSTAR 1997 Share Incentive Plan.

The following table summarizes the reconciling amounts between basic and diluted EPS:

****

Three Months Ended

Six Months Ended

June 30,

June 30,

(in thousands, except per share amounts)

2004

2003

2004

2003

Net income

$

37,525

$

39,154

$

87,241

$

81,492

   Basic EPS

$

0.71

$

0.74

$

1.64

$

1.54

   Diluted EPS

$

0.70

$

0.73

$

1.63

$

1.53

Weighted average common shares

   outstanding for basic EPS

53,085

53,033

53,059

53,033

Effect of diluted shares:

Weighted average dilutive potential common shares

498

371

474

325

Weighted average common shares outstanding for    diluted EPS

 53,583

 53,404

 53,533

 53,358

****

**Note G.  Long-Term Debt Redemption / Issuance**

On March 16, 2004, Boston Edison redeemed the entire outstanding balance of $181 million aggregate principal amount of its 7.80% Debentures due March 15, 2023.  The redemption also included payment of an approximate $6.1 millionpremium plus accrued interest.  On April 16, 2004, Boston Edison sold $300 million of ten-year fixed rate (4.875%) Debentures.  The net proceeds were used to repay outstanding short-term debt balances incurred, in part, to pay the redemption price of the7.80% Debentures.  The premium paid to redeem the 7.80% Debentures will be amortized over ten years, the term of the new 4.875% Debentures.

**Note H.  Segment and Related Information**

For the purpose of providing segment information, NSTAR’s principal operating segments, or its traditional core businesses, are the electric and natural gas utilities that provide energy delivery services in 107 cities and townsin Massachusetts.  NSTAR subsidiaries also supply electricity at wholesale to municipalities.  The unregulated operating segment engages in business activities that include district energy operations, telecommunications and liquefied natural gasservices.  Amounts shown on the following table include the allocation of NSTAR’s (parent company) results of operations and assets, net of inter-company transactions, and primarily consist of interest charges and investment assets, respectively, to thesebusiness segments.  The allocation of parent company charges is based on an indirect allocation of the parent company’s investment relating to these various business segments.

Financial data for the operating segments were as follows:

Utility Operations

Unregulated

Consolidated

(in thousands)

Electric

Gas

Operations

Total

Three months ended June 30,

 

2004

 

Operating revenues

$

558,777

$

70,496

$

20,514

$

649,787

 

Segment net income

$

36,542

$

(1,288

)

$

2,271

$

37,525

 

2003

 

Operating revenues

$

539,192

$

81,788

$

26,049

$

647,029

 

Segment net income

$

32,862

$

143

$

6,149

$

39,154

 

 

Six months ended June 30,

 

2004

 

Operating revenues

$

1,119,999

$

282,197

$

57,499

$

1,459,695

 

Segment net income

$

63,704

$

18,957

$

4,580

$

87,241

 

2003

 

Operating revenues

$

1,064,303

$

284,757

$

60,901

$

1,409,961

 

Segment net income

$

55,523

$

19,261

$

6,708

$

81,492

 

 

Total assets

 

June 30, 2004

$

5,424,400

$

654,234

$

255,367

$

6,334,001

 

December 31, 2003

$

5,413,765

$

679,120

$

227,775

$

6,320,660

 

**Note I.  Commitments and Contingencies**

1.  Environmental Matters

As of June 30, 2004, NSTAR’s subsidiaries are involved in four state-regulated properties (“Massachusetts Contingency Plan, or “MCP” sites”) where oil or other hazardous materials were previously spilled orreleased.  The NSTAR subsidiaries are required to clean up or otherwise remediate these properties in accordance with specific state regulations.  There are sometimes uncertainties associated with total remediation costs due to the final selection of thespecific cleanup technology and the particular characteristics of the different sites.  Estimates of approximately $0.7 million are included as liabilities in the accompanying Condensed Consolidated Balance Sheets at both June 30, 2004 and December 31,2003.

In addition to the MCP sites, NSTAR subsidiaries also face possible liability as a result of involvement in 14 multi-party disposal sites or third party claims associated with contamination remediation.  NSTAR generally expects tohave only a small percentage of the total potential liability for these sites.  Estimates of approximately $3.4 million are included as liabilities in the accompanying Condensed Consolidated Balance Sheets at both June 30, 2004 and December 31, 2003.

The MCP and multi-party disposal site amounts have not been reduced by any potential rate recovery treatment of these costs or any potential recovery from NSTAR’s insurance carriers.  Prospectively, should NSTAR be allowed tocollect these specific costs from customers, it would record an offsetting regulatory asset and record a credit to operating expenses equal to previously expensed costs.

NSTAR Gas is participating in the assessment or remediation of five former manufactured gas plant (MGP) sites and alleged MGP waste disposal locations to determine if and to what extent such sites have been contaminated and whetherNSTAR Gas may be responsible for remedial action.  The MDTE has approved recovery of costs associated with MGP sites over a 7-year period, without carrying costs.  As of June 30, 2004 and December 31, 2003, NSTAR has recorded a liability of approximately$4.8 million and $4.4 million, respectively, as an estimate for site cleanup costs for several MGP sites for which NSTAR Gas was previously cited as a potentially responsible party.  A corresponding regulatory asset has been recorded that reflects the futurerate recovery for these costs.

Estimates related to environmental remediation costs are reviewed and adjusted periodically as further investigation and assignment of responsibility occurs and as either additional sites are identified or NSTAR’s responsibilitiesfor such sites evolve or are resolved.  NSTAR’s ultimate liability for future environmental remediation costs may vary from these estimates.  Based on NSTAR’s current assessment of its environmental responsibilities, existing legal requirementsand regulatory policies, NSTAR does not believe that these environmental remediation costs will have a material adverse effect on NSTAR’s consolidated financial position, results of operations or cash flows for a reporting period.

2.  Income Tax Matters

On December 24, 2003, NSTAR exited from its investment in RCN and formally abandoned its 11.6 million shares of RCN common stock.  The Company will claim an ordinary loss on its 2003 tax return as opposed to a capital loss thatwould have resulted from a sale of the stock.  The Company’s position relative to the tax consequences of the transaction is supported by an opinion from an independent tax advisor.

The ordinary loss tax treatment results in the Company realizing the benefits represented by the tax asset recorded on its books that resulted from the previous write-down of this asset for financial reporting purposes.  Therequirement for a tax valuation allowance, therefore, no longer exists.  The Company has reversed this reserve as of December 31, 2003.

The Company believes it more likely than not that it is entitled to an ordinary loss deduction.  The Company expects the IRS to review this transaction and it is reasonably possible that the IRS will disagree.  In accordancewith the Company’s tax policy as it relates to uncertain tax positions, the Company has established a loss contingency of approximately $44 million at December 31, 2003.  This amount represents the tax impact to the Company should the ordinary lossultimately be recharacterized to a capital loss.  This contingency is recorded as part of Deferred credits - other on the accompanying Condensed Consolidated Balance Sheets.

The Company believes that its position is well supported.  However, if the Company’s position proves incorrect, the Company may be required to make future cash expenditures to the IRS that may impact NSTAR’s cashrequirements in future periods.

