-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JJl/UdpvIgFTMm6czykzseBJQ2DEcAQvg6FIKEgisP9OzJs0plStdopf2avgjlYJ aESkexX+DKff6p6/r88RbQ== 0000049816-98-000012.txt : 19980312 0000049816-98-000012.hdr.sgml : 19980312 ACCESSION NUMBER: 0000049816-98-000012 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 19 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980311 SROS: CSX SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILLINOIS POWER CO CENTRAL INDEX KEY: 0000049816 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC & OTHER SERVICES COMBINED [4931] IRS NUMBER: 370344645 STATE OF INCORPORATION: IL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-03004 FILM NUMBER: 98563895 BUSINESS ADDRESS: STREET 1: 500 S 27TH ST STREET 2: C/O HARRIS TRUST & SAVINGS BANK CITY: DECATUR STATE: IL ZIP: 62525-1805 BUSINESS PHONE: 2174246600 FORMER COMPANY: FORMER CONFORMED NAME: ILLINOIS IOWA POWER CO DATE OF NAME CHANGE: 19660822 10-K 1 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the Fiscal Year Ended December 31, 1997 Or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to Registrant, State of Incorporation, Address Commission of Principal Executive I.R.S. Employer File Number Offices and Telephone Number Identification No. 1-11327 ILLINOVA CORPORATION 37-1319890 (an Illinois Corporation) 500 S. 27th Street Decatur, IL 62521 (217) 424-6600 1-3004 ILLINOIS POWER COMPANY 37-0344645 (an Illinois Corporation) 500 S. 27th Street Decatur, IL 62521 (217) 424-6600 Securities registered pursuant to Section 12(b) of the Act: Each of the following securities registered pursuant to Section 12(b) of the Act are listed on the New York Stock Exchange. Title of each class Registrant - ------------------- ---------- Common Stock (a) Illinova Corporation Preferred stock, cumulative, Illinois Power Company $50 par value 4.08% Series 4.26% Series 4.70% Series 4.20% Series 4.42% Series Mandatorily redeemable preferred securities of subsidiary (Illinois Power Capital, L.P.) 9.45% Series Trust originated preferred securities of subsidiary (Illinois Power Financing 1) 8.00% Series First mortgage bonds 6 1/2% Series due 1999 8 3/4% Series due 2021 7.95% Series due 2004 New mortgage bonds 6 1/8% Series due 2000 6 3/4% Series due 2005 5.625% Series due 2000 8% Series due 2023 6 1/2% Series due 2003 7 1/2% Series due 2025 (a) Illinova Common Stock is also listed on the Chicago Stock Exchange. Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Illinova Corporation Yes [X] No Illinois Power Company Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Illinova Corporation [X] Illinois Power Company [X] The aggregate market value of the voting common stock held by non-affiliates of Illinova Corporation at February 28, 1998, was approximately $2.0 billion. Illinova Corporation is the sole holder of the common stock of Illinois Power Company. The aggregate market value of the voting preferred stock held by non-affiliates of Illinois Power Company at February 28, 1998, was approximately $46 million. The determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and the registrants are not bound by this determination for any other purpose. The number of shares of Illinova Corporation Common Stock, without par value, outstanding on February 28, 1998, was 71,701,937. The number of shares of Illinois Power Company Common Stock, without par value, outstanding on February 28, 1998, was 66,215,292, all of which is owned by Illinova Corporation. Documents Incorporated by Reference 1. Portions of the 1997 Annual Report to Shareholders of Illinova Corporation in the appendix to the Illinova Corporation Proxy Statement. (Parts I, II, III and IV of Form 10-K) 2. Portions of the 1997 Annual Report to Shareholders of Illinois Power Company in the appendix to the Illinois Power Company Information Statement. (Parts I, II, III and IV of Form 10-K) 3. Portions of the Illinova 1997 Proxy Statement. (Part III of Form 10-K) 4. Portions of the Illinois Power 1997 Information Statement. (Part III of Form 10-K) ILLINOVA CORPORATION ILLINOIS POWER COMPANY FORM 10-K For the Fiscal Year Ended December 31, 1997 This combined Form 10-K is separately filed by Illinova Corporation and Illinois Power Company. Information contained herein relating to Illinois Power Company is filed by Illinova Corporation and separately by Illinois Power Company on its own behalf. Illinois Power Company makes no representation as to information relating to Illinova Corporation or its subsidiaries, except as it may relate to Illinois Power Company. TABLE OF CONTENTS Part I Page Item 1. Business 6 General 6 Open Access and Competition 7 Customer and Revenue Data 8 Accounting Matters 9 Dividends 9 IP Electric Business 9 Overview 9 Soyland Power Cooperative, Inc. 10 Fuel Supply 11 Construction Program 13 Clinton Power Station 14 General 14 Decommissioning Costs 15 Accounting Matters 15 IP Gas Business 16 Gas Supply 16 Diversified Business Activities 16 Environmental Matters 17 Air Quality 17 Clean Air Act 18 Global Warming 18 Manufactured-Gas Plant Sites 18 Water Quality 18 Other Issues 19 Electric and Magnetic Fields 19 Environmental Expenditures 19 Year 2000 Data Processing 19 Research and Development 20 Regulation 20 Executive Officers of Illinova Corporation 21 Executive Officers of Illinois Power Company 21 Operating Statistics 22 Item 2. Properties 22 Item 3. Legal Proceedings 23 Item 4. Submission of Matters to a Vote of Security Holders 23 Part II Item 5. Market for Registrants' Common Equity and Related Stockholder Matters 24 Item 6. Selected Financial Data 24 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 24 Item 8. Financial Statements and Supplementary Data 25 TABLE OF CONTENTS (Continued) Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 25 Part III Item 10. Directors and Executive Officers of the Registrants 26 Item 11. Executive Compensation 26 Item 12. Security Ownership of Certain Beneficial Owners and Management 26 Item 13. Certain Relationships and Related Transactions 26 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 27 Signatures 29 Exhibit Index 31 PART I ITEM 1. Business - ------ General ------- This report contains estimates, projections and other forward-looking statements that involve risks and uncertainties. Actual results or outcomes could differ materially as a result of such important factors as: the outcome of state and federal regulatory proceedings affecting the restructuring of the electric and gas utility industries; the impacts new laws and regulations relating to restructuring, environmental, and other matters, have on Illinova and its subsidiaries; the effects of increased competition on the utility businesses; risks of owning and operating a nuclear facility; changes in prices and cost of fuel; factors affecting non-utility investments, such as the risk of doing business in foreign countries; construction and operation risks; and increases in financing costs. Illinois Power Company (IP) was incorporated under the laws of the State of Illinois on May 25, 1923. Illinova Corporation (Illinova) was incorporated under the laws of the State of Illinois on May 27, 1994 and serves as the parent holding company of four principal operating subsidiaries: IP, Illinova Generating Company (IGC), Illinova Energy Partners, Inc. (IEP), and Illinova Insurance Company (IIC). In May 1996, another Illinova subsidiary, Illinova Power Marketing, (IPMI), consolidated its business activities with those of Illinova Energy Services and with the non-regulated marketing activities of Illinova, in a new company named IEP. On April 1, 1997, IEP and IPMI merged. In the merger, IPMI was the surviving corporation and subsequently changed its name to IEP. IP is engaged in the generation, transmission, distribution and sale of electric energy and the distribution, transportation and sale of natural gas in the State of Illinois. IP is affected by changes in the electric utility industry driven by regulatory and legislative initiatives to introduce competition and end monopoly franchises in at least the generation side of the business. One aspect of this change is "direct access," meaning giving customers the freedom to purchase electricity from suppliers they choose. In December 1997, electric regulatory restructuring legislation was enacted by the Illinois General Assembly and was signed by the Governor. For a more detailed discussion of these developments, refer to the "Open Access and Competition" section of this item. IP provides funds to Illinova for operations and investments. Illinova accrues interest due to IP on any borrowed funds at a rate equal to the higher of the rate that Illinova would have to pay if it used a currently outstanding line of credit, or IP's actual cost of the funds provided. At the end of each quarter, if needed, IP effects a common stock repurchase from Illinova by accepting shares having a market value equivalent to the amount of funds provided to Illinova during the quarter plus the accrued interest for the quarter. During 1997, IP provided approximately $122 million in funds to Illinova through this stock repurchase feature. IP also provides funds to Illinova in the form of cash dividends payable on the common stock of IP. In 1997, approximately $92 million in such dividends was declared and paid. For further information on IP common stock repurchases, see Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operation" of this report. IGC is Illinova's wholly-owned independent power subsidiary. IGC invests in energy-related projects throughout the world. For further discussion of IGC, see the "Diversified Business Activities" section later in this item. IEP is Illinova's wholly-owned subsidiary that engages in the brokering and marketing of electric power and gas and the development and sale of energy-related services. For further discussion of IEP, see the "Diversified Business Activities" section later in this item. IIC was licensed in August 1996 by the State of Vermont as a captive insurance company. The primary business of IIC is to insure the risks of the subsidiaries of Illinova and risks related to or associated with their business enterprises. Open Access and Competition Competition has become a dominant issue for the electric utility industry. It has been promoted by federal legislation, starting with the Public Utility Regulatory Policies Act of 1978, which facilitated the development of co-generators and independent power producers. Federal promotion of competition continued with enactment of the Energy Policy Act of 1992, which authorized the Federal Energy Regulatory Commission (FERC) to mandate wholesale wheeling of electricity by utilities at the request of certain authorized generating entities and electric service providers. Wheeling is the transport of electricity generated by one entity over transmission and distribution lines belonging to another entity. Competition arises not only from co-generation or independent power production, but also from municipalities seeking to extend their service boundaries to include customers being served by utilities. The right of municipalities to have power wheeled to them by utilities was established in 1973. IP has been obligated to wheel power for municipalities and cooperatives in its territory since 1976. Further competition may be introduced by state action, as has occurred in Illinois, or by federal regulatory action, although the Energy Policy Act currently precludes the FERC from mandating retail wheeling. Retail wheeling involves the transport of electricity to end-use customers. It is a significant departure from traditional regulation in which public utilities have a universal obligation to serve the public in return for protected service territories and regulated pricing designed to allow a reasonable return on prudent investment and recovery of operating costs. On December 16, 1997, Illinois Governor Edgar signed electric deregulation legislation, An Act in Relation to the Competitive Provision of Utility Services (House Bill 362). House Bill 362 guarantees IP's residential customers a 15 percent decrease in base electric rates beginning August 1, 1998, and an additional 5 percent decrease effective on May 1, 2002. The rate decreases are expected to result in revenue reductions of approximately $40 million in 1998, approximately $80 million in each of the years 1999 through 2001 and approximately $100 million in 2002, based on current consumption. Customers with demand greater than 4 MW at a single site will be free to choose their electric generation suppliers ("direct access") starting October 1999. Customers with at least 10 sites which aggregate at least 9.5 MW in total demand also will have direct access starting October 1999. Direct access for the remaining non-residential customers will occur in two phases: customers representing one-third of the remaining load in the non-residential class in October 1999 and customers representing the entire remaining non-residential load on December 31, 2000. Direct access will be available to all residential customers in May 2002. IP remains obligated to serve all customers who continue to take service from IP at tariff rates, and remains obligated to provide delivery service to all at regulated rates. In 1999, rates for unbundled delivery services will be established in proceedings mandated by the legislation. Although the specified residential rate reductions and the introduction of direct access will lead to lower electric service revenues, House Bill 362 is designed to protect the financial integrity of electric utilities in three principal ways: 1) Departing customers are obligated to pay transition charges, based on the utility's lost revenue from that customer, adjusted to deduct: a) delivery charges the utility will continue to receive from the customer, and b) the market value of the freed-up energy net of a mitigation factor, which is a percentage reduction of the transition charge amount. The mitigation factor is designed to provide incentive for management to continue cost reduction efforts and generate new sources of revenue; 2) Utilities are provided the opportunity to lower their financing and capital costs through the issuance of "securitized" bonds, also called transitional funding instruments; and 3) Utilities are permitted to seek rate relief in the event that the change in law leads to their return on equity falling below a specified minimum based on a prescribed test. Utilities are also subject to an "over-earnings" test which requires them, in effect, to share with customers earnings in excess of specified levels. The extent to which revenues are lowered will depend on a number of factors including future market prices for wholesale and retail energy, and load growth and demand levels in the current IP service territory. The impact on net income will depend on, among other things, the amount of revenues earned and the ongoing costs of doing business. Within the next several months, IP intends to seek Illinois Commerce Commission (ICC) approval for securitization financings up to $1.728 billion. It plans to issue the transitional funding instruments in two steps: 1) up to $864 million on or after August 1, 1998, and 2) the remainder on or after August 1, 1999. The transitional funding mechanism using securitized bonds as authorized in House Bill 362 is designed to provide these bondholders a prior claim on future IP revenue. This feature is intended to facilitate a favorable credit rating which should allow debt to be issued at an interest rate favorable to that currently available to IP. Proceeds would be used to refinance higher cost debt and reduce the capital structure through the purchase of outstanding equity. For related discussion of accounting implications of deregulation, see the "Accounting Matters" section under "IP Electric Business" in this item. In 1996, IP received approval from both the ICC and FERC to conduct an open access experiment beginning in 1996 and ending on December 31, 1999. The experiment allows certain industrial customers to purchase electricity and related services from other sources. Currently, 17 customers are participating in the experiment. Since its inception, the experiment has cost IP approximately $11.2 million in lost revenue net of avoided fuel cost and variable operating expenses. This loss was partially offset by selling the surplus energy and capacity on the open market and by $2.7 million in transmission service charges. Competition creates both risks and opportunities. At this time, the ultimate effect of competition on Illinova's consolidated financial position and results of operations is uncertain. Customer and Revenue Data - ------------------------- In 1997, approximately 57 percent and 14 percent of Illinova's operating revenues were derived from IP's sale of electricity and IP's sale and transportation of natural gas, respectively. Approximately 29 percent of Illinova's operating revenues came from its diversified enterprises in 1997. The territory served by IP comprises substantial areas in northern, central and southern Illinois, including ten cities with populations greater than 30,000 (1990 Federal Census data). IP supplies electric service at retail to an estimated aggregate population of 1,265,000 in 310 incorporated municipalities, adjacent suburban and rural areas, and numerous unincorporated communities and retail natural gas service to an estimated population of 920,000 in 257 incorporated municipalities and adjacent areas. IP holds franchises in all of the 310 incorporated municipalities in which it furnishes retail electric service and in all of the 257 incorporated municipalities in which it furnishes retail gas service. At February 10, 1998, IP served 577,322 active electric customers (billable meters) and 408,269 active gas customers (billable meters). These numbers do not include non-metered customers such as street lights. Sales of electricity and gas sales and transportation are affected by seasonal weather patterns, and, therefore, operating revenues and associated operating expenses are not distributed evenly during the year. For more information, see "Note 13 - Segments of Business" on page a-30 and "Note 2 - Illinova Subsidiaries" on pages a-16 and a-17 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. To the extent that information incorporated by reference herein appears identically in both the 1997 Annual Report to Shareholders of Illinova Corporation and the 1997 Annual Report to Shareholders of Illinois Power Company, reference will be made herein only to the 1997 Annual Report to Shareholders of Illinova Corporation, and such reference will be deemed to include a reference to the 1997 Annual Report of Illinois Power Company. Accounting Matters - ------------------ The Illinova consolidated financial statements include the accounts of Illinova Corporation, a holding company; IP, a combination electric and gas utility; IGC, a wholly-owned subsidiary that invests in energy-related projects and competes in the independent power market; IEP, a wholly-owned subsidiary that develops and markets energy-related services to the unregulated energy market; and IIC, a wholly-owned subsidiary whose primary business is to insure certain risks of Illinova and its subsidiaries. All significant intercompany balances and transactions have been eliminated from the consolidated financial statements. All non-utility operating transactions are included in the sections titled "Diversified Enterprises", "Interest Expense", "Income Taxes", and "Other Income and Deductions", in Illinova's Consolidated Statements of Income. The IP consolidated financial statements include the accounts of Illinois Power Capital, L.P., a limited partnership in which IP serves as the general partner and Illinois Power Financing I, a statutory business trust in which IP serves as sponsor. Dividends - --------- On December 10, 1997, Illinova declared a quarterly common stock dividend at $.31 per share payable February 1, 1998. On February 11, 1998, Illinova declared a quarterly common stock dividend at $.31 per share payable May 1, 1998. IP Electric Business -------------------- Overview - -------- IP supplies electric service at retail to residential, commercial and industrial consumers in substantial portions of northern, central and southern Illinois. Electric service at wholesale is supplied to numerous utilities and power marketing entities, as well as to the Illinois Municipal Electric Agency (IMEA) as agent for 11 municipalities and to Soyland Power Cooperative, Inc. (Soyland) for resale to its member cooperatives. For additional information related to Soyland, see "Note 6 - Facilities Agreement" on page a-23 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. In 1997, IP provided interchange power to 61 entities, including 37 power marketers. IP's highest system peak hourly demand (native load) in 1997 was 3,532,000 kilowatts on July 26, 1997. IP's record for peak load is 3,667,000 kilowatts, set on July 13, 1995. IP owns and operates generating facilities with a total net summer capability of 4,571,250 kilowatts. The generating capability comes from six major steam generating plants and three peaking service combustion turbine plants. See Item 2 "Properties" for further information. IP is a participant, together with Ameren - Union Electric Company (AmerenUE) and Ameren - Central Illinois Public Service Company (AmerenCIPS), in the Illinois-Missouri Power Pool which was formed in 1952. The Pool operates under an interconnection agreement which provides for the interconnection of transmission lines. This agreement has no expiration date, but any party may withdraw from the agreement by giving 36 months' notice to the other parties. IP, AmerenCIPS and AmerenUE have a contract with the Tennessee Valley Authority (TVA) providing for the interconnection of the TVA system with those of the three companies to exchange economy and emergency power and for other working arrangements. This contract has no expiration date, but any party may withdraw from the agreement by giving five years' written notice to the other parties. IP also has interconnections with Indiana-Michigan Power Company, Commonwealth Edison Company, Central Illinois Light Company, Mid-American Energy Corporation, Kentucky Utilities Company, Southern Illinois Power Cooperative, Electric Energy Inc. (EEI), Soyland, the City of Springfield, Illinois and the TVA. IP is a member of the Mid-America Interconnected Network, one of ten regional reliability councils established to coordinate plans and operations of member companies regionally and nationally. In January 1998, IP, in conjunction with eight other transmission-owning entities, filed with the FERC for all approvals necessary to create and implement the Midwest Independent Transmission System Operator, Inc. The goals of this joint undertaking are to: 1) put in place a tariff allowing easy and nondiscriminatory access to transmission facilities in a multi-state region, 2) enhance regional reliability and 3) establish an entity that operates independently of any transmission owner(s) or other market participants thus furthering competition in the wholesale generation market, consistent with the objectives of the FERC's Transmission Open Access Notice of Proposed Rulemaking, Order No. 888. The parties have requested that the FERC rule on the joint filing by no later than September 1, 1998, in order to allow the participants to create the infrastructure needed to allow the independent system operator to become operational. In 1996, IP transferred through a dividend its 20% ownership of the capital stock of EEI to Illinova. Illinova's interest was transferred to IGC in 1996. EEI was organized to own and operate a steam electric generating station and related transmission facilities near Joppa, Illinois to supply electric energy to the U.S. Department of Energy (DOE) for its project near Paducah, Kentucky. Soyland Power Cooperative, Inc. - ------------------------------- For discussion of the transfer to IP of Soyland's share of Clinton Power Station (Clinton) and the amended Power Coordination Agreement between Soyland and IP, see "Note 6 - Facilities Agreement" on page a-23 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. Fuel Supply - ----------- Coal was used to generate approximately 97% of the electricity produced by IP during 1997 with other fuels accounting for 3%. Based on current forecasts through 2002, after Clinton returns to service the percentages of generation attributable to nuclear fuel is projected to increase to as much as 31% while projected generation from coal will decline to about 69% during those years in which there is not a scheduled refueling outage for Clinton. IP's rate schedules contain provisions for passing through to its electric customers increases or decreases in the cost of energy provided to its native load customers under the Uniform Fuel Adjustment Clause (UFAC). Such costs include fuel and fuel transportation costs, emission allowance costs, DOE spent fuel disposal fees and costs of power purchased to serve native load. However, on March 6, 1998, IP made the ICC filing required for elimination of the UFAC. This will establish a new base fuel cost recoverable in IP's electric tariffs effective on the date of the filing. As provided in House Bill 362, the new base fuel cost is 1.287 cents per kwh, which is equal to 91 percent of IP's average prudent and allowable fuel and purchased power supply costs in the two most recent years for which the ICC has approved the level of recovery. Every year UFAC cost recoveries are audited by the ICC in a reconciliation proceeding in which they may be adjusted upward for actual costs not recovered, or downward through a disallowance of costs incurred. By opting out of the UFAC, IP eliminates exposure for potential disallowed replacement power costs for periods after December 31, 1996, as those years will no longer be subject to the ICC's annual reconciliation proceeding. This change will prevent IP from automatically passing through increases in cost and will expose IP to the risks and opportunities of price volatility in these areas. Prior to the elimination of the UFAC, under an IP petition approved by the ICC on September 29, 1997, fuel costs charged to customers were set at a maximum level of 1.291 cents per kwh until Clinton is back in service operating at least at a 65% capacity factor for two consecutive months. Whether electric energy costs will continue to be recovered in revenues from customers will depend on a number of factors, including the number of customers served, demand for electric service, and changes in fuel cost components. These variables may be influenced, in turn, by market conditions, availability of generating capacity, future regulatory proceedings, and environmental protection costs, among other things. For additional information see the information under the sub-captions "Revenue and Energy Cost" of "Note 1 - Summary of Significant Accounting Policies" on page a-15 and "Fuel Cost Recovery" of "Note 4 - Commitments and Contingencies" on page a-19 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. COAL - Coal is expected to be a major source of fuel for future generation. Through both long-term and short-term contracts, IP has obtained commitments for the major portion of future coal requirements. IP has new short-term contracts with two suppliers which last through 2000 and a third new contract which lasts through 2002. Contracts renegotiated in 1993 and 1994, which last through 1999 and 2010, are providing for the continued economic use of high sulfur Illinois coal while IP complies with Phase I of the Clean Air Act Amendments that became effective January 1, 1995. IP is currently evaluating its fuel options for compliance with Phase II of the Clean Air Act Amendments that becomes effective January 1, 2000. Spot purchases of coal in 1997 represented 9.0% of IP's total coal purchases. IP believes that it will be able to obtain sufficient coal to meet its future generating requirements. However, IP is unable to predict the extent to which coal availability and price may fluctuate in the future. Coal inventories on hand at December 31, 1997, represented a 20-day supply based on IP's average daily burn projections for 1998. IP continues to evaluate fuel options and alternate fuel delivery and unloading facilities for greater flexibility of fuel supplies. New rail unloading facilities at the Havana Station became operational in the spring of 1996. In addition, increased availability of nearby coal allowed for the return of year-round coal generation at the Vermilion Station in June 1997. NUCLEAR - IP leases nuclear fuel from Illinois Power Fuel Company (Fuel Company). The Fuel Company, which is 50% owned by IP, was formed in 1981 for the purpose of leasing nuclear fuel to IP for Clinton. Lease payments are equal to the Fuel Company's cost of fuel as consumed (including related financing and administrative costs). As of December 31, 1997, the Fuel Company had an investment in nuclear fuel of approximately $127 million. IP is obligated to make subordinated loans to the Fuel Company at any time the obligations of the Fuel Company which are due and payable exceed the funds available to the Fuel Company. At December 31, 1997, IP had no outstanding loans to the Fuel Company. For additional information relating to the nuclear fuel lease, see "Note 8 - Capital Leases" on page a-25 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. At December 31, 1997, IP's net investment in nuclear fuel consisted of $65 million of Uranium 308. This inventory represents fuel used in connection with the sixth and seventh reloads of Clinton. At December 31, 1997, the unamortized investment of the nuclear fuel assemblies in the reactor was $62 million. IP has one long-term contract for the supply of uranium concentrates with Cameco, a Canadian corporation. The Cameco contract was renegotiated in 1994 to lower the price and provide 55% to 65% of Clinton's estimated fuel requirements through 2000. The decision to utilize Cameco for the additional 10% of Clinton's fuel requirements is made the year before each delivery and depends on the estimated price and availability from the spot market versus the estimated contract price. The contract with Cameco is stated in terms of U.S. dollars. Conversion services for the period 1991-2001 are contracted with Sequoyah Fuels. Sequoyah Fuels closed its Oklahoma conversion plant in 1992 and joined with Allied Chemical Company to form a marketing company named CoverDyn. All conversion services will be performed at Allied's Metropolis, Illinois facility, but Sequoyah Fuels retains the contract with IP. IP has a utility services contract for uranium enrichment requirements with the DOE which provides 70% of the enrichment requirements of Clinton through September 1999. The remaining 30% has been contracted with the DOE through an amendment to its incentive pricing plan through 1999. This amendment allows IP to either purchase the enrichment services at the DOE's incentive price or provide electricity at DOE's Paducah, Kentucky enrichment plant at an agreed exchange rate. A contract with General Electric Company provides fuel fabrication requirements for the initial core and approximately 19 reloads, or through 2019. Beyond the stated commitments, IP may enter into additional contracts for uranium concentrates, conversion to uranium hexafluoride, enrichment and fabrication. Currently, commercial reprocessing of spent nuclear fuel is not allowed in the U.S. The Nuclear Waste Policy Act of 1982 (NWPA) was enacted to establish a government policy with respect to disposal of spent nuclear fuel and high-level radioactive waste. On July 6, 1984, as required by NWPA, IP signed a contract with the DOE for disposal of spent nuclear fuel and/or high-level radioactive waste. Under the contract, IP is required to pay the DOE one mill (one-tenth of a cent) per net kilowatt-hour (one dollar per megawatt-hour) of electricity generated and sold. IP had been recovering this amount through its UFAC subject to UFAC limitations discussed under the heading "Fuel Supply" previously in this item. With the elimination of UFAC, IP may continue to recover some portion of these costs through the new base fuel cost included in electric tariffs. On June 20, 1994, IP, along with other utilities and state utility commissions, filed an action in the D.C. Circuit Court of Appeals asking the Court to rule that the DOE is obligated to take responsibility for spent nuclear fuel by January 31, 1998 under the NWPA. The utilities asked the Court to confirm the DOE's commitment and to order the DOE to develop a compliance program with appropriate deadlines. The utilities also asked for relief from the ongoing funding requirements or to have an escrow account established for future funds paid to DOE. Subsequently, the petition was amended to seek, in addition, relief in the form of specific performance. A three-judge panel ruled in July 1996 that the DOE's obligation to take spent fuel, by the January 1998 date specified in the NWPA, is binding and unconditional. The DOE notified utilities in December 1996 that it may not be able to meet the 1998 deadline, and solicited utility suggestions on how to accommodate the potential delay. In January 1997, petitions were filed in the D.C. Circuit Court of Appeals by IP and other utilities and state utility commissions, seeking further enforcement of DOE's obligation. In response, the Court has reaffirmed its ruling that the DOE obligation is unconditional, but has not granted injunctive relief. This means that the Court has found the DOE in breach of DOE's obligation but has not literally ordered the DOE to perform. The litigation is continuing. IP has on-site storage capacity that will accommodate its spent fuel storage needs until the year 2007, based on current operating levels. If by that date the DOE has not complied with its statutory obligation to dispose of spent fuel, and IP has continued to operate the plant, IP will have to use alternative means of disposal, such as dry storage in casks on site or transportation of the fuel rods to private or collectively-owned utility repositories. IP is currently an equity partner with seven other utilities in an effort to develop a private temporary repository. Attempts to reach agreement with the Mescalaro Apache Tribe of New Mexico ended in early 1996; however, the group signed a lease in December 1996 with the Goshute Tribe to use land on its Utah reservation. A spent fuel storage license was filed with the Nuclear Regulatory Commission (NRC) in 1997, initiating a process which will take the NRC up to three years to complete. Continued participation in the partnership will depend on the technological and economic viability of the project. Safe, dry, on-site storage is technologically feasible, but is subject to licensing and local permitting requirements, for which there may be effective opposition. Under the Energy Policy Act of 1992, IP is responsible for a portion of the cost to decontaminate and decommission the DOE's uranium enrichment facilities. Each utility is assessed an annual fee for a period of fifteen years based on quantities purchased from the DOE facilities prior to passage of the Act. At December 31, 1997, IP has a remaining liability of $4.3 million representing future assessments. IP had been recovering these costs, as amortized, through its UFAC subject to UFAC limitations discussed under the heading "Fuel Supply" previously in this item. With the elimination of UFAC, IP may continue to recover some portion of these costs through the new base fuel cost included in electric tariffs. OIL and GAS - IP used natural gas and oil to generate 1.0% of the electricity produced in 1997. IP has not experienced difficulty in obtaining adequate supplies of these resources. However, IP is unable to predict the extent to which oil and gas availability and price may fluctuate in the future. Reference is made to the section "Environmental Matters" hereunder for information regarding pollution control matters relating to IP's fuel supply. Construction Program - -------------------- To meet anticipated needs, Illinova and IP have used internally generated funds and external financings. The timing and amount of external financings depend primarily on economic and financial market conditions, cash needs and capitalization ratio objectives. For more information on Illinova's construction program and liquidity, see "Note 4 - Commitments and Contingencies" on page a-19 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference; "Note 5 - Lines of Credit and Short-Term Loans" on page a-23 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference; and "Capital Resources and Requirements" in "Management's Discussion and Analysis" on pages a-8 and a-9 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. For more information on IP's construction program and liquidity, see "Note 3 - Commitments and Contingencies" on pages a-18 and a-19 of the 1997 Annual Report to Shareholders in the appendix to the Illinois Power Information Statement which is incorporated herein by reference; "Note 4 - Lines of Credit and Short-Term Loans" on page a-23 of the 1997 Annual Report to Shareholders in the appendix to the Illinois Power Information Statement which is incorporated herein by reference; and "Capital Resources and Requirements" in "Management's Discussion and Analysis" on pages a-7 through a-9 of the 1997 Annual Report to Shareholders in the appendix to the Illinois Power Information Statement which is incorporated herein by reference. Clinton Power Station - --------------------- General ------- In March 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton. Soyland's title to the plant and directly related assets such as nuclear fuel was transferred to IP in May 1997. Soyland's nuclear decommissioning trust assets were transferred to IP in May 1997, consistent with IP's assumption of all of Soyland's ownership obligations including those related to decommissioning. Clinton was placed in service in 1987 and represents approximately 20% of IP's installed generation capacity. For more information on the Clinton Power Station, see "Note 3 - Clinton Power Station" on pages a-17 and a-18 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. In September 1996, a leak in a recirculation pump seal caused IP operations personnel to shut down Clinton. As of the date of this report, Clinton has not resumed operation. In January 1997 and again in June 1997, the NRC named Clinton among plants having a trend of declining performance. In June 1997, IP committed to conduct an Integrated Safety Assessment (ISA) to thoroughly assess Clinton's performance. The ISA was conducted by a team of 30 individuals with extensive nuclear experience and no substantial previous involvement at Clinton. Their report concluded that the underlying reasons for the performance problems at Clinton were ineffective leadership throughout the organization in providing standards of excellence, complacency throughout the organization, barrier weaknesses and weaknesses in teamwork. In late October, a team commissioned by the NRC performed an evaluation to validate the ISA results. In December, this team concluded that the findings of the ISA accurately characterized Clinton's performance deficiencies and their causes. On January 5, 1998, IP and PECO Energy Company (PECO) announced an agreement under which PECO will provide management services for Clinton. Although a PECO team will help manage the plant, IP will continue to maintain the operating license for Clinton and retain ultimate oversight of the plant. PECO employees will assume senior positions at Clinton, but the plant will remain primarily staffed by IP employees. IP made this decision based on a belief that bringing in PECO's experienced management team would be the most efficient way to get Clinton back on line and operating at a superior level as quickly as possible. On January 21, 1998, the NRC placed Clinton on its Watch List of nuclear plants that require additional regulatory oversight because of declining performance. Twice a year the NRC evaluates the performance of nuclear power plants in the United States and identifies those which require additional regulatory oversight. Once placed on the Watch List a plant must demonstrate consistent improved performance before it is removed from the list. The NRC will monitor Clinton more closely than plants not on the Watch List. This may include increased inspections, additional required documentation, NRC-required approval of processes and procedures, and higher-level NRC oversight. The NRC has advised IP that it must submit a written report to the NRC at least two weeks prior to restarting Clinton, giving the agency reasonable assurance that IP's actions to correct recurring weaknesses in the corrective action program have been effective. After the report is submitted, the NRC staff plans to meet with IP's management to discuss the plant's readiness for restart. The prolonged outage at Clinton is having an adverse effect on Illinova's and IP's financial condition, through higher operating and maintenance and capital costs, lost opportunities to sell energy, and replacement power costs. The magnitude of these costs and lost opportunities is unknown because of uncertainty regarding the timing of Clinton's return to service and uncertain future market conditions. Decommissioning Costs --------------------- IP is responsible for the costs of decommissioning Clinton and for spent nuclear fuel disposal costs. IP is collecting future decommissioning costs through its electric rates based on an ICC-approved formula that allows IP to adjust rates annually for changes in decommissioning cost estimates and through its Power Coordination Agreement with Soyland. Illinois deregulation legislation provides for the continued recovery of decommissioning costs from IP's delivery customers. For more information on the decommissioning costs related to Clinton, see "Decommissioning and Nuclear Fuel Disposal" in "Note 4 - Commitments and Contingencies" on page a-20 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. Accounting Matters - ------------------ Prior to the passage of House Bill 362, IP prepared its consolidated financial statements in accordance with Statement of Financial Accounting Standards (FAS) 71, "Accounting for the Effects of Certain Types of Regulation." Reporting under FAS 71 allows companies whose service obligations and prices are regulated to maintain assets on their balance sheets representing costs they expect to recover from customers, through inclusion of such costs in their future rates. In July 1997, the Emerging Issues Task Force of the Financial Accounting Standards Board (EITF) concluded that application of FAS 71 accounting should be discontinued at the date of enactment of deregulation legislation for business segments for which a plan of deregulation has been established. The EITF further concluded that regulatory assets and liabilities that originated in the portion of the business being deregulated should be written off unless their recovery is specifically provided for through future cash flows from the regulated portion of the business. Because House Bill 362 provides for market-based pricing of electric generation services, IP discontinued application of FAS 71 for its generating segment as of December 1997. IP evaluated its regulatory assets and liabilities associated with its generation segment and determined that recovery of these costs was not probable through rates charged to transmission and distribution customers, the regulated portion of the business. IP wrote off generation-related regulatory assets and liabilities of approximately $195 million (net of income taxes) in December 1997. These net assets related to previously incurred costs that had been expected to be collected through future revenues, including deferred Clinton costs, unamortized gains and losses on reacquired debt, recoverable income taxes and other generation-related regulatory assets. At December 31, 1997, IP's net investment in generation facilities was $3.5 billion and was reflected in "Utility Plant, at Original Cost" on IP's balance sheet. In addition, IP evaluated its generation segment plant investments to determine if they had been impaired as defined in FAS 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of." This evaluation determined that future revenues were expected to be sufficient to recover the costs of its generation segment plant investments and as a result, no plant write-downs were necessary. However, ultimate recovery depends on a number of factors and variables including market conditions and IP's ability to operate its generation assets efficiently. The provisions of House Bill 362 allow for an acceleration in the rate at which any utility-owned assets are expensed without regulatory approval provided such charges are consistent with generally accepted accounting principles. Under this legislation, up to an aggregate of $1.5 billion in additional expense for generation-related assets could be accelerated through the year 2008. This reduction in the net book value of IP's generation-related assets should help position IP to operate competitively and profitably in the changing business environment. This accelerated charge would have a direct impact on earnings but not on cash flows. IP Gas Business --------------- IP supplies retail natural gas service to an estimated aggregate population of 920,000 in 257 incorporated municipalities, adjacent suburban areas and numerous unincorporated communities. IP does not sell gas for resale. IP's rate schedules contain provisions for passing through to its gas customers increases or decreases in the cost of purchased gas. For information on revenue and energy costs, see the sub-caption "Revenue and Energy Cost" of "Note 1 - Summary of Significant Accounting Policies" on page a-15 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement that is incorporated herein by reference. IP has eight underground gas storage fields having a total capacity of approximately 15.2 million MMBtu and a total deliverability on a peak day of about 347,000 MMBtu. In addition to the capacity of the eight underground storage fields, IP has contracts with various natural gas suppliers and producers for 9.9 million MMBtu of underground storage capacity and a total deliverability on a peak day of 160,000 MMBtu. Operation of underground storage permits IP to increase deliverability to its customers during peak load periods by taking gas into storage during the off-peak months. IP owns one active liquefied petroleum gas plant having an aggregate peak-day deliverability of about 20,000 MMBtu for peak-shaving purposes. Gas properties include approximately 8,000 miles of mains. IP experienced its 1997 peak-day send out of 705,725 MMBtu of natural gas on January 10, 1997. This compares with IP's record peak-day send out of 857,324 MMBtu of natural gas on January 10, 1982. Gas Supply - ---------- IP has contracts with six interstate pipeline companies for firm transportation and storage services. These contracts have varying expiration dates ranging from 1998 to 2002. IP also enters into contracts for the acquisition of natural gas supply. Those contracts range in duration from one month to five months. Diversified Business Activities ------------------------------- IGC, a wholly-owned subsidiary of Illinova, invests in energy-related projects throughout the world. IGC is an equity partner with Tenaska, Inc. in four natural gas-fired generation plants, of which three plants totaling approximately 700 megawatts (MW) are in operation and one 240 MW plant has had construction suspended. Tenaska, Inc. is an Omaha, Nebraska-based developer of independent power projects throughout the United States. IGC also owns 50 percent of the North American Energy Services Company (NAES). NAES supplies a broad range of operations, maintenance and support services to the world-wide independent power generation industry and operates the Tenaska generation plants in which IGC has an equity interest. IGC is an equity partner in the Indeck North American Power Fund (Fund). The Fund has generation projects in Long Beach, California, and Pepperell, Massachusetts. In addition to these ventures, IGC is involved in generation projects in Teesside, England; Puerto Cortez, Honduras; Zhejiang Province and Hunan Province, People's Republic of China; Aguaytia, Peru; Old Harbour, Jamaica; Barranquilla, Columbia; and Balochistan, Pakistan. In August 1996, Illinova's interest in the 1000 MW coal-fired plant in Joppa, Illinois was transferred to IGC. IEP is Illinova's wholly-owned subsidiary that engages in the brokering and marketing of electric power and gas, respectively; and the development and sale of energy-related products and services. In May 1995, IEP obtained approval from the FERC to conduct business as a marketer of electric power and gas to various customers outside of IP's present service territory. In September 1995, IEP began buying and selling wholesale electricity in the Western United States. IEP owns 50 percent of Tenaska Marketing Ventures (TMV). TMV focuses on natural gas marketing in the Midwestern United States. IEP and TMV have formed Tenaska Marketing Canada to market natural gas in Canada. In July 1996, IP received FERC approval to sell electricity to IEP without prior transaction approval from FERC. For more information on the activities of the Illinova's diversified enterprises, see "Note 2 - Illinova Subsidiaries" on pages a-16 and a-17 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. Environmental Matters --------------------- IP is subject to regulation by certain federal and Illinois authorities with respect to environmental matters and may in the future become subject to additional regulation by such authorities or by other federal, state and local governmental bodies. Existing regulations affecting IP are principally related to air and water quality, hazardous wastes and toxic substances. Air Quality - ----------- Pursuant to the Federal Clean Air Act (Act), the United States Environmental Protection Agency (USEPA) has established ambient air quality standards for air pollutants which, in its judgment, have an adverse effect on public health or welfare. The Act requires each state to adopt laws and regulations, subject to USEPA approval, designed to achieve such standards. Pursuant to the Illinois Environmental Protection Act, the Illinois Pollution Control Board (Board) adopted and, along with the Illinois Environmental Protection Agency (IEPA), is enforcing a comprehensive set of air pollution control regulations which include emission limitations, permit issuances, monitoring and reporting requirements. The air pollution regulations of the Board impose limitations on emissions of particulate, sulfur dioxide, carbon monoxide, nitrogen oxides and various other pollutants. Enforcement of emission limitations is accomplished in part through the regulatory permitting process. IP's practice is to obtain an operating permit for each source of regulated emissions. Presently, it has a total of approximately 100 permits for emission sources at its power stations and other facilities, expiring at various times. In addition to having the requisite operating permits, each source of regulated emissions must be operated within the regulatory limitations on emissions. Verification of