3.  Purchase Power Contract Buy-outs / Restructuring

NSTAR previously disclosed in its consolidated financial statements for the year ended December 31, 2003 that NSTAR Electric had initiated a process to auction off certain purchase power agreements under which the Company hasentitlements to approximately 1,100 MW of capacity under long-term contracts with non-utility generators.  The auction was intended to further NSTAR’s efforts to mitigate stranded costs, which continue to be recovered from customers.   As of the dateof this filing, NSTAR Electric has executed agreements with certain parties through which NSTAR Electric has entitlements to approximately 620 MW of capacity.  These agreements are contingent upon MDTE approval.  Most of these contracts are buy-outarrangements whereby NSTAR Electric has committed to pay amounts for the full release of its obligation under these purchase power agreements.  NSTAR plans to seek approval for full recovery of these costs and the issuance of securitization bonds to provide thefunds for the buy-out agreements. 

4.  Legal Proceedings

In the normal course of its business, NSTAR and its subsidiaries are involved in certain legal matters, including civil litigation.  Management is unable to fully determine a range of reasonably possible court-ordered damages,settlement amounts, and related litigation costs (“legal liabilities”) that would be in excess of amounts accrued and amounts covered by insurance.  Based on the information currently available, NSTAR does not believe that it is probable that anysuch legal liability will have a material impact on its consolidated financial position.  However, it is reasonably possible that additional legal liabilities that may result from changes in estimates could have a material impact on its results of operations,cash flows and financial condition for a reporting period.

Table of Contents

**Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)**

The accompanying MD&A focuses on factors that had a material effect on the financial condition, results of operations and cash flows of NSTAR during the periods presented and should be read in conjunction with the accompanyingcondensed consolidated financial statements and related notes and with the MD&A in NSTAR’s 2003 Annual Report on Form 10-K.

**Overview**

NSTAR (or the Company) is an energy delivery company serving approximately 1.4 million customers in 107 cities and towns in Massachusetts, including approximately 1.1 million electric customers in 81 communities and approximately300,000 gas customers in 51 communities.  NSTAR’s retail utility subsidiaries are Boston Edison Company (Boston Edison), Commonwealth Electric Company (ComElectric), Cambridge Electric Light Company (Cambridge Electric) (collectively operating as“NSTAR Electric”) and NSTAR Gas Company (NSTAR Gas).  Reference in this report to “NSTAR” shall mean the registrant NSTAR or one or more of its subsidiaries as the context requires.  Reference in this report to “NSTARElectric” shall mean each of Boston Edison, ComElectric and Cambridge Electric.  NSTAR also has ownership interests in and conducts non-utility, unregulated operations.

**Cautionary Statement**

****

The MD&A, as well as other portions of this report, contain statements that are considered forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934.  Theseforward-looking statements may also be contained in other filings with the Securities and Exchange Commission (SEC), in press releases and oral statements.  You can identify these statements by the fact that they do not relate strictly to historical or currentfacts.  They use words such as “anticipate,”  “estimate,” “expect,” “project,” “intend,” “plan,” “believe” and other words and terms of similar meaning in connection withany discussion of future operating or financial performance.  These statements are based on the current expectations, estimates or projections of management and are not guarantees of future performance.  Some or all of these forward-looking statements maynot turn out to be what NSTAR expected.  Actual results could differ materially from these statements.  Therefore, no assurance can be given that the outcomes stated in such forward-looking statements and estimates will be achieved.

Examples of some important factors that could cause our actual results or outcomes to differ materially from those discussed in the forward-looking statements include, but are not limited to, the following:

   -   

impact of continued cost control procedures on operating results

   -   

weather conditions that directly influence the demand for electricity and natural gas

   -   

changes in tax laws, regulations and rates

   -   

financial market conditions including, but not limited to, changes in interest rates and the availability and cost of capital

   -   

prices and availability of operating supplies

   -   

prevailing governmental policies and regulatory actions (including those of the Massachusetts Department of Telecommunications and Energy (MDTE) and Federal Energy Regulatory Commission (FERC)) with respect to allowed rates of return,rate structure, continued recovery of regulatory assets, financings, purchased power, acquisition and disposition of assets, operation and construction of facilities, changes in tax laws and policies and changes in, and compliance with, environmental and safety lawsand policies

   -   

changes in financial accounting and reporting standards

   -   

new governmental regulations or changes to existing regulations that impose additional operating requirements or liabilities

   -   

changes in specific hazardous waste site conditions and the specific cleanup technology

   -   

impact of uninsured losses

   -   

changes in available information and circumstances regarding legal issues and the resulting impact on our estimated litigation costs

   -   

future economic conditions in the regional and national markets

   -   

ability to maintain current credit ratings, and

   -   

the impact of terrorist acts

Any forward-looking statement speaks only as of the date of this filing and NSTAR undertakes no obligation to publicly update forward-looking statements, whether as a result of new information, future events, or otherwise.  You areadvised, however, to consult all further disclosures NSTAR makes in its filings to the SEC.  Other factors in addition to those listed here could also adversely affect NSTAR.  This report also describes material contingencies and critical accountingpolicies and estimates in this section and in the accompanying Notes to Condensed Consolidated Financial Statements and NSTAR encourages a review of these Notes.

**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’s 2003 Form 10-K.  There have been no substantive changes to those policies andestimates.

**Rate and Regulatory Proceedings**

a.  Service Quality Indicators

Service quality indicators are established performance benchmarks for identified measures of service quality relating to customer service and billing performance, customer satisfaction, and reliability and safety performance for allMassachusetts utilities.  NSTAR Electric and NSTAR Gas are required to report annually to the MDTE concerning their performance as to each measure and are subject to maximum penalties of up to two percent of transmission and distribution revenues shouldperformance fail to meet the applicable benchmarks. 

On March 1, 2004, NSTAR Electric and NSTAR Gas filed their 2003 Service Quality Reports with the MDTE that reflected sufficient levels of reliability and performance; the reports indicate that no penalty will be assessed for 2003. The MDTE will review this filing and will likely issue an order later in 2004.  NSTAR monitors its service quality continuously to determine its contingent liability, and if it were determined that a liability has been incurred and is estimable, an appropriateliability would be accrued.  Annually, each NSTAR utility subsidiary makes a service quality performance filing with the MDTE.  Any settlement or rate order that would result in a different liability level from what has been accrued would be adjusted in theperiod that the MDTE issues an order determining the amount of any such liability.

As of June 30, 2004, NSTAR Electric’s and NSTAR Gas’ 2004 performance has exceeded the applicable established benchmarks such that no liability has been accrued for 2004.  However, these results may not be indicative ofthe results that may be expected for the remainder of the year, including the peak demand period anticipated during the summer period.

b.  Retail Electric Rates

Electric distribution companies in Massachusetts are required to obtain and resell power to retail customers through either standard offer or default service for those who choose not to buy energy from a competitive energysupplier.  Currently, standard offer service is scheduled to be available to eligible customers through February 2005 at prices approved by the MDTE.  The total rate paid by customers taking standard offer service are set at levels so as to guaranteemandatory overall rate reductions required by the Massachusetts Electric Restructuring Act of 1997 (Restructuring Act) (excluding the impact of standard offer service fuel index adjustments).  Currently, new retail customers in the NSTAR Electric serviceterritories and other customers who are no longer eligible for standard offer service and have not chosen to receive service from a competitive supplier are provided default service.  Default service rates are reset every six months (every three months for largecommercial and industrial customers).  The price of default service is intended to reflect the average competitive market price for power.  NSTAR anticipates that upon the expiration of standard offer service, effective March 1, 2005, all customers notpurchasing generation service from competitive retail suppliers will be eligible for default service.  However, Massachusetts officials are considering whether new deregulation legislation is needed after March 1, 2005.  NSTAR cannot predict or anticipatethe outcome of this process or its impact on NSTAR or its customers.  As of June 30, 2004 and December 31, 2003, customers of NSTAR Electric had approximately 25% and 26%, respectively, of their load requirements provided by competitive suppliers.

c.  Natural Gas Rates

****

NSTAR Gas generates revenues primarily through the sale and/or transportation of natural gas.  Gas sales and transportation services are divided into two categories: firm, whereby NSTAR Gas must supply gas and/or transportationservices to customers on demand; and interruptible, whereby NSTAR Gas may, generally during colder months, temporarily discontinue service to high volume commercial and industrial customers.  Sales and transportation of gas to interruptible customers do notmaterially affect NSTAR Gas’ operating income because substantially the entire margin for such service is returned to its firm customers as rate reductions.