such compliance is usually accomplished by reports to regulatory authorities and inspections by such authorities. In accordance with the requirements of the Illinois Clean Air Act Permit Program (CAAPP), IP submitted new air permit applications for each of its generating facilities in 1995. The IEPA will review these applications and is expected to issue CAAPP permits in 1998. In addition to the sulfur dioxide emission limitations for existing facilities, both the USEPA and the State of Illinois adopted New Source Performance Standards (NSPS) applicable to coal-fired generating units limiting emissions to 1.2 pounds of sulfur dioxide per million Btu of heat input. This standard is applicable to IP's Unit 6 at the Havana Power Station. The federal NSPS also limit nitrogen oxides, opacity and particulate emissions and imposes certain monitoring requirements. In 1977 and 1990 the Act was amended and, as a result, USEPA has adopted more stringent emission standards for new sources. These standards would apply to any new plant constructed by IP. Clean Air Act - ------------- For information on the impacts of the Clean Air Act Amendments of 1990, see "Environmental Matters" in "Note 4 - Commitments and Contingencies" on page a-21 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. Global Warming - -------------- For information on the impacts of the international negotiations to reduce greenhouse gas emissions and the Kyoto Protocol, see "Environmental Matters" in "Note 4 - Commitments and Contingencies" on page a-21 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. Manufactured-Gas Plant Sites - ---------------------------- IP's estimated liability for MGP site remediation is $65 million. This amount represents IP's current best estimate of the cost that it will incur in remediation of the 24 MGP sites for which it is responsible. Because of the unknown and unique characteristics at each site, IP cannot presently determine its ultimate liability for remediation of the sites. IP is currently recovering MGP site remediation costs through tariff riders approved by the ICC. Accordingly, IP has recorded a regulatory asset on its balance sheet totaling $65 million as of December 31, 1997. Management expects that cleanup costs will be fully recovered from IP's customers. In October 1995, to offset the burden imposed on its customers, IP initiated litigation against a number of insurance carriers. As of February 1998, settlements or settlements in principle have been reached with all of the carriers. Dismissal of the litigation is proceeding pending the necessary documentation with the court. The settlement proceeds recovered from the carriers will offset a significant portion of the remediation costs and will be credited to customers through the tariff rider mechanism which the ICC previously approved. Water Quality - ------------- The Federal Water Pollution Control Act Amendments of 1972 require that National Pollutant Discharge Elimination System (NPDES) permits be obtained from USEPA (or, when delegated, from individual state pollution control agencies) for any discharge into navigable waters. Such discharges are required to conform with the standards, including thermal, established by USEPA and also with applicable state standards. Enforcement of discharge limitations is accomplished in part through the regulatory permitting process similar to that described previously under "Air Quality". Presently, IP has approximately two dozen permits for discharges at its power stations and other facilities, which must be periodically renewed. In addition to obtaining such permits, each source of regulated discharges must be operated within the limitations prescribed by applicable regulations. Verification of such compliance is usually accomplished by monitoring results reported to regulatory authorities and inspections by such authorities. The Clinton permit was reissued in the third quarter of 1995. The Havana Power Station permit was reissued in the first quarter of 1996. The Hennepin Power Station permit application for reissuance was submitted in the fourth quarter of 1996 and is not expected until 1998. The Vermilion Power Station permit was reissued in the fourth quarter of 1996. The Wood River Power Station permit was reissued in the first quarter of 1996. The Baldwin Power Station permit was reissued in the first quarter of 1998. Other Issues - ------------ Hazardous and non-hazardous wastes generated by IP must be managed in accordance with federal regulations under the Toxic Substances Control Act (TSCA), the Comprehensive Environmental Response, Compensation and Liability Act and the Resource Conservation and Recovery Act (RCRA) and additional state regulations promulgated under both RCRA and state law. Regulations promulgated in 1988 under RCRA govern IP's use of underground storage tanks. The use, storage, and disposal of certain toxic substances, such as polychlorinated biphenyls (PCBs) in electrical equipment, are regulated under the TSCA. Hazardous substances used by IP are subject to reporting requirements under the Emergency Planning and Community-Right-To-Know Act. The State of Illinois has been delegated authority for enforcement of these regulations under the Illinois Environmental Protection Act and state statutes. These requirements impose certain monitoring, recordkeeping, reporting and operational requirements which IP has implemented or is implementing to assure compliance. IP does not anticipate that compliance will have a material adverse effect on its financial position or results of operations. Electric and Magnetic Fields - ---------------------------- For information on Electric and Magnetic Fields, see "Electric and Magnetic Fields" in "Note 4 Commitments and Contingencies" on page a-22 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. Environmental Expenditures - -------------------------- Operating expenses for environmentally-related activities were $49 million in 1997 (including the incremental costs of alternative fuels to meet environmental requirements). IP's net capital expenditures (including AFUDC) for environmental protection programs were approximately $7 million in 1997. Accumulated net capital expenditures since 1969 have reached approximately $800 million. Year 2000 Data Processing ------------------------- In November 1996, Illinova deployed a project team to coordinate the identification, evaluation, and implementation of changes to computer systems and applications necessary to achieve a year 2000 date conversion with no effect on customers or disruption to business operations. These actions are necessary to ensure that systems and applications will recognize and process coding for the year 2000 and beyond. Major areas of potential business impact have been identified and initial conversion efforts are underway. Illinova also is communicating with third parties with whom it does business to ensure continued business operations. The cost of achieving year 2000 compliance is estimated to be at least $14 million through 1999. Contingency plans for operating without year 2000 compliance have not been developed. Such activity will depend on assessment of progress. Project completion is planned for the fourth quarter of 1999. Research and Development ------------------------ Illinova's research and development expenditures for 1997 included approximately $5.4 million for IP and $2.0 million for Illinova. In 1996 and 1995, Illinova's research and development expenditures consisting entirely of IP expenditures, were $5.4 million and $5.5 million, respectively. Regulation ---------- The Illinois Public Utilities Act was significantly modified in 1997 by House Bill 362, but the ICC continues to have broad powers of supervision and regulation with respect to the rates and charges of IP, its services and facilities, extensions or abandonment of service, classification of accounts, valuation and depreciation of property, issuance of securities and various other matters. Before a significant plant addition may be included in IP's rate base, the ICC must determine that the addition is reasonable in cost, prudent and used and useful in providing utility service to customers. IP must continue to provide bundled retail electric service to all who choose to continue to take service at tariff rates, and IP must provide unbundled electric distribution services to all customers at rates to be determined in a future ICC proceeding. Illinova and IP are exempt from all the provisions of the Public Utility Holding Company Act of 1935 except Section 9(a)(2) thereof. That section requires approval of the Securities and Exchange Commission prior to certain acquisitions of any securities of other public utility companies or public utility holding companies. IP is subject to regulation under the Federal Power Act by the FERC as to rates and charges in connection with the transmission of electric energy in interstate commerce and the sale of such energy at wholesale in interstate commerce, the issuance of debt securities maturing in not more than 12 months, accounting and depreciation policies, interaction with affiliates, and certain other matters. The FERC has declared IP exempt from the Natural Gas Act and related FERC orders, rules and regulations. IP is subject to the jurisdiction of the NRC with respect to Clinton. NRC regulations control the granting of permits and licenses for the construction and operation of nuclear power stations and subject such stations to continuing review and regulation. Additionally, the NRC review and regulatory process covers decommissioning, radioactive waste, environmental and radiological aspects of such stations. IP is subject to the jurisdiction of the Illinois Department of Nuclear Safety (IDNS) with respect to Clinton. IDNS and the NRC entered a memorandum of understanding which allows IDNS to review and regulate nuclear safety matters at state nuclear facilities. The IDNS review and regulatory process covers radiation safety, environmental safety, non-nuclear pressure vessels, emergency preparedness and emergency response. Executive Officers of Illinova Corporation ------------------------------------------ Name of Officer Age Position - --------------- --- -------- Larry D. Haab 60 Chairman, President and Chief Executive Officer Larry F. Altenbaumer 49 Chief Financial Officer, Treasurer and Controller Leah Manning Stetzner 49 General Counsel and Corporate Secretary Mr. Haab was elected Chairman, President and Chief Executive Officer in December 1993. Mr. Altenbaumer was elected Chief Financial Officer, Treasurer and Controller in June 1994. Ms. Stetzner was elected General Counsel and Corporate Secretary in June 1994. The executive officers are elected annually by the Board of Directors at the first meeting of the Board held after the annual meeting of shareholders, and hold office until their successors are duly elected or until their death, resignation or removal by the Board. Executive Officers of Illinois Power Company -------------------------------------------- Name of Officer Age Position - --------------- --- -------- Larry D. Haab 60 Chairman, President and Chief Executive Officer Larry F. Altenbaumer 49 Senior Vice President and Chief Financial Officer Paul L. Lang 57 Senior Vice President Walter G. MacFarland, IV 48 Senior Vice President and Chief Nuclear Officer John G. Cook 50 Senior Vice President Richard W. Eimer, Jr. 49 Vice President Kim B. Leftwich 50 Vice President Robert D. Reynolds 41 Vice President Robert A. Schultz 57 Vice President Leah Manning Stetzner 49 Vice President, General Counsel and Corporate Secretary Cynthia G. Steward 40 Controller Eric B. Weekes 46 Treasurer Each of the IP executive officers, except for Mr. Weekes and Mr. MacFarland, has been employed by IP or another subsidiary of Illinova for more than five years in executive or management positions. Prior to election to the positions shown above, the following executive officers held the following positions since January 1, 1993. Mr. Altenbaumer was elected Senior Vice President, Chief Financial Officer and Treasurer in September 1995. Prior to being elected Senior Vice President and Chief Financial Officer in June 1992, Mr. Altenbaumer was Vice President, Chief Financial Officer and Controller. Mr. Lang was elected Senior Vice President in June 1992. He joined IP as Vice President in July 1986. Mr. MacFarland was contracted from PECO Energy Company in Philadelphia in January 1998. He was elected Senior Vice President in February 1998 after being named Chief Nuclear Officer in January 1998. Prior to joining IP as a contractor from PECO, Mr. MacFarland held the positions of Vice President and Director of Outage Management, both at PECO's Limerick Generating Station. Mr. Cook was elected Senior Vice President in December 1995. Prior to being elected Vice President in 1992, Mr. Cook was Manager of Clinton Power Station. Mr. Eimer was elected Vice President in December 1995. He previously held the positions of Assistant to the Vice President and Manager of Marketing. Mr. Leftwich was elected Vice President in February 1998. He previously held the positions of Managing Director - Customer Management Processes and Manager of Marketing. Mr. Reynolds was elected Vice President in May 1996. Prior to his election to Vice President, Mr. Reynolds served as Director of Pricing and Manager of Electric Supply. Mr. Schultz was elected Vice President in February 1998. He previously held the positions of President of Illinova Energy Partners, President of Illinova Power Marketing and Treasurer of IP. Ms. Stetzner was elected Vice President, General Counsel and Corporate Secretary in February 1993. She joined IP as General Counsel and Corporate Secretary in October 1989. Ms. Steward was elected Controller in September 1995. She previously held the positions of Manager of Employee Services and Director of Accounting. Mr. Weekes joined IP as Treasurer in January 1997. He previously served as Director of Financial Analysis, Budgets and Controls with a unit of Kraft Foods. The present term of office of each of the above executive officers extends to the first meeting of Illinova's and IP's Board of Directors after the Annual Election of Directors. There are no family relationships among any of the executive officers and directors of Illinova and IP. Operating Statistics --------------------- For Illinova the information under the caption "Selected Illinois Power Company Statistics" on page a-33 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference. For IP the information under the caption "Selected Statistics" on page a-33 of the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference. Item 2. Properties - ------- IP owns and operates six steam generating stations with composite net summer capacity of 4,419,000 kilowatts. In addition, IP owns nine quick start combustion turbine peaking units at three locations with a combined net summer capacity of 147,000 kilowatts. All of IP's generating stations are in the State of Illinois, including IP's only nuclear generating station, Clinton. IP owns 50% of three combustion turbine units, located in Bloomington, Illinois, with combined net capacity of 5,250 kilowatts. State Farm Insurance Company owns the other 50% of these units. The total IP available net summer capability is 4,571,250 kilowatts. The major coal-fired units at Baldwin, Havana, Hennepin, Vermilion and Wood River make up 3,112,000 kilowatts of summer capacity. Three natural gas-fired units at Wood River were reactivated in 1997. These units have a combined net summer capacity of 139,000 kilowatts. Five oil-fired units at Havana remain in cold standby status, not currently staffed for operation. In December 1996, the control and computer rooms for Wood River Units 4 and 5 were damaged by an in-plant fire. Unit 4 was returned to service in June 1997 and Unit 5 was returned to service in October 1997. During 1995, natural gas firing capability was added to the Vermilion station. Vermilion now has the capability for either coal or natural gas firing to achieve its summer capacity of 176,000 kilowatts. In June 1997, the Vermilion units returned to coal as its primary fuel. IP owns an interconnected electric transmission system of approximately 2,800 circuit miles, operating from 69,000 to 345,000 volts and a distribution system which includes about 35,800 circuit miles of overhead and underground lines. All outstanding first mortgage bonds issued under the Mortgage and Deed of Trust dated November 1, 1943 are secured by a first mortgage lien on substantially all of the fixed property, franchises and rights of IP with certain exceptions expressly provided in the mortgage securing the bonds. All outstanding New Mortgage Bonds issued under the General Mortgage and Deed of Trust dated November 1, 1992, are secured by a lien on IP's properties used in the generation, purchase, transmission, distribution and sale of electricity and gas. On October 24, 1997, a special meeting of First Mortgage Bondholders was held. At this meeting the Trustee, holding more that the required two-thirds of First Mortgage Bonds outstanding, voted in favor of a resolution amending the Mortgage and Deed of Trust dated November 1, 1943, to conform in certain respects to the General Mortgage and Deed of Trust dated November 1, 1992. On December 10, 1997, the IP Board of Directors approved the resolution adopted by the Bondholders and forwarded a certified resolution approving the Bondholders' resolution of amendment to the Mortgage Trustee. This resolution was received by the Mortgage Trustee on December 11, 1997, at which time the amendment became effective. Item 3. Legal Proceedings - ------- See discussion of legal proceedings in "Manufactured-Gas Plant" in "Note 4 - Commitments and Contingencies" on pages a-21 and a-22 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. See "Environmental Matters" reported under Item 1 of this report for information regarding legal proceedings concerning environmental matters. See "Fuel Supply" reported under Item 1 of this report for information regarding legal proceedings concerning nuclear fuel disposal. Item 4. Submission of Matters to a Vote of Security Holders - ------- On October 24, 1997, a special meeting of First Mortgage Bondholders was held. At this meeting the Trustee, holding more that the required two-thirds of First Mortgage Bonds outstanding, voted in favor of a resolution amending the Mortgage and Deed of Trust dated November 1, 1943, to conform in certain respects to the General Mortgage and Deed of Trust dated November 1, 1992. PART II - ------------------------------------------------------------------------------- Item 5. Market for Registrants' Common Equity and Related - ------- Stockholder Matters For Illinova the information under the caption "Quarterly Consolidated Financial Information and Common Stock Data (Unaudited)" on page a-31 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference. For IP the information under the caption "Quarterly Consolidated Financial Information and Common Stock Data (Unaudited)" on page a-31 of the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference. Item 6. Selected Financial Data - ------- For Illinova the information under the caption "Selected Consolidated Financial Data" on page a-32 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference. For IP the information under the caption "Selected Consolidated Financial Data" on page a-32 of the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial - ------- Condition and Results of Operations For Illinova the information under the caption "Management's Discussion and Analysis" on pages a-2 through a-9 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference. For IP the information under the caption "Management's Discussion and Analysis" on pages a-2 through a-9 of the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference. In March 1995, the ICC approved a program whereby IP will reacquire shares of its common stock from Illinova, from time to time, at prices determined to be equivalent to current market value. The reacquired stock will be retained as treasury stock or canceled. The ICC did not set a limit on the number of shares of common stock that can be repurchased, subject to meeting certain financial tests. Authorization for this program expires October 3, 1998. The repurchase program may be extended subject to ICC approval. During 1997, IP repurchased 6,017,748 shares for a total of $121.5 million, averaging about $20 per share. For information regarding the redemption of IP preferred stock, see "Note 10 - Preferred Stock of Subsidiary" in the "Notes to Consolidated Financial Statements" on page a-27 in the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement or "Note 9 - Preferred Stock" in the "Notes to Consolidated Financial Statements" on page a-27 in the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement. On February 26, 1998, IP issued a redemption notice for all outstanding bonds of its 6.00% Pollution Control First Mortgage Bonds due 2007 ($18.7 million) and its 8.30% Pollution Control First Mortgage Bonds due 2017 ($33.8 million). The effective call date for both series is April 1, 1998. On March 6, 1998, IP issued $18.7 million of 5.40% Pollution Control First Mortgage Bonds due 2028 and $33.8 million of 5.40% Pollution Control First Mortgage Bonds due 2028. Item 8. Financial Statements and Supplementary Data - ------- For Illinova the consolidated financial statements and related notes on pages a-11 through a-31 and Report of Independent Accountants on page a-10 of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated in Items 1, 3, 5, 6 and 7, the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is not to be deemed filed as part of this Form 10-K Annual Report. For IP the consolidated financial statements and related notes on pages a-11 through a-31 and Report of Independent Accountants on page a-10 of the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated in Items 1, 3, 5, 6 and 7, the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement is not to be deemed filed as part of this form 10-K Annual Report. Item 9. Changes in and Disagreements With Accountants on - ------- Accounting and Financial Disclosure None. PART III - ------------------------------------------------------------------------------- Item 10. Directors and Executive Officers of the Registrants - -------- For Illinova the information under the caption "Board of Directors" on pages 3 through 7 of Illinova's Proxy Statement for its 1998 Annual Meeting of Stockholders is incorporated herein by reference. The information relating to Illinova's executive officers is set forth in Part I of this Annual Report on Form 10-K. For IP the information under the caption "Board of Directors" on pages 4 through 7 of IP's Information Statement for its 1998 Annual Meeting of Stockholders is incorporated herein by reference. The information relating to Illinois Power Company's executive officers is set forth in Part I of this Annual Report on Form 10-K. Item 11. Executive Compensation - -------- For Illinova the information under the caption "Executive Compensation" on pages 8 through 12 of Illinova's Proxy Statement for its 1998 Annual Meeting of Stockholders is incorporated herein by reference. For IP the information under the caption "Executive Compensation" on pages 8 through 13 of IP's Information Statement for its 1998 Annual Meeting of Stockholders is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management - -------- For Illinova the information under the caption "Security Ownership of Management and Certain Beneficial Owners" on page 7 and the information regarding securities owned by certain officers and directors under the caption "Board of Directors" on pages 3 through 7 of Illinova's Proxy Statement for its 1998 Annual Meeting of Stockholders is incorporated herein by reference. For IP the information under the caption "Security Ownership of Management and Certain Beneficial Owners" on page 7 and the information regarding securities owned by certain officers and directors under the caption "Board of Directors" on pages 4 through 7 of IP's Information Statement for its 1998 Annual Meeting of Stockholders is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions - -------- None. PART IV - ------------------------------------------------------------------------ Item 14. Exhibits, Financial Statement Schedules, and Reports on - -------- Form 8-K (a) Documents filed as part of this report. (1a) Financial Statements: Page in 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement* ---------------- Report of Independent Accountants a-10 Consolidated Statements of Income for the three years ended December 31, 1997 a-11 Consolidated Balance Sheets at December 31, 1997 and 1996 a-12 Consolidated Statements of Cash Flows for the three years ended December 31, 1997 a-13 Consolidated Statements of Retained Earnings for the three years ended December 31, 1997 a-13 Notes to Consolidated Financial Statements a-14 - a-31 * Incorporated by reference from the indicated pages of the 1997 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement. (1b) Financial Statements: Page in 1997 Annual Report to Shareholders in the appendix to the IP Information Statement** --------------- Report of Independent Accountants a-10 Consolidated Statements of Income for the three years ended December 31, 1997 a-11 Consolidated Balance Sheets at December 31, 1997 and 1996 a-12 Consolidated Statements of Cash Flows for the three years ended December 31, 1997 a-13 Consolidated Statements of Retained Earnings for the three years ended December 31, 1997 a-13 Notes to Consolidated Financial Statements a-14 - a-31 ** Incorporated by reference from the indicated pages of the 1997 Annual Report to Shareholders in the appendix to the IP Information Statement Item 14. Exhibits, Financial Statement Schedules, and Reports on - -------- Form 8-K (Continued) (2) Financial Statement Schedules: All Financial Statement Schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. (3) Exhibits The exhibits filed with this Form 10-K are listed in the Exhibit Index located elsewhere herein. All management contracts and compensatory plans or arrangements set forth in such list are marked with a ~. (b) Reports on Form 8-K since September 30, 1997: Report filed on Form 8-K on November 21, 1997 Other Events: IP releases results of independent assessment of the Clinton Power Station. Report filed on Form 8-K on January 8, 1998 Other Events: IP selects PECO Nuclear to manage Clinton Power Station. Impacts of Illinois House Bill 362 and returning Clinton to operation will result in a fourth quarter 1997 charge of $260 million (net of income taxes). Report filed on Form 8-K on January 21, 1998 Other Events: The Nuclear Regulatory Commission places IP's Clinton Power Station on its Watch List. Report filed on Form 8-K on January 21, 1998 Other Events: Illinova offers Medium-Term Notes under its shelf Registration Statement on Form S-3. Financial Statements, Pro Forma Financial Information and Exhibits: Exhibits Report filed on Form 8-K on February 13, 1998 Other Events: Illinova releases 1997 earnings and discloses that it will not take a previously announced $40 million charge (net of income taxes) in 1997 for returning Clinton Power Station to operation. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ILLINOIS POWER COMPANY (REGISTRANT) By Larry D. Haab Larry D. Haab, Chairman, President and Chief Executive Officer Date: March 11, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the dates indicated. Signature Title Date Larry D. Haab Chairman, President, Chief Larry D. Haab Executive Officer and Director (Principal Executive Officer) Larry F. Altenbaumer Senior Vice President and Larry F. Altenbaumer Chief Financial Officer (Principal Financial Officer) Cynthia G. Steward Controller Cynthia G. Steward (Principal Accounting Officer) J. Joe Adorjan J. Joe Adorjan C. Steven McMillan C. Steven McMillan Robert M. Powers Robert M. Powers Sheli Z. Rosenberg Sheli Z. Rosenberg Director March 11, 1998 Walter D. Scott Walter D. Scott Ronald L. Thompson Ronald L. Thompson Walter M. Vannoy Walter M. Vannoy Marilou von Ferstel Marilou von Ferstel John D. Zeglis John D. Zeglis SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ILLINOVA CORPORATION (REGISTRANT) By Larry D. Haab Larry D. Haab, Chairman, President and Chief Executive Officer Date: March 11, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the dates indicated. Signature Title Date Larry D. Haab Chairman, President, Chief Larry D. Haab Executive Officer and Director (Principal Executive Officer) Larry F. Altenbaumer Chief Financial Officer, Larry F. Altenbaumer Treasurer and Controller (Principal Financial and Accounting Officer) J. Joe Adorjan J. Joe Adorjan C. Steven McMillan C. Steven McMillan Robert M. Powers Robert M. Powers Sheli Z. Rosenberg Sheli Z. Rosenberg Walter D. Scott Walter D. Scott Director March 11, 1998 Joe J. Stewart Joe J. Stewart Ronald L. Thompson Ronald L. Thompson Walter M. Vannoy Walter M. Vannoy Marilou von Ferstel Marilou von Ferstel John D. Zeglis John D. Zeglis Exhibit Index Exhibit Description (3)(i) Articles of Incorporation Illinova Corporation (a)(1) Articles of Amendment to the Articles of Incorporation of Illinova Corporation, filed as of October 31, 1994. Filed as Exhibit 3(a) to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended September 30, 1994 (File No. 1-11327). * (a)(2) Statement of Correction to the Articles of Incorporation of Illinova Corporation, filed as of October 31, 1994. Filed as Exhibit 3(b) to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended September 30, 1994 (File No. 1-11327). * Illinois Power Company (b)(1) Amended and Restated Articles of Incorporation of Illinois Power Company, dated September 7, 1994. Filed as Exhibit 3(a) to the Current Report on Form 8-K dated September 7, 1994 (File No. 1-3004). * (3)(ii) By-Laws (a) By-laws of Illinova Corporation, as amended December 14, 1994. Filed as Exhibit 3(b)(2) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1994 (File No. 1-11327). * (b) By-laws of Illinois Power Company, as amended December 14, 1994. Filed as Exhibit 3(b)(1) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1994 (File No. 1-3004). * (4) Instruments Defining Rights of Security Holders, Including Indentures Illinova Corporation (a)(1) See (4)(b) below for instruments defining the rights of holders of long-term debt of Illinois Power Company. (a)(2) Indenture dated February 1, 1997, between Illinova Corporation and The First National Bank of Chicago, as trustee. Filed as Exhibit (4)(a)(2) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1996. (File No. 1-11327) * (a)(3) Distribution Agreement dated January 16, 1998, and Officers' Certificate and Issuer Order of Illinova Corporation, dated January 16, 1998 (with forms of Fixed Rate Note and Floating Rate Note attached), delivered pursuant to the terms of the Indenture dated as of February 1, 1997, between Illinova Corporation and The First National Bank of Chicago. Filed as Exhibit (1) and (4) of Form 8-K under the Securities Exchange Act of 1934 dated January 21, 1998. (File No. 1-11327) * Illinois Power Company (b)(1) Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 2(b) Registration No. 2-14066. * (b)(2) Supplemental Indenture dated May 1, 1974. Filed as Exhibit 2(v) Registration No. 2-51674. * (b)(3) Supplemental Indenture dated May 1, 1977. Filed as Exhibit 2(w) Registration No. 2-59465. * (b)(4) Supplemental Indenture dated July 1, 1979. Filed as Exhibit 2 to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended June 30, 1979. * (b)(5) Supplemental Indenture dated March 1, 1985. Filed as exhibit 4(a) to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended March 31, 1985 (File No. 1-3004). * (b)(6) Supplemental Indenture dated July 1, 1987, providing for $33,755,000 principal amount of 8.30% First Mortgage Bonds, Pollution Control Series I, due April 1, 2017. Filed as Exhibit 4(ll) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1987 (File No. 1-3004). * (b)(7) Supplemental Indenture dated December 13, 1989, providing for $300,000,000 principal amount of Medium-Term Notes, Series A. Filed as Exhibit 4(nn) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1989 (File No. 1-3004). * (b)(8) Supplemental Indenture dated July 1, 1991, providing for $84,710,000 principal amount of 7 3/8% First Mortgage Bonds due July 1, 2021. Filed as Exhibit 4(mm) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1991 (File No. 1-3004). * (b)(9) Supplemental Indenture No. 1 dated June 1, 1992. Filed as Exhibit 4(nn) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). * (b)(10) Supplemental Indenture No. 2 dated June 1, 1992. Filed as Exhibit 4(oo) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). * (b)(11) Supplemental Indenture No. 1 dated July 1, 1992. Filed as Exhibit 4(pp) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). * (b)(12) Supplemental Indenture No. 2 dated July 1, 1992. Filed as Exhibit 4(qq) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). * (b)(13) Supplemental Indenture dated September 1, 1992, providing for $72,000,000 principal amount of 6 1/2% First Mortgage Bonds due September 1, 1999. Filed as Exhibit 4(rr) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1992 (File No. 1-3004). * (b)(14) General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(cc) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). * (b)(15) Supplemental Indenture dated February 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(dd) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). * (b)(16) Supplemental Indenture dated February 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(ee) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). * (b)(17) Supplemental Indenture No. 1 dated March 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(ff) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). * (b)(18) Supplemental Indenture No. 1 dated March 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(gg) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). * (b)(19) Supplemental Indenture No. 2 dated March 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(hh) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). * (b)(20) Supplemental Indenture No. 2 dated March 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(ii) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). * (b)(21) Supplemental Indenture dated July 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(jj) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). * (b)(22) Supplemental Indenture dated July 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(kk)to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). * (b)(23) Supplemental Indenture dated August 1, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(ll) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). * (b)(24) Supplemental Indenture dated August 1, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(mm) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). * (b)(25) Supplemental Indenture dated October 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(nn) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 1-3004). * (b)(26) Supplemental Indenture dated October 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(oo) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 1-3004). * (b)(27) Supplemental Indenture dated November 1, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(pp) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 1-3004). * (b)(28) Supplemental Indenture dated November 1, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(qq) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 1-3004). * (b)(29) Supplemental Indenture dated February 1, 1994, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(hh) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1993 (File No. 1-3004). * (b)(30) Indenture dated October 1, 1994 between Illinois Power Company and the First National Bank of Chicago. Filed as Exhibit 4(a) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 1-3004). * (b)(31)Supplemental Indenture dated October 1, 1994, to Indenture dated as of October 1, 1994. Filed as Exhibit 4(b) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No.1-3004). * (b)(32) Indenture dated January 1, 1996 between Illinois Power Company and Wilmington Trust Company. Filed as Exhibit 4(b)(36) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1995 (File No. 1-3004). * (b)(33) First Supplemental Indenture dated January 1, 1996, between Illinois Power Company and Wilmington Trust Company. Filed as Exhibit 4(b)(37) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1995 (File No. 1-3004). * (b) (34) Supplemental Indenture dated April 1, 1997, to Mortgage and Deed of Trust dated November 1, 1943 Filed as Exhibit 4(a) to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. (File No. 1-3004) * (b) (35) Supplemental Indenture dated April 1, 1997 to General Mortgage Indenture and Deed of Trust dated November 1, 1992. Filed as Exhibit 4(b) to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. (File No. 1-3004) * (b) (36) Supplemental Indenture dated December 1, 1997 to Mortgage and Deed of Trust dated November 1, 1943. (10) Material Contracts Illinova Corporation (a)(1) Illinova Corporation Deferred Compensation Plan for Certain Directors, as amended April 10, 1991. Filed as Exhibit 10(b) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1991 (File No. 1-3004).~ * (a)(2) Illinova Corporation Director Emeritus Plan for Outside Directors. Filed as Exhibit 10(e) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1989 (File No. 1-3004).~ * (a)(3) Illinova Corporation Stock Plan for Outside Directors as amended and restated by the Board of Directors on April 9, 1992 and as further amended April 14, 1993. Filed as Exhibit 10(h) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1993 (File No. 1-3004).~ * (a)(4) Illinova Corporation Retirement Plan for Outside Directors, as amended through December 11, 1991. Filed as Exhibit 10(j) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1991 (File No. 1-3004).~ * (a)(5) Illinova Corporation 1992 Long-Term Incentive Compensation Plan. Filed as Exhibit 10(k) to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1992 (File No. 1-3004).~ * (a)(6) Illinova Corporation Comprehensive Deferred Stock Plan for Outside Directors, as approved by the Board of Directors on February 7, 1996. Filed as Exhibit 10 (a)(6) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1995 (File No. 1-11327).~ * (a)(7) Form of Employee Retention Agreement in place between Illinova Corporation and its elected officers, Illinois Power Company's elected officers, and the Presidents of Illinova Corporation's subsidiaries. Filed as Exhibit 10(g) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1989 (File no. 1-3004).~ * (a)(8) Illinova Corporation Leadership Incentive Program, effective January 1, 1996.~ (a)(9) Illinova Corporation Retirement Plan for Outside Directors, as amended by resolutions adopted by the Board of Directors on February 7, 1996.~ (a)(10) Illinova Corporation Employee Retention Agreement, as amended by resolutions adopted by the Board of Directors on February 7, 1996.~ (a)(11) Illinova Corporation Deferred Compensation Plan for Certain Directors as amended October 9, 1996, effective January 1, 1997.~ (a)(12) Illinova Corporation Employee Retention Agreement, as amended by resolutions adopted by the Board of Directors on June 10-11, 1997.~ (a)(13) Illinova Corporation Deferred Compensation Plan for Certain Directors, as amended by resolutions adopted by the Board of Directors on June 10-11, 1997.~ Illinois Power Company (b)(1) Group Insurance Benefits for Managerial Employees of Illinois Power Company as amended January 1, 1983. Filed as Exhibit 10(a) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1983 (File No. 1-3004).~ * (b)(2) Illinois Power Company Incentive Savings Trust and Illinois Power Company Incentive Savings Plan and Amendment I thereto. Filed as Exhibit 10(d) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1984 (File No. 1-3004).~ * (b)(3) Illinois Power Company's Executive Incentive Compensation Plan. Filed as Exhibit 10(f) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1989 (File No. 1-3004).~ * (b)(4) Illinois Power Company Incentive Savings Plan, as amended and restated effective January 1, 1991. Filed as Exhibit 10(h) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1990 (File No. 1-3004).~ * (b)(5) Illinois Power Company Executive Deferred Compensation Plan. Filed as Exhibit 10(l) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1993. (File No. 1-3004)~ * (b)(6) Illinois Power Company Retirement Income Plan for salaried employees as amended and restated effective January 1, 1989, as further amended through January 1, 1994. Filed as Exhibit 10(m) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1994 (File No. 1-3004).~ * (b)(7) Illinois Power Company Retirement Income Plan for employees covered under a collective bargaining agreement as amended and restated effective as of January 1, 1994. Filed as Exhibit 10(n)to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1994 (File No. 1-3004).~ * (b)(8) Illinois Power Company Incentive Savings Plan as amended and restated effective January 1, 1991 and as further amended through amendments adopted December 28, 1994. Filed as Exhibit 10(o)to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1994 (File No. 1-3004).~ * (b)(10) Illinois Power Company Incentive Savings Plan for employees covered under a collective bargaining agreement as amended and restated effective January 1, 1991 and as further amended through amendments adopted December 28, 1994. Filed as Exhibit 10(p) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1994 (File No. 1-3004).~ * (b)(11) Illinois Power Company Executive Incentive Compensation Plan, as amended, effective January 1, 1997. ~ (b)(12) Illinois Power Company Executive Deferred Compensation Plan as amended by resolutions adopted by the Board of Directors on June 10-11, 1997.~ (b)(13) Illinois Power Company Supplemental Retirement Income Plan for Salaried Employees of Illinois Power Company as amended by resolutions adopted by the Board of Directors on June 10-11, 1997.~ (b)(14) Retirement and Consulting Agreement entered into as of June 30, 1997 between Illinois Power Company and Wilfred Connell.~ (12) Statement Re Computation of Ratios (a) Computation of ratio of earnings to fixed charges for Illinova Corporation. (b) Computation of ratio of earnings to fixed charges for Illinois Power Company. (13) Annual Reports to Shareholders (a) Illinova Corporation Proxy Statement and 1997 Annual Report to Shareholders. (b) Illinois Power Company Information Statement and 1997 Annual Report to Shareholders. (21) Subsidiaries of Registrants (a) Subsidiaries of Illinova Corporation and Illinois Power Company. (23) Consents of Experts Consent of Independent Accountants for Illinova Corporation. (27) Financial Data Schedules (a) Illinova Corporation (b) Illinois Power Company * Incorporated herein by reference. ~ Management contract and compensatory plans or arrangements. EX-4 2 EX-4 Exhibit (b)(36) [Conformed Copy] ILLINOIS POWER COMPANY TO HARRIS TRUST AND SAVINGS BANK, as Trustee Supplemental Indenture DATED AS OF DECEMBER 1, 1997 TO Mortgage and Deed of Trust DATED NOVEMBER 1, 1943 SUPPLEMENTAL INDENTURE, dated as of the first day of December, Nineteen hundred and ninety-seven (1997) (the "Supplemental Indenture"), made by and between ILLINOIS POWER COMPANY, a corporation organized and existing under the laws of the State of Illinois (the "Company"), and HARRIS TRUST AND SAVINGS BANK, a corporation organized and existing under the laws of the State of Illinois (the "Trustee"), as Trustee under the Mortgage and Deed of Trust dated November 1, 1943. WHEREAS, the Company has heretofore executed and delivered its Mortgage and Deed of Trust dated November 1, 1943 (the "Original Indenture"), to the Trustee, for the security of the First Mortgage Bonds of the Company issued and to be issued thereunder (the "Bonds"); and WHEREAS, the Company desires to amend the Original Indenture in certain respects, and in connection therewith has complied with the applicable provisions of Articles XIV and XV of the Original Indenture; and WHEREAS, the Company, in the exercise of the powers and authority conferred upon and reserved to it under the provisions of the Original Indenture, and pursuant to appropriate resolutions of the Board of Directors, has duly resolved and determined to make, execute and deliver to the Trustee a Supplemental Indenture in the form hereof for the purposes herein provided; and WHEREAS, all the conditions and requirements necessary to make this Supplemental Indenture a valid, binding and legal instrument have been done, performed and fulfilled and the execution and delivery hereof have been in all respects duly authorized: NOW, THEREFORE, THIS INDENTURE WITNESSETH: THAT Illinois Power Company, in consideration of the purchase and ownership from time to time of the Bonds and the service by the Trustee, and its successors, under the Original Indenture and of One Dollar to it duly paid by the Trustee at or before the ensealing and delivery of these presents, the receipt whereof is hereby acknowledged, hereby covenants and agrees to and with the Trustee and its successors in the trust under the Original Indenture, for the benefit of those who shall hold the Bonds and coupons, if any, appertaining thereto, as follows: ARTICLE I AMENDMENT OF ORIGINAL INDENTURE Section 1. The Original Indenture is hereby amended to delete the terms "St. Clair bonds" and "St. Clair mortgage" and all references thereto. Section 2. Article I of the Original Indenture, "Definitions," is hereby amended in the following respects: (a) The definition of "Net bondable value of property additions not subject to an unfunded prior lien" is hereby amended by changing the fractions set forth in each of Subdivisions (e)(1) and (f) thereof from "ten-sixths (10/6ths)" to "133 1/3%." (b) The definition of "Net bondable value of property additions subject to an unfunded prior lien" is hereby amended by changing the fractions set forth in each of Subdivisions (c) and (d) thereof from "ten-sixths (10/6ths)" to "133 1/3%." (c) The definition of "Net earnings of the Company available for interest and property retirement appropriations" is hereby amended and restated in its entirety as follows: "The term net earnings of the Company available for interest and property retirement appropriations shall mean the net earnings of the Company ascertained as follows, specifying: (a) its operating revenues (which may include revenues of the Company subject when collected or accrued to possible refund at a future date) with the principal divisions thereof. (b) its operating expenses, with the principal divisions thereof, excluding (A) expenses for income, profits and other taxes measured by, or dependent on, net income, (B) provisions for reserves for renewals, replacements, depreciation, depletion or retirement of property (or any expenditures therefor), or provisions for amortization of property, (C) expenses or provisions for interest on any indebtedness of the Company, for the amortization of debt discount, premium, expense or loss on reacquired debt, for any maintenance and replacement, improvement or sinking fund or other device for the retirement of any indebtedness, or for other amortization, (D) expenses or provisions for any non-recurring charge to income or to retained earnings of whatever kind or nature (including without limitation the recognition of expense due to the non-recoverability of assets or expense), whether or not recorded as a non-recurring charge in the Company's books of account, and (E) provisions for any refund of revenues previously collected or accrued by the Company subject to possible refund; (c) the amount remaining after deducting the amount in clause (b) above from the amount in clause (a) above; (d) its rental revenues (net of rental expenses not included in clause (b) above); (e) the sum of the amounts in clauses (c) and (d); (f) its other income, which amount may include any portion of the allowance for funds used during construction and other income related to deferred costs (or any analogous amounts) which is not included in "other income" (or any analogous item) in the Company's books of account; (g) Net earnings of the Company available for interest and property retirement appropriations (being the sum of clauses (e) and (f) above). Notwithstanding anything herein to the contrary, neither profits nor loss from the sale or other disposition of property, nor non-recurring charges of any kind or nature, whether items of revenue or expense, shall be included in calculating net earnings of the Company available for interest and property retirement appropriations. If any of the property of the Company owned by it at the time of calculating net earnings of the Company available for interest and property retirement appropriations (a) shall have been acquired during or after any period for which net earnings of the Company available for interest and property retirement appropriations are to be computed, (b) shall not have been acquired in exchange or substitution for property the net earnings of which have been included in the net earnings of the Company available for interest and property retirement appropriations, and (c) had been operated as a separate unit and items of revenue and expense attributable thereto are readily ascertainable, then the net earnings of such property (computed in the manner in this Section provided for the computation of the net earnings of the Company available for interest and property retirement appropriations) during such period or such part of such period as shall have preceded the acquisition thereof, to the extent that the same have not otherwise been included in the net earnings of the Company available for interest and property retirement appropriations, shall be so included." (d) The definition of "Net earnings of the Company available for interest after property retirement appropriations" and all references thereto are hereby deleted in their entirety. Section 3. Article III of the Original Indenture, "Authentication and Delivery of Bonds," is hereby amended in the following respects: (a) Section 3, Subdivision (b)(1) is hereby amended by (i) changing the period "fifteen calendar months" to "eighteen calendar months," (ii) deleting the phrase "the greater of" and changing the figure "two and one-half" to "two," and (iii) deleting the phrase "or ten percent (10%) of the principal amount of". (b) Section 3, Subdivision (b)(2) and all references thereto are hereby deleted in their entirety. (c) The first paragraph of Section 4 is hereby amended by changing the percentage set forth in the first sentence thereof from 60% to 75%. (d) Section 4, Subdivisions (a)(7)(i) and (a)(8) are hereby amended by changing the fraction set forth in each such Subdivision thereof from "ten-sixths (10/6ths)" to "133 1/3%." Section 4. Article IV of the Original Indenture, "Particular Covenants of the Company," is hereby amended in the following respects: (a) Section 6, Subdivision (a) is hereby amended by (i) deleting the phrase "such hazards and risks as are usually insured by companies similarly situated and operating like properties" and replacing in lieu thereof the word "fire," (ii) deleting the phrase "Fifty thousand dollars" and replacing in lieu thereof "the greater of Five Million Dollars ($5,000,000) or three per cent (3%) of the aggregate principal amount of the Bonds then outstanding under this Indenture, and (iii) deleting the phrase "hazards and risks covered thereby" in Subdivision (a)(1) and replacing in lieu thereof the word "fire." (b) Section 6, Subdivision (b) is hereby amended by deleting the phrase "Twenty five thousand dollars" and replacing in lieu thereof "the greater of Five Million Dollars or three per cent (3%) of the aggregate principal amount of Bonds then outstanding under this Indenture." (c) Section 6, Subdivision (c) is hereby amended by deleting the phrase "any insurance" and replacing in lieu thereof "any fire insurance required to be maintained by it pursuant to Subdivision (a) of this Section." (d) Section 14, Subdivision (a) is hereby amended by changing the percentage set forth therein from "50%" to "75%." (e) Section 14, Subdivision (b)(1) is hereby amended by (i) changing the period "fifteen calendar months" to "eighteen calendar months," (ii) deleting the phrase "the greater of" and changing the figure "two and one-half" to "two," and (iii) deleting the phrase "or ten percent (10%) of the principal amount of." (f) Section 14, Subdivision (b)(2) and all references thereto are hereby deleted in their entirety. (g) Section 16, Subdivisions (a)(1) and (a)(2) are hereby amended by changing the percentages set forth in each such Subdivision from "60%" to "75%." (h) Section 16, Subdivision (b)(1) is hereby amended by (a) changing the period "fifteen calendar months" to "eighteen calendar months," (b) deleting the phrase "the greater of" and changing the figure "two and one-half" to "two," and (c) deleting the phrase "or ten percent (10%) of the principal amount of, and." (i) Section 16, Subdivision (b)(2) and all references thereto are hereby deleted in their entirety. (j) Sections 24, 25 and 26 and all references thereto are hereby deleted in their entirety. Section 5. Article VI of the Original Indenture, "Concerning Securities Held by the Trustee," is hereby amended to delete Sections 6, 7, 8, 9, 10, 11 and 12 and all references thereto in their entirety. Section 6. Article VII of the Original Indenture, "Possession, Use and Release of Property," is hereby amended in the following respects: (a) Section 3 is amended by adding the following paragraph at the end of Section 3:\ "Notwithstanding any of the foregoing, if the property constituting part of the trust estate to be released is (i) capital stock of any Subsidiary owned by the Company, or (ii) secured funded indebtedness of any Subsidiary owned by the Company, the Company shall not be required to comply with any of the provisions of this Section 3." (b) Article VII is hereby amended by adding the following new Section 9: "SECTION 9. Notwithstanding the other provisions of this Article VII, unless an Event of Default shall have occurred and be continuing, the Company may obtain the release from the lien of this Indenture, any part of the property constituting part of the trust estate, or any part thereof, and the Trustee shall whenever from time to time requested by the Company, and without requiring compliance with any of the other provisions of this Article VII, release the same from the lien hereof all the right, title and interest of the Trustee in and to the same, provided either that: (a) the aggregate fair value of the property to be so released on any date in a given calendar year, together with all other property released pursuant to this Subdivision (a) in such calendar year, shall not exceed the greater of Five Million Dollars ($5,000,000) or one percent (1%) of the aggregate principal amount of the Bonds at the time outstanding, provided that there shall be delivered to the Trustee an engineer's certificate stating the fair value, in the judgment of the signers, of the property to be released, the aggregate fair value of all other property theretofore released pursuant to this Subdivision (a) in such calendar year and that, in the judgment of the signers, the release thereof will not impair the security under this Indenture in contravention of the provisions hereof; or (b) the aggregate fair value of the property to be so released on any date in a given calendar year, together with all other property released pursuant to Subdivision (a) of this Section 9 or this Subdivision (b) in such calendar year, shall exceed the greater of Five Million Dollars ($5,000,000) or one percent (1%) of the aggregate principal amount of the Bonds at the time outstanding, but shall not exceed three percent (3%) of the aggregate principal amount of the Bonds at the time outstanding, provided that there shall be delivered to the Trustee an engineer's certificate stating the fair value, in the judgment of the signers, of the property to be released, the aggregate fair value of all other property theretofore released pursuant to Subdivision (a) of this Section 9 and this Subdivision (b) in such calendar year and, as to property additions, the cost thereof (or, if the fair value to the Company of such property at the time the same became property additions was less than the cost thereof, then such fair value, in the judgment of the signers, in lieu of cost), and that, in the judgment of the signers, the release thereof will not impair the security under this Indenture in contravention of the provisions hereof. On or before December 1st of each year, the Company shall deposit with the Trustee an amount in cash equal to the aggregate cost of the properties constituting property additions so released pursuant to this Subdivision (b) during the previous calendar year (or, if the fair value to the Company of any particular property at the time the same became property additions was less than the cost thereof, then such fair value in lieu of cost); provided, however, that no such deposit shall be required to be made hereunder to the extent that cash or other consideration shall, as indicated in an Officer's certificate delivered to the Trustee, have been deposited with the trustee or other holder of a funded prior lien, a unfunded prior lien or other lien prior to the lien of this Indenture in accordance with the provision thereof. Any cash deposited with the Trustee under this Subdivision (b) may thereafter be withdrawn, used or applied in the manner, to the extent and for the purposes, and subject to the conditions, provided in this Article VII." Section 7. Article VIII of the Original Indenture, "Application of Moneys Received by the Trustee," is hereby amended in the following respects: (a) The first paragraph of Section 1 is hereby amended and restated in its entirety as follows: "Section 1. Any moneys held by the Trustee as part of the trust estate (other than moneys received by the Trustee pursuant to Section 5(a) of Article III or on account of judgment liens or in order to make a prior lien a funded prior lien) shall be paid over from time to time by the Trustee to or upon the order of the Treasurer or an Assistant Treasurer of the Company, in amount equal to the cost, or the fair value to the Company if the fair value is less than the cost, of all property additions purchased, constructed or otherwise acquired by the Company not previously included within the definition of "net bondable value of property additions not subject to an unfunded prior lien" for purposes of issuing Bonds or withdrawing cash, but only upon the receipt by the Trustee of :" (b) Section 1, Subdivision (b)(1) is hereby amended by deleting the following in its entirety: "during the period specified in such certificate, commencing, (i) in the case of withdrawal of moneys received by the Trustee pursuant to Sections 3, 4 or 5 of Article VII upon the release of any property (other than obligations deposited pursuant to Section 3(d) of Article VII) from the lien of this Indenture, on a date not earlier than the date of the application for such release, (ii) in the case of withdrawal of moneys received by the Trustee upon the payment of principal of obligations deposited pursuant to Section 3(d) of Article VII, or upon the release of such obligations from the lien of this Indenture, on a date not earlier than the date of the application for the release of the property with respect to which such obligations were deposited, (iii) in the case of withdrawal of moneys deposited with the Trustee pursuant to Section 6 of Article IV, on the date of the loss or destruction of the property with respect to which such moneys were deposited, and (iv) in the case of withdrawal of any other moneys which may be withdrawn pursuant to this Section 1, on a date not earlier than the date of the receipt by the Trustee of such moneys." (c) Section 3, Subdivision (a) is hereby amended by changing the percentage set forth therein from "60%" to "75%." (d) Section 8 and all references thereto are hereby deleted in their entirety. Section 8. Article IX of the Original Indenture, "Remedies Upon Default," is hereby amended by deleting Section 1, Subdivisions (a) through (k) thereof and substituting therefor the following: "(a) failure to pay interest, if any, on any Bond within forty-five (45) days after the same becomes due and payable; or (b) failure to pay the principal of or premium, if any, on any Bond within three (3) business days after its maturity; or (c) failure to make any payment to any sinking, maintenance or other analogous fund within sixty (60) days after the same becomes due and payable; (d) failure to perform or breach of any covenant or warranty of the Company in this Indenture (other than a covenant or warranty a default in the performance of which or breach of which is elsewhere in this Section specifically dealt with) for a period of sixty (60) days after there has been given, by registered or certified mail, to the Company by the Trustee, or to the Company and the Trustee by the Bondholders of at least twenty-five percent (25%) in principal amount of the Bonds then outstanding under this Indenture, a written notice specifying such default or breach and requiring it to be remedied and stating that such notice is a "notice of default" hereunder, unless the Trustee, or the Trustee and the Bondholders of a principal amount of Bonds not less than the principal amount of Bonds the Bondholders of which gave such notice, as the case may be, shall agree in writing to an extension of such period prior to its expiration; provided, however, that that Trustee, or the Trustee and the Bondholders of such principal amount of Bonds, as the case may be, shall be deemed to have agreed to an extension of such period if corrective action is initiated by the Company within such period and is being diligently pursued; or (e) the entry by a court having jurisdiction in the premises of (i) a decree or order for relief in respect of the Company in an involuntary case or proceeding under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law or (ii) a decree or order adjudging the Company a bankrupt or insolvent, or approving as properly filed a petition by one or more Persons other than the Company seeking reorganization, arrangement, adjustment or composition of or in respect of the Company under any applicable Federal or State law, or appointing a custodian, receiver, liquidator, assignee, trustee, sequestrator or other similar official of the Company or of any substantial part of for the Company or for any substantial part of its property, or ordering the winding up or liquidation of its affairs, and any such decree or order for relief or any such other decree or order shall have remained unstayed and in effect for a period of ninety (90) consecutive days; or (f) the commencement by the Company of a voluntary case or proceeding under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law or of any other case or proceeding to be adjudicated a bankrupt or insolvent, or the consent by it to the entry of a decree or order for relief in respect of the Company in a case or proceeding under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law or to the commencement of any bankruptcy or insolvency case or proceeding against it, or the filing by it of a petition or answer or consent seeking reorganization or relief under any applicable Federal or State law, or the consent by it to the filing of such petition or to the appointment of or taking possession by a custodian, receiver, liquidator, assignee, trustee, sequestrator or similar official of the Company or of any substantial part of its property, or the making by it of an assignment for the benefit of creditors, or the admission by it in writing of its inability to pay its debts generally as they become due, or the authorization of such action by the Board of Directors; or (g) an "Event of Default" under the General Mortgage Indenture and Deed of Trust, dated as of November 1, 1992 (the "1992 Mortgage"), from the Company to Harris Trust and Savings Bank, trustee, or a Matured Event of Default under any Prior Mortgage (as such terms are defined in the 1992 Mortgage); provided, however, that, anything in this Indenture to the contrary notwithstanding, the waiver of cure of such "Event of Default" or event of default and the rescission and annulment of the consequences thereof shall constitute a waiver of the corresponding completed default under this Indenture and a rescission and annulment of the consequences thereof;" Section 9. Article XII of the Original Indenture, "Consolidation, Merger and Sale," is hereby amended in the following respects: (a) Section 1, Subdivision (b)(1) is hereby amended by changing the percentage set forth therein from "50%" to "75%." (b) Section 1, Subdivision (b)(2) is hereby amended by (a) changing the period "fifteen calendar months" to "eighteen calendar months," (b) deleting the phrase "the greater of" and changing the figure "two and one-half" to "two," and (c) deleting the phrase "or ten percent (10%) of the principal amount of, and the net earnings of such other corporation available for interest after property retirement appropriations (determined in the manner provided in Article I) for the same twelve month period shall have amounted in the aggregate to at least two times the amount of the annual interest charges on". ARTICLE II THE TRUSTEE The Trustee hereby accepts the trusts hereby declared and provided and agrees to perform the same upon the terms and conditions in the Original Indenture set forth and upon the following terms and conditions: The Trustee shall not be responsible in any manner whatsoever for or in respect of the validity or sufficiency of this Supplemental Indenture or the due execution hereof by the Company or for or in respect of the recitals contained herein, all of which recitals are made by the Company solely. In general, each and every term and condition contained in Article XIII of the Original Indenture shall apply to this Supplemental Indenture with the same force and effect as if the same were herein set forth in full, with such omissions, variations and modifications thereof as may be appropriate to make the same conform to this Supplemental Indenture. ARTICLE III MISCELLANEOUS This Supplemental Indenture may be simultaneously executed in any number of counterparts, each of which when so executed shall be deemed to be an original; but such counterparts shall together constitute but one and the same instrument. IN WITNESS WHEREOF, said Illinois Power Company has caused this Indenture to be executed on its behalf by its Chairman and President, one of its Executive Vice Presidents, one of its Senior Vice Presidents or one of its Vice Presidents and its corporate seal to be hereto affixed and said seal and this Indenture to be attested by its Secretary or one of its Assistant Secretaries; and said Harris Trust and Savings Bank, in evidence of its acceptance of the trust hereby created, has caused this Indenture to be executed on its behalf by its President or one of its Vice Presidents and its corporate seal to be hereto affixed and said seal and this Indenture to be attested by its Secretary or one of its Assistant Secretaries; all as of the first day of December, nineteen hundred and ninety-seven. ILLINOIS POWER COMPANY, By /s/ Larry F. Altenbaumer (CORPORATE SEAL) Senior Vice President and Chief Financial Officer ATTEST: /s/ Leah Manning Stetzner Secretary HARRIS TRUST AND SAVINGS BANK, Trustee, By /s/ J. Bartolini (CORPORATE SEAL) Vice President /s/ C. Potter Assistant Secretary STATE OF ILLINOIS ) ) SS. COUNTY OF MACON ) BE IT REMEMBERED, that on this 19th day of December, 1997, before me, the undersigned Teresa Stewart, a Notary Public within and for the County and State aforesaid, personally came Larry F. Altenbaumer, Senior Vice President and Chief Financial Officer, and Leah Manning Stetzner, Secretary, of Illinois Power Company, a corporation duly organized, incorporated and existing under the laws of the State of Illinois, who are personally known to me to be such officers, and who are personally known to me to be the same persons who executed as such officers the within instrument of writing, and such persons duly acknowledged that they signed, sealed and delivered the said instrument as their free and voluntary act as such Senior Vice President, Chief Financial Officer and Secretary, respectively, and as free and voluntary act of said Illinois Power Company for the uses and purposes therein set forth. IN WITNESS WHEREOF, I have hereunto subscribed my name and affixed my official seal on the day and year last above written. /s/ Teresa Stewart Notary Public, Macon County, Illinois My Commission Expires September 17, 2001. (NOTARIAL SEAL) STATE OF ILLINOIS ) ) SS. COUNTY OF COOK ) BE IT REMEMBERED, that on this 17th day of December, 1997, before me, the undersigned Marianne Tinerella, a Notary Public within and for the County and State aforesaid, personally came J. Bartolini, Vice President, and C. Potter, Assistant Secretary, of Harris Trust and Savings Bank, a corporation duly organized, incorporated and existing under the laws of the State of Illinois, who are personally known to me to be such officers, and who are personally known to me to be the same persons who executed as such officers the within instrument of writing, and such persons duly acknowledged that they signed, sealed and delivered the said instrument as their free and voluntary act as such Vice President and Assistant Secretary, respectively, and as free and voluntary act of said Harris Trust and Savings Bank for the uses and purposes therein set forth. IN WITNESS WHEREOF, I have hereunto subscribed my name and affixed my official seal on the day and year last above written. /s/ Marianne Tinerella Notary Public, Cook County, Illinois My Commission Expires May 21, 2001. (NOTARIAL SEAL) CHI2:149570.5 03.06.98 10.41 EX-10.1 3 EX-10.1 Exhibit (a)(8) ILLINOVA CORPORATION LEADERSHIP INCENTIVE PROGRAM (Effective as of January 1, 1996) Effective Date The Illinova Corporation Leadership Incentive Program (the "Plan") was established by Illinova Corporation (the "Company") effective as of January 1, 1996 (the "Effective Date"). Objectives The objectives of the Plan are: o To link incentives with performance in order to encourage improved Company performance. o To focus attention on value enhancement for shareholders. o To foster and encourage teamwork at the Illinova Leadership Team level. o To motivate and reward performance above a planned or expected level. o To attract and retain strong management personnel. o To develop a more competitive compensation package relative to market. Eligibility The Chief Executive Officer of the Company (the "CEO"), in his discretion, shall designate those management employees of the Company who will participate in the Plan ("Participants") for each Plan Year, which is the calendar year. The Participants for each Plan Year will normally be designated by the CEO prior to the beginning of the year. If an individual is designated as a Participant in the middle of a Plan Year, the Participant's award may be pro-rated based upon the number of completed months of service between the date of eligibility and the end of the Plan Year. Awards For each Plan Year, Participants will receive incentive payments for corporate, business group and departmental performance that exceeds normal expectations. Determination of whether performance exceeds normal expectations for a Plan Year shall be made on the basis of measurement of internal achievement levels against the goals established under the Plan for the year. Participants will have the opportunity to earn up to 14% of salary in any Plan Year for achievement of corporate goals established for that year. Two levels of Company performance will be identified for each goal -- a threshold level and a maximum level. Attainment of any goal at the threshold level for any Plan Year will qualify for an award for that year with respect to that goal equal to a percentage of the Participant's salary for the year times the weighting factor (described below) for that goal. Attainment of any goal at or above the maximum level qualifies for the maximum award of 14% of the Participant's salary for the year times the weighting factor for that goal. Attainment at a level between threshold and maximum will result in a pro-rated award. In addition, Participants will have the opportunity to earn up to 6% of salary in any Plan Year for achievement of business group and departmental goals for that year ("variable goals"). A Participant's "Total Award" for any Plan Year will equal the sum of the awards with respect to each corporate goal (including the award with respect to the discretionary category, if any) for the year, plus the sum of the awards with respect to the Participant's variable goals. A Participant's Total Award for any Plan Year shall not exceed 20% of the Participant's salary for the year. Awards under the Plan shall not be considered part of a Participant's base salary. It is intended that, in determining whether such base salaries for Participants are at a competitive level relative to base salaries in the utility industry, awards under the Plan shall be disregarded. Goals No later than the first meeting of the Company's Board of Directors in each Plan Year, the Chief Executive Officer of the Company (the "CEO") shall establish specific goals for corporate performance for that Plan Year. The corporate goals (except for the discretionary performance goal, if any) shall be the same for all Participants with respect to any Plan Year. Goals shall focus on major challenges and issues facing the Company. The goals shall include specific performance criteria that are determined to be vital to the achievement of the Company's long term strategic objectives. A "weighting factor" will be assigned to each of the goals that recognizes the relative importance and influence of the goal to the overall success of the Company. Except as otherwise provided in the Plan, the corporate goals for each Plan Year, and the manner of measuring performance against those goals, will be developed in conjunction with the annual planning and budgeting activities of the Company for the year. In addition to establishing specific performance categories and assigning weighting factors to those categories, the [CEO] may establish a discretionary performance category for any Plan Year and assign a weighting factor to it. The performance factors with respect to any such discretionary category for any Plan Year shall be established by the Participant's business group leader at any time before, during or after the end of the year. The level of achievement with respect to the discretionary category for any Plan Year, and the award payable with respect to that category, shall be determined by comparing the Company's performance for the year with factors that the Participant's business group leader determines to be appropriate measures of such performance. The total of the weighting factors with respect to the corporate performance goals for each Plan Year will equal 100%. No awards will be earned under the Plan with respect to the corporate performance goals for any Plan Year unless the Company has declared a dividend for that Plan Year. Variable goals with respect to any Plan Year will be established by the Participant's business group leader prior to the beginning of the Plan Year. Payment of Award A Participant's Total Award for any Plan Year shall be made in two cash payments, known as the Short-Term Payment and the Long-Term Payment. Subject to the following provisions of the Plan, the Short-Term Payment earned for any Plan Year shall be made to the Participant in the first quarter of the following year. A Participant's Short-Term Payment shall equal one-half of the Participant's Total Award for the year. Subject to the following provisions of the Plan, the Long-Term Payment for any Plan Year shall be made to the Participant in the first quarter of the fourth year following the Plan Year for which the award is earned. The Long-Term Payment earned for a Plan Year shall equal one-half of the Total Award for that Plan Year, increased or decreased to the same extent that the value of a share of Company common stock has increased or decreased for the Holding Period (based on the closing prices of the stock on the first and last day of the Holding Period, and adjusted by the CEO to reflect stock splits and other extraordinary events) and further increased to reflect Dividend Equivalents for the Holding Period. The "Holding Period" for a Long-Term Payment is the period beginning on last trading day of the Plan Year for which the payment was earned, and ending on the first trading day of the fourth year thereafter. The "Dividend Equivalents" for a Long-Term Payment for the Holding Period are the dividends that would be paid during the Holding Period on the number of shares of common stock of the Company that could be purchased with 50% of the Total Award, determined by dividing 50% of the Total Award by the closing price of the stock on the first day of the Holding Period, and adjusted by the CEO to reflect subsequent stock splits and other extraordinary events. For purposes of determining the Dividend Equivalents, it is assumed that the dividends are reinvested in a manner that is comparable to the manner of reinvesting dividends set forth in Illinova Corporation Automatic Reinvestment and Stock Purchase Plan; provided that dividends paid in the last six months of the Holding Period shall not be deemed to be reinvested; and further provided that if a Participant's employment with the Company and its affiliates terminates prior to the end of the Holding Period, the amount payable to the Participant will be adjusted so that dividends for the six-month period prior to the termination of employment are not deemed to be reinvested. If a Participant for any Plan Year ceases to be employed by the Company and its affiliates during the year for reasons of retirement after attaining age 55, disability (as determined by the CEO) or death, the Participant (or the Participant's beneficiary) shall be entitled to the amount of the Total Award for the year, pro-rated based on the number of months between the beginning of the Plan Year and the date of retirement, disability or death. The payment of such amount shall be made in the first quarter of the year following the year in which occurs the termination of employment because of retirement, disability or death. If a Participant for any Plan Year ceases to be employed by the Company and its affiliates during that year for reasons other than retirement after attaining age 55, disability (as determined by the CEO) or death, the Participant shall forfeit the Total Award for the year. If a Participant for any Plan Year ceases to be employed by the Company and its affiliates after the end of such Plan Year for any reason, the Participant's Short-Term Payment shall be unaffected by the termination of employment. If a Participant for any Plan Year ceases to be employed by the Company and its affiliates after the end of that Plan Year, and prior to the end of the Holding Period, for reasons of retirement after attaining age 55, disability (as determined by the CEO) or death, the Participant (or the Participant's beneficiary) shall be entitled to the Long-Term Payment, determined as though the Holding Period ended on the last business day of the Participant's employment. The payment of such amount shall be made as soon as practicable after termination of employment. If a Participant for any Plan Year ceases to be employed by the Company and its affiliates after the end of such Plan Year, and prior to the end of the Holding Period, for reasons other than retirement after attaining age 55, disability (as determined by the CEO) or death, the Participant shall forfeit the Long-Term Payment for the year. Administration The Plan shall be administered by the CEO; provided that, the Employee Services department shall have responsibility for the day-to-day administration of the Plan. Amendment and Termination The Plan may be amended or terminated by the Board of Directors of the Company at any time, except that no such amendment or termination adopted in any Plan Year shall adversely affect the awards of any Participant for that Plan Year or any prior Plan Year. EX-10.2 4 EX-10.2 Exhibit (a)(9) ILLINOVA CORPORATION BOARD OF DIRECTORS RESOLUTIONS WHEREAS, the continuation of the Retirement Plan for Outside Directors, except for those beneficiaries for whom the rights have already vested through retirement, is viewed as no longer desirable. THEREFORE, BE IT RESOLVED, that the Plan be terminated as to those directors not yet retired, and that benefits under the Plan continue to be paid to those otherwise qualified directors who have retired on or before the date of this resolution; and RESOLVED, that the proper officers of the Company are authorized and directed to adopt a new compensation plan for outside directors, in substantially the form presented to the meeting, in which such directors receive an annual award of stock units having a value of $6,000, to be paid to the beneficiary in cash on retirement in a lump sum or in installments, as such director may elect, together with dividend equivalents attributable to such stock units; and RESOLVED, that the proper officers of the Company are authorized and directed to make a cash payment to each current outside director equal to the present value of the payments such director would have received, had he or she retired under the Plan, based on each such director's actual years of service but not to exceed ten years of service; and RESOLVED, that the proper officers of the Company are authorized to take all such further action as may be necessary or desirable to effect the purpose and intent of the foregoing resolutions. EX-10.3 5 EX-10.3 Exhibit (a)(10) ILLINOIS POWER COMPANY BOARD OF DIRECTORS RESOLUTIONS WHEREAS, the Company and its Board of Directors believe it is in the best interests of the Company to make certain modifications to the Illinois Power Company Employee Retention Plan (the "Plan") and Agreements, to preserve the original purpose of the Plan and the Agreements, which is to facilitate the retention of the services of motivated officers and employees of the Company and to clarify certain administrative issues; RESOLVED, that pursuant to the amending authority reserved to the Board of Directors of the Company, the Plan and the Employee Retention Agreements are hereby amended, effective February 7, 1996, in the following respects: 1. Employees in Salary Band 4 who have not entered in separate Employee Retention Agreements with the Company shall be eligible for participation in the Plan. 2. The definition of "Good Reason" set forth in Section 3(a)(ii) of the Plan is hereby expanded to include a reduction in any material element of an eligible employee's compensation. 3. The definition of "Change in Control" set forth in Section 3(a)(iii) of the Plan and as set forth in the Agreements is hereby modified to clarify that the acquisition of stock by a trustee of any employee benefit plan maintained by the Company will not be treated as a Change in Control, and to clarify that in no event will a merger or other transaction result in a Change in Control if the Company's shareholders own at least 80 percent of the surviving entity. 4. Eligible employees who are terminated prior to a Change in Control at the request of a potential acquiror will be eligible for Plan, or Agreement, benefits. 5. The provision in Section 2 of the Plan and in the Agreements which authorizes the Board to determine, after the fact, that a transaction is not a Change in Control is hereby eliminated. 6. The Company, and its successors and assigns, waive any contract formation or other defenses it may otherwise be entitled to assert with respect to the Plan. RESOLVED, that the proper officers of the Company are hereby authorized and directed to do any and all acts and things and to execute and deliver any and all documents or instruments, including but not limited to the preparation and execution of an amended Plan document and of amended Agreements, as they shall deem necessary or appropriate to carry of the intent and purposes of the foregoing resolution. EX-10.4 6 EX-10.4 Exhibit (a)(11) AMENDMENT OF ILLINOVA CORPORATION DEFERRED COMPENSATION PLAN FOR CERTAIN DIRECTORS WHEREAS, Illinova Corporation (the "Company") maintains the Illinova Corporation Deferred Compensation Plan for Certain Directors (the "Plan"); and WHEREAS, the Company has determined that it would be beneficial to contract with Fidelity Institutional Retirement Service Company for provision of certain record keeping and administrative services in connection with the Plan, beginning on or about January 1, 1997, and, because of Fidelity Institutional Retirement Service Company's highly automated systems, Fidelity Institutional Retirement Service Company can promptly convert deferred funds into common stock (or equivalent stock units) so that Plan participants may be credited with common stock ownership immediately rather than on a quarterly basis as is currently provided in the Plan. NOW, THEREFORE, BE IT RESOLVED that the Plan is hereby amended by adding a new subsection (d) to Section 3, worded as follows: "(d) Notwithstanding the foregoing, if administrators of this Plan have the capability to convert funds in the Deferred Money Accounts sooner or more frequently than on a quarterly basis, conversions will be made as quickly as they may feasibly be accomplished." EX-10.5 7 EX-10.5 Exhibit (a)(12) AMENDMENT TO EMPLOYEE RETENTION AGREEMENT OF ILLINOVA CORPORATION WHEREAS, Illinova Corporation (Corporation) has entered into Employee Retention Agreements with certain of its employees (the "Agreements"); and WHEREAS, amendment of the Agreements is now deemed desirable; NOW, THEREFORE, BE IT RESOLVED that, pursuant to the amending authority reserved to the Corporation in paragraph 8 of each of the Agreements, each Agreement is hereby amended by adding the following sentence at the end of paragraph 1 thereof: "Notwithstanding any provision in this Agreement to the contrary, the benefits under this paragraph 1 shall be in lieu of, and not in addition to, any benefits to which the Eligible Employee might otherwise be entitled under any other severance plan maintained by the Company." EX-10.6 8 EX-10.6 Exhibit (a)(13) AMENDMENT OF ILLINOVA CORPORATION DEFERRED COMPENSATION PLAN FOR CERTAIN DIRECTORS WHEREAS, Illinova Corporation (the "Company") maintains the Illinova Corporation Company Deferred Compensation Plan for Certain Directors (the "Plan"); and WHEREAS, amendment of the Plan is now deemed desirable; NOW, THEREFORE, BE IT RESOLVED that, pursuant to the amending authority reserved to the Corporation in Section 6 of the Plan, the Plan is hereby amended by substituting the following for Section 4 of the Plan: "4. Distribution. (a) As of a Participant's Date of Termination, the number of stock units in his Stock Unit Account shall be converted to a dollar value, which shall be determined by multiplying the number of stock units in such Account as of his Date of Termination by the closing market composite price per share of the Company's Common Stock as reported on the New York Stock Exchange Composite Tape as of the last day of the month immediately preceding such Date of Termination or, if such shares are not traded on that date, on the next preceding date on which shares were traded. Such dollar value, in addition to the balance in the Participant's Deferred Money Account, if any, is the Participant's "Account Value". For purposes of this Section 4, a Participant's `Date of Termination' means the last day on which the Participant ceases to serve as a member of the Company's Board of Directors. (b) Payment of a Participant's Account Value shall be made solely in cash and shall be made, or commence to be made, as soon as practicable following the Participant's Date of Termination, as follows: (i) in a lump sum payment; or (ii) in ten or fewer annual installments, as elected by the Participant; provided, however, any such election that has not been on file with the Committee at least 12 months prior to the Participant's Date of Termination shall be disregarded and payments shall be made in accordance with the Participant's most recent election form that has been on file with the Committee at least 12 months, or if no such election has been filed, in accordance with paragraph (i) next above. (c) In the event of a Participant's death before he has received payment of his full Account Value, the remaining unpaid Account Value shall be paid to his designated beneficiary or beneficiaries as soon as practicable thereafter in a lump sum. If no designated beneficiary has been named or survives the Participant, the beneficiary will be the Participant's estate." EX-10.7 9 EX-10.7 Exhibit (b)(11) AMENDMENT OF ILLINOIS POWER COMPANY EXECUTIVE INCENTIVE COMPENSATION PLAN (As Amended and Restated Effective as of January 1, 1992) WHEREAS, Illinois Power Company (the "Company") maintains the Illinois Power Company Executive Incentive Compensation Plan (the "Plan"); and WHEREAS, amendment of the Plan is now deemed desirable; NOW, THEREFORE, IT IS RESOLVED that, by virtue and in exercise of the amending authority reserved to the Company under the Plan, the Plan is hereby amended, effective January 1, 1997, by substituting the following for the "Eligibility" section of the Plan: "Eligibility The Board of Directors of the Company (the 'Board'), in its discretion, shall designate those elected officers of the Company who will participate in the Plan for each Plan Year, which is the calendar year. The Board of Directors of each Subsidiary (as defined below), in its discretion, shall designate those officers of such Subsidiary who will participate in the Plan for each Plan Year. The Participants for each Plan Year normally will be designated by the applicable Board of Directors prior to the beginning of the year; provided, however, for the Plan Year beginning January 1, 1997, Participants who are employed by a Subsidiary may be designated by the Board of Directors of such Subsidiary no later than [February 28, 1997]. If an individual is designated as a Participant in the middle of a Plan Year, the Participant's award will be pro-rated based upon the number of completed months of service between the date of eligibility and the end of the Plan Year. For purposes of the Plan, 'Subsidiary' means any company during any period in which it is a 'subsidiary corporation' as that term is defined in section 424(f) of the Internal Revenue Code with respect to the Company." EX-10.8 10 EX-10.8 Exhibit (b)(12) AMENDMENT OF ILLINOIS POWER COMPANY EXECUTIVE DEFERRED COMPENSATION PLAN WHEREAS, Illinois Power Company (the "Company") maintains the Illinois Power Company Executive Deferred Compensation Plan (the "Plan"); and WHEREAS, amendment of the Plan is now deemed desirable; NOW, THEREFORE, BE IT RESOLVED that, pursuant to the amending authority reserved to the Corporation in Section 8 of the Plan, the Plan is hereby amended in the following particulars: 1. By substituting the following for subsection 3.5 of the Plan: "3.5 Employee Selection of Investment Return Rate. Subject to the terms of the Plan, a Participant may elect the Investment Return Rate(s) that will apply to all of his Accounts from time to time by filing an election in accordance with such rules as the Plan Administrator may establish regarding the form and timing of such elections, including to the extent provided by the Plan Administrator rules relating to daily Investment Return Rate changes and telephonic filing of elections. To the extent permitted by the Committee, the Participant may elect to have different Investment Return Rates apply to different portions of his Account balances." 2. By substituting the phrase "Employee Services Department" for the phrase "Employee Relations Department" where the latter phrase appears in paragraph 7.2(b) of the Plan. EX-10.9 11 EX-10.9 Exhibit (b)(13) AMENDMENT OF SUPPLEMENTAL RETIREMENT INCOME PLAN FOR SALARIED EMPLOYEES OF ILLINOIS POWER COMPANY WHEREAS, Illinois Power Company (the "Company") maintains the Supplemental Retirement Income Plan for Salaried Employees of Illinois Power Company (the "Plan"); and WHEREAS, amendment of the Plan is now deemed desirable; NOW, THEREFORE, BE IT RESOLVED that, pursuant to the amending authority reserved to the Corporation in Section 6.1 of the Plan, the Plan is hereby amended by substituting the following for Section 1.5 of the Plan: "1.5 `Participant' means an elected officer of the Company and any officer of a Subsidiary designated as a Participant by the Company's Chairman of the Board of Directors who is a participant under the Qualified Plan and to whom or with respect to whom a benefit is payable under the Plan. `Subsidiary' means (i) any company during any period in which it is a member of a controlled group of corporations (as defined in Section 414(b) of the Code) that includes the Company; (ii) any trade or business (whether or not incorporated) that is under common control (as defined in Section 414(c) of the Code) with the Company; and (iii) any corporation or other entity that is a member of an affiliated service group (as defined in Section 414(m) of the Code) that includes the Company." EX-10.10 12 EX-10.10 Exhibit (b)(14) June 30, 1997 Mr. Wilfred Connell 2899 Forrest Lane Decatur, IL 62521 Dear Wilfred: This letter represents the full and complete terms of the agreement between Wilfred Connell and Illinois Power (Company) regarding your retirement from the Company. 1. You will remain an active employee of the Company, at your present monthly rate of $16,000, through July 31, 1997. During this period you will continue to report to John Cook and will be assigned projects as appropriate. 2. You agree to make yourself available to perform consulting services for the Company during the period August 1, 1997 through December 31, 1997 as may be requested by the Company from time to time. The Company will give you advance notice when consulting services are required and agrees that such consulting services will not require more than 60 hours of your time in any month and will not exceed 300 hours in total. In consideration of the consulting services to be provided under this paragraph 2 and the other covenants contained in this Agreement, within 15 days after July 31, 1997, the Company will pay you a lump sum payment of $80,000. This payment will not be treated as compensation for purposes of any retirement or other benefit plan maintained by the Company. 3. On August 1, 1997 your status will change from active to retired. 4. You and your spouse are entitled to active employee medical in retirement. 5. Based on your age at retirement, life insurance of $112,000 per year will be provided. 6. Long Term Incentives are divided into two components: SVA Award and Stock Options. SVA Award: Performance permitting, you will receive your previously earned SVA Award(s) on the regular payout cycle based on previously established goals. Stock Options: Unvested options will continue to vest in accordance with our preestablished schedule. Vested options must be exercised before your fifth anniversary after retirement. 7. Executive Incentive Compensation: Vested awards and deferred compensation will be distributed according to your previous declarations. 8. Executive tax assistance and financial planning are available to you as a retiring officer for the reminder of 1997 and calendar years 1998 and 1999, not to exceed $2500 per year. 9. Outplacement assistance of up to $1000 will be reimbursed for expenses you incur prior to August 1, 1998. 10. In the event the NRC determines individual enforcement is appropriate for events that occurred on June 2, 1997, Illinois Power will provide appropriate legal representation to aid you in defense of NRC enforcement actions. 11. Your company vehicle must be returned to the Headquarter's parking garage by August 1, 1997. 12. You must make the proper arrangements for out processing according to Clinton Power Station Procedure. 13. The total monthly benefit you are entitled to with a August 1, 1997 retirement date is $3594.16 consisting of $2900.05 from the Qualified Plan and $694.11 from the Supplemental Retirement Income Plan (Plan). Additionally, by special Amendment to the Plan, an additional supplemental monthly payment of $765.58 will be paid through the Plan. A contingent annuity options available for your qualified benefit. The amount payable to you through the Plan is only paid while you are living. 14. You understand and agree that the benefits provided under this Agreement exceed those to which you would otherwise be entitled and Illinois Power shall not be obligated to pay you any additional compensation or to provide any additional benefits to you except as provided in this Agreement or as required by law. 15. In consideration of the foregoing, you, on behalf of yourself, your heirs, agents, successors, representatives and assigns, hereby release Illinois Power, its past, present and future officers, directors,, employees, agents and representatives and their successors and assigns, from any and all claims of whatever sort which you had or now have against each or any one of them relating in any way to or arising out of your employment with Illinois Power or the severance thereof, including, but not limited to, any claims of age discrimination under the Age Discrimination in Employment Act or other statute, constructive discharge, wrongful termination, or any other claims under any federal, state or local statute, ordinance or common law. Nothing in this paragraph shall be construed to release any claims or waive any right to sue arising out of violations of this Agreement or acts subsequent to the date of this Agreement. You are advised to consult with your attorney prior to signing this Agreement. Illinois Power, on behalf of itself and its past, present and future officers, directors, employees, agents and representatives hereby releases you from any and all claims of whatever sort which they had or now have against you relating in any way to or arising out of your employment with Illinois Power. Nothing in this paragraph shall be construed to release any claims or waive any right to sue arising out of violations of this Agreement or acts subsequent to the date of this Agreement. You agree that, except as required by law, you will not use or disclose any non-public information about the company, and that you will promptly return all materials containing confidential material about the Company which still may be in your possession. You also agree to cooperate with the company in any third party lawsuits or other claims involving the Company, to the extent that the claims relate to your work for the Company, and the Company will provide you with reasonable compensation for the time you spend in connection with such cooperation. If you concur with the terms of this Agreement, please sign and date in the appropriate place below. Sincerely, /s/Larry D. Haab Larry D. Haab Accepted and agreed to this 30 day of June, 1997 /s/Wilfred Connell Wilfred Connell EX-12.1 13 EX-12.1 Exhibit (12)(a) ILLINOVA CORPORATION STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Thousands of Dollars) Year ended December 31, Supplemental** Supplemental*** ------------------------------------------------------------------------------------- 1992 1993 1993 1994 1995 1996 1997 1997 ---- ---- ---- ---- ---- ---- ---- ---- Earnings Available for Fixed Charges: Net Income (Loss).................... $ 93,234 ($ 81,874) ($ 81,874) $ 151,786 $ 151,601 $ 191,021 ($ 90,553) ($ 90,553) Add: Income Taxes: Current ..................... 22,930 25,260 25,260 58,354 98,578 163,873 70,975 70,975 Deferred - Net............... 63,739 82,057 82,057 71,177 34,137 (16,028) 36,963 36,963 Allocated income taxes ........ (6,632) (12,599) (12,599) (8,285) (11,851) (12,641) (20,345) (20,345) Investment tax credit - deferred (519) (782) (782) (11,331) (6,894) (7,278) (7,278) (7,278) Income tax effect of disallowed costs -- (70,638) (70,638) -- -- -- -- -- Income tax effect of FAS 71 write-off ... -- -- -- -- -- -- (117,998) (117,998) Interest on long-term debt....... 160,795 154,110 154,110 135,115 125,581 118,438 116,137 116,137 Amortization of debt expense and premium-net, and other interest charges 12,195 17,007 17,007 15,826 29,558 24,031 27,984 27,984 One-third of all rentals (Estimated to be representative of the interest component) 5,117 5,992 5,992 5,847 5,221 4,346 4,229 4,229 Interest on in-core fuel 8,278 6,174 6,174 7,185 6,716 4,757 3,842 3,842 Disallowed Clinton plant costs... -- -- 270,956 -- -- -- -- -- FAS 71 Regulatory Write-Offs..... -- -- -- -- -- -- -- 313,030 --------- --------- --------- --------- --------- -------- --------- -------- Earnings (loss) available for fixed $ 359,137 $ 124,707 $ 395,663 $ 425,674 $ 432,647 $ 470,519 $ 23,956 $ 336,986 charges ========= ========= ========= ======== ======== ========= ========= ========= Fixed charges: Interest on long-term debt $ 160,795 $ 154,110 $ 154,110 $ 135,115 $ 125,581 $ 118,438 $ 116,137 $ 116,137 Amortization of debt expense and premium-net, and other interest charges 25,785 27,619 27,619 25,381 38,147 30,663 32,928 32,928 One-third of all rentals (Estimated to be representative of the interest component) 5,117 5,992 5,992 5,847 5,221 4,346 4,229 4,229 --------- -------- -------- --------- --------- --------- --------- --------- Total Fixed Charges........................ $ 191,697 $ 187,721 $ 187,721 $ 166,343 $ 168,949 $ 153,447 $ 153,294 $ 153,294 ========= ========= ========= ========= ========= ========= ========= ========= Ratio of earnings to fixed charges 1.87 0.66* 2.11 2.56 2.56 3.07 0.16* 2.20 ========= ========= ======== ========= ========= ========= ========= ========= * Earnings are inadequate to cover fixed charges. Additional earnings (thousands) for 1993 and 1997 of $63,014 and $129,338, respectively, are required to attain a one-to-one ratio of Earnings to Fixed Charges. ** Supplemental ratio of earnings to fixed charges presented to exclude nonrecurring item - Disallowed Clinton plant costs. *** Supplemental ratio of earnings to fixed charges presented to exclude write-off related to the discontinued application of SFAS 71, "Accounting for the Effects of Certain Types of Regulation" for the generation segment of the business.