In addition to delivery service rates, NSTAR Gas’ tariffs include a seasonal Cost of Gas Adjustment Clause (CGAC) and a Local Distribution Adjustment Clause (LDAC).  The CGAC provides for the recovery of all gas supply costsfrom firm sales customers or default service customers.  The LDAC provides for the recovery of certain costs applicable to both sales and transportation customers.  The CGAC is filed semi-annually for approval by the MDTE.  The LDAC is filed annuallyfor approval.  In addition, NSTAR Gas is required to file interim changes to its CGAC factor when the actual costs of gas supply vary from projections by more than 5%.

d.  Regional Transmission Organization (RTO)

On March 24, 2004, the FERC conditionally approved RTO status to the Independent System Operator - New England (ISO-NE), pending the acceptance of certain conditions.  The ISO-NE will be transformed into an RTO through a change ofname and governance structure, designed to ensure independence from market participants.  RTO-NE, which will be responsible for the day-to-day operation of New England’s bulk generation and transmission systems, together with the utility companies that owntransmission facilities in New England including NSTAR, filed a proposal with FERC creating a RTO in compliance with FERC directives and pronouncements. 

RTO-NE will be an independent entity, without a financial interest in the region’s marketplace, having operating authority over the New England transmission grid and the responsibility to make impartial decisions on thedevelopment and implementation of market rules.  The new RTO will enter into a series of contractual arrangements that will define its functions and responsibilities, including a Transmission Operating Agreement, which will govern the relationship between theowners of transmission facilities, such as NSTAR Electric and the RTO, as the operator of the New England transmission grid.  Separate agreements will govern the operation of the spot power and related markets, and merchant transmission facilities. Management cannot estimate the impact of this approval on the Company.

**Other Legal Matters**

In the normal course of its business, NSTAR and its subsidiaries are involved in certain legal matters, including civil litigation.  Management is unable to fully determine a range of reasonably possible court-ordered damages,settlement amounts, and related litigation costs (“legal liabilities”) that would be in excess of amounts accrued and amounts covered by insurance.  Based on the information currently available, NSTAR does not believe that it is probable that anysuch legal liability will have a material impact on its consolidated financial position.  However, it is reasonably possible that additional legal liabilities that may result from changes in estimates could have a material impact on its results of operations,cash flows and financial condition for a reporting period.

**Results of Operations - Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003**

****

**Results of Operations**

The following section of MD&A compares the results of operations for the three-month periods ended June 30, 2004 and 2003 and should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and theaccompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this report.

Earnings and operations overview

Earnings per common share were as follows:

Three Months Ended June 30,  

     

  

2004

   

  

2003

   

% Change

Basic

      

$

0.71

   

$

0.74

   

(4.1)

Diluted

      

$

0.70

    

$

0.73

   

(4.1)

Net income was $37.5 million for the quarter ended June 30, 2004 compared to $39.2 million for the same period in 2003.  Factors that contributed to the $1.7 million, or 4.3%, decrease in 2004 earnings include higher depreciationassociated with system improvements, a decline in firm gas sales reflecting milder weather and higher property taxes.  These reductions in earnings were partially offset by additional revenue earned as part of a reconciliation rate adjustment mechanism relatedto pension and postretirement benefits other than pensions (PBOP), higher electric distribution revenues, and interest savings on the Company’s outstanding indebtedness.

For the second quarter of 2004, NSTAR generated $103.1 million of cash from operations to fund approximately $70.6 million of net capital expenditures, and $29.9 million of cash dividends.  In comparison to the same period of theprior year, cash from operations increased $5.7 million primarily due to the timing of the collection of energy costs.  Favorable market conditions and the Company’s strong credit ratings contributed to the Company’s recent refinancingactivities.  These financing activities included the issuance of the 10-year, $300 million 4.875% series of Debentures in April 2004.  The proceeds from this issuance were used to pay down short-term borrowings.

Energy sales and weather

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

Retail Electric Sales - MWH

Three Months Ended June 30,

   

2004

   

2003

   

% Change

   

   

   

  Residential

   

1,480,173

   

1,396,317

   

6.0

  Commercial

   

3,098,476

   

2,922,562

   

6.0

  Industrial

   

420,671

   

411,584

   

2.2

  Other

   

35,859

   

36,096

   

(0.7)

    Total retail sales

   

5,035,179

   

4,766,559

   

5.6

Firm Gas Sales - BBTU

Three Months Ended June 30,

   

2004

   

2003

   

% Change

   

   

   

  Residential

   

2,441

   

3,422

   

(28.7)

  Commercial

   

2,448

   

2,985

   

(18.0)

  Industrial and other

   

2,002

   

1,845

   

8.5

    Total firm sales

   

6,891

   

8,252

   

(16.5)

The 5.6% increase in retail MWH sales and the 16.5% decrease in firm gas sales in the second quarter of 2004 primarily reflect warmer overall temperatures than in 2003. 

In terms of customer sectors, industrial sales are less sensitive to weather while residential and commercial sales are influenced by temperature extremes.  In addition to the overall warmer weather in the second quarter of 2004,the increase in electric sales is attributable in part to commercial building and expansion of existing units and the resulting extension of commercial energy uses, while residential electric sales were due to greater air conditioning use due to warmer weather. Electric residential and commercial customers were approximately 29% and 62%, respectively, of NSTAR’s total retail sales mix for the second quarter of 2004 and provided 41% and 53% of distribution and transmission revenues, respectively.  Refer to the“Electric revenues” section below for a more detailed discussion.  Industrial sales are primarily influenced by national and local economic conditions and sale to these customers reflect an improving economic environment and increased manufacturingproduction.

Weather conditions impact electric and, to a greater extent during the winter, gas sales in NSTAR’s service area.  The average daily temperature during the second quarter of 2004 was 58.3 degrees, as compared to 55.0 degreesin the same period of 2003.

Operating revenues

Operating revenues for the second quarter of 2004 increased 0.4% from the same period in 2003 as follows:

(in millions)

Three Months Ended June 30,

Increase/(Decrease)

 

2004

2003

Amount

Percent

Electric revenues

 

  Retail distribution and transmission

 

$

208.0

$

197.2

   

$

10.8

5.5

  Energy, transition and other

 

346.6

338.2

8.4

2.5

    Total retail

554.6

535.4

19.2

3.6

  Wholesale

4.2

3.8

0.4

10.5

    Total electric revenues

558.8

539.2

19.6

3.6

Gas revenues

  Firm and transportation

22.6

24.8

(2.2

)

(8.9

)

  Energy supply and other

47.9

57.0

(9.1

)

(16.0

)

    Total gas revenues

70.5

81.8

(11.3

)

(13.8

)

Unregulated operations revenues

20.5

26.0

(5.5

)

(21.2

)

    Total operating revenues

$

649.8

$

647.0

   

$

2.8

0.4

  Electric revenues

Electric retail distribution revenues primarily represent charges to customers for the Company’s recovery of its capital investment, including a return component, and operation and maintenance related to its electric distributioninfrastructure.  The transmission revenue component represents charges to customers for the recovery of costs to move the electricity over high voltage lines from the generator to the Company’s substations.  The increase in retail revenues primarilyreflects the 5.6% increase in retail MWH sales substantially all in the residential and commercial sectors.  Retail electric revenues also include approximately $4.9 million in additional revenues received as part of a reconciliation rate adjustment mechanismrelated to pension and PBOP.