EX-12.2 14 EX-12.2 Exhibit (12)(b) ILLINOIS POWER COMPANY STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Thousands of Dollars) Year Ended December 31, Supplemental** Supplemental*** ------------------------------------------------------------------------------------------------------- 1992 1993 1993 1994 1995 1996 1997 1997 ---- ---- ---- ---- ---- ---- ---- ---- Earnings Available for Fixed Charges: Net Income (Loss) $ 122,088 ($ 56,038) ($ 56,038) $ 180,242 $ 182,713 $ 228,618 ($ 65,669)($ 65,669) Add: Income Taxes: Current 22,930 25,260 25,260 58,354 98,578 163,873 72,680 72,680 Deferred - Net 63,739 82,057 82,057 71,177 34,137 (16,028) 36,963 36,963 Allocated income taxes (6,632) (12,599) (12,599) (8,285) (8,417) (2,642) (1,446) (1,446) Investment tax credit - deferred (519) (782) (782) (11,331) (6,894) (7,278) (7,278) (7,278) Income tax effect of disallowed costs -- (70,638) (70,638) -- -- -- -- -- Income tax effect of FAS 71 write-off -- -- -- -- -- -- (117,998) (117,998) Interest on long-term debt 160,795 154,110 154,110 135,115 125,581 118,438 109,595 109,595 Amortization of debt expense and premium-net, and other interest charges 12,195 17,007 17,007 15,826 29,558 22,325 26,260 26,260 One-third of all rentals(Estimated to be representative of the interest component) 5,117 5,992 5,992 5,847 5,221 4,346 4,229 4,229 Interest on in-core fuel 8,278 6,174 6,174 7,185 6,716 4,757 3,842 3,842 Disallowed Clinton plant costs -- -- 270,956 -- -- -- -- -- FAS 71 Regulatory Write-Offs -- -- -- -- -- -- -- 313,030 --------- --------- --------- --------- --------- --------- --------- --------- Earnings (loss) available for fixed charges $ 387,991 $ 150,543 $ 421,499 $ 454,130 $ 467,193 $ 516,409 $ 61,178 $ 374,208 ========= ========= ========= ========= ========= ========= ========= ========= Fixed charges: Interest on long-term debt $ 160,795 $ 154,110 $ 154,110 $ 135,115 $ 125,581 $ 118,438 $ 109,595 $ 109,595 Amortization of debt expense and premium-net, and other interest charges 25,785 27,619 27,619 25,381 38,147 28,957 31,204 31,204 One-third of all rentals (Estimated to be representative of the interest component) 5,117 5,992 5,992 5,847 5,221 4,346 4,229 4,229 --------- --------- --------- --------- --------- --------- --------- --------- Total Fixed Charges $ 191,697 $ 187,721 $ 187,721 $ 166,343 $ 168,949 $ 151,741 $ 145,028 $ 145,028 ========= ========= ========= ========= ========= ========= ========= ========= Ratio of earnings to fixed charges 2.02 0.80 * 2.25 2.73 2.77 3.40 0.42 * 2.58 ========= ========= ========= ========= ========= ========= ========= ========= * Earnings are inadequate to cover fixed charges. Additional earnings (thousands) for 1993 and 1997 of $63,014 and $83,850, respectively, are required to attain a one-to-one ratio of Earnings to Fixed Charges. ** Supplemental ratio of earnings to fixed charges presented to exclude nonrecurring item - Disallowed Clinton plant costs. *** Supplemental ratio of earnings to fixed charges presented to exclude write-off related to the discontinued application of SFAS 71, "Accounting for the Effects of Certain Types of Regulation" for the generation segment of the business.
EX-13.1 15 EX-13.1 1997 PROXY STATEMENT AND ANNUAL REPORT TO SHAREHOLDERS UNLOCKING THE POWER 1997 NOTICE OF ANNUAL MEETING OF SHAREHOLDERS Proxy Statement Table of Contents Notice of Annual Meeting 2 Proxy Statement 3 Appendix: 1997 Annual Report to Shareholders a-1 To the Shareholders of Illinova Corporation: Notice is Hereby Given that the Annual Meeting of Shareholders of Illinova Corporation ("Illinova") will be held at 10 a.m. Wednesday, April 8, 1998, at Shilling Community Education Center, Richland Community College, One College Park, Decatur, Illinois 62521, for the following purposes: (1) To elect the Board of Directors for the ensuing year. (2) To transact any other business which may properly come before the meeting or any adjournment. Shareholders of record at the close of business on February 9, 1998, will be entitled to receive notice of and to vote at the Annual Meeting. By Order of the Board of Directors, Leah Manning Stetzner, General Counsel and Corporate Secretary Decatur, Illinois March 10, 1998 IMPORTANT Illinova invites each of its approximately 35,000 shareholders to attend the Annual Meeting. Shareholders will be admitted on verification of record share ownership at the admission desk. Shareholders who own shares through banks, brokerage firms, nominees or other account custodians must present proof of beneficial share ownership (such as a brokerage account statement) at the admission desk. If you are unable to be present at the meeting, it is important that you sign and return the enclosed proxy, no matter how many shares you own. An envelope on which postage will be paid by Illinova is enclosed for that purpose. Return of your executed proxy will ensure that you are represented at the Annual Meeting. Your cooperation is appreciated. PROXY STATEMENT Solicitation and Revocation of Proxies This Proxy Statement is furnished in connection with a solicitation of proxies by the Board of Directors of Illinova, for use at the Annual Meeting of Shareholders to be held at Shilling Community Education Center, Richland Community College, One College Park, Decatur, Illinois 62521, at 10 a.m. Wednesday, April 8, 1998, and at any adjournment thereof (the "Annual Meeting"). Any shareholder giving a proxy may revoke it at any time by giving a later proxy or by giving written notice of revocation to the Corporate Secretary of Illinova prior to the Annual Meeting. All duly executed proxies received prior to the Annual Meeting will be voted. Shares credited to the accounts of participants in Illinova's Investment Plus Plan and Illinois Power Company's Incentive Savings Plans will be voted in accordance with the instructions of the participants or otherwise in accordance with the terms of those plans. Voting Rights Shareholders of record at the close of business on Monday, February 9, 1998 (the "Record Date"), will be entitled to receive notice of and to vote at the Annual Meeting. As of that date, Illinova had outstanding 71,701,937 shares of Common Stock. Shareholders who are present at the Annual Meeting in person or by proxy will be entitled to one vote for each share of Illinova's Common Stock which they held of record at the close of business on the Record Date. When voting for candidates nominated to serve as directors, all shareholders will be entitled to 11 votes (the number of directors to be elected) for each of their shares and may cast all of their votes for any one candidate whose name has been placed in nomination prior to the voting, or distribute their votes among two or more such candidates in such proportions as they determine. In voting on other matters presented for consideration at the Annual Meeting, each shareholder will be entitled to one vote for each share of Common Stock held of record at the close of business on the Record Date. The affirmative vote of the holders of a majority of the shares of Common Stock present in person or represented by proxy and entitled to vote at the Annual Meeting is required for the election of directors. Annual Report, Proxy and Proxy Statement Accompanying this Proxy Statement, which includes Consolidated Financial Statements, is a Notice of Annual Meeting of Shareholders, a form of Proxy and the Summary Annual Report to Shareholders covering operations of Illinova for the year 1997. This Proxy Statement and accompanying documents are first being mailed to shareholders on or about March 10, 1998. Board of Directors Information Regarding the Board of Directors The Board of Directors held eight Board meetings during 1997. Other than Mr. Adorjan, who joined the Board in August 1997, and Mr. Berry, who retired from the Board December 1, 1997, all directors attended at least 75 percent of the aggregate meetings of the Board and Committees of which they were members during 1997. The Board has three standing committees: the Audit Committee, the Finance Committee, and the Compensation and Nominating Committee. The duties and members of the standing committees are: Audit Committee (1) Review with the Chairman, President and Chief Executive Officer and the independent accountants the scope and adequacy of Illinova's system of internal controls; (2) review the scope and results of the annual examination performed by the independent accountants; (3) review the activities of Illinova's internal auditors; (4) report its findings to the Board and provide a line of communication between the Board and both the internal auditors and the independent accountants; and (5) recommend to the Board the appointment of the independent accountants and approval of the services performed by the independent accountants, considering their independence with regard thereto. The Audit Committee met three times during 1997. This Committee consists of the following non-employee directors ("Outside Directors"): Robert M. Powers, Chairman, Richard R. Berry, C. Steven McMillan, Sheli Z. Rosenberg, Walter M. Vannoy, and Marilou von Ferstel. Finance Committee (1) Review management's cash flow forecasts, financial forecasts and financing program, and make recommendations to the Board regarding the approval of such plans; (2) review Illinova's banking relationships, short-term borrowing arrangements, dividend policies, arrangements with the transfer agent and registrar, investment objectives and the performance of Illinois Power's pension and other trust funds, evaluate fund managers, and make recommendations to the Board concerning such matters; (3) review Illinova's risk management programs, including insurance coverage, and make recommendations to the Board; and (4) act in an advisory capacity to management, the Board of Directors, and the Chairman, President and Chief Executive Officer on other financial matters as they may arise. The Finance Committee met three times during 1997. This Committee consists of the following members of the Board: Walter D. Scott, Chairman, J. Joe Adorjan, Richard R. Berry, Larry D. Haab, C. Steven McMillan, Sheli Z. Rosenberg, Marilou von Ferstel, and John D. Zeglis. Compensation and Nominating Committee (1) Review performance and recommend salaries plus other forms of compensation of elected Illinova officers and the Board of Directors; (2) review Illinova's benefit plans for elected Illinova officers and make recommendations to the Board regarding any changes deemed necessary; (3) review with the Chairman, President and Chief Executive Officer any organizational or other personnel matters; and (4) recommend to the Board nominees to stand for election as director to fill vacancies on the Board of Directors as they occur. The Compensation and Nominating Committee will consider shareholders' recommendations for nominees for director made pursuant to timely notice in writing addressed to the Chairman of the Committee at the executive offices of Illinova. The recommendation should include a full description of the qualifications and business and professional experience of the proposed nominees and a statement of the nominees' willingness to serve. To be timely, the notice must be delivered to or mailed and received at the executive offices of Illinova not less than 90 nor more than 120 days prior to the Annual Meeting. The Compensation and Nominating Committee met seven times during 1997. This Committee consists of the following Outside Directors: Ronald L. Thompson, Chairman, J. Joe Adorjan, C. Steven McMillan, Robert M. Powers, Walter D. Scott, Marilou von Ferstel, and John D. Zeglis. Board Compensation The Outside Directors of Illinova receive a retainer fee of $18,000 per year. Outside Directors who also chair Board Committees receive an additional $2,000, increased in February 1998 to $2,500, per year retainer. Outside Directors receive a grant of 650 shares of Common Stock on the date of each Annual Shareholders Meeting, representing payment in lieu of attendance-based fees for all Board and Committee meetings to be held during the subsequent one-year period. Outside Directors elected to the Board between Annual Shareholders Meetings are paid $850 for each Board and Committee meeting attended prior to the first Annual Shareholders Meeting after their election to the Board. Illinova had a Retirement Plan for Outside Directors. Under this plan, each Outside Director who attained age 65 and served on the Board for a period of 60 or more consecutive months was eligible for annual retirement benefits at the rate of the annual retainer fee in effect when the director retired. In 1996, the Board of Directors adopted a Comprehensive Deferred Stock Plan for Outside Directors, replacing the Retirement Plan. Each former Outside Director whose right to receive the retirement benefit had vested continues to receive such benefits in accordance with the terms of the Retirement Plan. All Outside Directors serving at the time this new plan was adopted were granted a lump sum amount based on the net present value of these benefits to them, were they to have retired under the Retirement Plan, based on the number of years they have served on the Board but not to exceed 10. This dollar amount was converted into stock units, based on the then market value of Illinova Common Stock, and placed into an account. The value of these stock units is to be paid out to the director in cash on termination of service, based on the then market value of Illinova Common Stock, plus dividend equivalents, in a lump sum or installments. In addition, each Outside Director receives an annual award of stock units having a value of $6,000, to be paid to the Outside Director in cash on retirement, at once or in installments as the director may elect, with the amount of such payment determined by multiplying the number of stock units in the account times the then market value of Illinova Common Stock, and adding the dividend equivalents attributable to such stock units. Pursuant to Illinova's Deferred Compensation Plan for Certain Directors, the Outside Directors may elect to defer all or any portion of their fees and stock grants until termination of their services as directors. Such deferred amounts are converted into stock units representing shares of Illinova's Common Stock with the value of each stock unit based on the last reported sales price of such stock. Additional credits are made to the participating director's account in dollar amounts equal to the dividends paid on Common Stock which the director would have received if the director had been the record owner of the shares represented by stock units, and these amounts are converted into additional stock units. On termination of the participating directors' services as directors, payment of their deferred fees and stock grants was made in shares of Common Stock in an amount equal to the aggregate number of stock units credited to their accounts. The plan was amended in 1997 to provide for a payout in cash instead of shares of Common Stock. Deferred amounts are still converted into stock units representing shares of Common Stock with the value of each stock unit based on the last reported sales price of such stock. Payment is made in cash, in a lump sum or installments, as soon as practical following a director's termination. The cash paid on termination equals the number of stock units times the share price at the close of market on the last business day of the month preceding termination. No other payments are made after service on the Board ceases. Election of Directors Illinova's entire Board of Directors is elected at each Annual Meeting of Shareholders. Directors hold office until the next Annual Meeting of Shareholders or until their successors are elected and qualified. At the Annual Meeting a vote will be taken on a proposal to elect the 11 directors nominated by Illinova's Board of Directors. The names and certain additional information concerning each of the director nominees is set forth on the following pages. The dates shown for service as a director include service as a director of Illinois Power prior to the May 1994 restructuring in which Illinois Power became a subsidiary of Illinova. If any nominee should become unable to serve as a director, another nominee may be selected by the current Board of Directors. Walter M. Vannoy would normally have not been eligible for election as a director at the Annual Meeting of Shareholders pursuant to a Bylaw provision which mandates retirement from Board service at age 70. Because there is a current need for his nuclear expertise, the Board of Directors has elected to waive this requirement in Mr. Vannoy's case, and he has agreed to serve if elected. BOARD OF DIRECTORS Name of Director Nominee, Age, Year in Which First Business Experience and Elected a Director Other Information of Illinova J. Joe Adorjan, 59 1997 Chairman and Chief Executive Officer of Borg-Warner Security Corporation, Chicago, Ill., a security systems services firm, since 1995. He was President of Emerson Electric Company from 1993 to 1995. Prior to that, he was Chairman and Chief Executive Officer of ESCO Electronics Corporation. He is a director of The Earthgrains Company, ESCO Electronics Corporation and Goss Graphics Systems, Inc. Larry D. Haab, 60 1986 Chairman, President, and Chief Executive Officer of Illinova since December 1993, and of Illinois Power since June 1991, and an employee of Illinois Power since 1965. He is a director of First Decatur Bancshares, Inc.; The First National Bank of Decatur; and Firstech, Incorporated. C. Steven McMillan, 52 1996 President, Chief Operating Officer, and Director of Sara Lee Corporation, Chicago, Ill., a global packaged food and consumer products company, since 1997. He was Executive Vice President of Sara Lee from 1993 to 1997 and Senior Vice President-Strategy Development from 1986 to 1993. He is Chairman of the Board of Electrolux Corporation. Robert M. Powers, 66 1984 From 1980 until retirement in December 1988, Mr. Powers was President and Chief Executive Officer of A. E. Staley Manufacturing Company, Decatur, Ill., a processor of grain and oil seeds. He is a director of A. E. Staley Manufacturing Company. Sheli Z. Rosenberg, 56 1997 President and Chief Executive Officer since 1994 and General Counsel 1980 to 1994 of Equity Group Investments, Inc., Chicago, Ill., a privately held business conglomerate holding controlling interests in nine publicly traded corporations involved in basic manufacturing, radio stations, retail, insurance, and real estate. She is a director of American Classic Voyages Company; Quality Food Centers, Inc.; Jacor Communications, Inc.; Anixter International, Inc.; Equity Office Properties Trust; Equity Residential Properties Trust; CVS Corporation; and Manufactured Home Communities, Inc. Walter D. Scott, 66 1990 Professor of Management and Senior Austin Fellow, J. L. Kellogg Graduate School of Management, Northwestern University, Evanston, Ill., since 1988. He was Chairman of GrandMet USA from 1984 to 1986 and President and Chief Executive Officer of IDS Financial Services from 1980 to 1984. He is a director of Chicago Title and Trust Company, Chicago Title Insurance Company, Neodesic Corporation, Orval Kent Holding Company, Inc., and Intermatic Incorporated. Joe J. Stewart, 59 1998 President of BWX Technologies, Inc., formerly The Babcock & Wilcox Government Group, Lynchburg, Va., a diversified energy equipment and services company, and Executive Vice President of McDermott International, Inc. (parent of BWX Technologies, Inc. and The Babcock & Wilcox Company), since 1995. He was President and Chief Operating Officer of The Babcock and Wilcox Company and Executive Vice President of McDermott International, Inc., from 1993 to 1995 and Executive Vice President of the Power Generation Group of The Babcock and Wilcox Company from 1987 to 1993. Ronald L. Thompson, 48 1991 Chairman and Chief Executive Officer of Midwest Stamping and Manufacturing Co., Bowling Green, Ohio, a manufacturer of automotive parts, since 1993. He was President and Chief Executive Officer and a director of The GR Group, Inc., St. Louis, Mo., from 1980 to 1993. He is a director of Teachers Insurance and Annuity Association, and Ryerson Tull. Walter M. Vannoy, 70 1990 Chairman until retirement in May 1995 and Chief Executive Officer from May 1994 until January 1995 of Figgie International, Inc., Willoughby, Ohio, a diversified operating company serving consumer, industrial, technical, and service markets world-wide. From 1980 to 1988 he was President and Chief Operating Officer, Babcock and Wilcox, and Vice Chairman of McDermott International. Marilou von Ferstel, 60 1990 Executive Vice President and General Manager of Ogilvy Adams & Rinehart, Inc., a public relations firm in Chicago, Ill., from June 1990 until retirement in April 1997. She was Managing Director and Senior Vice President of Hill and Knowlton, Chicago, Ill., from 1981 to 1990. She is a director of Walgreen Company. John D. Zeglis, 50 1993 President of AT&T, Basking Ridge, N.J., a diversified communications company, since October 1997. He was Vice Chairman from June 1997 to October 1997, Senior Executive Vice President and General Counsel, from 1995 to June 1997 and Senior Vice President - General Counsel and Government Affairs from 1989 to 1995. He is a director of the Helmerich & Payne Corporation. Security Ownership of Management and Certain Beneficial Owners The table below shows shares of Illinova Common Stock beneficially owned as of January 31, 1998, by each director nominee, executive officers named in the Summary Compensation Table, and entities owning more than 5 percent. Number Number of Stock of Shares Units in Deferred Name of Beneficially Compensation Percent Beneficial Owner Owned (1)(2) Plans of Class J. Joe Adorjan 0 0 (3) Larry D. Haab 68,250 0 (3) C. Steven McMillan 1,300 289 (3) Robert M. Powers 8,550 289 (3) Sheli Z. Rosenberg 0 1,539 (3) Walter D. Scott 5,150 289 (3) Joe J. Stewart 0 0 (3) Ronald L. Thompson 3,677 3,275 (3) Walter M. Vannoy 5,010 289 (3) Marilou von Ferstel 4,420 1,603 (3) John D. Zeglis 2,626 1,603 (3) Paul L. Lang 21,216 0 (3) Larry F. Altenbaumer 13,092 0 (3) John G. Cook 11,894 0 (3) Robert A. Schultz 8,551 0 (3) Hotchkis & Wiley (4) 6,321,233 8.8% Merrill Lynch Asset Management, L.P.(5) 6,321,253 8.8% State of Michigan Retirement Systems(6) 3,714,300 5.18% (1) With sole voting and/or investment power. (2) Includes the following shares issuable pursuant to stock options exercisable March 31, 1998: Mr. Haab, 56,900; Mr. Lang, 17,800; Mr. Altenbaumer, 17,800; Mr. Cook, 9,900; and Mr. Schultz, 6,750. (3) No director or executive officer owns any other equity securities of Illinova or as much as 1% of the Common Stock. As a group, directors and executive officers of Illinova and Illinois Power own 187,021 shares of Common Stock (less than 1%). (4) With sole voting and dispositive power, as of January 31, 1998, Hotchkis & Wiley, 800 W. 6th Street, 5th Floor, Los Angeles, CA 90017. (5) With shared voting and dispositive power, per February 2, 1998, Schedule 13G, Merrill Lynch Asset Management, L.P., 800 Scudders Mill Road, Plainsboro, NJ 08536. (6) With sole voting and dispositive power, as of January 31, 1998, State of Michigan Retirement Systems, 430 W. Allegan, Lansing, MI 48909. Executive Compensation The following table sets forth a summary of the compensation of the Chief Executive Officer and the four other most highly compensated executive officers of Illinova subsidiaries for the years indicated. The compensation shown includes all compensation paid for service to Illinova and its subsidiaries, including Illinois Power, Illinova Generating Company, and Illinova Energy Partners. Summary Compensation Table Long-Term Compensation Annual Compensation Awards Other Restricted Securities All Other Bonus Annual Stock Awards Underlying Compensation Name and Principal Position Year Salary (1) Compensation (2) Options (3) Larry D. Haab 1997 $514,952 $41,840 $ 16,557 $ 41,840 20,000 shs. $2,614 Chairman, President and 1996 493,709 69,267 15,973 69,267 22,000 shs. 2,615 Chief Executive Officer of 1995 472,250 91,144 19,088 91,144 20,000 shs. 2,550 Illinova and Illinois Power Paul L. Lang 1997 $242,325 $ 10,602 $ 8,305 $ 10,601 6,500 shs. $2,615 Senior Vice President 1996 233,450 19,747 8,863 19,747 6,500 shs. 2,595 of Illinois Power 1995 222,812 23,841 8,265 23,841 6,500 shs. 2,510 Larry F. Altenbaumer 1997 $232,048 $ 8,992 $ 9,521 $ 8,992 6,500 shs. $1,985 Chief Financial Officer, 1996 222,374 19,832 8,459 19,832 7,500 shs. 1,976 Treasurer and Controller 1995 204,937 20,391 7,686 20,391 6,500 shs. 2,378 of Illinova, and Senior Vice President and Chief Financial Officer of Illinois Power John G. Cook 1997 $203,413 $ - $ 7,642 $ - 6,000 shs. $ 2,575 Senior Vice President 1996 196,474 16,293 7,409 16,293 6,500 shs. 2,575 and former chief nuclear 1995 179,069 16,620 6,930 16,620 4,500 shs. 2,530 officer of Illinois Power Robert A. Schultz 1997 $185,560 $ - $ 8,480 $ - 6,000 shs. $ 2,214 Vice President of Illinois 1996 176,170 23,604 6,957 23,604 6,500 shs. 2,114 Power, formerly President 1995 150,000 20,539 7,316 20,639 4,000 shs. 2,584 of Illinova Energy Partners
(1) The amounts shown in this column are the cash award portion of grants made to these individuals under the Executive Incentive Compensation Plan ("Compensation Plan") for 1997, including amounts deferred under the Executive Deferred Compensation Plan. See the Compensation Plan description in footnote (2) below. (2) This table sets forth stock unit awards for 1997 under the Compensation Plan. One-half of each year's award under this plan is converted into stock units representing shares of Illinova Common Stock based on the closing price of Common Stock on the last trading day of the award year. The other one-half of the award is cash and is included under Bonus in the Summary Compensation Table. Stock units awarded in a given year, together with cash representing the accumulated dividend equivalents on those stock units, become fully vested after a three-year holding period. Stock units are converted into cash based on the closing price of Common Stock on the first trading day of the distribution year. Participants (or beneficiaries of deceased participants) whose employment is terminated by retirement on or after age 55, disability, or death receive the present value of all unpaid awards on the date of such termination. Participants whose employment is terminated for reasons other than retirement, disability, or death forfeit all unvested awards. In the event of a termination of employment within two years after a change in control of Illinova, without good cause or by any participant with good reason, all awards of the participant become fully vested and payable. As of December 31, 1997, named executive officers were credited with the following total aggregate number of unvested stock units under the Compensation Plan since its inception, valued on the basis of the closing price of Common Stock on December 31, 1997: Mr. Haab, 7,619 units valued at $205,241; Mr. Lang, 2,044 units valued at $55,071; Mr. Altenbaumer, 1,862 units valued at $50,151; Mr. Cook, 1,250 units valued at $33,685; Mr. Schultz, 1,509 units valued at $40,635. Although stock units have been rounded, valuation is based on total stock units, including partial shares. (3) The amounts shown in this column are Illinois Power's contributions under the Incentive Savings Plan (including the market value of shares of Illinova Common Stock at the time of allocation). The following tables summarize grants during 1997 of stock options under Illinova's 1992 Long-Term Incentive Compensation Plan ("LTIC") and awards outstanding at year end for the individuals named in the Summary Compensation Table. Option Grants In 1997 Individual Grants Number of Securities % of Total Options Underlying Options Granted to Employees Exercise or Base Grant Date Granted (1) in 1997 Price Per Share (1) Expiration Date Present Value (2) Larry D. Haab 20,000 24% $26.125 2/12/2007 $107,200 Paul L. Lang 6,500 8% 26.125 2/12/2007 34,840 Larry F. Altenbaumer 6,500 8% 26.125 2/12/2007 34,840 John G. Cook 6,000 7% 26.125 2/12/2007 32,160 Robert A. Schultz 6,000 7% 26.125 2/12/2007 32,160
(1) Each option becomes exercisable on February 12, 2000. In addition to the specified expiration date, the grant expires on the first anniversary of the recipient's death and/or 5 years following date of retirement, and is not exercisable in the event a recipient's employment terminates. In the event of certain change-in-control circumstances, the Compensation and Nominating Committee may declare the option immediately exercisable. The exercise price of each option is equal to the fair market value of the Common Stock on the date of the grant. Recipients shall also receive, on or shortly after February 12, 2000, a target performance award, determined by calculating the difference between the return earned by Illinova on its invested capital and its cost of capital (the "spread"), then comparing this spread to that of a peer group and reducing or increasing the target award depending on Illinova's relative performance, but not reducing the payment below zero. The target award is equal to one-half of the mid-point of compensation for each officer's salary grade (a market-based number) times a percentage, determined by the Compensation and Nominating Committee. In 1997 those percentages ranged between 20 and 45 percent. At the discretion of the Board of Directors, the foregoing payment may be made in the form of Illinova Common Stock of equivalent value based on the average New York Stock Exchange price of the stock during February 2000, or in cash. (2) The Grant Date Present Value has been calculated using the Black-Scholes option pricing model. Disclosure of the Grant Date Present Value, or the potential realizable value of option grants assuming 5% and 10% annualized growth rates, is mandated by regulation; however, Illinova does not necessarily view the Black-Scholes pricing methodology, or any other present methodology, as a valid or accurate means of valuing stock option grants. The calculation was based on the following assumptions: (i) As of the grant date, Illinova's calculated Black-Scholes ratio was .2248. After discounting for risk of forfeiture at three percent per year over Illinova's three-year vesting schedule, the ratio is reduced to .2052; (ii) An annual dividend yield on Illinova Common Stock of 4.11%; (iii) A risk-free interest rate of 6.57%, based on the yield of a zero-coupon government bond maturing at the end of the option term; and (iv) Stock volatility of 19.54%. Aggregated Option and Fiscal Year-End Option Value Table Number of Securities Underlying Unexercised Value of Unexercised In-the-Money Options at Fiscal Year-End Options at Fiscal Year-End Name Exercisable/Unexercisable Exercisable/Unexercisable Larry D. Haab 56,900 shs./62,000 shs. $237,414/$57,400 Paul L. Lang 17,800 shs./19,500 shs. $75,148/$18,655 Larry F. Altenbaumer 17,800 shs./20,500 shs. $75,148/$18,655 John G. Cook 9,900 shs./17,000 shs. $43,634/$14,130 Robert A. Schultz 6,750 shs./16,500 shs $29,165/$13,100
Pension Benefits Illinois Power maintains a Retirement Income Plan for Salaried Employees (the "Retirement Plan") providing pension benefits for all eligible salaried employees. In addition to the Retirement Plan, Illinois Power also maintains a nonqualified Supplemental Retirement Income Plan for Salaried Employees (the "Supplemental Plan") that covers certain officers eligible to participate in the Retirement Plan and provides for payments from general funds of Illinois Power of any monthly retirement income not payable under the Retirement Plan because of benefit limits imposed by law or because of certain Retirement Plan rules limiting the amount of credited service accrued by a participant. The following table shows the estimated annual pension benefits on a straight life annuity basis payable upon retirement based on specified annual average earnings and years of credited service classifications, assuming continuation of the Retirement Plan and Supplemental Plan and employment until age 65. This table does not show, but any actual pension benefit payments would be subject to, the Social Security offset. Estimated Annual Benefits (rounded) Annual 15 Yrs. 20 Yrs. 25 Yrs. 30 Yrs. 35 Yrs. Average Credited Credited Credited Credited Credited Earnings Service Service Service Service Service $125,000 $ 37,500 $ 50,000 $ 62,500 $ 75,000 $ 87,500 150,000 45,000 60,000 75,000 90,000 105,000 175,000 52,500 70,000 87,500 105,000 122,500 200,000 60,000 80,000 100,000 120,000 140,000 250,000 75,000 100,000 125,000 150,000 175,000 300,000 90,000 120,000 150,000 180,000 210,000 350,000 105,000 140,000 175,000 210,000 245,000 400,000 120,000 160,000 200,000 240,000 280,000 450,000 135,000 180,000 225,000 270,000 315,000 500,000 150,000 200,000 250,000 300,000 350,000 550,000 165,000 220,000 275,000 330,000 385,000 600,000 180,000 240,000 300,000 360,000 420,000 650,000 195,000 260,000 325,000 390,000 455,000 700,000 210,000 280,000 350,000 420,000 490,000
The earnings used in determining pension benefits under the Retirement Plan are the participants' regular base compensation, as set forth under Salary in the Summary Compensation Table. At December 31, 1997, for purposes of both the Retirement Plan and the Supplemental Plan, Messrs. Haab, Lang, Altenbaumer, Cook and Schultz had completed 32, 16, 25, 23 and 16 years of credited service, respectively. Employee Retention Agreements Illinova has entered into Employee Retention Agreements with each of its executive officers and with officers of its subsidiaries. Under each agreement, the officer would be entitled to receive a lump sum cash payment if his or her employment were terminated without good cause or voluntarily by the officer for good reason within two years following a change in control of Illinova (as defined in the Agreement) or terminated prior to a change of control at the request of a potential acquirer. The amount of the lump sum payment would be equal to (1) 36 months' salary at the greater of the officer's salary rate in effect on the date the change in control occurred or the salary rate in effect on the date the officer's employment with Illinova terminated; plus (2) three times the latest bonus earned by the officer during the three calendar years preceding termination of employment. Under the agreement, the officer would continue, after any such termination of employment, to participate in and receive benefits under other benefit plans of Illinova. Such coverage would continue for 36 months following termination of employment, or, if earlier, until the officer reached age 65 or was employed by another employer; provided that, if the officer was 50 years of age or older at the time of such termination, then coverage under health, life insurance and similar welfare plans would continue until the officer became 55 years of age, at which time he or she would be eligible to receive the benefits extended to the employees of Illinova who elect early retirement. Compensation and Nominating Committee Report on Officer Compensation The seven-member Compensation and Nominating Committee of the Board of Directors (the "Committee") is composed entirely of Outside Directors. The Committee's role includes an assessment of Illinova's Compensation Strategy, a review of the performance of the elected officers and the establishment of specific officer salaries subject to Board approval. The Committee establishes performance goals for the officers under the Compensation Plan, approves payments made pursuant to the Compensation Plan and recommends grants under the Long-Term Incentive Compensation Plan approved by the shareholders in 1992. The Committee also reviews other forms of compensation and benefits making recommendations to the Board on changes whenever appropriate. The Committee carries out these responsibilities with assistance from an executive compensation consulting firm and with input from the Chief Executive Officer and management as it deems appropriate. Officer Compensation Philosophy Illinova's compensation philosophy reflects a commitment to compensate officers competitively with other companies while rewarding executives for achieving levels of operational and financial excellence consistent with continuous improvement. Illinova's current compensation policy is to provide a total compensation opportunity targeted to the median of all utilities in the Edison Electric Institute (EEI) database. All but one of the electric power companies in the S&P Utilities Index are also in the EEI database. The S&P Utilities Index is used to relate Illinova's shareholder value in the following performance graphs. The S&P index covers the industry broadly including electric and gas utilities. After careful consideration, the Committee has decided to maintain a separate compensation peer group limited to electric or combination electric and gas companies for reference purposes. While the philosophy described above was used by Illinova in 1997 as an indicator of future utility pay practices, as the industry migrates toward deregulation and diversification, it is anticipated that the company will broaden its competitive reference beyond the regulated utility industry in order to compete sufficiently for talent in the deregulated environment of the future. The compensation program for officers consists of base salary, annual incentive and long-term incentive components. The combination of these three elements balances short- and long-term business performance goals and aligns officer financial rewards with those of Illinova's shareholders. The compensation program is structured so that, depending on the salary level, between 25 and 45 percent of an officer's total compensation target is composed of incentive compensation. Base Salary Plan The Committee determines base salary ranges for executive officers based on competitive pay practices of similarly sized utilities. Officer salaries correspond to approximately the median of the companies in the compensation peer group. Individual increases are based on several factors, including the officer's performance during the year, the relationship of the officer's salary to the market salary level for the position and competitive industry salary increase practices. Annual Incentive Compensation Plan Annual incentive awards are earned based on the achievement of specific annual financial and operational goals by the Illinois Power officer group as a whole and consideration of the officer's individual contribution. If payment is earned under this Plan, one-half of the bonus is payable in cash during the year following the award year, and one-half is credited to the participants in the form of Common Stock units, the number of which is determined by dividing half of the earned bonus amount by the closing price of the Common Stock on the last trading day of the award year. The officer's interest in the stock units vests at the end of the three-year period, which begins the year after the award year. The officer receives this award in cash equal to (1) the closing stock price on the first trading day of the distribution year times the number of units held plus (2) dividend equivalents that would have been received if the stock had actually been issued. Maximum awards under the plan may be up to 150 percent of target; threshold awards are 50 percent of target. For Illinois Power officers, 1997 awards under the Compensation Plan are based on achievement in the performance areas: earnings per share, customer satisfaction, safety and employee teamwork, cost management and shareholder value added. Up to 50 percent of the awarded amount is based on an assessment of the individual officer's performance during the year. Awards shown under Bonus in the Summary Compensation Table for performance during 1997 were based on achievement of officer's individual goals. There was no payout for the identified performance areas. For the unregulated subsidiaries, Illinova Generating and Illinova Energy Partners, 1997 officer awards were based on achievement of specific marketing objectives and earnings objectives of the units. Up to 50 percent of the awarded amount is based on an assessment of the individual officer's performance during the year. Long-Term Incentive Compensation (LTIC) Plan Awards under the LTIC plan are based on corporate performance as well as individual officer's contributions to corporate performance subject to the review of this Committee. In 1997, it was determined that awards under the LTIC plan be delivered in two components. One-half of each officer's LTIC plan award is delivered in the form of stock options granted at fair market value. The stock options granted to the officers for 1997 represent an award based on Illinova and individual performance as evaluated by the Chairman and reviewed by the Committee. The other half of the LTIC plan award is distributed to officers in cash based upon Illinova's Shareholder Value-Added (SVA) performance relative to a peer group of utility companies, as measured in overlapping three-year periods. SVA measures Illinova's return on the Company's weighted average cost of capital. SVA performance at the median of the peer group will result in target award levels. Performance above the median will result in payouts greater than target to a maximum of two times target; performance significantly below the median results in no payouts. Since 1996 represented the first year of the SVA plan's first three-year measurement cycle, no awards are due to be paid out under the plan until 1999. CEO Compensation Larry Haab became Chairman, President, and Chief Executive Officer ("CEO") of Illinois Power on June 12, 1991, and Chairman, President and Chief Executive Officer of Illinova in December 1993. Illinova based Mr. Haab's 1997 compensation on the policies and plans described above. The Committee invokes the active participation of all non-management directors in reviewing Mr. Haab's performance before it makes recommendations regarding his compensation. The Committee is responsible for administering the processes for completing this review. The process starts early in the year when the Board of Directors works with Mr. Haab to establish his personal goals and short- and long-term strategic goals for Illinova. At the conclusion of the year, Mr. Haab reviews his performance with the non-management directors. The Committee oversees this review and recommends to the Board appropriate adjustments to compensation. In setting the CEO's salary for 1997, the Committee, with the participation of all Outside Directors determined that Mr. Haab had provided very strong leadership in promoting electric deregulation in the State of Illinois. The continuing outage at the Clinton Power Station was a major setback. Significant progress was made in advancing other strategic objectives of the Company. The 1997 Annual Incentive Compensation Plan award for the Chief Executive Officer was calculated consistent with the determination of awards for all other Illinois Power officers. Under the terms of the plan, one-half of the award was paid in cash and one-half was converted to 1,539 stock units which vest over a three-year period as described above. The 20,000 option shares granted to the CEO reflect the Committee's recognition of this work in directing Illinova towards its long-term objectives. Compensation and Nominating Committee Ronald L. Thompson, Chairman J. Joe Adorjan C. Steven McMillan Robert M. Powers Walter D. Scott Marilou von Ferstel John D. Zeglis Stock Performance Graphs The following performance graphs compare the cumulative total shareholder return on Illinova's Common Stock to the cumulative total return on the S&P 500 Index, S&P MidCap 400 Index and S&P Utilities Index from (i) December 31, 1992, through December 31, 1997, and (ii) December 31, 1994, through December 31, 1997. Comparison of Five-Year Cumulative Total Return Among Illinova, S&P 500, S&P Midcap 400, and S&P Utilities Assumes $100 