NSTAR’s largest earnings sources are the revenues derived from distribution rates approved by the MDTE.  The level of distribution revenues is affected by weather conditions and the economy.  Weather conditions affectsales to NSTAR’s residential and small commercial customers.  Economic conditions affect NSTAR’s large commercial and industrial customers. 

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 ofthe Company’s prior investments in generating plants and the costs related to long-term power contracts.  The energy supply revenues relate to customers being provided energy supply under either standard offer or default service.  Energy supplycontract prices vary among the NSTAR Electric companies and for standard offer and default service customers.  However, the retail revenues related to standard offer and default services are fully reconciled to the costs incurred and have no impact onNSTAR’s consolidated net income. Furthermore, energy and transition revenues are fully reconciled with the cost currently recognized by the Company and, as a result, do not have an effect on the Company’s earnings.  Other revenues primarily relate tothe Company’s ability to effectively reduce stranded costs (mitigation incentive), rental revenue from electric property and annual cost reconciliation true-up adjustments.  During the first quarter of 2004, for instance, cost reconciliation true-upadjustments increased revenues by approximately $4.7 million.  The $8.4 million increase in energy, transition and other revenues is primarily attributable to higher rates for default service and standard offer service, which include the ComElectric andCambridge Electric standard offer service fuel index adjustments.

Wholesale revenues relate to services provided to municipalities and certain other governmental authorities.  Amounts collected from wholesale customers are credited to retail customers through the transition charge.  AfterOctober 2005, NSTAR Electric anticipates that it will no longer have contracts for the supply of wholesale power.   Therefore, the expiration of these contracts will have no impact on results of operations.

  Gas revenues

Firm and transportation gas revenues primarily represent charges to customers for NSTAR Gas’ recovery of costs of its capital investment in its gas infrastructure, including a return component, and for the recovery of costs forthe ongoing operation and maintenance of that infrastructure.  The transportation revenue component represents charges to customers for the recovery of costs to move the natural gas over pipelines from gas suppliers to take stations located within NSTARGas’ service area.  The $2.2 million decrease in firm and transportation revenues is attributable to warmer weather that decreased sales and includes approximately $1.1 million in additional revenues received as part of a reconciliation rate adjustmentmechanism related to the pension and PBOP.

Energy supply and other gas revenues primarily represent charges to customers for the recovery of costs to the Company in order to acquire natural gas in the marketplace and a charge for recovery of the Company’s gas supplierservice costs.  The revenue decrease of $9.1 million primarily reflects the impact of warmer weather conditions and the corresponding decrease in gas usage and lower costs of gas supply that reflected a weighted average cost of gas per therm decrease over thesame period in 2003 of approximately 8.8%.  These revenues are fully reconciled with the cost currently recognized by the Company and, as a result, do not have an effect on the Company’s earnings.

  Unregulated operations revenues

Unregulated operations revenues are derived from NSTAR’s businesses that include district energy operations and telecommunications.  Unregulated revenues were $20.5 million in the second quarter of 2004 compared to $26.0million in the same period of 2003, a decrease of $5.5 million, or 21%.  The decrease in unregulated revenues is primarily the result of the gain on sale of Blackstone Station to Harvard University in April 2003, partially offset by an increase in the rates forelectric and chilled water services and higher steam revenues from the Company’s other district energy operations.

Operating expenses

Purchased power costs were $304.4 million in the second quarter of 2004 compared to $298.7 million in the same period of 2003, an increase of $5.7 million, or 2%.  The increase is primarily the result of increased sales and thehigher costs of fuel, partially offset by the recognition of $9.3 million relating to the recovery of deferred standard offer and default service supply costs.  NSTAR Electric adjusts its rates to collect the costs related to energy supply from customers on afully reconciling basis.  Due to the rate adjustment mechanisms, changes in the amount of energy supply expense have no impact on earnings.

The cost of gas sold, representing NSTAR Gas’ supply expense, was $42.3 million in the second quarter of 2004 compared to $50.6 million in 2003, a decrease of $8.3 million, or 16%, due to a reduction in the volume of gassales.  NSTAR Gas maintains a flexible resource portfolio consisting of gas supply contracts, transportation contracts on interstate pipelines, market area storage and peaking services. However, as these expenses are also fully reconciled to the current level ofrevenues collected, they have no impact on earnings.

Operations and maintenance expense was $103.2 million in the second quarter of 2004 compared to $105.0 million in the same period of 2003, a decrease of $1.8 million, or 2%.  This decrease primarily reflects lower labor andlabor-related costs.

Depreciation and amortization expense was $61.1 million in the second quarter of 2004 compared to $57.5 million in the same period of 2003, an increase of $3.6 million or 6%.  The increase primarily reflects higher depreciabledistribution and transmission plant in service, an increase to the transmission depreciation rate, and increased expense related to software and merger costs to achieve amortization.

Demand side management and renewable energy programs expense was $15.6 million in the second quarter of 2004 compared to $15.4 million in the same period of 2003, an increase of $0.2 million, or 1%, which are consistent with thecollection of conservation and renewable energy revenues.  These costs are in accordance with program guidelines established by the MDTE and are collected from customers on a fully reconciling basis. 

Property and other taxes were $25.0 million in the second quarter of 2004 compared to $22.8 million in the same period of 2003, an increase of $2.2 million, or 10%.  This increase was due to higher overall municipal property taxescaused primarily by higher property assessments.  The overall level of municipal property taxes paid by NSTAR has increased due to increased rates associated with legislation passed in Massachusetts allowing for the temporary shift of property tax burdens fromresidential to commercial property owners, in particular, in the City of Boston.

Income taxes attributable to operations were $24.8 million in the second quarter of 2004 compared to $23.9 million in the same period of 2003, an increase of $0.9 million, or 4%, reflecting higher pre-tax operating income in2004.

Other income, net

Other income, net was approximately $2.9 million in the second quarter of 2004 compared to $6.0 million in the same period of 2003, a decrease in other income of $3.1 million.  The decrease is primarily due to the absence in 2004of the recognition of $4.1 million in tax benefits related to deferred tax valuation allowance adjustments recognized in 2003 and the 2003 sale of Blackstone Station to Harvard University that resulted in a pretax gain of $1.3 million.  In 2004, other incomeincludes proceeds from an executive life insurance policy of $1.2 million and $1.7 million in employee-related contract fees as a result of the Blackstone Station sale.

Interest charges

Interest on long-term debt and transition property securitization certificates was $36.5 million in the second quarter of 2004 compared to $37.8 million in the same period of 2003, a decrease of $1.3 million, or 3%.  The decreasein expense primarily reflects the absence in 2004 of $3.5 million in expense resulting from the retirement of Boston Edison’s $181 million 7.80% Debentures on March 15, 2004 and the lower principal balance of transition property securitization certificatesoutstanding that resulted in reduced interest expense of $1.1 million.  Securitization interest represents interest on debt of BEC Funding collateralized by the future income stream associated primarily with the stranded costs of the Pilgrim Unitdivestiture.  The future income stream was sold to BEC Funding by Boston Edison.  These certificates are non-recourse to Boston Edison.  Partially offsetting these interest declines was additional interest expense of $3 million on Boston Edison’s$300 million, 4.875% fixed-rate Debentures issued on April 16, 2004 and an increase in interest expense of $394,000 on ComElectric’s Term Loan issued on May 14, 2003 ($150 million, three-year, variable rate); (2.145% at June 30, 2004). 

Short-term and other interest expense was $2.1 million in the second quarter of 2004 compared to $2.7 million in the same period of 2003, a decrease of $0.6 million, or 22%.  The decrease in short-term and other interest expenseprimarily relates to a lower average level of debt outstanding of $177.0 million as compared to $299.9 million for the three-month periods ended June 30, 2004 and 2003, respectively, combined with lower bank borrowing rates that averaged 1.14% for the quarter endedJune 2004 as compared to 1.33% in the same period last year.  The lower rates decreased short-term borrowing costs by $483,000.  In addition, there were reduced bank service fees and other charges ($0.7 million) resulting from a reduction in NSTAR’srevolving credit.

Allowance for funds used during construction/capitalized interest decreased nearly $0.6 million, or 66%, in the second quarter of 2004 primarily due to a lower average balance of construction work in progress as compared to the sameperiod in 2003 due to the completion of construction in December 2003 of combustion turbines at a subsidiary, Advanced Energy Systems’ MATEP facility.

****

**Results of Operations - Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003**

****

**Results of Operations**

The following section of MD&A compares the results of operations for the six-month periods ended June 30, 2004 and 2003 and should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and theaccompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this report.

Earnings and operations overview

Earnings per common share were as follows:

Six Months Ended June 30,  

     

  

2004

   

  

2003

   

% Change

Basic

      

$

1.64

   

$

1.54

   

6.5

Diluted

      

$

1.63

    

$

1.53

   

6.5

Net income was $87.2 million for the first six months of 2004 compared to $81.5 million for the same period in 2003.  Factors that contributed to the $5.7 million, or 7.0%, increase in 2004 earnings include higher electricdistribution revenues due to higher sales, additional revenue earned as part of a reconciliation rate adjustment mechanism related to pension and postretirement benefits other than pensions (PBOP), interest savings on the Company’s outstanding indebtedness, anda reduction in operations and maintenance expense.

For the first six months of 2004, NSTAR generated $181.7 million of cash from operations to fund approximately $120.3 million of net capital expenditures, and $59.8 million of cash dividends.  In comparison to the same period ofthe prior year, cash from operations increased $12.1 million due to higher earnings offset by the timing of the collection of energy costs.  Favorable market conditions and the Company’s strong credit ratings contributed to the Company’s recentrefinancing activities.  These financing activities included the retirement of $181 million of 7.80% series of Debentures in March 2004.  This retirement was temporarily funded with short-term borrowings pending the issuance of 10-year, $300 million 4.875%series of Debentures, which was completed in April 2004.

Energy sales and weather

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

Retail Electric Sales - MWH

Six Months Ended June 30,

   

2004

   

2003

   

% Change

   

   

   

  Residential

   

3,245,799

   

3,161,250

   

2.7

  Commercial

   

6,234,092

   

5,971,018

   

4.4

  Industrial

   

813,856

   

808,144

   

0.7

  Other

   

82,923

   

83,499

   

(0.7)

    Total retail sales

   

10,376,670

   

10,023,911

   

3.5

Firm Gas Sales - BBTU

Six Months Ended June 30,

   

2004

   

2003

   

% Change

   

   

   

  Residential

   

14,165

   

15,062

   

(6.0)

  Commercial

   

9,588

   

10,152

   

(5.6)

  Industrial and other

   

5,221

   

5,257

   

(0.7)

    Total firm sales

   

28,974

   

30,471

   

(4.9)

The 3.5% increase in retail MWH sales in the first six months of 2004 reflects, by customer sectors, an improvement of 2.7% in residential, 4.4% in commercial sales and a slight improvement of 0.7% in the industrial sector.  The4.9% decrease in firm gas sales in the first six months of 2004 primarily reflects warmer overall temperatures than in 2003.  Electric and gas sales both reflect the impact of one additional day in 2004 due to the leap year.

In terms of customer sectors, industrial sales are less sensitive to weather while residential and commercial sales are influenced by temperature extremes.  Despite the overall warmer winter weather in 2004, the increase inelectric sales is attributable in part to commercial building and expansion of existing units and the resulting extension of commercial energy uses, while residential electric sales reflect higher air conditioning use.  Electric residential and commercialcustomers were approximately 31% and 60%, respectively, of NSTAR’s total retail sales mix for the first six months of 2004 and provided 45% and 49% of distribution and transmission revenues, respectively.  Refer to the “Electric revenues”section below for a more detailed discussion.  Industrial sales are primarily influenced by national and local economic conditions and sales to these customers reflect an improving economic environment and increased manufacturing production. 

   

    

    

Normal

   

    

    

30-Year

   

2004

    

2003

    

Average

    

    

    

Heating degree-days

    

3,929

4,245

3,859

  Percentage change from prior year

    

(7.4)%

25.8%

  Percentage change from 30-year average  

    

1.8%

10.0%

    

    

    

Cooling degree-days

    

131

97

176

  Percentage change from prior year

    

35.1%

(39.0)%

  Percentage change from 30-year average  

    

(25.6)%

(44.9)%

Weather conditions impact electric and, to a greater extent during the winter, gas sales in NSTAR’s service area.  The comparative information above relates to heating and cooling degree-days for the first six months of 2004and 2003 and the number of degree-days in a “normal” six-month period as represented by a 30-year average.  A “degree-day” is a unit measuring how much the outdoor mean temperature falls above (cooling degree-day) or below (heatingdegree-day) a base of 65 degrees.  Each degree above or below the base temperature is measured as one degree-day.

Operating revenues

Operating revenues for the first six months of 2004 increased 3.5% from the same period in 2003 as follows:

(in millions)

Six Months Ended June 30,

Increase/(Decrease)

 

2004

2003

Amount

Percent

Electric revenues

 

  Retail distribution and transmission

 

$

400.2

 

$

383.1

   

$

17.1

4.5

  Energy, transition and other

 

710.8

667.7

43.1

6.5

    Total retail

1,111.0

1,050.8

60.2

5.7

  Wholesale

9.0

13.5

(4.5

)

(33.3

)

    Total electric revenues

1,120.0

1,064.3

55.7

5.2

Gas revenues

  Firm and transportation

88.6

89.0

(0.4

)

(0.4

)

  Energy supply and other

193.6

195.8

(2.2

)

(1.1

)

    Total gas revenues

282.2

284.8

(2.6

)

(0.9

)

Unregulated operations revenues

57.5

60.9

(3.4

)

(5.6

)

    Total operating revenues

$

1,459.7

$

1,410.0

   

$

49.7

3.5

  Electric revenues

Electric retail distribution revenues primarily represent charges to customers for the Company’s recovery of its capital investment, including a return component, and operation and maintenance related to its electric distributioninfrastructure.  The transmission revenue component represents charges to customers for the recovery of costs to move the electricity over high voltage lines from the generator to the Company’s substations.  The increase in retail revenues primarilyreflects the 3.5% increase in retail MWH sales substantially all in the residential and commercial sectors.  Retail electric revenues also include approximately $9.8 million in additional revenues received as part of a reconciliation rate adjustment mechanismrelated to pension and PBOP.

NSTAR’s largest earnings sources are the revenues derived from distribution rates approved by the MDTE.  The level of distribution revenues is affected by weather conditions and the economy.  Weather conditions affectsales to NSTAR’s residential and small commercial customers.  Economic conditions affect NSTAR’s large commercial and industrial customers. 