invested on December 31, 1992, in Illinova Common Stock, S&P 500 Index, S&P MidCap 400 Index, and S&P Utilities Index. Fiscal year ended December 31. Comparison of Three-Year Cumulative Total Return Among Illinova, S&P 500, S&P Midcap 400, and S&P Utilities Assumes $100 invested on December 31, 1994, in Illinova Common Stock, S&P 500 Index, S&P MidCap 400 Index, and S&P Utilities Index. Fiscal year ended December 31. Independent Auditors The Board of Directors of Illinova has selected Price Waterhouse LLP as independent auditors for Illinova for 1998. A representative of that firm will be present at the Annual Meeting and available to make a statement and to respond to questions. Other Matters Illinova's 1997 Summary Annual Report to Shareholders was mailed to shareholders commencing on or about March 10, 1998. Copies of Illinova's Annual Report on Form 10-K will be available to shareholders, after its filing with the Securities and Exchange Commission on or before March 31, 1998. Requests should be addressed to Investor Relations, G-21, Illinova Corporation, 500 South 27th Street, Decatur, Illinois 62525-1805. Any proposal by a shareholder to be presented at the next Annual Meeting must be received at Illinova's executive offices not later than November 12, 1998. Other Business Management does not know of any matter which will be presented for consideration at the Annual Meeting other than the matters described in the accompanying Notice of Annual Meeting. By Order of the Board of Directors, Leah Manning Stetzner, General Counsel and Corporate Secretary Decatur, Illinois March 10, 1998 APPENDIX: 1997 ANNUAL REPORT TO SHAREHOLDERS Table of Contents Management's Discussion and Analysis a-2 Responsibility for Information a-10 Report of Independent Accountants a-10 Consolidated Statements of Income a-11 Consolidated Balance Sheets a-12 Consolidated Statements of Cash Flows a-13 Consolidated Statements of Retained Earnings a-13 Notes to Consolidated Financial Statements a-14 Selected Consolidated Financial Data a-32 Selected Illinois Power Company Statistics a-33 Abbreviations Used Throughout this Report AFUDC Allowance for Funds Used During Construction Baldwin Baldwin Power Station Clinton Clinton Power Station DOE Department of Energy EITF Emerging Issues Task Force of the Financial Accounting Standards Board EMF Electric and Magnetic Fields EPS Earnings Per Share ESOP Employees' Stock Ownership Plan FAS Statement of Financial Accounting Standards FASB Financial Accounting Standards Board FERC Federal Energy Regulatory Commission Fuel Company Illinois Power Fuel Company HB 362 House Bill 362, An Act in Relation to the Competitive Provision of Utility Services ICC Illinois Commerce Commission IEP Illinova Energy Partners, Inc. IGC Illinova Generating Company IIC Illinova Insurance Company Illinova Illinova Corporation IP Illinois Power Company IPFI Illinois Power Financing I IPMI Illinova Power Marketing, Inc. ISA Integrated Safety Assessment kw Kilowatt kwh Kilowatt-Hour MGP Manufactured-Gas Plant MIPS Monthly Income Preferred Securities MW Megawatt MWH Megawatt-Hour NOPR Notice of Proposed Rulemaking NOx Nitrogen Oxide NRC Nuclear Regulatory Commission PCA Power Coordination Agreement PECO PECO Energy Company S&P Standard & Poor's SO2 Sulfur Dioxide Soyland Soyland Power Cooperative, Inc. TOPrS Trust Originated Preferred Securities UFAC Uniform Fuel Adjustment Clause UGAC Uniform Gas Adjustment Clause U.S. EPA United States Environmental Protection Agency Vermilion Vermilion Power Station Wood River Wood River Power Station MANAGEMENT'S DISCUSSION AND ANALYSIS In this report, we refer to the Consolidated Financial Statements, related Notes to Consolidated Financial Statements, Selected Consolidated Financial Data and Selected Illinois Power Company Statistics for information concerning consolidated financial position and results of operations. This report contains estimates, projections and other forward-looking statements that involve risks and uncertainties. Actual results or outcomes could differ materially as a result of such important factors as: the outcome of state and federal regulatory proceedings affecting the restructuring of the electric and gas utility industries; the impacts new laws and regulations relating to restructuring, environmental, and other matters have on Illinova and its subsidiaries; the effects of increased competition on the utility businesses; risks of owning and operating a nuclear facility; changes in prices and cost of fuel; factors affecting non-utility investments, such as the risk of doing business in foreign countries; construction and operation risks; and increases in financing costs. Below is discussion of the factors having significant impact on consolidated financial position and results of operations since January 1, 1995. Illinova Subsidiaries The Consolidated Financial Statements include the accounts of Illinova Corporation, a holding company; Illinois Power Company, a combination electric and gas utility; Illinova Generating Company, which invests in energy-related projects throughout the world; Illinova Energy Partners, Inc., which develops and markets energy-related services throughout the United States and Canada; and Illinova Insurance Company, whose purpose is to insure the risks of the subsidiaries of Illinova and risks related to or associated with their business enterprises. On February 12, 1997, the Illinova Board of Directors approved a merger of Illinova Energy Partners, Inc. and Illinova Power Marketing, Inc., another Illinova subsidiary. In the merger, Illinova Power Marketing, Inc. was the surviving entity but changed its name to Illinova Energy Partners, Inc. Illinova Generating Company and Illinova Energy Partners, Inc. are wholly owned subsidiaries of Illinova. Illinois Power has preferred shares outstanding, but its common stock is wholly owned by Illinova. See "Note 2 - Illinova Subsidiaries" for additional information. Open Access and Wheeling On March 29, 1995, the FERC issued a NOPR initiating the process of mandating non-discriminatory open access to public utility transmission facilities at cost-based rates. Transmission of electricity for a reseller or redistributor of energy is called wholesale wheeling. Transmission of electricity for end-use customers is known as retail wheeling. On April 24, 1996, FERC issued Orders 888 and 889 which established the Final Rule resulting from the NOPR. The Orders became effective July 9, 1996. The Rule requires all public utilities under FERC jurisdiction that own transmission facilities to file transmission service tariffs that comply with Pro Forma Tariffs attached to the Orders. FERC also requires that all wholesale sales made by a utility provide for transmission of the power under the prescribed terms and conditions. IP made a compliance filing as required on July 9, 1996, which has been accepted by FERC. Public utilities serving customers at retail are not required, at this time, to use FERC-mandated terms and conditions. FERC does not require public utilities to give retail customers access to alternate energy suppliers or direct transmission service. The move to open access transmission service likely will increase competition in the wholesale energy market, but this alone is not expected to have a significant financial impact. Competition On December 16, 1997, Illinois Governor Edgar signed electric deregulation legislation. HB 362 guarantees IP's residential customers a 15 percent decrease in base electric rates beginning August 1, 1998, and an additional 5 percent decrease effective on May 1, 2002. The rate decreases are expected to result in revenue reductions of approximately $40 million in 1998, approximately $80 million in each of the years 1999 through 2001 and approximately $100 million in 2002, based on current consumption. Customers with demand greater than 4 MW at a single site will be free to choose their electric generation supplier ("direct access") starting October 1999. Customers with at least 10 sites which aggregate at least 9.5 MW in total demand also will have direct access starting October 1999. Direct access for the remaining non-residential customers will occur in two phases: customers representing one-third of the remaining load in the non-residential class in October 1999 and customers representing the entire remaining non-residential load on December 31, 2000. Direct access will be available to all residential customers in May 2002. IP remains obligated to serve all customers who continue to take service from IP at tariff rates, and remains obligated to provide delivery service to all at regulated rates. Although the specified residential rate reductions and the introduction of direct access will lead to lower electric service revenues, HB 362 is designed to protect the financial integrity of electric utilities in three principal ways: 1) Departing customers are obligated to pay transition charges, based on the utility's lost revenue from that customer, adjusted to deduct: 1) delivery charges the utility will continue to receive from the customer, and 2) the market value of the freed-up energy net of a mitigation factor (i.e., percentage reduction of the transition charge amount). The mitigation factor is designed to provide incentive for management to continue cost reduction efforts and generate new sources of revenue; 2) Utilities are provided the opportunity to lower their financing and capital costs through the issuance of "securitized" bonds; and 3) Utilities are permitted to seek rate relief in the event that the change in law leads to their return on equity falling below a specified minimum based on a prescribed test. The extent to which revenues are lowered will depend on a number of factors including future market prices for wholesale and retail energy, and load growth and demand levels in the current IP service territory. The impact on net income will depend on, among other things, the amount of revenues earned and the ongoing costs of doing business. In 1996, IP received approval from both the ICC and FERC to conduct an open access experiment beginning in 1996 and ending on December 31, 1999. The experiment allows certain industrial customers to purchase electricity and related services from other sources. Currently, 17 customers are participating in the experiment. Since its inception, the experiment has cost IP approximately $11.2 million in lost revenue net of avoided fuel cost and variable operating expenses. This loss was partially offset by selling the surplus energy and capacity on the open market and by $2.7 million in transmission service charges. Accounting Matters Prior to the passage of HB 362, IP prepared its consolidated financial statements in accordance with FAS 71, "Accounting for the Effects of Certain Types of Regulation." Reporting under FAS 71 allows companies whose service obligations and prices are regulated to maintain on their balance sheets assets representing costs they expect to recover from customers, through inclusion of such costs in their future rates. In July 1997, the EITF concluded that application of FAS 71 accounting should be discontinued at the date of enactment of deregulation legislation for business segments for which a plan of deregulation has been established. The EITF further concluded that regulatory assets and liabilities that originated in the portion of the business being deregulated should be written off unless their recovery is specifically provided for through future cash flows from the regulated portion of the business. Because HB 362 provides for market-based pricing of electric generation services, IP discontinued application of FAS 71 for its generating segment. IP evaluated its regulatory assets and liabilities associated with its generation segment and determined that recovery of these costs was not probable through rates charged to transmission and distribution customers, the regulated portion of the business. IP wrote off generation-related regulatory assets and liabilities of approximately $195 million (net of income taxes) in December 1997. These net assets related to previously incurred costs that were expected to be collected through future revenues, including deferred costs for Clinton, unamortized losses on reacquired debt, recoverable income taxes and other generation-related regulatory assets. At December 31, 1997, IP's net investment in generation facilities was $3.5 billion and was reflected in "Utility Plant, at Original Cost" on IP's balance sheet. In addition, IP evaluated its generation segment plant investments to determine if they had been impaired as defined in FAS 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of." This evaluation determined that future revenues were expected to be sufficient to recover the costs of its generation segment plant investments and as a result, no plant write-downs were necessary. However, ultimate recovery depends on a number of factors and variables including market conditions and IP's ability to operate its generation assets efficiently. The provisions of HB 362 allow an acceleration in the rate at which any utility-owned assets are expensed without regulatory approval provided such charges are consistent with generally accepted accounting principles. Under this legislation, up to an aggregate of $1.5 billion in additional expense for the generation-related assets could be accelerated through the year 2008. This reduction in the net book value of IP's generation- related assets should help position IP to operate competitively and profitably in the changing business environment. This accelerated charge would have a direct impact on earnings but not on cash flows. The FASB continues to review the accounting for liabilities related to closure and removal of long-lived assets, including decommissioning. See "Note 4 - - Commitments and Contingencies" for a discussion of decommissioning. See "Note 1 - Summary of Significant Accounting Policies" for a discussion of other accounting issues. Regulatory Matters In September 1996, a leak in a recirculation pump seal caused IP operations personnel to shut down Clinton. Clinton has not resumed operation. In January 1997 and again in June 1997, the NRC named Clinton among plants having a trend of declining performance. In June 1997, IP committed to conduct an ISA to thoroughly assess Clinton's performance. The ISA was conducted by a team of 30 individuals with extensive nuclear experience and no substantial previous involvement at Clinton. Their report concluded that the underlying reasons for the performance problems at Clinton were ineffective leadership throughout the organization in providing standards of excellence, complacency throughout the organization, barrier weaknesses and weaknesses in teamwork. In late October, a team commissioned by the NRC performed an evaluation to validate the ISA results. In December, this team concluded that the findings of the ISA accurately characterized Clinton's performance deficiencies and their causes. On January 5, 1998, IP and PECO announced an agreement under which PECO will provide management services for Clinton. Although a PECO team will help manage the plant, IP will continue to maintain the operating license for Clinton and retain ultimate oversight of the plant. PECO employees will assume senior positions at Clinton, but the plant will remain primarily staffed by IP employees. IP made this decision based on a belief that bringing in PECO's experienced management team would be the most efficient way to get Clinton back on line and operating at a superior level as quickly as possible. On January 21, 1998, the NRC placed Clinton on its Watch List of nuclear plants that require additional regulatory oversight because of declining performance. Twice a year the NRC evaluates the performance of nuclear power plants in the United States and identifies those which require additional regulatory oversight. Once placed on the Watch List a plant must demonstrate consistent improved performance before it is removed from the list. The NRC will monitor Clinton more closely than plants not on the Watch List. This may include increased inspections, additional required documentation, NRC-required approval of processes and procedures, and higher-level NRC oversight. The NRC has advised IP that it must submit a written report to the NRC at least two weeks prior to restarting Clinton, giving the agency reasonable assurance that IP's actions to correct recurring weaknesses in the corrective action program have been effective. After the report is submitted, the NRC staff plans to meet with IP's management to discuss the plant's readiness for restart. In March 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership, in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton. Soyland's title to the plant and directly related assets such as nuclear fuel was transferred to IP in May 1997. Soyland's nuclear decommissioning trust assets were transferred to IP in May 1997, consistent with IP's assumption of all of Soyland's ownership obligations including those related to decommissioning. The FERC approved an amended PCA between IP and Soyland in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least 10 years. The amended PCA provides that a contract cancellation fee will be paid by Soyland to IP in the event that a Soyland Cooperative member terminates its membership from Soyland. On May 31, 1997, three distribution cooperative members terminated membership by buying out of their long-term wholesale power contracts with Soyland. This action resulted in Soyland paying a fee of $20.8 million to IP in June 1997 to reduce its base capacity charges. Fee proceeds of $2.9 million were used to offset the costs of acquiring Soyland's share of Clinton with the remaining $17.9 million recorded as interchange revenue. In December 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million will be deferred and recognized as interchange revenue over the initial term of the PCA. The payment is contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. In September 1997, the ICC approved a petition filed by IP which stipulates customers will not be charged for certain additional costs of energy incurred as a result of Clinton being out of service. IP did not collect from its customers $36.3 million for higher-cost replacement power in 1997. IP will forego recovery of additional fuel costs as the Clinton outage continues into 1998. Under the petition, fuel costs charged to customers will be no higher than average 1995 - 1996 levels until Clinton is back in service operating at least at a 65% capacity factor for two consecutive months. Under HB 362, IP may choose to eliminate application of the UFAC. IP's base rates will still include a component for some level of recovery of fuel costs, but IP would not be able to pass through to customers increased costs of purchasing fuel, emission allowances, or replacement power. On elimination of the UFAC, base rates will include a fixed fuel-cost factor equivalent to the average 1995 - 1996 fuel cost levels. Future recovery of fuel costs is uncertain as IP will decrease base electric rates to residential customers beginning August 1998 and certain customers will be free to choose their electric generation supplier beginning in October 1999. The extent to which fuel costs are recovered will depend on a number of factors including the future market prices for wholesale and retail energy, when Clinton returns to service, and whether IP elects to eliminate the UFAC. Year 2000 In November 1996, Illinova deployed a project team to coordinate the identification, evaluation, and implementation of changes to computer systems and applications necessary to achieve a year 2000 date conversion with no effect on customers or disruption to business operations. These actions are necessary to ensure that systems and applications will recognize and process coding for the year 2000 and beyond. Major areas of potential business impact have been identified and initial conversion efforts are underway. Illinova also is communicating with third parties with whom it does business to ensure continued business operations. The cost of achieving year 2000 compliance is estimated to be at least $14 million through 1999. Contingency plans for operating without year 2000 compliance have not been developed. Such activity will depend on assessment of progress. Project completion is planned for the fourth quarter of 1999. Enhanced Retirement In December 1994, IP announced plans for voluntary enhanced retirement and severance programs. During the fourth quarter of 1995, 727 employees accepted enhanced retirement or severance under these programs. The combined enhanced retirement and severance programs generated a pretax charge of $38 million against fourth quarter 1995 earnings. Consolidated Results of Operations Overview Earnings (loss) applicable to common stock were $(90) million for 1997, $190 million for 1996, and $148 million for 1995. Basic and diluted earnings (loss) per common share were $(1.22) for 1997 ($1.41 before the extraordinary item related to discontinued application of FAS 71 for the generation segment), $2.51 for 1996, and $1.96 for 1995 ($2.26 before the one-time charge of $38 million for enhanced retirement and severance). The decrease in 1997 earnings compared to 1996 was due primarily to the extraordinary item related to discontinued application of FAS 71 for the generation segment, higher operation and maintenance expenses due to Clinton, higher power purchased costs due to Clinton and Wood River outages, IEP losses and an increase in uncollectible accounts expense. The increase in 1996 earnings per share over 1995 was due primarily to the one-time charge in 1995 for the enhanced retirement and severance programs, lower operations expense due to the employment decrease and lower financing costs. The 1995 basic and diluted earnings per share include $(.30) net-of-tax for the enhanced retirement and severance program and $(.05) for the carrying amount under consideration paid for IP preferred stock redeemed in December 1995. Regulators historically have determined IP's rates for electric service, the ICC at the retail level and the FERC at the wholesale level. The ICC determines IP's rates for gas service. These rates have been designed to recover the cost of service and allow shareholders the opportunity to earn a fair rate of return. As described under "Competition" above, Illinois electric deregulation legislation phases in a competitive marketplace for electric generation while maintaining cost-based regulation for electric delivery service and gas service, protecting the financial integrity of the company during the transition period. Future electric and natural gas sales, including interchange sales, will continue to be affected by an increasingly competitive marketplace, changes in the regulatory environment, increased transmission access, weather conditions, competing fuel sources, interchange market conditions, plant availability, fuel cost recoveries, customer conservation efforts and the overall economy. Illinova and Illinois Power - Results of Operations Electric Operations For the years 1995 through 1997, electric revenues including interchange increased 3.7% and the gross electric margin decreased 6.4% as follows: (Millions of dollars) 1997 1996 1995 Electric revenues $ 1,244.4 $ 1,202.9 $ 1,252.6 Interchange revenues 175.6 137.6 116.3 Fuel cost & power purchased (450.3) (313.3) (333.4) Electric margin $ 969.7 $ 1,027.2 $ 1,035.5 The components of annual changes in electric revenues were: (Millions of dollars) 1997 1996 1995 Price $ (11.5) $ (7.2) $ 13.3 Volume and other 9.7 6.4 42.7 Fuel cost recoveries 43.3 (48.9) 19.1 Revenue increase (decrease) $ 41.5 $ (49.7) $ 75.1 1997 Electric revenues excluding interchange sales increased 3.4%, primarily due to an increase in revenues under the UFAC and increased wheeling revenues. Interchange revenues increased 27.6% due to the receipt of an opt-out fee from Soyland per the amended PCA and increased interchange activity. Electric margin decreased primarily due to increased power purchased costs as a result of outages at the nuclear and fossil facilities. 1996 Electric revenues excluding interchange sales decreased 4.0%, primarily due to reduction in revenues under the UFAC. Volume changes by customer class were insignificant, as kwh sales to ultimate consumers (excluding interchange sales and wheeling) decreased .3%. Interchange revenues increased 18.3% as a result of higher plant availability in the first half of the year. 1995 The 6.4% increase in electric revenues was primarily due to a 1.9% increase in kwh sales to ultimate consumers (excluding interchange sales and wheeling). Volume increases resulted from higher residential sales (4.8%) and higher commercial sales (8.2%) due to an improving economy and warmer summer temperatures compared to 1994. Industrial sales remained essentially unchanged from 1994. Interchange revenues increased $6.3 million (5.8%) as a result of increased sales opportunities. The cost of meeting IP's system requirements was reflected in fuel costs for electric plants and power purchased. Changes in these costs are detailed below: (Millions of dollars) 1997 1996 1995 Fuel for electric plants Volume and other $ (37.7) $ 15.4 $ 9.8 Price (8.5) (12.0) (35.5) Emission allowances 12.3 .8 18.5 Fuel cost recoveries 18.2 (30.0) 14.5 (15.7) (25.8) 7.3 Power purchased 152.7 5.7 6.9 Total increase (decrease) $ 137.0 $ (20.1) $ 14.2 Weighted average system generating fuel cost ($/MWH) $ 12.06 $ 11.01 $ 11.41 System load requirements, generating unit availability, fuel prices, purchased power prices, resale of energy to other utilities, emission allowance costs and fuel cost recovery through UFAC caused changes in these costs. Changes in factors affecting the cost of fuel for electric generation are below: 1997 1996 1995 Increase (decrease) in generation (25.4)% 5.4% .7% Generation mix Coal and other 100% 78% 73% Nuclear 0% 22% 27% 1997 The cost of fuel decreased 6.3% and electric generation decreased 25.4%. The decrease in fuel cost was primarily attributable to decreased generation and a favorable price variance. These factors were partially offset by effects of the UFAC and increased emission allowance costs. Power purchased increased $152.7 million primarily due to Clinton and Wood River being out of service. 1996 The cost of fuel decreased 9.4% and electric generation increased 5.4%. The decrease in fuel cost was primarily attributable to the effects of the UFAC, as well as a favorable price variance. These factors were partially offset by an increase in fuel cost due to the increase in generation. Power purchased increased $5.7 million primarily due to the extended Clinton outage. Clinton's equivalent availability and generation were lower than in 1995 due to that outage. 1995 The cost of fuel increased 2.8% and electric generation increased .7%. The increase in fuel cost was attributable to the effects of the UFAC, the increase in higher-cost fossil generation and the cost of emission allowances. Clinton's equivalent availability and generation were lower in 1995 as compared to 1994 due to the scheduled refueling and maintenance outage. Clinton returned to service April 29, 1995, after completing its fifth refueling and maintenance outage, which began March 12, 1995. Power purchased increased $6.9 million. Gas Operations For the years 1995 through 1997, gas revenues including transportation increased 29.9%, while the gross margin on gas revenues increased 9.3% as follows: (Millions of dollars) 1997 1996 1995 Gas revenues $ 345.2 $ 341.4 $ 264.5 Gas cost (207.7) (202.6) (138.8) Transportation revenues 8.7 6.8 8.0 Gas margin $ 146.2 $ 145.6 $ 133.7 (Millions of therms) Therms sold 537 703 588 Therms transported 309 251 273 Total consumption 846 954 861 Changes in the cost of gas purchased for resale were: (Millions of dollars) 1997 1996 1995 Gas purchased for resale Cost $ 8.0 $ 49.0 $ (43.5) Volume (30.0) 8.5 25.3 Gas cost recoveries 27.1 6.3 (15.4) Total increase (decrease) $ 5.1 $ 63.8 $ (33.6) Average cost per therm delivered $ .28 $ .267 $ .201 The 1997 increase in gas costs was due to slightly higher prices from suppliers and effects of the UGAC, offset by a decrease in volume. The 1996 increase in gas costs was primarily due to higher prices from suppliers and the effects of the UGAC. The 1995 decrease in the cost of gas purchased was due to lower gas prices caused by unusually warm winter weather nationwide. Also contributing to the higher gas margins in 1995 was the 6.1% increase in gas base rates approved by the ICC in April 1994. Diversified Enterprises Due primarily to increased power sales activity at IEP, diversified enterprises revenues increased $678 million for 1997. However, diversified enterprises expenses increased $705 million, offsetting the growth in revenues. Diversified expenses primarily reflect the cost of power purchased for resale. Other Expenses A comparison of significant increases (decreases) in other operating expenses, maintenance and depreciation for the last three years is presented in the following table: (Millions of dollars) 1997 1996 1995 Other operating expenses $ 40.6 $ (9.8) $ (.3) Maintenance 12.0 (.3) 10.4 Depreciation and amortization 8.8 3.5 7.2 The increase in operating and maintenance expenses for 1997 is primarily due to increased company and contractor labor at the nuclear and fossil plants. An increase in uncollectible accounts expense and disposal of surplus inventory also contributed to the increase. The decrease in operating expenses for 1996 is due primarily to the savings from the enhanced retirement and severance program, partially offset by the costs of the extended Clinton outage and increased amortization of MGP site expenses. The ICC approved tariff riders in March 1996 that resulted in the current recognition of MGP site remediation costs in operating expenses. The 1996 increase amounted to $5.5 million. This increase is offset by increased revenues collected under the riders. The increase in maintenance expenses for 1995 is primarily due to the refueling and maintenance outage at Clinton. The increases in depreciation and amortization for each of the three years were due to increases in utility plant balances. Miscellaneous - Net The 1997 decrease of $5.1 million in Miscellaneous-net deductions is due primarily to 1996 accruals recorded for the planned disposition of property. The 1996 and 1995 change in Miscellaneous-net deductions was negligible. Equity Earnings in Affiliates The increase of $11.1 million in 1997 and $3.7 million in 1996 in equity earnings in affiliates is primarily due to increased earnings from IGC investments. Interest Charges Total interest charges, including AFUDC and preferred dividend requirements, increased $2.8 million in 1997, decreased $15.8 million in 1996, and increased $2.4 million in 1995. The 1997 increase is primarily due to higher Illinova debt expenses, increased IP short-term borrowings and lower AFUDC, partially offset by the continued benefits of IP refinancing efforts and capitalization reductions. The 1996 decrease was due to lower short-term interest rates and the impact of IP refinancing efforts and capitalization reduction during 1996. The 1995 increase was due to increased short-term borrowings at higher interest rates. Inflation Inflation, as measured by the Consumer Price Index, was 2.3%, 3.3%, and 2.5% in 1997, 1996, and 1995, respectively. IP recovers historical rather than current plant costs in its regulated rates. Liquidity and Capital Resources Dividends On December 10, 1997, Illinova declared the quarterly common stock dividend at $.31 per share payable February 1, 1998, to stockholders of record as of January 9, 1998. On December 11, 1996, Illinova increased the quarterly common stock dividend by 11% declaring the common stock dividend for the first quarter of 1997 at $.31 per share. On December 13, 1995, Illinova increased the quarterly common stock dividend 12%, declaring the common stock dividend for the first quarter of 1996 at $.28 per share. Capital Resources and Requirements Illinova and IP need cash for operating expenses, interest and dividend payments, debt and certain IP preferred stock retirements, construction programs and non-regulated subsidiary funding requirements. To meet these needs, Illinova and IP have used internally generated funds and external financings, including the issuance of debt and revolving lines of credit. The timing and amount of external financings depend primarily on economic and financial market conditions, cash needs and capitalization ratio objectives. IP cash flows from operations during 1997 provided sufficient working capital to meet ongoing operating requirements, to service existing common and IP preferred stock dividends and debt requirements and to meet all of IP's construction requirements. Additionally, Illinova expects that future cash flows and external financings will enable it to meet operating requirements and continue to service IP's and Illinova's existing debt, IP's preferred and Illinova's common stock dividends, IP's sinking fund requirements and all of IP's anticipated construction requirements. Continued sufficiency of cash flows for these purposes will depend on a number of factors and variables, including market conditions, business expenses and the ability to compete. To a significant degree, the availability and cost of external financing depend on the financial health of the company seeking those funds. Security ratings are an indication of a company's financial position and may affect the cost of securities, as well as the willingness of investors to invest in these securities. The current ratings of Illinova's and IP's securities by three principal securities rating agencies are as follows: Standard Duff & Moody's & Poor's Phelps Illinova long-term debt Baa3 BBB- - IP first/new mortgage bonds Baa1 BBB BBB+ IP preferred stock baa2 BBB- BBB- IP commercial paper P-2 A-2 D-2 Under current market conditions, these ratings would afford Illinova and IP the ability to issue additional securities through external financing. Illinova and IP have adequate short-term and intermediate-term bank borrowing capacity. Based on its 1993 revised standards for review of utility business and financial risks, S&P placed IP, along with approximately one-third of the industry, in a "somewhat below average" category. In April 1994, S&P lowered IP's mortgage bond rating to BBB from BBB+. In August 1995, S&P revised its ratings outlook from stable to positive. In February 1996, Moody's also revised its ratings outlook from stable to positive. Moody's upgraded IP's securities on July 1, 1996. The rating for mortgage bonds was raised from Baa2 to Baa1, while preferred stock ratings went from baa3 to baa2. Duff & Phelps has indicated that it expects IP's ratings to remain stable, reflecting a modestly strengthening financial profile characterized by good cash flow and an average business risk profile. Illinova did not petition Duff & Phelps for a rating of its long-term debt. For the years 1997, 1996 and 1995, changes in long-term debt, IP preferred stock and Illinova common stock outstanding, including normal maturities and elective redemptions, were as follows: (Millions of dollars) 1997 1996 1995 Illinova long-term debt $ 100 $ - $ - IP long-term debt (11) (154) (5) Preferred stock (39) 71 (135) Common stock (90) - - Total decrease $ (40) $ (83) $(140) The amounts shown in the preceding table for debt retirements do not include all mortgage sinking fund requirements. IP has generally met these requirements by pledging property additions as permitted under IP's 1943 Mortgage and Deed of Trust and the 1992 New Mortgage. For additional information, see "Note 9 - Long-Term Debt" and "Note 10 - Preferred Stock of Subsidiary." During 1997, IP redeemed $34.9 million (all of the remaining) Adjustable Rate Series A serial preferred stock. IP also redeemed $4.2 million of various issues of serial preferred stock. In addition, $10.5 million of medium-term notes matured and were retired. During the year IP issued $150 million of Adjustable Rate Pollution Control Revenue Bonds, due April 1, 2032. The proceeds were used on June 2, 1997, to retire $150 million of IP's 7 5/8% Pollution Control First Mortgage Bonds due 2016. In January 1997, a $300 million shelf registration statement for Illinova debt securities became effective. On February 5, 1997, Illinova issued $100 million of 7 1/8% Senior Notes due 2004. The proceeds were used to redeem $77 million of short-term borrowings, and to invest in Illinova's non-regulated subsidiaries. On January 28, 1998, Illinova issued (under its $300 million shelf registration statement) $40 million of 6.46% medium-term notes due October 1, 2002. During 1997, Illinova repurchased four million shares of its common stock through an open market program. During 1996, IP redeemed $2.2 million of Adjustable Rate Series A serial preferred stock, $20.5 million (all of the remaining) Adjustable Rate Series B serial preferred stock and $6.7 million of 7.75% serial preferred stock. During the year, IP also retired $62.9 million of 8.75% First Mortgage Bonds due 2021, $6 million of 8% New Mortgage Bonds due 2023 and $23 million of 7.5% New Mortgage Bonds due 2025. The $40 million of 5.85% First Mortgage Bonds matured and were retired. In addition, $21.5 million of medium-term notes matured and were retired. In February 1995, IP redeemed $12 million of 8.00% mandatorily redeemable serial preferred stock. In May 1995, IP redeemed the remaining $24 million of 8.00% mandatorily redeemable serial preferred stock. In March 1995, IP redeemed $.2 million of 7.56% serial preferred stock and $3 million of 8.24% serial preferred stock. In August 1995, IP redeemed $5 million of 8.75% First Mortgage Bonds. In December 1995, IP redeemed $34.7 million of 8.00% serial preferred stock, $33.6 million of 7.56% serial preferred stock and $27 million of 8.24% serial preferred stock. IPFI is a statutory business trust in which IP serves as sponsor. IPFI issued $100 million of TOPrS at 8% (4.8% after-tax rate) in January 1996. The TOPrS were issued by IPFI, which invested the proceeds in an equivalent amount of IP subordinated debentures due in 2045. The proceeds were used by IP to repay short-term indebtedness on varying dates on or before March 1, 1996. IP incurred the indebtedness in December 1995 to redeem $95.3 million (principal value) of higher-cost outstanding preferred stock of IP. In 1992, IP executed a general obligation mortgage (New Mortgage) to replace, over time, IP's 1943 Mortgage and Deed of Trust (First Mortgage). Both mortgages are secured by liens on substantially all of IP's properties. A corresponding issue of First Mortgage bonds, under the First Mortgage, secures any bonds issued under the New Mortgage. In October 1997, at a special bondholders meeting, the 1943 First Mortgage was amended to be generally consistent with the New Mortgage. The New Mortgage provides IP with increased financial flexibility. At December 31, 1997, based on the most restrictive earnings test contained in the New Mortgage, IP could issue approximately $800 million of additional New Mortgage bonds for other than refunding purposes. Also at December 31, 1997, the unused portion of Illinova and IP total bank lines of credit was $465 million. The amount of available IP unsecured borrowing capacity totaled $168 million at December 31, 1997. On February 12, 1997, the IP Board of Directors approved a change to the Articles of Incorporation to remove the limitation on the amount of unsecured debt that IP can issue. The change will be voted on by the preferred stockholders at a special meeting planned to be held in 1998. Under HB 362, IP may issue transitional funding instruments for up to 25% of its December 31, 1996, capitalization on or after August 1, 1998. IP is continuing to review its refinancing plans but could issue up to $864 million of transitional funding instruments on or after August 1, 1998, under this provision. In addition, IP would be eligible to issue up to an additional $864 million of transitional funding instruments on or after August 1, 1999. Of the proceeds from the issuance of transitional funding instruments, 80% or more must be used to retire and repurchase IP debt and equity while 20% or less can be used to fund certain other transition costs. Construction expenditures for the years 1995 through 1997 were approximately $620.5 million, including $17.5 million of AFUDC. Illinova estimates that it will spend approximately $225 million for construction expenditures for IP in 1998. IP construction expenditures for the period 1998-2002 are expected to total about $1 billion. Additional expenditures may be required during this period to accommodate transitional expenditures related to a competitive environment, environmental compliance costs and system upgrades, which cannot be determined at this time. Illinova's capital expenditures for the years 1998 through 2002, in addition to the IP construction expenditures, are expected to include $129 million for nuclear fuel, $331 million for mandatory debt retirement and $762 million for investments by the non-regulated subsidiaries. See "Note 4 - Commitments and Contingencies" for additional information. Internal cash generation will meet substantially all construction and capital requirements. Environmental Matters See "Note 4 - Commitments and Contingencies" for a discussion of environmental matters that impact or could potentially impact Illinova and IP. Tax Matters See "Note 7 - Income Taxes" for a discussion of effective tax rates and other tax issues. ILLINOVA CORPORATION RESPONSIBILITY FOR INFORMATION The consolidated financial statements and all information in this annual report are the responsibility of management. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the consolidated financial statements. In the opinion of management, the consolidated financial statements fairly reflect Illinova's financial position, results of operations and cash flows. Illinova believes that its accounting and internal accounting control systems are maintained so that these systems provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition and that the financial records are reliable for preparing the consolidated financial statements. The consolidated financial statements have been audited by Illinova's independent accountants, Price Waterhouse LLP, in accordance with generally accepted auditing standards. Such standards include the evaluation of internal accounting controls to establish a basis for developing the scope of the examination of the consolidated financial statements. In addition to the use of independent accountants, Illinova maintains a professional staff of internal auditors who conduct financial, procedural and special audits. To assure their independence, both Price Waterhouse LLP and the internal auditors have direct access to the Audit Committee of the Board of Directors. The Audit Committee is composed of members of the Board of Directors who are not active or retired employees of Illinova. The Audit Committee meets with Price Waterhouse LLP and the internal auditors and makes recommendations to the Board of Directors concerning the appointment of the independent accountants and services to be performed. Additionally, the Audit Committee meets with Price Waterhouse LLP to discuss the results of their annual audit, Illinova's internal accounting controls and financial reporting matters. The Audit Committee meets with the internal auditors to assess the internal audit work performed, including tests of internal accounting controls. Larry D. Haab Chairman, President and Chief Executive Officer Larry F. Altenbaumer Chief Financial Officer, Treasurer and Controller ILLINOVA CORPORATION REPORT OF INDEPENDENT ACCOUNTANTS PRICE WATERHOUSE LLP To the Board of Directors and Shareholders of Illinova Corporation In our opinion, the consolidated financial statements of Illinova Corporation and its subsidiaries appearing on pages a-11 through a-31 of this report present fairly, in all material respects, the financial position of Illinova Corporation and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 1 to the consolidated financial statements, the Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulations," for its generation segment of the business in December 1997. Price Waterhouse LLP St. Louis, Missouri February 12, 1998 ILLINOVA CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Millions of dollars except per share amounts) For the Years Ended December 31, 1997 1996 1995 Operating Revenues Electric $ 1,244.4 $1,202.9 $ 1,252.6 Electric interchange 175.6 137.6 116.3 Gas 353.9 348.2 272.5 Diversified enterprises 735.6 57.6 2.0 Total 2,509.5 1,746.3 1,643.4 Operating Expenses Fuel for electric plants 232.4 248.1 273.9 Power purchased 217.9 65.2 59.5 Gas purchased for resale 207.7 202.6 138.8 Diversified enterprises 792.3 87.5 15.2 Other operating expenses 290.5 249.9 259.7 Maintenance 111.7 99.7 100.0 Enhanced retirement and severance - - 37.8 Depreciation and amortization 198.8 190.0 186.5 General taxes 133.8 131.3 135.0 Total 2,185.1 1,274.3 1,206.4 Operating income 324.4 472.0 437.0 Other Income and Deductions Miscellaneous-net (3.9) (9.0) (7.8) Equity earnings in affiliates 17.5 6.4 2.7 Total 13.6 (2.6) (5.1) Income before interest charges and income taxes 338.0 469.4 431.9 Interest Charges Interest expense 136.8 134.7 148.6 Allowance for borrowed funds used during construction (5.0) (6.5) (6.0) Preferred dividend requirements of subsidiary 21.5 22.3 23.7 Total 153.3 150.5 166.3 Income before income taxes 184.7 318.9 265.6 Income taxes 80.3 127.9 114.0 Net income before extraordinary item 104.4 191.0 151.6 Extraordinary item net of income tax benefit of $118.0 million (Note 1) (195.0) - - Net income (loss) (90.6) 191.0 151.6 Carrying amount over (under) consideration paid for redeemed preferred stock of subsidiary .2 (.7) (3.5) Net income (loss) applicable to common stock $ (90.4) $ 190.3 $ 148.1 Earnings per common share before extraordinary item (basic and diluted) $ 1.41 $ 2.51 $ 1.96 Extraordinary item per common share (basic and diluted) $ (2.63) - $ - Earnings (loss) per common share (basic and diluted) $ (1.22 $ 2.51 $ 1.96 Cash dividends declared per common share $ 1.24 $ 1.15 $ 1.03 Cash dividends paid per common share $ 1.24 $ 1.12 $ 1.00 Weighted average common shares 73,991,651 75,681,937 75,643,937