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 ofthe 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 either standard offer or default service.  Energy supply contractprices vary among the NSTAR Electric companies and for standard offer and default service customers.  However, the retail revenues related to standard offer and default services are fully reconciled to the costs incurred and have no impact on NSTAR’sconsolidated net income. Furthermore, energy and transition revenues are fully reconciled with the cost currently recognized by the Company and, as a result, do not have an effect on the Company’s earnings.  Other revenues primarily relate to theCompany’s ability to effectively reduce stranded costs (mitigation incentive), rental revenue from electric property and annual cost reconciliation true-up adjustments.  In 2004, the cost reconciliation true-up adjustments increased revenues byapproximately $4.7 million.  The $43.1 million increase in energy, transition and other revenues is primarily attributable to higher rates for default service and standard offer service, which include the ComElectric and Cambridge Electric standard offer servicefuel index adjustments.

Wholesale revenues relate to services provided to municipalities and certain other governmental authorities.  This decrease in 2004 wholesale revenues reflects the expiration of two wholesale power supply contracts in January andMarch of 2003.  After October 2005, NSTAR Electric anticipates it will no longer have contracts for the supply of wholesale power.  Amounts collected from wholesale customers are credited to retail customers through the transition charge.  Therefore,the expiration of these contracts will have no impact on results of operations.  In October 2004, a municipal wholesale electric contract will expire resulting in a further decline in wholesale revenues and sales.

  Gas revenues

Firm and transportation gas revenues primarily represent charges to customers for NSTAR Gas’ recovery of costs of its capital investment in its gas infrastructure, including a return component, and for the recovery of costs forthe ongoing operation and maintenance of that infrastructure.  The transportation revenue component represents charges to customers for the recovery of costs to move the natural gas over pipelines from gas suppliers to take stations located within NSTARGas’ service area.  The $0.4 million decrease in firm and transportation revenues is attributable to warmer weather and the decrease in sales volumes of almost 5% and is offset by approximately $2.3 million in additional revenues received as part of areconciliation rate adjustment mechanism related to the pension and PBOP.

Energy supply and other gas revenues primarily represent charges to customers for the recovery of costs to the Company in order to acquire the natural gas in the marketplace and a charge for recovery of the Company’s gas supplierservice costs.  This revenue decrease of $2.2 million primarily reflects warmer weather partially offset by the higher costs of gas supply that reflected a weighted average cost of gas per therm increase over the same period in 2003 of approximately 3%. These revenues are fully reconciled with the cost currently recognized by the Company and, as a result, do not have an effect on the Company’s earnings.

  Unregulated operations revenues

Unregulated operations revenues are derived from NSTAR’s businesses that include district energy operations and telecommunications.  Unregulated revenues were $57.5 million in the first half of 2004 compared to $60.9 millionin the same period of 2003, a decrease of $3.4 million, or 6%.  The decrease in unregulated revenues is primarily the result of the sale of Blackstone Station to Harvard University in April 2003, partially offset by an increase in the rates for electric andchilled water services and higher steam revenues resulting from the significantly colder weather in January.

Operating expenses

Purchased power costs were $637.9 million in the first six months of 2004 compared to $603.1 million in the same period of 2003, an increase of $34.8 million, or 6%.  The increase is primarily the result of increased sales and thehigher costs of fuel, partially offset by the recognition of $24.3 million relating to the recovery of deferred standard offer and default service supply costs.  NSTAR Electric adjusts its rates to collect the costs related to energy supply from customers on afully reconciling basis.  Due to the rate adjustment mechanisms, changes in the amount of energy supply expense have no impact on earnings.

The cost of gas sold, representing NSTAR Gas’ supply expense, was $179.9 million in the first six months of 2004 compared to $180.8 million in 2003, a decrease of $0.9 million, or 1%, due to the lower volume of gas sales of almost5%.  NSTAR Gas maintains a flexible resource portfolio consisting of gas supply contracts, transportation contracts on interstate pipelines, market area storage and peaking services. However, these expenses are also fully reconciled to the current level ofrevenues collected and have no impact on earnings.

Operations and maintenance expense was $209.7 million in the first six months of 2004 compared to $214.8 million in the same period of 2003, a decrease of $5.1 million, or 2%.  This decrease reflects lower labor and labor-relatedcosts as well as the absence in 2004 of operation and maintenance costs associated with Blackstone Station, which was sold in April 2003.

Depreciation and amortization expense was $126.6 million in the first six months of 2004 compared to $119.6 million in the same period of 2003, an increase of $7.0 million or 6%.  The increase primarily reflects higher depreciabledistribution and transmission plant in service, an increase to the transmission depreciation rate, and increased expense related to software and merger costs to achieve amortization.

DSM and renewable energy programs expense was $33.1 million in the first six months of 2004 compared to $32.3 million in the same period of 2003, an increase of $0.8 million, or 2%, which are consistent with the collection ofconservation and renewable energy revenues.  These costs are in accordance with program guidelines established by the MDTE and are collected from customers on a fully reconciling basis. 

Property and other taxes were $53.8 million in the first six months of 2004 compared to $49.1 million in the same period of 2003, an increase of $4.7 million, or 10%.  This increase was due to higher overall municipal propertytaxes of $3.8 million caused primarily by higher property assessments.  The overall level of municipal property taxes paid by NSTAR has increased due to increased rates associated with legislation passed in Massachusetts allowing for the temporary shift ofproperty tax burdens from residential to commercial property owners, in particular, in the City of Boston.

Income taxes attributable to operations were $57.9 million in the first six months of 2004 compared to $52.4 million in the same period of 2003, an increase of $5.5 million, or 10%, reflecting higher pre-tax operating income in2004.

Other income, net

Other income, net was approximately $3.8 million in the first half of 2004 compared to $6.5 million in the same period of 2003, a decrease in other income of $2.7 million.  The decrease is primarily due to the absence in 2004 ofthe recognition of $4.1 million in tax benefits related to deferred tax valuation allowance adjustments recognized in 2003 and the 2003 sale of Blackstone Station to Harvard University that resulted in a pre-tax gain of $1.3 million.  In 2004, other incomeincludes proceeds from an executive life insurance policy of $1.2 million and $1.7 million in employee-related contract fees as a result of the Blackstone Station sale.

Interest charges

Interest on long-term debt and transition property securitization certificates was $73.0 million in the first six months of 2004 compared to $78.2 million in the same period of 2003, a decrease of $5.2 million, or 7%.  The decreasein expense primarily reflects the absence of $2.1 million in 2004 resulting from the retirement of Boston Edison’s $150 million 6.80% Debentures in March 2003, the retirement of Boston Edison’s $181 million 7.80% Debentures on March 15, 2004 that loweredexpense by $4.1 million and the lower principal balance of transition property securitization certificates outstanding that resulted in reduced interest expense of $2.1 million.  Securitization interest represents interest on debt of BEC Funding collateralizedby the future income stream associated primarily with the stranded costs of the Pilgrim Unit divestiture.  The future income stream was sold to BEC Funding by Boston Edison.  These certificates are non-recourse to Boston Edison.  Partially offsettingthese interest expense declines was additional interest expense of $3 million on Boston Edison’s $300 million, 4.875% Debenture, issued on April 16, 2004 and an increase in interest expense of $1.1 million on ComElectric’s Term Loan issued on May 14, 2003($150 million, three-year, variable rate); (2.145% at June 30, 2004). 

Short-term and other interest expense was $4.0 million in the first six months of 2004 compared to $5.8 million in the same period of 2003, a decrease of $1.8 million, or 31%.  The decrease in short-term and other interest expenseprimarily relates to a reduction in bank service fees and other charges ($1.8 million) resulting from a reduction in NSTAR’s revolving credit.  In addition, the decrease in short-term and other expenses includes a lower average level of debt outstanding of$217.9 million as compared to $261.9 million for the six-month periods ended June 30, 2004 and 2003, respectively, combined with lower bank borrowing rates that averaged 1.12% through June 2004 as compared to 1.42% in the same period last year.  This decreasedshort-term borrowing costs by $804,000.  These decreases were slightly offset by higher regulatory interest.

Allowance for funds used during construction/capitalized interest decreased $1.5 million, or 71%, in the first six months of 2004 primarily due to a lower average balance of construction work in progress as compared to the same periodin 2003 due to the completion of construction in December 2003 of combustion turbines at AES’ MATEP facility.

****

**Liquidity and Capital Resources**

NSTAR’s primary uses of cash in the first six months of 2004 include capital expenditures, dividend payments, debt reductions, minimum lease commitments, electric capacity charge obligations under contracts and natural gascontractual agreements.

Operating Activities

The net cash provided by the first six months of 2004 operating activities of $181.7 million was partially attributable to net income of $87.2 million, which, when adjusted for depreciation and amortization, deferred income taxesprovided $266.1 million of cash as compared to $253.2 million in the same period of 2003 from net income as similarly adjusted.  Deferred income taxes for the first six months of 2004 were nearly level with the same period in 2003 and reflect the deferred taximpact of a change in the tax laws that allows for an additional 50% acceleration of tax depreciation on current year additions.  In February 2003, the tax law allowance was for only 30% accelerated tax depreciation on current year additions.  Anothercomponent affecting cash from operating activities is working capital, which declined slightly from the same period in 2003.  Major drivers to slightly decreased working capital were a decrease in accounts payable of approximately $64 million year-to-year due tothe timing of energy supply invoices and a decrease in accounts receivable and unbilled revenues of approximately $14 million year-to-year due to the timing of customers billed during the period and decreased recovery of energy costs of approximately $15 millionyear-to-year.  There is no impact on earnings from the timing of the recovery of energy costs other than the accrued costs on outstanding balances.  These decreases were offset by reduced pension contributions year-to-year of approximately $18million.  NSTAR has contributed approximately $40 million to its Pension Plan and approximately $5 million to its other postretirement benefit plans in 2004.  NSTAR plans to contribute an additional $15 million to its other postretirement benefit plans overthe remaining half of 2004.

Investing Activities

The net cash used in investing activities in the first six months of 2004 of $109.3 million consists primarily of capital expenditures related to transmission and distribution systems.

Financing Activities

The net cash used in financing activities in the first six months of 2004 of $61.0 million reflects long-term debt redemptions and sinking funds payments of $219.8 million, dividends paid of $59.8 million and a lower level of short-termborrowings of $79.5 million as a result of the $300 million financing by Boston Edison in April.

NSTAR is continuing the regulatory filing process to obtain approval to construct a 345 kv transmission line from the southern suburbs of Boston to South Boston in order to assure continued reliability of service and improve power inputcapacity in the Northeast Massachusetts area (NEMA).  If approved, construction is estimated to begin in the fourth quarter of 2004 and the new transmission line is anticipated to be placed in service during the summer of 2006.  This project is a regionaltransmission investment and, as a result, the cost will be shared by all of New England and recovered in rates by NSTAR.  This proposed plan is subject to siting and license requirements. 

Short-Term Financing Activities

NSTAR’s short-term debt decreased by $79.5 million to $159.6 million at June 30, 2004 as compared to $239.1 million at December 31, 2003.  The decrease resulted primarily from the proceeds of the $300 million financing beingused to pay down short-term balances.

Previously, on March 16, 2004, Boston Edison redeemed the entire $181 million aggregate principal amount of its 7.80% Debentures due March 15, 2023.  The redemption included payment of an approximate $6.1 million premium plusaccrued interest. 

Long-Term Financing Activities

NSTAR previously disclosed in its consolidated financial statements for the year ended December 31, 2003 that NSTAR Electric had initiated a process to auction off certain purchase power agreements under which the Company hasentitlements to approximately 1,100 MW of capacity under long-term contracts with non-utility generators.  The auction was intended to further NSTAR’s efforts to mitigate stranded costs, which continue to be recovered from customers.  As of the dateof this filing, NSTAR Electric has executed several agreements with certain parties through which NSTAR Electric has entitlements to approximately 620 MW of capacity.  Most of these contracts are buy-out arrangements whereby NSTAR Electric has committed to payamounts for the full release of its obligation under previous purchase power agreements.  NSTAR plans to seek approval for full recovery of these costs and the issuance of securitization bonds to provide the funds for the buy-out agreements.  NSTAR cannotdetermine the timing and ultimate outcome of these approvals.

Management continuously reviews its capital expenditure and financing programs.  These programs and, therefore, the forecasts included in NSTAR’s 2003 Form 10-K are subject to revision due to changes in regulatoryrequirements, operating requirements, environmental standards, availability and cost of capital, interest rates and other assumptions.

**Sources of Additional Capital and Financial Covenant Requirements**

NSTAR and Boston Edison have no financial covenant requirements under their respective long-term debt arrangements.  ComElectric, Cambridge Electric and NSTAR Gas have financial covenant requirements under their long-term debtarrangements and were in compliance at June 30, 2004 and December 31, 2003.  NSTAR’s long-term debt other than the Mortgage Bonds of NSTAR Gas is unsecured.

The Transition Property Securitization Certificates issued by Boston Edison’s subsidiary, BEC Funding, LLC, are collaterized with a securitized regulatory asset that was sold to BEC Funding with a balance of $391.3 million and$425.4 million as of June 30, 2004 and December 31, 2003, respectively.  Boston Edison, as servicing agent for BEC Funding, collected $50.4 million in the first six months of 2004.  These collected funds are remitted daily to the trustee of BECFunding.  These Certificates are non-recourse to Boston Edison.

NSTAR has a credit facility that consists of a three year, $175 million revolving credit agreement that expires on November 14, 2005.  At June 30, 2004 and December 31, 2003, there were no amounts outstanding under this revolvingcredit agreement.  The $175 million credit facility serves as a backup to NSTAR’s $175 million commercial paper program that, at June 30, 2004 and December 31, 2003, had $42.0 million and $1.5 million outstanding, respectively.  Under the terms ofthis credit agreement, NSTAR is required to maintain a maximum total consolidated debt to total capitalization ratio of not greater than 65% at all times, excluding Transition Property Securitization Certificates, and excluding Accumulated other comprehensive income(loss) from Common equity, and to maintain a ratio of consolidated earnings before interest and taxes to consolidated total interest expense of not less than 2 to 1 for each period of four consecutive fiscal quarters.  Commitment fees must be paid on the totalagreement amount.  At June 30, 2004 and December 31, 2003, NSTAR was in full compliance with all of the aforementioned covenants.

In December 2003, Boston Edison filed a shelf registration with the SEC to allow Boston Edison to issue up to $500 million in debt securities.  The registration went effective on January 9, 2004.  On April 1, 2004, the MDTEapproved the issuance by Boston Edison of up to $500 million of debt securities from time to time on or before December 31, 2005.  On April 16, 2004, Boston Edison sold $300 million of ten-year fixed rate (4.875%) Debentures under this shelf registration. The net proceeds were used to repay outstanding short-term debt balances. 