See notes to consolidated financial statements which are an integral part of these statements. Prior years restated to conform to new financial format. ILLINOVA CORPORATION CONSOLIDATED BALANCE SHEETS (Millions of dollars) December 31, 1997 1996 Assets Utility Plant, at original cost Electric (includes construction work in progress of $214.3 million and $212.5 million, respectively) $ 6,690.4 $ 6,335.4 Gas (includes construction work in progress of $10.7 million and $21.2 million, respectively) 663.0 646.1 7,353.4 6,981.5 Less - accumulated depreciation 2,808.1 2,419.7 4,545.3 4,561.8 Nuclear fuel in process 6.3 5.3 Nuclear fuel under capital lease 126.7 96.4 4,678.3 4,663.5 Investments and Other Assets 198.8 146.2 Current Assets Cash and cash equivalents 33.0 24.6 Accounts receivable (less allowance for doubtful accounts of $5.5 million and $3.0 million, respectively) Service 115.6 138.8 Other 102.3 62.0 Accrued unbilled revenue 86.3 106.0 Materials and supplies, at average cost Fossil fuel 12.6 7.9 Gas in underground storage 29.3 27.2 Operating materials 76.7 78.1 Prepayments and other 64.4 24.1 520.2 468.7 Deferred Charges Deferred Clinton costs - 103.9 Recoverable income taxes - 101.3 Other 185.7 229.2 185.7 434.4 $ 5,583.0 $ 5,712.8 Capital and Liabilities Capitalization Common stock - No par value, 200,000,000 shares authorized; 71,681,937 and 75,681,937 shares outstanding, respectively, stated at $ 1,425.7 $ 1,425.7 Less - Deferred compensation - ESOP 10.2 14.3 Retained earnings 51.7 233.0 Less - Capital stock expense 7.3 8.2 Less - 4,000,000 shares of common stock in treasury at cost 90.4 - Total common stock equity 1,369.5 1,636.2 Preferred stock of subsidiary 57.1 96.2 Mandatorily redeemable preferred stock of subsidiary 197.0 197.0 Long-term debt 1,717.5 1,636.4 Total capitalization 3,341.1 3,565.8 Current Liabilities Accounts payable 177.3 166.7 Notes payable 415.3 387.0 Long-term debt and lease obligations of subsidiary maturing within one year 87.5 47.7 Dividends declared 22.9 24.7 Taxes accrued 26.7 43.9 Interest accrued 36.0 34.3 Other 96.0 43.7 861.7 748.0 Deferred Credits Accumulated deferred income taxes 969.0 1,034.9 Accumulated deferred investment tax credits 208.3 215.5 Other 202.9 148.6 1,380.2 1,399.0 $ 5,583.0 $ 5,712.8
(Commitments and Contingencies Note 4) See notes to consolidated financial statements which are an integral part of these statements. ILLINOVA CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Millions of dollars) For the Years Ended December 31, 1997 1996 1995 Cash Flows from Operating Activities Net income (loss) $ (90.6) $ 191.0 $ 151.6 Items not requiring (providing) cash - Depreciation and amortization 202.1 195.3 190.0 Allowance for funds used during construction (5.0) (6.5) (6.0) Deferred income taxes 30.8 57.4 39.1 Enhanced retirement and severance - - 37.8 Extraordinary item 195.0 - - Changes in assets and liabilities - Accounts receivable (19.4) (52.2) (7.8) Accrued unbilled revenue 19.7 (16.9) (10.2) Materials and supplies (5.4) (2.1) 22.8 Accounts payable 26.4 46.8 (13.6) Interest accrued and other, net 14.7 (5.4) 9.5 Net cash provided by operating activities 368.3 407.4 413.2 Cash Flows from Investing Activities Construction expenditures (223.9) (187.3) (209.3) Allowance for funds used during construction 5.0 6.5 6.0 Other investing activities (33.5) (75.0) (34.9) Net cash used in investing activities (252.4) (255.8) (238.2) Cash Flows from Financing Activities Dividends on common stock (92.4) (84.7) (75.6) Repurchase of common stock (90.4) - - Redemptions - Short-term debt (241.1) (355.8) (213.6) Long-term debt (160.8) (153.7) (5.2) Preferred stock of subsidiary (39.0) (29.5) (134.5) Issuances - Short-term debt 269.5 383.2 209.5 Long-term debt 250.0 - - Preferred stock of subsidiary - 100.0 - Common stock - 1.1 - Other financing activities (3.3) 1.1 5.0 Net cash used in financing activities (107.5) (138.3) (214.4) Net change in cash and cash equivalents 8.4 13.3 (39.4) Cash and cash equivalents at beginning of year 24.6 11.3 50.7 Cash and cash equivalents at end of year $ 33.0 $ 24.6 $ 11.3
ILLINOVA CORPORATION CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (Millions of dollars) For the Years Ended December 31, 1997 1996 1995 Balance at beginning of year $ 233.0 $ 129.6 $ 58.8 Net income (loss) before dividends and carrying amount adjustment (69.1) 213.3 175.3 163.9 342.9 234.1 Less - Dividends - Preferred stock of subsidiary 21.7 22.6 23.6 Common stock 90.7 86.6 77.4 Plus - Carrying amount over (under) consideration paid for redeemed preferred stock of subsidiary .2 (.7) (3.5) (112.2) (109.9) (104.5) Balance at end of year $ 51.7 $ 233.0 $ 129.6
See notes to consolidated financial statements which are an integral part of these statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Illinova, a holding company, and its subsidiaries: IP, IGC, IIC, and IEP. IP is a combination electric and gas utility. IGC invests in energy-related projects and competes in the independent power market. IIC's purpose is to insure the risks of the subsidiaries of Illinova and risks related to or associated with their business enterprises. IEP develops and markets energy-related services to the unregulated energy market throughout the United States and Canada, and engages in the brokering and marketing of electric power and gas. On February 12, 1997, the Illinova Board of Directors approved a merger of IEP and IPMI, another Illinova subsidiary. In the merger, IPMI was the surviving entity but changed its name to IEP. See "Note 2 - Illinova Subsidiaries" for additional information. All significant intercompany balances and transactions have been eliminated from the consolidated financial statements. All nonutility operating transactions are included in the sections "Diversified enterprises," "Interest expense," "Income taxes" and "Other Income and Deductions," in Illinova's Consolidated Statements of Income. Preparation of financial statements in conformity with generally accepted accounting principles requires the use of management's estimates. Actual results could differ from those estimates. Regulation IP is subject to regulation by the ICC and the FERC. Prior to the passage of HB 362, IP prepared its consolidated financial statements in accordance with FAS 71, "Accounting for the Effects of Certain Types of Regulation." Reporting under FAS 71 allows companies whose service obligations and prices are regulated to maintain on their balance sheets assets which represent costs they expect to recover from customers through inclusion of such costs in their future rates. In July 1997, the EITF concluded that application of FAS 71 accounting should be discontinued at the date of enactment of deregulation legislation for business segments for which a plan of deregulation has been established. The EITF further concluded that regulatory assets and liabilities that originated in the portion of the business being deregulated should be written off unless their recovery is specifically provided for through future cash flows from the regulated portion of the business. Because HB 362 provides for market-based pricing of electric generation services, IP discontinued application of FAS 71 for its generating segment in December 1997 when HB 362 was signed by Illinois Governor Edgar. IP evaluated its regulatory assets and liabilities associated with its generation segment and determined that recovery of these costs was not probable through rates charged to transmission and distribution customers, the regulated portion of its business. Therefore, IP wrote off generation-related regulatory assets and liabilities of approximately $195 million (net of income taxes) in December 1997. These net assets related to previously incurred costs that had been expected to be collected through future revenues, including deferred Clinton post construction costs, unamortized losses on reacquired debt, recoverable income taxes and other generation-related regulatory assets. At December 31, 1997, IP's net investment in generation facilities was $3.5 billion and was included in "Utility Plant, at Original Cost" on IP's Consolidated Balance Sheets. Illinova's principal accounting policies are: Regulatory Assets Regulatory assets represent probable future revenues to IP associated with certain costs that are expected to be recovered from customers through the ratemaking process. Significant regulatory assets are as follows: (Millions of dollars) 1997 1996 Deferred Clinton post-construction costs $ - $ 103.9 Recoverable income taxes $ - $ 101.3 Unamortized losses on reacquired debt $ 32.3 $ 87.7 Manufactured-gas plant site cleanup costs $ 64.8 $ 69.1 DOE decontamination and decommissioning fees $ 6.3 $ 5.4 Utility Plant The cost of additions to utility plant and replacements for retired property units is capitalized. Cost includes labor, materials, and an allocation of general and administrative costs, plus AFUDC as described below. Maintenance and repairs, including replacement of minor items of property, are charged to maintenance expense as incurred. When depreciable property units are retired, the original cost and dismantling charges, less salvage value, are charged to accumulated depreciation. Allowance for Funds Used During Construction The FERC Uniform System of Accounts defines AFUDC as the net costs for the period of construction of borrowed funds used for construction purposes and a reasonable rate on other funds when so used. AFUDC is capitalized as a component of construction work in progress by those business segments applying the provisions of FAS 71. In 1997, 1996 and 1995, the pre-tax rate used for all construction projects was 5.6%, 5.8% and 6.5%, respectively. Although cash is not currently realized from the allowance, it is realized under the ratemaking process over the service life of the related property through increased revenues resulting from a higher rate base and higher depreciation expense. Non-regulated business segments capitalize interest under the guidelines in FAS 34, "Capitalization of Interest Cost." Depreciation For financial statement purposes, IP depreciates the various classes of depreciable property over their estimated useful lives by applying composite rates on a straight-line basis. In 1997, 1996 and 1995, provisions for depreciation were 2.8%, 2.8% and 2.8%, respectively, of the average depreciable cost for Clinton. Provisions for depreciation for all other electric plant were 2.8%, 2.6% and 2.6% in 1997, 1996 and 1995, respectively. Provisions for depreciation of gas utility plant, as a percentage of the average depreciable cost, were 3.3%, 3.9% and 3.9% in 1997, 1996 and 1995, respectively. Amortization of Nuclear Fuel IP leases nuclear fuel from the Fuel Company under a capital lease. Amortization of nuclear fuel (including related financing costs) is determined on a unit of production basis. A provision for spent fuel disposal costs is charged to fuel expense based on kwh generated. See "Note 4 - Commitments and Contingencies" for discussion of decommissioning and nuclear fuel disposal costs. Unamortized Debt Discount, Premium and Expense Discount, premium and expense associated with long-term debt are amortized over the lives of the related issues. Costs related to refunded debt for business segments applying the provisions of FAS 71 are amortized over the lives of the related new debt issues or the remaining life of the old debt if no new debt is issued. Costs related to refunded debt for the generating segment are expensed when incurred. Revenue and Energy Cost IP records revenue for services provided but not yet billed to more closely match revenues with expenses. Unbilled revenues represent the estimated amount customers will be billed for service delivered from the time meters were last read to the end of the accounting period. Operating revenues include related taxes that have been billed to customers in the amount of $71 million in 1997, $68 million in 1996 and $66 million in 1995. The costs of fuel for the generation of electricity, purchased power and gas purchased for resale are recovered from customers pursuant to the electric fuel and purchased gas adjustment clauses. Accordingly, allowable energy costs that are to be passed on to customers in a subsequent accounting period are deferred. The recovery of costs deferred under these clauses is subject to review and approval by the ICC. In September 1997, IP filed a petition with the ICC that stipulated customers will not be charged for certain additional costs of energy incurred as a result of Clinton being out of service. During 1997, as a result of this stipulation, IP did not collect $36.3 million of fuel costs. IP will also forego recovery of additional fuel costs in 1998 for the duration of the Clinton outage. Under the petition, fuel costs charged to customers will be no higher than average 1995 - 1996 levels until Clinton is back in service operating at least at a 65% capacity factor for two consecutive months. Income Taxes Deferred income taxes result from temporary differences between book income and taxable income, and the tax bases of assets and liabilities on the balance sheet. The temporary differences relate principally to plant in service and depreciation. Investment tax credits used to reduce federal income taxes have been deferred and are being amortized to income over the service life of the property that gave rise to the credits. Illinova and its subsidiaries file a consolidated federal income tax return. Income taxes are allocated to the individual companies based on their respective taxable income or loss. See "Note 7 - Income Taxes" for additional discussion. Preferred Dividend Requirements of Subsidiary Preferred dividend requirements of IP reflected in the Consolidated Statements of Income are recorded on the accrual basis. Consolidated Statements of Cash Flows Cash and cash equivalents include cash on hand and temporary investments purchased with an initial maturity of three months or less. Capital lease obligations not affecting cash flows increased by $30 million, $31 million and $19 million during 1997, 1996 and 1995, respectively. Income taxes and interest paid are as follows: Years ended December 31, (Millions of dollars) 1997 1996 1995 Income taxes $ 96.2 $ 65.9 $ 64.7 Interest $ 145.3 $ 148.5 $ 152.4 Interest Rate Cap Generally, premiums paid for purchased interest rate cap agreements are being amortized to interest expense over the terms of the caps. Unamortized premiums are included in "Current Assets," "Prepayments and other," in the Consolidated Balance Sheets. Amounts to be received under the cap agreements are accrued and recognized as a reduction in interest expense. Forward Contracts of Subsidiary In the normal course of business, IEP enters into contracts for the purchase and sale (physical delivery) of electricity. When, through use of a market price analysis, it is deemed probable that a loss will occur on fulfillment of a contract, a loss (contingent liability) is recorded. When markets allow, IEP will hedge price exposure through the use of electricity futures contracts and swaps. New Pronouncements The FASB issued FAS 128, "Earnings Per Share" in February 1997, effective for financial statements issued after December 15, 1997. FAS 128 establishes standards for computing and presenting EPS and replaces the presentation of primary EPS and fully diluted EPS with a presentation of basic EPS and diluted EPS, respectively. Reconciliations of the income (loss) and number of shares for the basic and diluted EPS calculations are as follows: (Millions of dollars) 1997 1996 1995 Net income before extraordinary item (basic and diluted) $ 104.6 $ 190.3 $ 148.1 Extraordinary item (basic and diluted) $(195.0) $ - $ - Net income (loss) applicable to common stock (basic and diluted) $ (90.4) $ 190.3 $ 148.1 Weighted average common shares for basic EPS 73,991,651 75,681,937 75,643,937 Effect of dilutive securities - stock options 7,745 33,745 19,914 Adjusted weighted average common shares for diluted EPS 73,999,396 75,715,682 75,663,851 The FASB issued FAS 129, "Disclosure of Information about Capital Structure" in February 1997, effective for financial statements for periods ending after December 15, 1997. FAS 129 establishes standards for disclosing information about an entity's capital structure and contains no change in disclosure requirements for entities that were previously subject to the requirements of Accounting Principles Board Opinions 10 and 15 and FAS 47. No new requirements are imposed on Illinova by FAS 129. The FASB issued FAS 130, "Reporting Comprehensive Income" in June 1997, effective for fiscal years beginning after December 15, 1997. FAS 130 establishes standards for reporting and display of comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements. Illinova continues to analyze FAS 130 and does not currently expect it to have a significant impact on its financial statement presentation. The FASB issued FAS 131, "Disclosures about Segments of an Enterprise and Related Information" in June 1997, effective for periods beginning after December 15, 1997. FAS 131 supersedes FAS 14, "Financial Reporting for Segments of a Business Enterprise." FAS 131 establishes standards for the way public business enterprises report financial and descriptive information about their reportable operating segments in their financial statements. Generally, financial information is required to be reported on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments. Illinova continues to evaluate the provisions of FAS 131 and determine the impact of the revised disclosure requirements on its 1998 financial statements. Note 2 - Illinova Subsidiaries Illinova, a holding company, is the parent of IP, IGC, IEP and IIC. IP is engaged in the generation, transmission, distribution and sale of electric energy and the distribution, transportation and sale of natural gas in the state of Illinois. IGC invests in energy-related projects throughout the world and competes in the independent power market. IEP develops and markets energy-related services to the unregulated energy market throughout the United States and Canada. On February 12, 1997, the Illinova Board of Directors approved a merger of IEP and IPMI, another wholly owned subsidiary of Illinova. IPMI formerly engaged in the brokering and marketing of electric power and gas. In the merger, IPMI was the surviving entity but changed its name to IEP. IIC is a captive insurance company whose primary business is to insure the risks of the subsidiaries of Illinova and risks related to or associated with their business enterprises. IGC and IEP are wholly owned subsidiaries of Illinova. IP has preferred shares outstanding, but its common stock is wholly owned by Illinova. IGC has investments in power-producing facilities throughout the world, some operating and some under construction. The following table summarizes its investments: Year of Fuel Total In Service Location Investment Type MW Date Domestic & England Teesside, England 1993 Natural Gas 1875 1993 Ferndale, Washington 1994 Natural Gas 245 1994 Paris, Texas 1994 Natural Gas 230 1989 Cleburne, Texas 1994 Natural Gas 258 1996 Long Beach, California 1995 Natural Gas 70 1989 Pepperell, Massachusetts 1995 Natural Gas 38 1995 Joppa, Illinois 1996 Coal 1015 1955 Latin America Puerto Cortez, Honduras 1994 Diesel 80 1994/95 Old Harbour, Jamaica 1995 Diesel 74 1995 Aguaytia, Peru 1995 Natural Gas 155 1998 Barranquilla, Colombia 1996 Natural Gas 400 1995/96/98 Asia Zhejiang Province, China 1995 Coal 24 1996 Balochistan, Pakistan 1996 Natural Gas 586 1998 Hunan Province, China 1997 Coal 24 1999 IGC's ownership interest totals 440 MW for the domestic and English plants, 259 MW for the Latin American plants, and 130 MW for the Asian plants. As of December 31, 1997, IGC has approximately $160 million invested in the 829 MW it owns. IGC's investments are primarily accounted for under the equity method. At December 31, 1997, Illinova's net investment in IGC was $180 million. IEP focuses on the development and sale of energy and energy-related services primarily in the Midwestern and Western regions of North America. IEP develops and sells energy-related services designed to assist target customers in assessing current energy consumption patterns, and to enable customers to reduce energy usage through increased efficiency by changing practices and upgrading equipment and facilities. Currently IEP is developing and marketing a series of energy-related information collection and analysis tools, collectively known as EQ services. These services include software tools that a customer may utilize to conduct its own analysis as well as a service bureau that will perform these services and bill consolidation for the customer. IEP has also expanded the project management and engineered solutions business, formerly known as Illinova Energy Services, to provide delivery capability for energy-related equipment and facilities improvements throughout the Midwestern and Western United States. IEP owns 50% of Tenaska Marketing Ventures, in partnership with Tenaska Marketing, Inc. Tenaska Marketing Ventures focuses on natural gas marketing in the Midwestern United States. In the Western United States, IEP is one of the largest power marketers, purchasing and selling electricity in the wholesale market. In the Midwest, IEP has developed a retail natural gas business, serving industrial and commercial customers. During 1997, IEP incurred losses of $30 million (before taxes) associated with the wholesale power marketing business, including accrued losses of $13.5 million (before taxes) for contracts not yet settled. These losses were primarily caused by a single contract entered into by IEP during 1996. See "Note 4 - Commitments and Contingencies" for information about IEP contingencies. At December 31, 1997, Illinova's net investment in IEP was $28 million. In 1997, IIC insured certain risks of IP for a premium of $16.7 million. In turn, IIC will reinsure this risk with a reinsurer. At December 31, 1997, Illinova's net investment in IIC was approximately $1.5 million. Note 3 - Clinton Power Station Clinton Operations In September 1996, a leak in a recirculation pump seal caused IP operations personnel to shut down Clinton. Clinton has not resumed operation. In January 1997 and again in June 1997, the NRC named Clinton among plants having a trend of declining performance. In June 1997, IP committed to conduct an ISA to thoroughly assess Clinton's performance. The ISA was conducted by a team of 30 individuals with extensive nuclear experience and no substantial previous involvement at Clinton. Their report concluded that the underlying reasons for the performance problems at Clinton were ineffective leadership throughout the organization in providing standards of excellence, complacency throughout the organization, barrier weaknesses and weaknesses in teamwork. In late October, a team commissioned by the NRC performed an evaluation to validate the ISA results. In December, this team concluded that the findings of the ISA accurately characterized Clinton's performance deficiencies and their causes. In September 1997, the NRC advised IP that it must submit a written report to the NRC at least two weeks prior to restarting Clinton, giving the agency reasonable assurance that IP's actions to correct recurring weaknesses in the corrective action program have been effective. After the report is submitted, the NRC staff plans to meet with IP's management to discuss the plant's readiness for restart. In November 1997, Larry Haab, Chief Executive Officer of IP, publicly pledged to address the findings of the ISA, to improve Clinton, and provide the resources necessary to restart the plant. Further, in January 1998, IP and PECO announced an agreement under which PECO will provide management services for Clinton. The new management team initially will consist of nine people in key positions, including chief nuclear officer and plant manager. Although a PECO team will help manage the plant, IP will continue to maintain the operating license for Clinton and retain ultimate oversight of the plant. The plant will remain staffed primarily by IP employees. PECO operates two stations, Limerick and Peach Bottom, each with two boiling water reactors similar to the one at Clinton. Although PECO's Peach Bottom Station was a troubled plant that experienced a two-year outage, it was turned around, and both plants have set performance records for long operating runs and short refueling outages, receiving excellent performance ratings from the NRC and the Institute of Nuclear Power Operations. On January 21, 1998, the NRC placed Clinton on its Watch List. Nuclear plants are placed on the Watch List when the NRC believes additional regulatory oversight is required because of declining performance. Clinton will remain on the Watch List until consistent improved performance is demonstrated. During the period Clinton remains on the Watch List, the NRC will monitor it more closely than plants not on the Watch List. This may include increased inspections, additional required documentation, NRC-required approval of processes and procedures and higher-level NRC oversight. Transfer of Soyland's Ownership Share to IP In March 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton. Soyland's title to the plant and directly related assets such as nuclear fuel was transferred to IP in May 1997. Soyland's nuclear decommissioning trust assets were transferred to IP in May 1997, consistent with IP's assumption of all of Soyland's ownership obligations, including those related to decommissioning. The FERC approved an amended PCA in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least 10 years. The amended PCA provides that a contract cancellation fee be paid by Soyland to IP in the event that a Soyland member terminates its membership from Soyland. In May 1997, three distribution cooperative members terminated membership by buying out of their long-term wholesale power contracts with Soyland. As a result, Soyland paid a fee of $20.8 million to IP in June 1997 to reduce its future base capacity charges. Fee proceeds of $2.9 million were used to offset the costs of acquiring Soyland's share of Clinton with the remaining $17.9 million recorded as interchange revenue. In December 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million will be deferred and recognized as interchange revenue over the initial term of the PCA. The payment is contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. Clinton Cost and Risks Clinton was placed in service in 1987 and represents approximately 20.3% of IP's installed generation capacity. The investment in Clinton represented approximately 54% of Illinova's total assets at December 31, 1997. See "Note 1 - Summary of Significant Accounting Policies" for additional information. IP's Clinton-related costs represented 38% of Illinova's total 1997 other operating, maintenance and depreciation expenses. Clinton's equivalent availability was 0%, 66% and 76% for 1997, 1996 and 1995, respectively. Ownership of an operating nuclear generating unit exposes IP to significant risks, including increased and changing regulatory, safety and environmental requirements and the uncertain future cost of closing and dismantling the unit. IP expects to be allowed to continue to operate Clinton; however, if any unforeseen or unexpected developments would prevent it from doing so, IP would be materially adversely affected. See "Note 4 - Commitments and Contingencies" for additional information. Note 4 - Commitments and Contingencies Commitments Illinova estimates that it will spend approximately $225 million for construction expenditures for IP in 1998. IP construction expenditures for the period 1998-2002 are expected to total about $1 billion. Additional expenditures may be required during this period to accommodate transitional expenditures related to a competitive environment, environmental compliance costs and system upgrades, which cannot be determined at this time. Illinova's capital expenditures for the years 1998 through 2002, in addition to the IP construction expenditures, are expected to include $129 million for nuclear fuel, $331 million for mandatory debt retirement and $762 million for investments by the non-regulated subsidiaries. In addition, IP has substantial commitments for the purchase of coal under long-term contracts. Estimated coal contract commitments for 1998 through 2002 are $619 million (excluding price escalation provisions.) Total coal purchases for 1997, 1996 and 1995 were $181 million, $184 million and $168 million, respectively. IP has contracts with various natural gas suppliers and interstate pipelines to provide natural gas supply, transportation and leased storage. Estimated committed natural gas, transportation and leased storage costs (including pipeline transition costs) for 1998 through 2002 total $56 million. Total natural gas purchased for 1997, 1996 and 1995 was $185 million, $207 million and $150 million, respectively. IP's estimated nuclear fuel commitments for Clinton are approximately $11 million for uranium concentrates through 2001, $3 million for conversion services through 2002, $35 million for enrichment services through 1999 and $232 million for fabrication services through 2019. IP is committed to purchase approximately $20 million of emission allowances through 1999. IP anticipates that all gas-related costs will be recoverable under IP's UGAC. See the subcaption "Fuel Cost Recovery" below for discussion of the UFAC. Fuel Cost Recovery On September 29, 1997, the ICC approved an IP petition that stipulates customers will not be charged for certain additional costs of energy incurred as a result of Clinton being out of service. Under the petition, fuel costs charged to customers will be no higher than average 1995 - 1996 levels until Clinton is back in service operating at least at a 65% capacity factor for two consecutive months. See "Note 3 - Clinton Power Station" for additional information about Clinton. As a result of Illinois deregulation legislation, IP may choose to eliminate application of the UFAC. IP's base rates would still include a component for some level of recovery of fuel costs, but IP would not be able to pass through to customers increased costs of purchasing fuel, emission allowances or replacement power. Upon elimination of the UFAC, base rates will include a fixed fuel cost factor equivalent to the average 1995 - 1996 fuel cost levels. Future recovery of fuel costs is uncertain, as IP will decrease base electric rates to residential customers beginning August 1998 and certain customers will be free to choose their electric generation supplier beginning in October 1999. The extent to which fuel costs are recovered will depend on a number of factors including the future market prices for wholesale and retail energy, when Clinton returns to service, and whether IP elects to eliminate the UFAC. Insurance IP maintains insurance for certain losses involving the operation of Clinton. For physical damage to the plant, IP's insurance program has two layers: 1) a primary layer of $500 million provided by nuclear insurance pools; and 2) an excess coverage layer of $1.1 billion provided by an industry-owned mutual insurance company for a total coverage of $1.6 billion. In the event of an accident with an estimated cost of reactor stabilization and site decontamination exceeding $100 million, NRC regulations require that insurance proceeds be dedicated and used first to return the reactor to, and maintain it in, a safe and stable condition, and second to decontaminate the reactor station site. The insurers also provide coverage for the shortfall in the Decommissioning Trust Fund caused by the premature decommissioning of the reactor due to an accident. In the event insurance limits are not exhausted by the above, the remaining coverage will be applied to property damage and a portion of the value of the undamaged property. In addition, while IP has no reason to anticipate a serious nuclear accident at Clinton, if such an incident should occur, the claims for property damage and other costs could materially exceed the limits of current or available insurance coverage. In the event of an extended shutdown of Clinton due to accidental property damage, IP also purchases approximately $1.5 million per week of business interruption insurance coverage through an industry-owned mutual insurance company. This insurance does not provide coverage until Clinton has been out of service for 21 weeks. All United States nuclear reactor licensees are subject to the Price-Anderson Act. This act currently limits public liability for a nuclear incident to $8.9 billion. Private insurance covers the first $200 million. Retrospective premium assessments against each licensed nuclear reactor in the United States provide excess coverage. Currently, the liability to these nuclear reactor licensees for such an assessment would be up to $79.3 million per incident, not including premium taxes which may be applicable, payable in annual installments of not more than $10 million. A Master Worker Policy covers worker tort claims alleging bodily injury, sickness or disease due to the nuclear energy hazard for workers whose initial radiation exposure occurred on or after January 1, 1988. The policy has an aggregate limit of $200 million that applies to the commercial nuclear industry as a whole. A provision provides for automatic reinstatement of policy limits up to an additional $200 million. IP may be subject to other risks that may not be insurable, or the amount of insurance carried to offset the various risks may not be sufficient to meet potential liabilities and losses. There is also no assurance that IP will be able to maintain insurance coverage at its present level. Under those circumstances, such losses or liabilities may have a substantial adverse effect on Illinova's and IP's financial positions. Decommissioning and Nuclear Fuel Disposal IP is responsible for the costs of decommissioning Clinton and for spent nuclear fuel disposal costs. In May 1997, consistent with IP's assumption of all of Soyland's ownership obligations of Clinton, Soyland's nuclear decommissioning trust assets were transferred to IP. Future decommissioning costs related to Soyland's former share of Clinton will be provided through the PCA between Soyland and IP. IP is collecting future decommissioning costs for the remaining portion of Clinton through its electric rates based on an ICC-approved formula that allows IP to adjust rates annually for changes in decommissioning cost estimates. Illinois deregulation legislation provides for the continued recovery of decommissioning costs from IP's delivery customers. IP concluded a site-specific study in 1996 to estimate the costs of dismantlement, removal and disposal of Clinton. This study resulted in projected decommissioning costs of $538 million (1996 dollars) or $969 million (2026 dollars, assuming a 2% inflation factor.) Regulatory approval of this increased decommissioning cost level was received in August 1997. This estimate is the basis used for funding decommissioning costs through rates charged to IP's customers and through the PCA with Soyland. External decommissioning trusts, as prescribed under Illinois law and authorized by the ICC, accumulate funds for the future decommissioning of Clinton based on the expected service life of the plant. For the years 1997, 1996 and 1995, IP contributed $5.3 million, $3.9 million and $5.0 million, respectively, to its external nuclear decommissioning trust funds. The balances in these nuclear decommissioning funds at December 31, 1997 and 1996 were $62.5 million and $41.4 million, respectively. Decommissioning funds are recorded as assets on the balance sheet. A decommissioning liability approximately equivalent to trust assets is also recorded. IP recognizes earnings and expenses from the trust fund as changes in its assets and liabilities relating to these funds occur. The FASB is reviewing the accounting for closure and removal costs of long-lived assets. Changes to current electric utility industry accounting practices for decommissioning may result in recording the estimated total cost for decommissioning as a liability and an increase to plant balances, depreciating the increased plant balances, and reporting trust fund income from the external decommissioning trusts as investment income rather than as a reduction to decommissioning expense. Based on current information, management believes that these changes will not have an adverse effect on results of operations due to existing and anticipated future ability to recover decommissioning costs through rates. Under the Nuclear Waste Policy Act of 1982, the DOE is responsible for the permanent storage and disposal of spent nuclear fuel. The DOE currently charges one mill ($0.001) per net kwh (one dollar per MWH) generated and sold for future disposal of spent fuel. IP is recovering these charges through rates. In 1996, the District of Columbia Circuit Court of Appeals issued an order, at the request of nuclear-owning utilities and state regulatory agencies, confirming DOE's unconditional obligation to take responsibility for spent nuclear fuel commencing in 1998, even if it has no permanent repository at that time. Notwithstanding this decision, which the DOE did not appeal, the DOE has indicated to all nuclear utilities that it may experience delay in performance. The impact of any such delay on IP will depend on many factors, including the duration of such delay and the cost and feasibility of interim, on-site storage. Environmental Matters Clean Air Act To comply with the SO2 emission reduction requirements of Phase I (1995-1999) of the Acid Rain Program of the 1990 Clean Air Act Amendments, IP continues to purchase emission allowances. An emission allowance is the authorization by the U.S. EPA to emit one ton of SO2. The ICC approved IP's Phase I Acid Rain Compliance Plan in September 1993, and IP is continuing to implement that plan. IP has acquired sufficient emission allowances to meet most of its anticipated needs for 1998 and 1999 and will purchase the remainder on the spot market. In 1993, the Illinois General Assembly passed and the governor signed legislation authorizing, but not requiring, the ICC to permit expenditures and revenues from emission allowance purchases and sales to be included in rates charged to customers as a cost of fuel. In December 1994, the ICC approved the recovery of emission allowance costs through the UFAC. See the subcaption "Fuel Cost Recovery" above for discussion of the UFAC. IP's compliance plan will defer, until at least 2000, any need for scrubbers or other capital projects associated with SO2 emission reductions. Phase II (2000 and beyond) SO2 emission reduction requirements of the Acid Rain Program could require additional actions and may result in capital expenditures and the purchase of emission allowances. To comply with the Phase I NOx emission reduction requirements of the acid rain provisions of the Clean Air Act, IP installed low-NOx burners at Baldwin Unit 3 and Vermilion Unit 2. On November 29, 1994, the Phase I NOx rules were remanded to the U.S. EPA. On April 13, 1995, the U.S. EPA reinstated, with some modifications, the Phase I NOx rules effective January 1, 1996. IP was positioned to comply with these revised rules without additional modifications to any of its generating plants. The U.S. EPA issued revised Phase II NOx emission limits on December 10, 1996. IP has prepared a Phase II Compliance Plan. Litigation over the scope and legality of these Phase II NOx limits precludes a precise quantification of anticipated capital costs for compliance; however, capital expenditures for IP's NOx Compliance Plan are expected to be $100 million prior to the year 2000. The majority of this investment will be directed to Baldwin Units 1 and 2 and will occur in conjunction with replacement of the air heaters on these units. In addition, regulators are continuing to examine potential approaches for compliance with current federal ozone air quality standards. On November 7, 1997, the U.S. EPA proposed air pollution rules which would require substantial reductions of NOx emissions in Illinois and 21 other states. The proposal would require the installation of NOx controls by September 2002. This proposal is expected to be finalized by November 1998 with Illinois utility reduction requirements specified in 1999. Preliminary cost estimates to comply with the proposed NOx limitations are $130 to $150 million beyond what is already needed to comply with the NOx requirements of Phase II of the Acid Rain Program. The legality of this proposal along with its technical feasibility is expected to be challenged by a number of utilities and utility groups, including IP. Global Warming On December 11, 1997, international negotiations to reduce greenhouse gas emissions concluded with the adoption of the Kyoto Protocol. This Protocol requires the United States to reduce greenhouse gas emissions to 7% below 1990 levels during the years 2008 through 2012 and to make further reductions thereafter. This Protocol must be ratified by the United States Senate. United States Senate Resolution 98 (passed 95 - 0) indicates the Senate would not ratify an agreement that fails to involve all countries or would damage the United States economy. Ratification will be a major political issue since the Protocol does not contain key elements that Senate Resolution 98 said would be necessary for ratification. It is anticipated that ratification will be delayed until after 1998. IP will face major changes in how it generates electricity if the Kyoto Protocol is ratified, or if the Protocol's reduction goals are incorporated into other environmental regulations. IP would have to repower some generating units and change from coal to natural gas in other units to reduce greenhouse gas emissions. IP estimates that compliance with these proposed regulations may require significant capital outlays and annual operating expenses which could have a material adverse impact on Illinova and IP. Manufactured-Gas Plant IP's estimated liability for MGP site remediation is $65 million. This amount represents IP's current best estimate of the costs that it will incur in remediation of the 24 MGP sites for which it is responsible. Because of the unknown and unique characteristics at each site, IP cannot presently determine its ultimate liability for remediation of the sites. IP is currently recovering MGP site remediation through tariff riders approved by the ICC. Accordingly, IP has recorded a regulatory asset on its balance sheet totaling $65 million as of December 31, 1997. Management expects that cleanup costs will be fully recovered from IP's customers. To offset the burden imposed on its customers, IP has initiated litigation against a number of insurance carriers. Any settlement proceeds or damages recovered from the carriers will continue to be credited to IP's customers through the tariff rider mechanism which the ICC previously approved. Electric and Magnetic Fields The possibility that exposure to EMF emanating from power lines, household appliances and other electric sources may result in adverse health effects continues to be the subject of litigation and governmental, medical and media attention. Litigants have also claimed that EMF concerns justify recovery from utilities for the loss in value of real property exposed to power lines, substations and other such sources of EMF. The number of EMF cases has declined in the last few years as more national and international science commissions have concluded that an EMF health risk has not been established. Additional research is being conducted to attempt to resolve continuing scientific uncertainties. On July 3, 1997, President Clinton signed legislation extending the National EMF Research and Public Information Dissemination Program through 1998. Research results, policy decisions and public information developments will continue into 1999. It is too soon to tell what, if any, impact these actions may have on IP's and Illinova's consolidated financial positions. IP continues its commitment to address customer and employee concerns related to the EMF issue. Other Legal Proceedings IP is involved in legal or administrative proceedings before various courts and agencies with respect to matters occurring in the ordinary course of business, some of which involve substantial amounts of money. Management believes that the final disposition of these proceedings will not have a material adverse effect on the consolidated financial position or the results of operations. Accounts Receivable IP sells electric energy and natural gas to residential, commercial and industrial customers throughout Illinois. At December 31, 1997, 72%, 17% and 11% of "Accounts receivable - Service" were from residential, commercial and industrial customers, respectively. IP maintains reserves for potential credit losses and such losses have been within management's expectations. During 1997, IP increased its reserve for doubtful accounts from $3.0 million to $5.5 million. Contingencies Soyland In March 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton. The FERC approved an amended PCA in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least ten years (the initial term of the PCA) and includes a provision that allows Soyland to pay its base capacity charges in advance. The amended PCA also provides that a contract cancellation fee will be paid by Soyland to IP in the event that a Soyland Cooperative member terminates its membership from Soyland. In May 1997, three distribution cooperative members terminated their membership by buying out of their respective long-term wholesale power contracts with Soyland. As a result, Soyland paid a fee of $20.8 million to IP in June 1997 to reduce its future base capacity charges. In December 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million will be deferred and recognized as interchange revenue over the initial term of the PCA. The payment will be contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. Nuclear Fuel Lease See "Note 8 - Capital Leases" for discussion of contingencies related to IP's nuclear fuel lease. Internal Revenue Service Audit The Internal Revenue Service is currently auditing IP's federal income tax returns for the years 1991 through 1993. At this time, the outcome of the audit cannot be determined; however, management does not expect that the results will have a material adverse effect on IP's and Illinova's consolidated financial positions or results of operations. For a detailed discussion of income taxes, see "Note 7 - Income Taxes." Illinova Energy Partners, Inc. IEP buys and sells electricity in the Western United States. In the normal course of business, IEP is required to incur price exposure on the electricity bought or sold. Where the markets allow, IEP will hedge such exposure through the use of electricity futures contracts or through swaps with qualified counterparties. The aggregate notional value, fair value and unrealized gain related to futures contracts outstanding at December 31, 1997, are immaterial. In addition, IEP considers the risk of counterparty non-performance to be remote. At December 31, 1997, IEP had electricity sales and purchase contracts which exposed the company to risk as a result of price volatility. For the year ended December 31, 1997, IEP accrued losses of $13.5 million (before taxes) relating to contracts not yet settled. Illinova guarantees the performance of IEP and Tenaska Marketing Ventures up to an aggregate of $80 million for credit support. The level of credit support in place at December 31, 1997, was $45 million. See "Note 2 - Illinova Subsidiaries" for additional information about IEP. Note 5 - Lines of Credit and Short-Term Loans IP has total lines of credit represented by bank commitments amounting to $354 million, all of which were unused at December 31, 1997. These lines of credit are renewable in May 1998, August 1998 and May 2002. These bank commitments support the amount of commercial paper outstanding at any time, limited only by the amount of unused bank commitments, and are available to support other IP activities. In addition, Illinova's total lines of credit represented by bank commitments amount to $150 million, of which $111.5 million was unused at December 31, 1997. Illinova's letters of credit total $31.1 million. IP pays facility fees up to .10% per annum on $350 million of the total lines of credit, regardless of usage. The interest rate on borrowings under these agreements is, at IP's option, based upon the lending banks' reference rate, their Certificate of Deposit rate, the borrowing rate of key banks in the London interbank market or competitive bid. IP has letters of credit totaling $206 million and pays fees up to .45% per annum on the unused amount of credit. In addition, IP and the Fuel Company each have a short-term financing option to obtain funds not to exceed $30 million. IP and the Fuel Company pay no fees for this uncommitted facility and funding is subject to availability upon request. Illinova had $38.5 million of borrowings against its lines of credit at December 31, 1997. For the years 1997, 1996 and 1995, Illinova (including IP) had short-term borrowings consisting of bank loans, commercial paper, extendible floating rate notes and other short-term debt outstanding at various times as follows: (Millions of dollars, except rates) 1997 1996 1995 Short-term borrowings at December 31, $ 415.3 $ 387.0 $ 359.6 Weighted average interest rate at December 31, 6.1% 5.8% 6.0% Maximum amount outstanding at any month end $ 415.3 $ 387.0 $ 359.6 Average daily borrowings outstanding during the year $ 298.5 $ 261.9 $ 306.5 Weighted average interest rate during the year 5.8% 5.7% 6.2% Interest rate cap agreements are used to reduce the potential impact of increases in interest rates on floating-rate debt. IP's two variable rate interest rate cap agreements cover up to $114.6 million of commercial paper. These agreements entitle IP to receive from a counterparty on a quarterly basis the amount, if any, by which IP's interest payments on a nominal amount of commercial paper exceed the interest rate set by the cap. On December 31, 1997, the cap rates were set at 7.75% and 8.0% while the current market rate available to IP was 5.8%. IP also has a $50 million interest rate swap in effect through October 1998 where IP pays 5.92% and receives the LIBOR variable rate, payable quarterly. Note 6 - Facilities Agreements On March 13, 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership obligations in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton pursuant to an agreement reached in 1996. Soyland's title to the plant and directly related assets such as nuclear fuel was transferred to IP on May 1, 1997. Soyland's nuclear decommissioning trust assets were transferred to IP on May 19, 1997, consistent with IP's assumption of all of Soyland's ownership obligations including those related to decommissioning. The FERC approved an amended PCA between Soyland and IP in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least ten years. The amended PCA provides that a contract cancellation fee will be paid by Soyland to IP in the event that a Soyland member terminates its membership in Soyland. In May 1997, three distribution cooperative members terminated their membership by buying out of their respective long-term wholesale power contracts with Soyland. This action resulted in Soyland paying a fee of $20.8 million to IP in June 1997, to reduce its future base capacity charges. Fee proceeds of $2.9 million were used to offset the costs of acquiring Soyland's share of Clinton with the remaining $17.9 million recorded as interchange revenue. In December 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million is deferred and recognized as interchange revenue over the initial term of the PCA. The payment will be contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. Note 7 - Income Taxes Deferred tax assets and liabilities were comprised of the following: Balances as of December 31, (Millions of dollars) 1997 1996 Deferred tax assets: Current: Misc. book/tax recognition differences $ 11.2 $ 7.7 Noncurrent: Depreciation and other property related 46.2 42.0 Alternative minimum tax 156.8 198.5 Tax credit and net operating loss carryforward - 32.8 Unamortized investment tax credit 116.9 120.9 Misc. book/tax recognition differences 51.9 78.9 371.8 473.1 Total deferred tax assets $ 383.0 $ 480.8 Deferred tax liabilities: Current: Misc. book/tax recognition differences $ .9 $ 11.3 Noncurrent: Depreciation and other property related 1,348.0 1,350.1 Deferred Clinton costs - 58.2 Misc. book/tax recognition differences (7.1) 99.7 1,340.9 1,508.0 Total deferred tax liabilities $ 1,341.8 $ 1,519.3 Income taxes included in the Consolidated Statements of Income consist of the following components: Years Ended December 31, (Millions of dollars) 1997 1996 1995 Current taxes $ 70.3 $ 64.7 $ 78.3 Deferred taxes- Property related differences 8.8 70.6 71.9 Alternative minimum tax 41.7 1.1 2.9 Gain/loss on reacquired debt .4 (1.6) (1.9) Net operating loss carryforward - - (.2) Enhanced retirement and severance .5 2.6 (15.0) Misc. book/tax recognition differences (34.1) (2.2) (15.1) Investment tax credit (7.3) (7.3) (6.9) Total deferred taxes 10.0 63.2 35.7 Total income taxes from continuing operations $ 80.3 $ 127.9 $ 114.0 Income tax - Extraordinary item Current tax expense (17.8) - - Deferred tax expense (100.2) - - Total extraordinary item (118.0) - - Total income taxes $ (37.7) $ 127.9 $ 114.0 The reconciliations of income tax expense to amounts computed by applying the statutory tax rate to reported pretax income from continuing operations for the period are set below: Years Ended December 31, (Millions of dollars) 1997 1996 1995 Income tax expense at the federal statutory tax rate $ 64.7 $ 111.4 $ 92.9 Increases/(decreases) in taxes resulting from- State taxes, net of federal effect 8.7 11.4 12.4 Investment tax credit amortization (7.3) (7.3) (6.9) Depreciation not normalized 11.3 9.4 7.4 Preferred dividend requirement of subsidiary 1.7 2.5 5.8 Other-net 1.2 .5 2.4 Total income taxes from continuing operations $ 80.3 $ 127.9 $ 114.0 Combined federal and state effective income tax rates were 43.4%, 40.2% and 42.9% for the years 1997, 1996 and 1995, respectively. Illinova is subject to the provisions of the Alternative Minimum Tax System. As a result, Illinova has an Alternative Minimum Tax credit carryforward at December 31, 1997, of approximately $156.8 million. This credit can be carried forward indefinitely to offset future regular income tax liabilities in excess of the tentative minimum tax. The Internal Revenue Service is currently auditing IP's consolidated federal income tax returns for the years 1991 through 1993. At this time, the outcome of the audit cannot be determined; however, the results of the audit are not expected to have a material adverse effect on Illinova's consolidated financial position or results of operations. Because of the passage of HB 362, IP's electric generation business no longer meets the criteria for application of FAS 71. As required by FAS 101, "Regulated Enterprises - Accounting for the Discontinuation of Application of FASB Statement No. 71," the income tax effects of the write-off of regulatory assets and liabilities related to electric generation are reflected in the extraordinary item for the cumulative effect of a change in accounting principle. Note 8 - Capital Leases The Fuel Company, which is 50% owned by IP, was formed in 1981 for the purpose of leasing nuclear fuel to IP for Clinton. Lease payments are equal to the Fuel Company's cost of fuel as consumed (including related financing and administrative costs). Billings under the lease agreement during 1997, 1996 and 1995 were $4 million, $35 million and $41 million, respectively, including financing costs of $4 million, $5 million and $7 million, respectively. IP is required to pay financing costs whether or not fuel is consumed. IP is obligated to make subordinated loans to the Fuel Company at any time the obligations of the Fuel Company that are due and payable exceed the funds available to the Fuel Company. Lease terms stipulate that in the event that Clinton is out of service for 24 consecutive months, IP will be obligated to purchase Clinton's in-core nuclear fuel for $62 million from the Fuel Company. IP has an obligation for nuclear fuel disposal costs of leased nuclear fuel. See "Note 4 - Commitments and Contingencies" for discussion of decommissioning and nuclear fuel disposal costs. Nuclear fuel lease payments are included with "Fuel for electric plants" on Illinova's Consolidated Statements of Income. At December 31, 1997 and 1996, current obligations under capital lease for nuclear fuel are $18.7 million and $36.9 million, respectively. Over the next five years estimated payments under capital leases are as follows: (Millions of dollars) 1998 $ 23.5 1999 44.3 2000 23.9 2001 21.5 2002 16.7 Thereafter 12.8 142.7 Less - Interest 16.0 Total $ 126.7 Note 9 - Long-Term Debt (Millions of dollars) December 31, 1997 1996 First mortgage bonds of subsidiary- 6 1/2% series due 1999 $ 72.0 $ 72.0 6.60% series due 2004 (Pollution Control Series A) 6.3 6.5 7.95% series due 2004 72.0 72.0 6% series due 2007 (Pollution Control Series B) 18.7 18.7 7 5/8% series due 2016 (Pollution Control Series F, G and H) - 150.0 8.30% series due 2017 (Pollution Control Series I) 33.8 33.8 7 3/8% series due 2021 (Pollution Control Series J) 84.7 84.7 8 3/4% series due 2021 57.1 57.1 5.70% series due 2024 (Pollution Control Series K) 35.6 35.6 7.40% series due 2024 (Pollution Control Series L) 84.1 84.1 Total first mortgage bonds of subsidiary 464.3 614.5 New mortgage bonds of subsidiary- 6 1/8% series due 2000 40.0 40.0 5.625% series due 2000 110.0 110.0 6 1/2% series due 2003 100.0 100.0 6 3/4% series due 2005 70.0 70.0 8% series due 2023 229.0 229.0 7 1/2% series due 2025 177.0 177.0 Adjustable rate series due 2028 (Pollution Control Series M, N and O) 111.8 111.8 Adjustable rate series due 2032 (Pollution Control Series P, Q and R) 150.0 - Total new mortgage bonds of subsidiary 987.8 837.8 Total mortgage bonds of subsidiary 1,452.1 1,452.3 Medium-term notes of subsidiary, series A 68.0 78.5 Variable rate long-term debt of subsidiary due 2017 75.0 75.0 Illinova 7 1/8% Senior Notes due 2004 100.0 - Total other long-term debt 243.0 153.5 1,695.1 1,605.8 Unamortized discount on debt (16.8) (18.1) Total long-term debt excluding capital lease obligations 1,678.3 1,587.7 Obligations under capital leases of subsidiary 126.7 96.4 1,805.0 1,684.1 Long-term debt and lease obligations of subsidiary maturing within one year (87.5) (47.7) Total long-term debt $ 1,717.5 $ 1,636.4
In February 1997, Illinova issued $100 million of 7 1/8% Senior Notes due 2004. In April 1997, IP refinanced $150 million of 7 5/8% First Mortgage Bonds due 2016 as Adjustable Rate New Mortgage Bonds due 2032. In 1989 and 1991, IP issued a series of fixed rate medium-term notes. At December 31, 1997, these notes had interest rates ranging from 9% to 9.31% and will mature at various dates in 1998. Interest rates on variable rate long-term debt due 2017 are adjusted weekly and ranged from 4.35% to 4.6% at December 31, 1997. For the years 1998, 1999, 2000, 2001 and 2002, IP has long-term debt maturities and cash sinking fund requirements in the aggregate of (in millions) $68.8, $72.8, $150.8, $.8 and $.8, respectively. These amounts exclude capital lease requirements. See "Note 8 - Capital Leases." At December 31, 1997, the aggregate total of unamortized debt expense and unamortized loss on reacquired debt was approximately $50.4 million. In 1992, IP executed a new general obligation mortgage (New Mortgage) to replace, over time, IP's 1943 Mortgage and Deed of Trust (First Mortgage). Both mortgages are secured by liens on substantially all of IP's properties. A corresponding issue of First Mortgage bonds, under the First Mortgage, secures any bonds issued under the New Mortgage. In October 1997, at a special bondholders meeting, the 1943 First Mortgage was amended to be generally consistent with the New Mortgage. The remaining balance of net bondable additions at December 31, 1997, was approximately $1.8 billion. Note 10 - Preferred Stock of Subsidiary (Millions of dollars) December 31, 1997 1996 Serial Preferred Stock of Subsidiary, cumulative, $50 par value- Authorized 5,000,000 shares; 1,139,110 and 1,221,700 shares outstanding, respectively Series Shares Redemption Prices 4.08% 283,290 $ 51.50 $ 14.1 $ 15.0 4.26% 136,000 51.50 6.8 7.5 4.70% 176,000 51.50 8.8 10.0 4.42% 134,400 51.50 6.7 7.5 4.20% 167,720 52.00 8.4 9.0 7.75% 241,700 50.00 after July 1, 2003 12.1 12.1 Net premium on preferred stock .2 .2 Total Preferred Stock of Subsidiary, $50 par value $ 57.1 $ 61.3 Serial Preferred Stock of Subsidiary, cumulative, without par value- Authorized 5,000,000 shares; 0 and 698,200 shares outstanding, respectively Series Shares Redemption Prices A - - $ - $ 34.9 Total Preferred Stock of Subsidiary, without par value $ - $ 34.9 Preference Stock of Subsidiary, cumulative, without par value- Authorized 5,000,000 shares; none outstanding - - Total Serial Preferred Stock, Preference Stock and Preferred Securities of Subsidiary $ 57.1 $ 96.2 Company Obligated Mandatorily Redeemable Preferred Securities of: Illinois Power Capital, L.P. Monthly Income Preferred Securities, cumulative, $25 liquidation preference- 3,880,000 shares authorized and outstanding $ 97.0 $ 97.0 Illinois Power Financing I Trust Originated Preferred Securities, cumulative, $25 liquidation preference- 4,000,000 shares authorized and outstanding 100.0 100.0 Total Mandatorily Redeemable Preferred Stock of Subsidiary $ 197.0 $ 197.0
Serial Preferred Stock ($50 par value) is redeemable at the option of IP in whole or in part at any time with not less than 30 days and not more than 60 days notice by publication. The MIPS are redeemable at the option in whole or in part on or after October 6, 1999 with not less than 30 days and not more than 60 days notice by publication. The TOPrS mature on January 31, 2045 and may be redeemed in whole or in part at any time on or after January 31, 2001. Quarterly dividend rates for Serial Preferred Stock, Series A, are determined based on market interest rates of certain U.S. Treasury securities. Dividends paid in 1997 and 1996 were $.75 per share per quarter. Illinois Power Capital, L.P., is a limited partnership in which IP serves as a general partner. Illinois Power Capital issued (1994) $97 million of tax-advantaged MIPS at 9.45% (5.67% after-tax rate) with a liquidation preference of $25 per share. IP consolidates the accounts of Illinois Power Capital. Illinois Power Financing I is a statutory business trust in which IP serves as sponsor. IPFI issued (1996) $100 million of TOPrS at 8% (4.8% after-tax rate). IP consolidates the accounts of IPFI. On September 29, 1997, IP issued a notice of redemption to all holders of its Adjustable Rate Series A Preferred Stock. All 698,200 shares outstanding were redeemed on November 1, 1997, at the price of $50 per share. In 1997, IP redeemed $4.2 million of various issues of Serial Preferred Stock. The carrying amount was $.2 million over consideration paid and was recorded in equity and included in Net income applicable to common stock. Note 11 - Common Stock and Retained Earnings In 1997, Illinova repurchased 4,000,000 shares of its common stock on the open market. Illinova holds the common stock as treasury stock and deducts it from common equity at the cost of the shares. In 1996, Illinova amended the Automatic Reinvestment and Stock Purchase Plan and the ESOP. These plans were replaced with the Illinova Investment Plus Plan for which 5,000,000 shares of common stock were designated for issuance. Illinova administers the Illinova Investment Plus Plan. The Illinova Investment Plus Plan provides investors a convenient way to purchase shares of common stock and reinvest all or a portion of the cash dividends paid on eligible securities in additional shares of common stock. It allows purchases of common stock on the open market, as well as purchases of new issue shares directly from Illinova. Under this plan, 4,608,712 shares of common stock were designated for issuance at December 31, 1997. All accounts, elections, notices, instructions and authorizations under the Automatic Reinvestment and Stock Purchase Plan and the ESOP automatically continue under the Illinova Investment Plus Plan, and participants in the Automatic Reinvestment and Stock Purchase Plan and the ESOP continue as participants in the Illinova Investment Plus Plan. The ESOP includes an incentive compensation feature which is tied to employee achievement of specified corporate performance goals. This arrangement began in 1991 when IP loaned $35 million to the Trustee of the Plans, which used the loan proceeds to purchase 2,031,445 shares of IP's common stock on the open market. The loan and common shares were converted to Illinova instruments with the formation of Illinova in May 1994. These shares are held in a suspense account under the plans and are being distributed to the accounts of participating employees as the loan is repaid by the Trustee with funds contributed by IP, together with dividends on the shares acquired with the loan proceeds. IP financed the loan with funds borrowed under its bank credit agreements. For the year ended December 31, 1997, 91,282 common shares were allocated to salaried employees and 83,418 shares to employees covered under the Collective Bargaining Agreement through the matching contribution feature of the ESOP arrangement. Under the incentive compensation feature, 70,720 common shares were allocated to employees for the year ended December 31, 1997. During 1997, IP contributed $5.0 million to the ESOP and using the shares allocated method, recognized $3.3 million of expense. Interest paid on the ESOP debt was approximately $1.3 million in 1997 and dividends used for debt service were approximately $2.3 million. In 1992, the Board of Directors adopted and the shareholders approved a Long-Term Incentive Compensation Plan (the Plan) for officers or employee members of the Board, but excluding directors who are not officers or employees. Restricted stock, incentive stock options, non-qualified stock options, stock appreciation rights, dividend equivalents and other stock-based awards may be granted under the plan, for up to 1,500,000 shares of Illinova's common stock. The following table outlines the activity under this plan at December 31, 1997. Of the options granted in 1992, 1993, 1994 and 1995 in the table below, 7,500, 10,500, 4,400 and 6,500 options, respectively, have been forfeited and are not exercisable. An additional 20,000 options were exercised in January 1998. Year Options Grant Year Expiration Options Granted Granted Price Exercisable Date Exercised 1992 62,000 $23 3/8 1996 6/10/01 38,000 1993 73,500 $24 1/4 1997 6/09/02 - 1994 82,650 $20 7/8 1997 6/08/03 - 1995 69,300 $24 7/8 1998 6/14/04 - 1996 80,500 $29 3/4 1999 2/07/05 - 1997 82,000 $26 1/8 2000 2/12/07 - In October 1995, the FASB issued FAS No. 123, "Accounting for Stock-Based Compensation," effective for fiscal years beginning after December 15, 1995. Based on the current and anticipated use of stock options, the impact of FAS 123 is not material on the current period and is not envisioned to be material in any future period. Illinova continues to account for its stock options in accordance with Accounting Principle Board Opinion No. 25. The provisions of Supplemental Indentures to IP's General Mortgage Indenture and Deed of Trust contain certain restrictions with respect to the declaration and payment of dividends. IP was not limited by any of these restrictions at December 31, 1997. Under the Restated Articles of Incorporation, common stock dividends are subject to the preferential rights of the holders of preferred and preference stock. Note 12 - Pension and Other Benefit Costs Illinova offers certain benefit plans to the employees of all of its subsidiaries. IP is sponsor and administrator of all of the benefit plans. IP is reimbursed by the other Illinova subsidiaries for their share of the expenses of the benefit plans. The discussion and values below represent the plans in total, including the amounts attributable to the other subsidiaries. IP has defined-benefit pension plans covering all officers and employees. Benefits are based on years of service and compensation. IP's funding policy is to contribute annually at least the minimum amount required by government funding standards, but not more than can be deducted for federal income tax purposes. Pension costs, a portion of which have been capitalized for 1997, 1996 and 1995, include the following components: Years Ended December 31, (Millions of dollars) 1997 1996 1995 Service cost on benefits earned during the year $ 10.1 $ 10.2 $ 10.4 Interest cost on projected benefit obligation 27.9 26.8 23.6 Return on plan assets (95.6) (42.2) (58.3) Net amortization and deferral 61.5 9.4 29.6 Effect of enhanced retirement program - - 15.7 Net periodic pension cost $ 3.9 $ 4.2 $ 21.0 The estimated funded status of the plans at December 31, 1997 and 1996, using discount rates of 7.5% and 8.0%, respectively, and future compensation increases of 4.5% was as follows: Balances as of December 31, (Millions of dollars) 1997 1996 Actuarial present value of: Vested benefit obligation $ (329.7) $ (291.7) Accumulated benefit obligation (350.6) (312.5) Projected benefit obligation (412.8) (361.5) Plan assets at fair value 432.1 357.2 Funded status 19.3 (4.3) Unrecognized net (gain)/loss (39.1) (13.8) Unrecognized net asset at transition (26.1) (30.3) Unrecognized prior service cost 17.4 19.3 Accrued pension cost included in deferred credits $ (28.5) $ (29.1) The plans' assets consist primarily of common stocks, fixed income securities, cash equivalents, alternative investments and real estate. The actuarial present value of accumulated plan benefits at January 1, 1997 and 1996, were $375 million and $361 million, respectively, including vested benefits of $353 million and $337 million, respectively. The pension cost for 1997, 1996 and 1995 was calculated using a discount rate of 8.0%, 7.75% and 8.75%, respectively; future compensation increases of 4.5% for 1997, 1996 and 1995; and a return on assets of 9.5% for 1997 and 1996, and 9.0% for 1995. The unrecognized net asset at transition and the unrecognized prior service cost are amortized on a straight-line basis over the average remaining service period of employees who are expected to receive benefits under the plan. IP made cash contributions of $5 million in 1997, $6 million in 1996 and $2 million in 1995. IP provides health care and life insurance benefits to certain retired employees, including their eligible dependents, who attain specified ages and years of service under the terms of the defined-benefit plans. Postretirement benefits, a portion of which have been capitalized, for 1997 and 1996 included the following components: Years Ended December 31, (Millions of dollars) 1997 1996 Service cost on benefits earned during the year $ 1.9 $ 2.2 Interest cost on projected benefit obligation 5.9 6.1 Return on plan assets (8.0) (5.9) Amortization of unrecognized transition obligation 7.4 6.4 Net periodic postretirement benefit cost $ 7.2 $ 8.8 The net periodic postretirement benefit cost in the preceding table includes amortization of the previously unrecognized accumulated postretirement benefit obligation, which was $41.4 million and $44.2 million as of January 1, 1997 and 1996, respectively, over 20 years on a straight-line basis. IP has established two separate trusts for those retirees who were subject to a collectively bargained agreement and all other retirees to fund retiree health care and life insurance benefits. IP's funding policy is to contribute annually an amount at least equal to the revenues collected for the amount of postretirement benefit costs allowed in rates. The plan assets consist of common stocks and fixed income securities at December 31, 1997 and 1996. The estimated funded status of the plans at December 31, 1997 and 1996, using weighted average discount rates of 7.0% and 8.0%, respectively, and a return on assets of 9.0% was as follows: Balances as of December 31, (Millions of dollars) 1997 1996 Accumulated postretirement benefit obligation Current retirees $ (51.1) $ (49.6) Current employees - fully eligible (5.5) (3.5) Current employees - not fully eligible (32.8) (28.6) Total benefit obligation (89.4) (81.7) Plan assets at fair value 49.7 34.4 Funded status (39.7) (47.3) Unrecognized transition obligation 38.7 41.4 Unrecognized net (gain)/loss (6.3) (7.1) Accrued postretirement benefit cost included in deferred credits $ (7.3) $ (13.0) The pre-65 health-care-cost trend rate decreases from 7.1% to 5.5% over nine years and the post-65 health-care-cost trend rate is level at 1.5%. A 1.0% increase in each future year's assumed health-care-cost trend rates increases the service and interest cost from $7.8 million to $8.7 million and the accumulated postretirement benefit obligation from $89.4 million to $99.9 million. Note 13 - Segments of Business (Millions of dollars) 1997 1996 1995 Diversified Diversified Diversified Enterprises Total Enterprises Total Enterprises Total Electric Gas Corp. Electric Gas Corp. Electric Gas Corp. Operation information - Operating revenues $1,420.0 $353.9 $735.6 $2,509.5 $1,340.5 $348.2 $57.6 $1,746.3 $1,368.9 $272.5 $1.9 $1,643.3 Operating expenses, excluding provision for income taxes 1,081.3 311.5 792.3 2,185.1 886.2 300.5 87.5 1,274.2 946.2 245.0 15.1 1,206.3 Pre-tax operating income 338.7 42.4 (56.7) 324.4 454.3 47.7 (29.9) 472.1 422.7 27.5 (13.2) 437.0 AFUDC 4.9 .1 - 5.0 6.3 .2 - 6.5 5.5 .5 - 6.0 Pre-tax operating income, including AFUDC $ 343.6 $ 42.5 $(56.7) $ 329.4 $ 460.6 $47.9 $(29.9) $ 478.6 $ 428.2 $ 28.0 $(13.2) $ 443.0 Other deductions, net (13.6) 2.6 5.1 Interest charges 136.8 134.7 148.6 Provision for income taxes 80.3 128.0 114.0 Preferred dividend requirements of subsidiary 21.5 22.3 23.7 Net income 104.4 191.0 151.6 Extraordinary item (net of taxes) (195.0) - - Carrying value over (under) consideration paid for redeemed preferred stock of subsidiary .2 (.7) (3.5) Net income (loss) applicable to common stock $ (90.4) $190.3 $ 148.1 Other information - Depreciation $171.5 $24.1 $ - $ 195.6 $164.0 $ 22.5 $ - $186.5 $161.4 $ 21.6 $ - $ 183.0 Capital expenditures $201.3 $22.6 $ - $ 223.9 $164.0 $ 23.3 $ - $187.3 $185.7 $ 23.6 $ - $ 209.3 Investment information - Identifiable assets* $4,508.1 $453.8 $1.2 $4,963.1 $4,578.1 $481.9 $ - $5,060.0 $4,580.4 $446.3 $ - $5,026.7 Nonutility plant and other investments 184.0 132.4 65.5 Assets utilized for overall operations 435.9 520.4 517.6 Total assets $5,583.0 $5,712.8 $5,609.8
Note 14 - Fair Value of Financial Instruments 1997 1996 Carrying Fair Carrying Fair (Millions of dollars) Value Value Value Value Nuclear decommissioning trust funds $ 62.5 $ 62.5 $ 41.4 $ 41.4 Cash and cash equivalents 33.0 33.0 24.6 24.6 Mandatorily redeemable preferred stock of subsidiary 197.0 202.7 197.0 199.3 Long-term debt 1,678.3 1,730.1 1,587.7 1,629.3 Notes payable 415.3 415.3 387.0 387.0 The following methods and assumptions were used to estimate the fair value of each class of financial instruments listed in the table above: Nuclear Decommissioning Trust Funds The fair values of available-for-sale marketable debt securities and equity investments held by the Nuclear Decommissioning Trust are based on quoted market prices at the reporting date for those or similar investments. Cash and Cash Equivalents The carrying amount of cash and cash equivalents approximates fair value due to the short maturity of these instruments. Mandatorily Redeemable Preferred Stock of Subsidiary and Long-Term Debt The fair value of IP mandatorily redeemable preferred stock and Illinova (including IP) long-term debt is estimated based on the quoted market prices for similar issues or by discounting expected cash flows at the rates currently offered to Illinova for debt of the same remaining maturities, as advised by Illinova's bankers. Notes Payable The carrying amount of notes payable approximates fair value due to the short maturity of these instruments. Note 15 - Quarterly Consolidated Financial Information and Common Stock Data (unaudited) (Millions of dollars except per common share amounts) First Quarter Second Quarter Third Quarter Fourth Quarter 1997 1997 1997 1997 Operating revenues $ 570.4 $ 542.9 $ 841.8 $ 554.4 Operating income (loss) 114.4 95.1 144.2 (29.3) Net income (loss) before extraordinary item 44.0 31.4 63.3 (34.3) Net income (loss) after extraordinary item 44.0 31.4 63.3 (229.3) Net income (loss) applicable to common stock 44.0 31.4 64.4 (230.2) Earnings (loss) per common share before extraordinary item (basic and diluted) $ .58 $ .42 $ .87 $ (.46) Earnings (loss) per common share after extraordinary item (basic and diluted) $ .58 $ .42 $ .87 $ (3.09) Common stock prices and dividends High $ 27 1/2 $ 23 3/4 $ 23 3/4 $ 27 3/16 Low $ 22 3/4 $ 20 1/8 $ 21 1/2 $ 20 3/8 Dividends declared $ .31 $ .31 $ .31 $ .31 First Quarter Second Quarter Third Quarter Fourth Quarter 1996 1996 1996 1996 Operating revenues (1) $ 453.1 $ 373.4 $ 479.1 $ 440.7 Operating income (1) 121.4 89.7 189.6 71.3 Net income 43.3 36.7 91.0 20.0 Net income applicable to common stock 43.3 36.2 90.7 20.1 Earnings per common share (basic and diluted) $ .57 .48 $ 1.20 $ .26 Common stock prices and dividends High $ 30 3/8 $ 29 $ 29 1/4 $ 28 5/8 Low $ 27 $ 24 5/8 $ 25 1/4 $ 26 1/4 Dividends declared $ .28 $ .28 $ .28 $ .31
(1) Amounts have been restated to conform with 1997 changes in income statement format. Illinova common stock is listed on the New York Stock Exchange and the Chicago Stock Exchange. The stock prices above are the prices reported on the Composite Tape. There were 35,123 registered holders of common stock at January 10, 1998. ILLINOVA CORPORATION SELECTED CONSOLIDATED FINANCIAL DATA* (Millions of dollars) 1997 1996 1995 1994 1993 1987 Operating revenues Electric $ 1,244.4 $ 1,202.9 $ 1,252.6 $1,177.5 $1,135.6 $ 910.8 Electric interchange 175.6 137.6 116.3 110.0 130.8 92.4 Gas 353.9 348.2 272.5 302.0 314.8 308.7 Diversified enterprises 735.6 57.6 1.9 - - - Total operating revenues $ 2,509.5 $ 1,746.3 $ 1,643.3 $1,589.5 $1,581.2 $ 1,311.9 Extraordinary item net of income tax benefit $ (195.0) $ - $ - $ - $ - $ - Net income (loss) after extraordinary item $ (90.6) $ 191.0 $ 151.6 $ 151.8 $ (81.9) $ 251.9 Effective income tax rate 43.4% 40.2% 42.9% 42.0% (39.8)% 21.3% Net income (loss) applicable to common stock $ (90.4) $ 190.3 $ 148.1 $ 158.2 $ (81.9) $ 251.9 Earnings (loss) per common share (basic and diluted) $ (1.22) $ 2.51 $ 1.96 $ 2.09 $ (1.08) $ 3.75 Cash dividends declared per common share $ 1.24 $ 1.15 $ 1.03 $ .65 $ .40 $ 2.64 Dividend payout ratio (declared) N/A 45.5% 52.3% 30.7% N/A 70.9% Book value per common share $ 19.11 $ 21.62 $ 20.19 $ 19.17 $ 17.46 $ 26.85 Price range of common shares High $ 27 1/2 $ 30 3/8 $ 30 $ 22 5/8 $ 25 7/8 $ 31 1/2 Low $ 20 1/8 $ 24 5/8 $ 21 1/4 $ 18 1/8 $ 20 1/8 $ 21 1/4 Weighted average number of common shares outstanding during the period (thousands) 73,992 75,682 75,644 75,644 75,644 67,251 Total assets $ 5,583.0 $ 5,712.8 $ 5,609.8 $ 5,576.7 $ 5,423.5 $ 5,922.7 Capitalization Common stock equity $ 1,369.5 $ 1,636.2 $ 1,527.0 $ 1,450.2 $ 1,321.0 $ 1,841.4 Preferred stock of subsidiary 57.1 96.2 125.6 224.7 303.7 315.2 Mandatorily redeemable preferred stock of subsidiary 197.0 197.0 97.0 133.0 48.0 160.0 Long-term debt 1,717.5 1,636.4 1,739.3 1,946.1 1,926.3 2,279.2 Total capitalization $ 3,341.1 $ 3,565.8 $ 3,488.9 $ 3,754.0 $ 3,599.0 $ 4,595.8 Retained earnings (deficit) $ 51.7 $ 233.0 $ 129.6 $ 58.8 $ (64.6) $ 554.8 Capital expenditures $ 223.9 $ 187.3 $ 209.3 $ 193.7 $ 277.7 $ 263.5 Cash flows from operations $ 368.4 $ 407.4 $ 413.2 $ 268.6 $ 369.7 $ 232.3 AFUDC as a percent of earnings applicable to common stock N/A 3.4% 4.1% 5.9% N/A 80.2% Return on average common equity (6.0)% 12.0% 9.9% 11.4% (6.0)% 14.3% Ratio of earnings to fixed charges .93 3.07 2.56 2.56 .66 2.51
* Millions of dollars except earnings (loss) per common share, cash dividends declared per common share, book value per common share and price range of common shares. ILLINOVA CORPORATION SELECTED ILLINOIS POWER COMPANY STATISTICS 1997 1996 1995 1994 1993 1987 Electric Sales in KWH (Millions) Residential 4,734 4,782 4,754 4,537 4,546 4,241 Commercial 3,943 3,894 3,804 3,517 3,246 2,862 Industrial 8,403 8,493 8,670 8,685 8,120 7,323 Other 426 367 367 536 337 910 Sales to ultimate consumers 17,506 17,536 17,595 17,275 16,249 15,336 Interchange 7,230 5,454 4,444 4,837 6,015 3,682 Wheeling 3,253 928 642 622 569 - Total electric sales 27,989 23,918 22,681 22,734 22,833 19,018 Electric Revenues (Millions) Residential $ 489 $ 483 $ 500 $ 471 $ 463 $ 352 Commercial 325 318 321 295 269 209 Industrial 376 360 392 378 360 325 Other 40 38 37 30 40 25 Revenues from ultimate consumers 1,230 1,199 1,250 1,174 1,132 911 Interchange 176 138 116 110 131 92 Wheeling 14 4 3 3 3 - Total electric revenues $ 1,420 $ 1,341 $ 1,369 $ 1,287 $ 1,266 $ 1,003 Gas Sales in Therms (Millions) Residential 343 427 356 359 371 332 Commercial 147 177 144 144 148 137 Industrial 47 99 88 81 78 96 Sales to ultimate consumers 537 703 588 584 597 565 Transportation of customer-owned gas 309 251 273 262 229 327 Total gas sold and transported 846 954 861 846 826 892 Interdepartmental sales 19 9 21 5 7 5 Total gas delivered 865 963 882 851 833 897 Gas Revenues (Millions) Residential $ 238 $ 216 $ 173 $ 192 $ 200 $ 192 Commercial 77 79 60 66 68 66 Industrial 20 40 24 31 34 35 Revenues from ultimate consumers 335 335 257 289 302 293 Transportation of customer-owned gas 9 7 8 9 8 15 Miscellaneous 10 6 7 4 5 2 Total gas revenues $ 354 $ 348 $ 272 $ 302 $ 315 $ 310 System peak demand (native load) in kw (thousands) 3,532 3,492 3,667 3,395 3,415 3,083 Firm peak demand (native load) in kw (thousands) 3,469 3,381 3,576 3,232 3,254 2,923 Net generating capability in kw (thousands) 3,289 4,148 3,862 4,121 4,045 3,400 Electric customers (end of year) 580,257 549,957 529,966 553,86 554,270 542,848 Gas customers (end of year) 405,710 389,223 374,299 388,170 394,379 384,091 Employees (end of year) 3,655 3,635 3,559 4,350 4,540 4,616