Boston Edison has approval from the FERC to issue short-term debt securities from time to time on or before December 31, 2004, with maturity dates no later than December 31, 2005, in amounts such that the aggregate principal does notexceed $350 million at any one time.  Boston Edison has a $350 million revolving credit agreement that expires on November 10, 2004.  At June 30, 2004 and December 31, 2003, there were no amounts outstanding under this revolving credit agreement.  Thisagreement serves as backup to Boston Edison’s $350 million commercial paper program that had a $71.0 million and $182.5 million balance at June 30, 2004 and December 31, 2003, respectively.  Under the terms of this agreement, Boston Edison is required tomaintain a consolidated maximum total debt to capitalization ratio of not greater than 60% at all times, excluding Transition Property Securitization Certificates, and excluding Accumulated other comprehensive income (loss) from Common equity.  At June 30, 2004and December 31, 2003, Boston Edison was in full compliance with all of its covenants in connection with its short-term credit facilities.  In April 2004, Boston Edison filed an application with FERC requesting approval to issue short-term securities from timeto time on or before December 31, 2006, with maturity dates no later than December 31, 2007, in amounts such that the aggregate principal does not exceed $450 million.

In addition, ComElectric, Cambridge Electric and NSTAR Gas, collectively, have $165 million available under several lines of credit and had $46.6 million and $55.1 million outstanding under these lines of credit at June 30, 2004 andDecember 31, 2003, respectively.  ComElectric and Cambridge Electric have FERC authorization to issue short-term securities from time-to-time on or before November 30, 2004 and June 27, 2004, with maturity dates no later than November 29, 2005 and June 26, 2005,respectively, in amounts such that the aggregate principal does not exceed $125 million and $60 million, respectively, at any one time.  In April 2004, ComElectric and Cambridge Electric filed applications with FERC requesting approval to issue short-term debtsecurities from time to time on or before November 30, 2006 and June 27, 2006, with maturity dates no later than November 30, 2007 and June 27, 2007, respectively, in amounts such that the aggregate principal does not exceed $125 million.  As of June 30, 2004,Cambridge Electric has received FERC approval.  ComElectric expects to receive FERC approval in the fourth quarter of 2004.  NSTAR Gas is not required to seek approval from FERC to issue short-term debt.

On June 30, 2004, NSTAR filed an S-3 Registration Statement with the SEC for the purpose of registering two million common shares in connection with the NSTAR Dividend Reinvestment and Direct Common Shares Purchase Plan.  TheRegistration Statement became effective on July 29, 2004.

Historically, NSTAR and its subsidiaries have had a variety of external sources of financing available, as indicated above, at favorable rates and terms to finance its external cash requirements.  However, the availability of suchfinancing at favorable rates and terms depends heavily upon prevailing market conditions and NSTAR’s or its subsidiaries’ financial condition and credit ratings.

An adverse change in NSTAR’s or its subsidiaries’ credit ratings or market conditions could have an adverse impact on the terms and conditions upon which NSTAR or its subsidiaries have access to capital markets.  NSTARhas no financial guarantees, commitments, debt or lease agreements that would require a change in terms and conditions, such as acceleration of payment obligations, as a result of a change in its credit rating.  However, NSTAR’s subsidiaries could berequired to provide additional security for power supply contract performance, such as a letter of credit for their pro-rata share of the remaining value of such contracts.  Refer to “Performance Assurances from Electricity and Gas Supply Agreements”and “Financial and Performance Guarantees” as disclosed in NSTAR’s Annual Report on Form 10-K for the year ended December 31, 2003.

NSTAR’s goal is to maintain a capital structure that preserves an appropriate balance between debt and equity.  Based on NSTAR’s key cash resources available as discussed above, management believes its liquidity andcapital resources are sufficient to meet its current and projected requirements.

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**Item 3.  Quantitative and Qualitative Disclosure About Market Risk**

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NSTAR’s exposure to financial market risk results primarily from fluctuations in interest rates.  There have been no material changes to NSTAR’s market risks as disclosed in NSTAR’s Annual Report on Form 10-K forthe year ended December 31, 2003.

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**Item 4.  Controls and Procedures**

NSTAR’s disclosure controls and procedures are designed to ensure that information required to be disclosed in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized andreported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

NSTAR carried out an evaluation, under the supervision and with the participation of NSTAR’s management, including NSTAR’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operationof NSTAR’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 as of the end of the period covered by this report.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that NSTAR’sdisclosure controls and procedures were effective (1) to timely alert them to material information relating to NSTAR’s information required to be disclosed by NSTAR in the reports that it files or submits under the Securities Exchange Act of 1934 and (2) toensure that appropriate information is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

During the most recent fiscal quarter, there have been no changes in NSTAR’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, internal control over financialreporting.
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**Part II.  Other Information**

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**Item 1.  Legal Proceedings**

In the normal course of its business, NSTAR and its subsidiaries are involved in certain legal matters, including civil litigation.  Management is unable to fully determine a range of reasonably possible court-ordered damages,settlement amounts, and related litigation costs (“legal liabilities”) that would be in excess of amounts accrued and amounts covered by insurance.  Based on the information currently available, NSTAR does not believe that it is probable that anysuch legal liability will have a material impact on its consolidated financial position.  However, it is reasonably possible that additional legal liabilities that may result from changes in estimates could have a material impact on its results of operations,cash flows and financial condition for a reporting period.

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**Item 2.  Changes in Securities and Use of Proceeds**

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Item 2(e).   Shares issued under the NSTAR Dividend Reinvestment and Common Shares Purchase Plan, the 1997 Share Incentive Plan and the NSTAR Savings Plan in connection with commonshare grants and the exercise of stock options may consist of newly issued shares from the Company or shares purchased in the open market by the Company or an independent agent.  During the three-month period ended June 30, 2004, the shares listed below wereacquired in the open market in connection with these plans.

              

Total Number of Common Shares   Purchased

              

 Average Price   Paid Per Share  

    

    

   April

    

69,334

$49.11

   May

    

90,583

$48.22

   June

    

5,254

$47.41

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**Item 6.  Exhibits and Reports on Form 8-K**

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a)  

Exhibits:

  

 

Exhibit   

4   

 - 

  

Instruments Defining the Rights of Security Holders, Including Indentures

 

  

 - 

Management agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any agreement or instrument defining the rights of holders of any long-term debt whose authorization does not exceed 10% of totalassets.

  

  

  

  

  

  

  

Exhibits filed herewith:

Exhibit   

15   

 - 

  

Letter Re Unaudited Interim Financial Information

15.1

PricewaterhouseCoopers LLP Awareness Letter

Exhibit   

31   

 - 

  

Rule 13a - 15/15d-15(e) Certifications

31.1

Certification Statement of Chief Executive Officer of NSTAR pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification Statement of Chief Financial Officer of NSTAR pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit   

32   

 - 

  

Section 1350 Certifications

32.1  

Certification Statement of Chief Executive Officer of NSTAR pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification Statement of Chief Financial Officer of NSTAR pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit   

99   

 - 

  

Additional Exhibits

99.1  

Report of Independent Registered Public Accounting Firm

  

  

  

  

  

  

  

b) 

Reports on Form 8-K:

A report on Form 8-K was filed/furnished on April 29, 2004 that announced NSTAR’s financial and operating results for the first quarter ended March 31, 2004.

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**SIGNATURE**

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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.

    

       

 

    

       

 

   

NSTAR

   

       

(Registrant)

   

   

   

   

    

Date: August 4, 2004          

      

By:  /s/ R. J. WEAFER, JR.                              

   

      

Robert J. Weafer, Jr.*Vice President, Controller and Chief Accounting Officer*