500 south 27th street, decatur, illinois 62521 n http://www.illinova.com unlocking the power 1997 This entire report is printed on recycled paper EX-13.2 16 EX-13.2 1997 INFORMATION STATEMENT AND ANNUAL REPORT TO SHAREHOLDERS UNLOCKING THE POWER 1997 NOTICE OF ANNUAL MEETING OF SHAREHOLDERS Information Statement Table of Contents Notice of Annual Meeting 2 Information Statement 3 Appendix: 1997 Annual Report to Shareholders a-1 To the Shareholders of Illinois Power: Notice is Hereby Given that the Annual Meeting of Shareholders of Illinois Power Company ("Illinois Power") will be at 10 a.m. Wednesday, April 8, 1998, at Shilling Community Education Center, Richland Community College, One College Park, Decatur, Illinois 62521, for the following purposes: (1) To elect the Board of Directors for the ensuing year. (2) To transact any other business which may properly come before the meeting or any adjournment. Shareholders of record at the close of business on February 9, 1998, will be entitled to receive notice of and to vote at the Annual Meeting. By Order of the Board of Directors, Leah Manning Stetzner, Vice President, General Counsel and Corporate Secretary Decatur, Illinois March 10, 1998 IMPORTANT Only shareholders of Illinois Power are entitled to attend the Annual Meeting. Shareholders will be admitted on verification of record share ownership at the admission desk. Shareholders who own shares through banks, brokerage firms, nominees or other account custodians must present proof of beneficial share ownership (such as a brokerage account statement) at the admission desk. INFORMATION STATEMENT March 10, 1998 (Date first sent or given to security holders) We are not asking you for a proxy and you are requested not to send us a proxy. This Information Statement is furnished in connection with the Annual Meeting of Shareholders of Illinois Power. The Annual Meeting will be held at 10 a.m. Wednesday, April 8, 1998, at Shilling Community Education Center, Richland Community College, One College Park, Decatur, Illinois 62521, for the purposes set forth in the accompanying Notice of Annual Meeting of Shareholders. On February 9, 1998 ("Record Date"), Illinova Corporation ("Illinova") beneficially owned all of the 66,215,292 shares of Illinois Power Common Stock then outstanding and there were 1,139,110 shares of Illinois Power Preferred Stock then outstanding, none of which was held by Illinova. Voting Rights Shareholders of record at the close of business on the Record Date will be entitled to receive notice of and to vote at the Annual Meeting. Shareholders who are present at the Annual Meeting will be entitled to one vote for each share of Illinois Power Stock which they held of record at the close of business on the Record Date. When voting for candidates nominated to serve as directors, all shareholders will be entitled to 11 votes (the number of directors to be elected) for each of their shares and may cast all of their votes for any one candidate whose name has been placed in nomination prior to the voting, or distribute their votes among two or more such candidates in such proportions as they determine. In voting on other matters presented for consideration at the Annual Meeting, each shareholder will be entitled to one vote for each share of Stock held of record at the close of business on the Record Date. Annual Report and Information Statement Accompanying this Information Statement, which includes Consolidated Financial Statements, is a Notice of Annual Meeting of Shareholders and the Summary Annual Report to Shareholders covering operations of Illinova for the year 1997. This Information Statement and accompanying documents are first being mailed to shareholders on or about March 10, 1998. Board of Directors Information Regarding the Board of Directors The Board of Directors held 10 Board meetings in 1997. Other than Mr. Adorjan, who joined the Board in August 1997, and Mr. Berry, who retired from the Board December 1, 1997, all directors attended at least 75% of the aggregate meetings of the Board and Committees of which they were members during 1997. The Board has four standing committees: the Audit Committee, the Finance Committee, the Compensation and Nominating Committee and the Nuclear Operations Committee. The duties and members of the standing committees are: Audit Committee (1) Review with the Chairman, President and Chief Executive Officer and the independent accountants the scope and adequacy of Illinois Power's system of internal controls; (2) review the scope and results of the annual examination performed by the independent accountants; (3) review the activities of Illinois Power's internal auditors; (4) report its findings to the Board and provide a line of communication between the Board and both the internal auditors and the independent accountants; and (5) recommend to the Board the appointment of the independent accountants and approval of the services performed by the independent accountants, considering their independence with regard thereto. The Audit Committee met three times during 1997. This Committee consists of the following non-employee directors ("Outside Directors"): Robert M. Powers, Chairman, Richard R. Berry, C. Steven McMillan, Sheli Z. Rosenberg, Walter M. Vannoy, and Marilou von Ferstel. Finance Committee (1) Review management's cash flow forecasts, financial forecasts and financing program, and make recommendations to the Board regarding the approval of such plans; (2) review Illinois Power's banking relationships, short-term borrowing arrangements, dividend policies, arrangements with the transfer agent and registrar, investment objectives and the performance of Illinois Power's pension and other trust funds, evaluate fund managers, and make recommendations to the Board concerning such matters; (3) review Illinois Power's risk management programs, including insurance coverage, and make recommendations to the Board; and (4) act in an advisory capacity to management, the Board of Directors, and the Chairman, President and Chief Executive Officer on other financial matters as they may arise. The Finance Committee met three times during 1997. This Committee consists of the following members of the Board: Walter D. Scott, Chairman, J. Joe Adorjan, Richard R. Berry, Larry D. Haab, C. Steven McMillan, Sheli Z. Rosenberg, Marilou von Ferstel, and John D. Zeglis. Compensation and Nominating Committee (1) Review performance and recommend salaries plus other forms of compensation of elected Illinois Power officers and the Board of Directors; (2) review Illinois Power's benefit plans for elected Illinova officers and make recommendations to the Board regarding any changes deemed necessary; (3) review with the Chairman, President and Chief Executive Officer any organizational or other personnel matters; and (4) recommend to the Board nominees to stand for election as director to fill vacancies in the Board of Directors as they occur. The Compensation and Nominating Committee will consider shareholders' recommendations for nominees for director made pursuant to timely notice in writing addressed to the Chairman of the Committee at the executive offices of Illinois Power. The recommendation should include a full description of the qualifications and business and professional experience of the proposed nominees and a statement of the nominees' willingness to serve. To be timely, the notice must be delivered to or mailed and received at the executive offices of Illinois Power not less than 90 nor more than 120 days prior to the Annual Meeting. The Compensation and Nominating Committee met four times during 1997. This Committee consists of the following Outside Directors: Ronald L. Thompson, Chairman, J. Joe Adorjan, C. Steven McMillan, Robert M. Powers, Walter D. Scott, Marilou von Ferstel, and John D. Zeglis. Nuclear Operations Committee (1) Review the safety, reliability and quality of nuclear operations; (2) review the effectiveness of the management of nuclear operations; (3) review the strategic plan for nuclear operations; (4) review various nuclear reports; and (5) report its findings to the Board. The Nuclear Operations Committee met four times during 1997. This Committee consists of the following members of the Board: Walter M. Vannoy, Chairman, Richard R. Berry, Larry D. Haab, Robert M. Powers, Walter D. Scott, and Ronald L. Thompson. Board Compensation The Outside Directors of Illinois Power, all of whom also serve on the Board of Illinova, receive a total retainer fee of $18,000 per year for their service on these boards. Outside Directors who also chair Board Committees receive an additional $2,000, increased in February 1998 to $2,500, per year retainer. Outside Directors receive a grant of 650 shares of Illinova Common Stock on the date of each Annual Shareholders Meeting, representing payment in lieu of attendance-based fees for all Board and Committee meetings to be held during the subsequent one-year period. Outside Directors elected to the Board between Annual Shareholders Meetings are paid $850 for each Board and Committee meeting attended prior to the first Annual Shareholders Meeting after their election to the Board. Illinova had a Retirement Plan for Outside Directors. Under this plan, each Outside Director who attained age 65 and served on the Board for a period of 60 or more consecutive months was eligible for annual retirement benefits at the rate of the annual retainer fee in effect when the director retired. In 1996, the Board of Directors adopted a Comprehensive Deferred Stock Plan for Outside Directors, replacing the Retirement Plan. Each former Outside Director whose right to receive the retirement benefit had vested continues to receive such benefits in accordance with the terms of the Retirement Plan. All Outside Directors serving at the time this new plan was adopted were granted a lump sum amount based on the net present value of these benefits to them, were they to have retired under the Retirement Plan, based on the number of years they have served on the Board but not to exceed 10. This dollar amount was converted into stock units, based on the then market value of Illinova Common Stock, and placed into an account. The value of these stock units is to be paid out to the director in cash on termination of service, based on the then market value of Illinova Common Stock, plus dividend equivalents, in a lump sum or installments. In addition, each Outside Director receives an annual award of stock units having a value of $6,000, to be paid to the Outside Director in cash on retirement, at once or in installments as the Director may elect, with the amount of such payment determined by multiplying the number of stock units in the account times the then market value of Illinova Common Stock, and adding the dividend equivalents attributable to such stock units. Pursuant to Illinova's Deferred Compensation Plan for Certain Directors, Outside Directors of Illinois Power may elect to defer all or any portion of their fees and stock grants until termination of their services as directors. Such deferred amounts are converted into stock units representing shares of Illinova Common Stock with the value of each stock unit based on the last reported sales price of such stock. Additional credits are made to the participating director's account in dollar amounts equal to the dividends paid on the Common Stock which the director would have received if the director had been the record owner of the shares represented by stock units, and these amounts are converted into additional stock units. On termination of the participating directors' services as directors, payment of their deferred fees and stock grants was made in shares of Illinova Common Stock in an amount equal to the aggregate number of stock units credited to their accounts. The plan was amended in 1997 to provide for a payout in cash instead of shares of Common Stock. Deferred amounts are still converted into stock units representing shares of Common Stock with the value of each stock unit based on the last reported sales price of such stock. Payment is made in cash, in a lump sum or installments, as soon as practical following a director's termination. The cash paid on termination equals the number of stock units times the share price at the close of market on the last business day of the month preceding termination. No other payments are made after service on the Board ceases. Election of Directors Illinois Power's entire Board of Directors is elected at each Annual Meeting of Shareholders. Directors hold office until the next Annual Meeting of Shareholders or until their successors are elected and qualified. At the Annual Meeting a vote will be taken on a proposal to elect the 11 directors nominated by Illinois Power's Board of Directors. The names and certain additional information concerning each of the director nominees is set forth on the following pages. If any nominee should become unable to serve as a director, another nominee may be selected by the current Board of Directors. Walter M. Vannoy normally would have not been eligible for election as a director at the Annual Meeting of Shareholders pursuant to a Bylaw provision which mandates retirement from Board service at age 70. Because there is a current need for his nuclear expertise, the Board of Directors has elected to waive this requirement in Mr. Vannoy's case, and he has agreed to serve if elected. BOARD OF DIRECTORS Name of Director Nominee, Age, Year in Which First Business Experience and Elected a Director Other Information of Illinois Power J. Joe Adorjan, 59 1997 Chairman and Chief Executive Officer of Borg-Warner Security Corporation, Chicago, Ill., a security systems services firm, since 1995. He was President of Emerson Electric Company from 1993 to 1995. Prior to that, he was Chairman and Chief Executive Officer of ESCO Electronics Corporation. He is a director of The Earthgrains Company, ESCO Electronics Corporation and Goss Graphics Systems, Inc. Larry D. Haab, 60 1986 Chairman, President, and Chief Executive Officer of Illinova since December 1993, and of Illinois Power since June 1991, and an employee of Illinois Power since 1965. He is a director of First Decatur Bancshares, Inc.; The First National Bank of Decatur; and Firstech, Incorporated. C. Steven McMillan, 52 1996 President, Chief Operating Officer, and Director of Sara Lee Corporation, Chicago, Ill., a global packaged food and consumer products company, since 1997. He was Executive Vice President of Sara Lee from 1993 to 1997 and Senior Vice President-Strategy Development from 1986 to 1993. He is Chairman of the Board of Electrolux Corporation. Robert M. Powers, 66 1984 From 1980 until retirement in December 1988, Mr. Powers was President and Chief Executive Officer of A. E. Staley Manufacturing Company, Decatur, Ill., a processor of grain and oil seeds. He is a director of A. E. Staley Manufacturing Company. Sheli Z. Rosenberg, 56 1997 President and Chief Executive Officer since 1994 and General Counsel 1980 to 1994 of Equity Group Investments, Inc., Chicago, Ill., a privately held business conglomerate holding controlling interests in nine publicly traded corporations involved in basic manufacturing, radio stations, retail, insurance, and real estate. She is a director of American Classic Voyages Company; Quality Food Centers, Inc.; Jacor Communications, Inc.; Anixter International , Inc.; Equity Office Properties Trust; Equity Residential Properties Trust; CVS Corporation; and Manufactured Home Communities, Inc. Walter D. Scott, 66 1990 Professor of Management and Senior Austin Fellow, J. L. Kellogg Graduate School of Management, Northwestern University, Evanston, Ill., since 1988. He was Chairman of GrandMet USA from 1984 to 1986 and President and Chief Executive Officer of IDS Financial Services from 1980 to 1984. He is a director of Chicago Title and Trust Company, Chicago Title Insurance Company, Neodesic Corporation, Orval Kent Holding Company, Inc., and Intermatic Incorporated. Joe J. Stewart, 59 President of BWX Technologies, Inc., formerly The Babcock & Wilcox Government Group, Lynchburg, Va., a diversified energy equipment and services company, and Executive Vice President of McDermott International, Inc. (parent of BWX Technologies, Inc. and The Babcock & Wilcox Company), since 1995. He was President and Chief Operating Officer of The Babcock & Wilcox Company and Executive Vice President of McDermott International, Inc., from 1993 to 1995 and Executive Vice President of the Power Generation Group of The Babcock & Wilcox Company from 1987 to 1993. Ronald L. Thompson, 48 1991 Chairman and Chief Executive Officer of Midwest Stamping and Manufacturing Co., Bowling Green, Ohio, a manufacturer of automotive parts, since 1993. He was President and Chief Executive Officer and a director of The GR Group, Inc., St. Louis, Mo., from 1980 to 1993. He is a director of Teachers Insurance and Annuity Association, and Ryerson Tull. Walter M. Vannoy, 70 1990 Chairman until retirement in May 1995 and Chief Executive Officer from May 1994 until January 1995 of Figgie International, Inc., Willoughby, Ohio, a diversified operating company serving consumer, industrial, technical, and service markets world-wide. From 1980 to 1988 he was President and Chief Operating Officer, The Babcock & Wilcox Company, and Vice Chairman of McDermott International, Inc. Marilou von Ferstel, 60 1990 Executive Vice President and General Manager of Ogilvy Adams & Rinehart, Inc., a public relations firm in Chicago, Ill., from June 1990 until retirement in April 1997. She was Managing Director and Senior Vice President of Hill and Knowlton, Chicago, Ill., from 1981 to 1990. She is a director of Walgreen Company. John D. Zeglis, 50 1993 President of AT&T, Basking Ridge, N.J., a diversified communications company, since October 1997. He was Vice Chairman from June 1997 to October 1997, Senior Executive Vice President and General Counsel, from 1995 to June 1997 and Senior Vice President - General Counsel and Government Affairs from 1989 to 1995. He is a director of the Helmerich & Payne Corporation. Security Ownership of Management and Certain Beneficial Owners The table below shows shares of Illinova Common Stock beneficially owned as of January 31, 1998, by each director nominee and executive officers named in the Summary Compensation Table. All of Illinois Power's Common Stock is owned by Illinova. To the best of Illinois Power's knowledge, no owner holds more than 5 percent of Illinois Power Preferred Stock. Number Number of Stock of Shares Units in Deferred Name of Beneficially Compensation Percent Beneficial Owner Owned (1)(2) Plans of Class J. Joe Adorjan 0 0 (3) Larry D. Haab 68,250 0 (3) C. Steven McMillan 1,300 289 (3) Robert M. Powers 8,550 289 (3) Sheli Z. Rosenberg 0 1,539 (3) Walter D. Scott 5,150 289 (3) Joe J. Stewart 0 0 (3) Ronald L. Thompson 3,677 3,275 (3) Walter M. Vannoy 5,010 289 (3) Marilou von Ferstel 4,420 1,603 (3) John D. Zeglis 2,626 1,603 (3) Paul L. Lang 21,216 0 (3) Larry F. Altenbaumer 13,092 0 (3) John G. Cook 11,894 0 (3) David W. Butts 8,817 0 (3) (1) With sole voting and/or investment power. (2) Includes the following shares issuable pursuant to stock options exercisable March 31, 1998: Mr. Haab, 56,900; Mr. Lang, 17,800; Mr. Altenbaumer, 17,800; Mr. Cook, 9,900; and Mr. Butts, 7,900. (3) No director or executive officer owns any other equity securities of Illinova or as much as 1% of the Common Stock. As a group, directors and executive officers of Illinova and Illinois Power own 187,021 shares of Common Stock (less than 1%). Executive Compensation The following table sets forth a summary of the compensation of the Chief Executive Officer and the four other most highly compensated executive officers of Illinois Power for the years indicated. The compensation shown includes all compensation paid for service to Illinois Power, its parent and subsidiaries. Summary Compensation Table Long-Term Compensation Annual Compensation Awards Other Restricted Securities All Other Bonus Annual Stock Awards Underlying Compensation Name and Principal Position Year Salary (1) Compensation (2) Options (3) Larry D. Haab 1997 $514,952 $ 41,840 $ 16,557 $ 41,840 20,000 shs. $ 2,614 Chairman, President and 1996 493,709 69,267 15,973 69,267 22,000 shs. 2,615 Chief Executive Officer of 1995 472,250 91,144 19,088 91,144 20,000 shs. 2,550 Illinova and Illinois Power Paul L. Lang 1997 $242,325 $ 10,602 $ 8,305 $ 10,601 6,500 shs. $ 2,615 Senior Vice President 1996 233,450 19,747 8,863 19,747 6,500 shs. 2,595 of Illinois Power 1995 222,812 23,841 8,265 23,841 6,500 shs. 2,510 Larry F. Altenbaumer 1997 $232,048 $ 8,992 $ 9,521 $ 8,992 6,500 shs. $ 1,985 Chief Financial Officer, 1996 222,374 19,832 8,459 19,832 7,500 shs. 1,976 Treasurer and Controller 1995 204,937 20,391 7,686 20,391 6,500 shs. 2,378 of Illinova, and Senior Vice President and Chief Financial Officer of Illinois Power John G. Cook 1997 $203,413 $ - $ 7,642 $ - 6,000 shs. $ 2,575 Senior Vice President 1996 196,474 16,293 7,409 16,293 6,500 shs. 2,575 and former Chief Nuclear 1995 179,069 16,620 6,930 16,620 4,500 shs. 2,530 Officer of Illinois Power David W. Butts 1997 $188,227 $ 7,529 $ 7,185 $ 7,529 6,000 shs. $ 2,595 President of Illinova 1996 181,402 17,314 7,350 17,314 6,500 shs. 2,595 Energy Partners, formerly 1995 153,333 18,132 6,990 18,132 5,000 shs. 2,540 Senior Vice President of Illinois Power
(1) The amounts shown in this column are the cash award portion of grants made to these individuals under the Executive Incentive Compensation Plan ("Compensation Plan") for 1997, including amounts deferred under the Executive Deferred Compensation Plan. See the Compensation Plan description in footnote (2) below. (2) This table sets forth stock unit awards for 1997 under the Compensation Plan. One-half of each year's award under this plan is converted into stock units representing shares of Illinova Common Stock based on the closing price of Common Stock on the last trading day of the award year. The other one-half of the award is cash and is included under Bonus in the Summary Compensation Table. Stock units awarded in a given year, together with cash representing the accumulated dividend equivalents on those stock units, become fully vested after a three-year holding period. Stock units are converted into cash based on the closing price of Common Stock on the first trading day of the distribution year. Participants (or beneficiaries of deceased participants) whose employment is terminated by retirement on or after age 55, disability, or death receive the present value of all unpaid awards on the date of such termination. Participants whose employment is terminated for reasons other than retirement, disability, or death forfeit all unvested awards. In the event of a termination of employment within two years after a change in control of Illinova, without good cause or by any participant with good reason, all awards of the participant become fully vested and payable. As of December 31, 1997, named executive officers were credited with the following total aggregate number of unvested stock units under the Compensation Plan since its inception, valued on the basis of the closing price of Common Stock on December 31, 1997: Mr. Haab, 7,619 units valued at $205,241; Mr. Lang, 2,044 units valued at $55,071; Mr. Altenbaumer, 1,862 units valued at $50,151; Mr. Cook, 1,250 units valued at $33,685; Mr. Butts, 1,626 units valued at $43,787. Although stock units have been rounded, valuation is based on total stock units, including partial shares. (3) The amounts shown in this column are Illinois Power's contributions under the Incentive Savings Plan (including the market value of shares of Illinova Common Stock at the time of allocation). The following tables summarize grants during 1997 of stock options under Illinova's 1992 Long-Term Incentive Compensation Plan ("LTIC") and awards outstanding at year end for the individuals named in the Summary Compensation Table. Option Grants In 1997 Individual Grants Number of Securities % of Total Options Underlying Options Granted to Employees Exercise or Base Grant Date Granted (1) in 1997 Price Per Share (1) Expiration Date Present Value (2) Larry D. Haab 20,000 24% $26.125 2/12/2007 $107,200 Paul L. Lang 6,500 8% 26.125 2/12/2007 34,840 Larry F. Altenbaumer 6,500 8% 26.125 2/12/2007 34,840 John G. Cook 6,000 7% 26.125 2/12/2007 32,160 David W. Butts 6,000 7% 26.125 2/12/2007 32,160
(1) Each option becomes exercisable on February 12, 2000. In addition to the specified expiration date, the grant expires on the first anniversary of the recipient's death and/or five years following date of retirement, and is not exercisable in the event a recipient's employment terminates. In the event of certain change-in-control circumstances, the Compensation and Nominating Committee may declare the option immediately exercisable. The exercise price of each option is equal to the fair market value of the Common Stock on the date of the grant. Recipients shall also receive, on or shortly after February 12, 2000, a target performance award, determined by calculating the difference between the return earned by Illinova on its invested capital and its cost of capital (the "spread"), then comparing this spread to that of a peer group and reducing or increasing the target award depending on Illinova's relative performance, but not reducing the payment below zero. The target award is equal to one-half of the mid-point of compensation for each officer's salary grade (a market-based number) times a percentage, determined by the Compensation and Nominating Committee. In 1997 those percentages ranged between 20 and 45 percent. At the discretion of the Board of Directors, the foregoing payment may be made in the form of Illinova Common Stock of equivalent value based on the average New York Stock Exchange price of the stock during February 2000, or in cash. (2) The Grant Date Present Value has been calculated using the Black-Scholes option pricing model. Disclosure of the Grant Date Present Value, or the potential realizable value of option grants assuming 5% and 10% annualized growth rates, is mandated by regulation; however, Illinova does not necessarily view the Black-Scholes pricing methodology, or any other present methodology, as a valid or accurate means of valuing stock option grants. The calculation was based on the following assumptions: (i) As of the grant date, Illinova's calculated Black-Scholes ratio was .2248. After discounting for risk of forfeiture at 3 percent per year over Illinova's three-year vesting schedule, the ratio is reduced to .2052; (ii) An annual dividend yield on Illinova Common Stock of 4.11%; (iii) A risk-free interest rate of 6.57%, based on the yield of a zero-coupon government bond maturing at the end of the option term; and (iv) Stock volatility of 19.54%. Aggregated Option and Fiscal Year-End Option Value Table Number of Securities Underlying Unexercised Value of Unexercised In-the-Money Options at Fiscal Year-End Options at Fiscal Year-End Name Exercisable/Unexercisable Exercisable/Unexercisable Larry D. Haab 56,900 shs./62,000 shs. $237,414/$57,400 Paul L. Lang 17,800 shs./19,500 shs. $75,148/$18,655 Larry F. Altenbaumer 17,800 shs./20,500 shs. $75,148/$18,655 John G. Cook 9,900 shs./17,000 shs. $43,634/$14,130 David W. Butts 7,900 shs./17,500 shs. $37,384/$13,100
Pension Benefits Illinois Power maintains a Retirement Income Plan for Salaried Employees (the "Retirement Plan") providing pension benefits for all eligible salaried employees. In addition to the Retirement Plan, Illinois Power also maintains a nonqualified Supplemental Retirement Income Plan for Salaried Employees (the "Supplemental Plan") that covers certain officers eligible to participate in the Retirement Plan and provides for payments from general funds of Illinois Power of any monthly retirement income not payable under the Retirement Plan because of benefit limits imposed by law or because of certain Retirement Plan rules limiting the amount of credited service accrued by a participant. The following table shows the estimated annual pension benefits on a straight life annuity basis payable upon retirement based on specified annual average earnings and years of credited service classifications, assuming continuation of the Retirement Plan and Supplemental Plan and employment until age 65. This table does not show, but any actual pension benefit payments would be subject to, the Social Security offset. Estimated Annual Benefits (rounded) Annual 15 Yrs. 20 Yrs. 25 Yrs. 30 Yrs. 35 Yrs. Average Credited Credited Credited Credited Credited Earnings Service Service Service Service Service $125,000 $37,500 $ 50,000 $62,500 $75,000 $87,500 150,000 45,000 60,000 75,000 90,000 105,000 175,000 52,500 70,000 87,500 105,000 122,500 200,000 60,000 80,000 100,000 120,000 140,000 250,000 75,000 100,000 125,000 150,000 175,000 300,000 90,000 120,000 150,000 180,000 210,000 350,000 105,000 140,000 175,000 210,000 245,000 400,000 120,000 160,000 200,000 240,000 280,000 450,000 135,000 180,000 225,000 270,000 315,000 500,000 150,000 200,000 250,000 300,000 350,000 550,000 165,000 220,000 275,000 330,000 385,000 600,000 180,000 240,000 300,000 360,000 420,000 650,000 195,000 260,000 325,000 390,000 455,000 700,000 210,000 280,000 350,000 420,000 490,000 The earnings used in determining pension benefits under the Retirement Plan are the participants' regular base compensation, as set forth under Salary in the Summary Compensation Table. At December 31, 1997, for purposes of both the Retirement Plan and the Supplemental Plan, Messrs. Haab, Lang, Altenbaumer, Cook and Butts had completed 32, 16, 25, 23 and 19 years of credited service, respectively. Employee Retention Agreements Illinova has entered into Employee Retention Agreements with each of its executive officers and with officers of its subsidiaries. Under each agreement, the officer would be entitled to receive a lump sum cash payment if his or her employment were terminated by Illinova without good cause or voluntarily by the officer for good reason within two years following a change in control of Illinova (as defined in the Agreement) or terminated prior to a change of control at the request of a potential acquirer. The amount of the lump sum payment would be equal to (1) 36 months' salary at the greater of the officer's salary rate in effect on the date the change in control occurred or the salary rate in effect on the date the officer's employment with Illinova terminated; plus (2) three times the latest bonus earned by the officer during the three calendar years preceding termination of employment. Under the agreement, the officer would continue, after any such termination of employment, to participate in and receive benefits under other benefit plans of Illinova and/or Illinois Power. Such coverage would continue for 36 months following termination of employment, or, if earlier, until the officer reached age 65 or was employed by another employer; provided that, if the officer was 50 years of age or older at the time of such termination, then coverage under health, life insurance and similar welfare plans would continue until the officer became 55 years of age, at which time he or she would be eligible to receive the benefits extended to the employees of Illinova and its subsidiaries who elect early retirement. Compensation and Nominating Committee Report on Officer Compensation The seven-member Compensation and Nominating Committee of the Board of Directors (the "Committee") is composed entirely of Outside Directors. The Committee's role includes an assessment of Illinova's and Illinois Power's Compensation Strategy, a review of the performance of the elected officers and the establishment of specific officer salaries subject to Board approval. The Committee establishes performance goals for the officers under the Compensation Plan, approves payments made pursuant to the Compensation Plan and recommends grants under the Long-Term Incentive Compensation Plan approved by the shareholders in 1992. The Committee also reviews other forms of compensation and benefits making recommendations to the Board on changes whenever appropriate. The Committee carries out these responsibilities with assistance from an executive compensation consulting firm and with input from the Chief Executive Officer and management as it deems appropriate. Officer Compensation Philosophy Illinova's compensation philosophy reflects a commitment to compensate officers competitively with other companies while rewarding executives for achieving levels of operational and financial excellence consistent with continuous improvement. Illinova's current compensation policy is to provide a total compensation opportunity targeted to the median of all utilities in the Edison Electric Institute (EEI) database. All but one of the electric power companies in the S&P Utilities Index are also in the EEI database. The S&P index covers the industry broadly including electric and gas utilities. After careful consideration, the Committee has decided to maintain a separate compensation peer group limited to electric or combination electric and gas companies for reference purposes. While the philosophy described above was used by Illinova in 1997 as an indicator of future utility pay practices, as the industry migrates toward deregulation and diversification, it is anticipated that the company will broaden its competitive reference beyond the regulated utility industry in order to compete sufficiently for talent in the deregulated environment of the future. The compensation program for officers consists of base salary, annual incentive and long-term incentive components. The combination of these three elements balances short- and long-term business performance goals and aligns officer financial rewards with those of Illinova's shareholders. The compensation program is structured so that, depending on the salary level, between 25 and 45 percent of an officer's total compensation target is composed of incentive compensation. Base Salary Plan The Committee determines base salary ranges for executive officers based on competitive pay practices of similarly sized utilities. Officer salaries correspond to approximately the median of the companies in the compensation peer group. Individual increases are based on several factors, including the officer's performance during the year, the relationship of the officer's salary to the market salary level for the position and competitive industry salary increase practices. Annual Incentive Compensation Plan Annual incentive awards are earned based on the achievement of specific annual financial and operational goals by the Illinois Power officer group as a whole and consideration of the officer's individual contribution. If payment is earned under this Plan, one-half of the bonus is payable in cash during the year following the award year, and one-half is credited to the participants in the form of Common Stock units, the number of which is determined by dividing half of the earned bonus amount by the closing price of the Common Stock on the last trading day of the award year. The officer's interest in the stock units vests at the end of the three-year period, which begins the year after the award year. The officer receives this award in cash equal to (1) the closing stock price on the first trading day of the distribution year times the number of units held plus (2) dividend equivalents that would have been received if the stock had actually been issued. Maximum awards under the plan may be up to 150 percent of target; threshold awards are 50 percent of target. For Illinois Power officers, 1997 awards under the Compensation Plan are based on achievement in the performance areas: earnings per share, customer satisfaction, safety and employee teamwork, cost management and shareholder value added. Up to 50 percent of the awarded amount is based on an assessment of the individual officer's performance during the year. Awards shown under Bonus in the Summary Compensation Table for performance during 1997 were based on achievement of officers' individual goals. There were no payouts for the identified performance areas. Long-Term Incentive Compensation (LTIC) Plan Awards under the LTIC plan are based on corporate performance as well as individual officers' contributions to corporate performance subject to the review of this Committee. In 1997, it was determined that awards under the LTIC plan be delivered in two components. One-half of each officer's LTIC plan award is delivered in the form of stock options granted at fair market value. The stock options granted to the officers for 1997 represent an award based on Illinova, Illinois Power, and individual performance as evaluated by the Chairman and reviewed by the Committee. The other half of the LTIC plan award is distributed to officers in cash based upon Illinova's Shareholder Value-Added (SVA) performance relative to a peer group of utility companies, as measured in overlapping three-year periods. SVA measures Illinova's return on the Company's weighted average cost of capital. SVA performance at the median of the peer group will result in target award levels. Performance above the median will result in payouts greater than target to a maximum of two times target; performance significantly below the median results in no payouts. Since 1996 represented the first year of the SVA plan's first three-year measurement cycle, no awards are due to be paid out under the plan until 1999. CEO Compensation Larry Haab became Chairman, President, and Chief Executive Officer ("CEO") of Illinois Power on June 12, 1991, and Chairman, President and Chief Executive Officer of Illinova in December 1993. Illinova based Mr. Haab's 1997 compensation on the policies and plans described above. The Committee invokes the active participation of all non-management directors in reviewing Mr. Haab's performance before it makes recommendations regarding his compensation. The Committee is responsible for administering the processes for completing this review. The process starts early in the year when the Board of Directors works with Mr. Haab to establish his personal goals and short- and long-term strategic goals for Illinova and Illinois Power. At the conclusion of the year, Mr. Haab reviews his performance with the non-management directors. The Committee oversees this review and recommends to the Board appropriate adjustments to compensation. In setting the CEO's salary for 1997, the Committee, with the participation of all Outside Directors determined that Mr. Haab had provided very strong leadership in promoting electric deregulation in the State of Illinois. The continuing outage at the Clinton Power Station was a major setback. Significant progress was made in advancing other strategic objectives of the Company. The 1997 Annual Incentive Compensation Plan award for the Chief Executive Officer was calculated consistent with the determination of awards for all other Illinois Power officers. Under the terms of the plan, one-half of the award was paid in cash and one-half was converted to 1,539 stock units which vest over a three-year period as described above. The 20,000 option shares granted to the CEO reflect the Committee's recognition of this work in directing Illinova and Illinois Power towards its long-term objectives. Compensation and Nominating Committee Ronald L. Thompson, Chairman J. Joe Adorjan C. Steven McMillan Robert M. Powers Walter D. Scott Marilou von Ferstel John D. Zeglis Independent Auditors The Board of Directors of Illinois Power has selected Price Waterhouse LLP as independent auditors for the Company for 1998. A representative of that firm will be present at the Annual Meeting and available to make a statement and to respond to questions. Other Matters Illinova's 1997 Summary Annual Report to Shareholders was mailed to Illinois Power's shareholders commencing on or about March 10, 1998. Copies of Illinois Power's Annual Report on Form 10-K will be available to shareholders after its filing with the Securities and Exchange Commission on or before March 31, 1998. Requests should be addressed to Investor Relations, G-21, Illinois Power Company, 500 South 27th Street, Decatur, Illinois 62521-2200. Any proposal by a shareholder to be presented at the next Annual Meeting must be received at Illinois Power's executive offices not later than November 12, 1998. Other Business Management does not know of any matter which will be presented for consideration at the Annual Meeting other than the matters described in the accompanying Notice of Annual Meeting. By Order of the Board of Directors, Leah Manning Stetzner, Vice President, General Counsel and Corporate Secretary Decatur, Illinois March 10, 1998 APPENDIX: 1997 ANNUAL REPORT TO SHAREHOLDERS Table of Contents Management's Discussion and Analysis a-2 Responsibility for Information a-10 Report of Independent Accountants a-10 Consolidated Statements of Income a-11 Consolidated Balance Sheets a-12 Consolidated Statements of Cash Flows a-13 Consolidated Statements of Retained Earnings a-13 Notes to Consolidated Financial Statements a-14 Selected Consolidated Financial Data a-32 Selected Illinois Power Company Statistics a-33 Abbreviations Used Throughout this Report AFUDC Allowance for Funds Used During Construction Baldwin Baldwin Power Station Clinton Clinton Power Station DOE Department of Energy EITF Emerging Issues Task Force of the Financial Accounting Standards Board EMF Electric and Magnetic Fields EPS Earnings Per Share ESOP Employees' Stock Ownership Plan FAS Statement of Financial Accounting Standards FASB Financial Accounting Standards Board FERC Federal Energy Regulatory Commission Fuel Company Illinois Power Fuel Company HB 362 House Bill 362, An Act in Relation to the Competitive Provision of Utility Services ICC Illinois Commerce Commission Illinova Illinova Corporation IP Illinois Power Company IPFI Illinois Power Financing I ISA Integrated Safety Assessment kw Kilowatt kwh Kilowatt-Hour MGP Manufactured-Gas Plant MIPS Monthly Income Preferred Securities MW Megawatt MWH Megawatt-Hour NOPR Notice of Proposed Rulemaking NOx Nitrogen Oxide NRC Nuclear Regulatory Commission PCA Power Coordination Agreement PECO PECO Energy Company S&P Standard & Poor's SO2 Sulfur Dioxide Soyland Soyland Power Cooperative, Inc. TOPrS Trust Originated Preferred Securities UFAC Uniform Fuel Adjustment Clause UGAC Uniform Gas Adjustment Clause U.S. EPA United States Environmental Protection Agency Vermilion Vermilion Power Station Wood River Wood River Power Station MANAGEMENT'S DISCUSSION AND ANALYSIS In this report, we refer to the Consolidated Financial Statements, related Notes to Consolidated Financial Statements, Selected Consolidated Financial Data and Selected Statistics for information concerning consolidated financial position and results of operations. This report contains estimates, projections and other forward-looking statements that involve risks and uncertainties. Actual results or outcomes could differ materially as a result of such important factors as: the outcome of state and federal regulatory proceedings affecting the restructuring of the electric and gas utility industries; the impacts new laws and regulations relating to restructuring, environmental, and other matters have on IP; the effects of increased competition on the utility businesses; risks of owning and operating a nuclear facility; changes in prices and cost of fuel; construction and operation risks; and increases in financing costs. Below is discussion of the factors having significant impact on consolidated financial position and results of operations since January 1, 1995. Illinois Power Company is a subsidiary of Illinova Corporation, a holding company. Illinova Generating Company, Illinova Energy Partners, Inc. and Illinova Insurance Company are wholly owned subsidiaries of Illinova. IP is engaged in the generation, transmission, distribution and sale of electric energy and the distribution, transportation and sale of natural gas in the State of Illinois. Open Access and Wheeling On March 29, 1995, the FERC issued a NOPR initiating the process of mandating non-discriminatory open access to public utility transmission facilities at cost-based rates. Transmission of electricity for a reseller or redistributor of energy is called wholesale wheeling. Transmission of electricity for end-use customers is known as retail wheeling. On April 24, 1996, FERC issued Orders 888 and 889 which established the Final Rule resulting from the NOPR. The Orders became effective July 9, 1996. The Rule requires all public utilities under FERC jurisdiction that own transmission facilities to file transmission service tariffs that comply with Pro Forma Tariffs attached to the Orders. FERC also requires that all wholesale sales made by a utility provide for transmission of the power under the prescribed terms and conditions. IP made a compliance filing as required on July 9, 1996, which has been accepted by FERC. Public utilities serving customers at retail are not required, at this time, to abide by FERC-mandated terms and conditions. FERC does not require public utilities to give retail customers access to alternate energy suppliers or direct transmission service. The move to open access transmission service likely will increase competition in the wholesale energy market, but this alone is not expected to have a significant financial impact. Competition On December 16, 1997, Illinois Governor Edgar signed electric deregulation legislation. HB 362 guarantees IP's residential customers a 15 percent decrease in base electric rates beginning August 1, 1998, and an additional 5 percent decrease effective on May 1, 2002. The rate decreases are expected to result in revenue reductions of approximately $40 million in 1998, approximately $80 million in each of the years 1999 through 2001 and approximately $100 million in 2002, based on current consumption. Customers with demand greater than 4 MW at a single site will be free to choose their electric generation suppliers ("direct access") starting October 1999. Customers with at least 10 sites which aggregate at least 9.5 MW in total demand also will have direct access starting October 1999. Direct access for the remaining non-residential customers will occur in two phases: customers representing one-third of the remaining load in the non-residential class in October 1999 and customers representing the entire remaining non-residential load on December 31, 2000. Direct access will be available to all residential customers in May 2002. IP remains obligated to serve all customers who continue to take service from IP at tariff rates, and remains obligated to provide delivery service to all at regulated rates. Although the specified residential rate reductions and the introduction of direct access will lead to lower electric service revenues, HB 362 is designed to protect the financial integrity of electric utilities in three principal ways: 1) Departing customers are obligated to pay transition charges, based on the utility's lost revenue from that customer, adjusted to deduct: 1) delivery charges the utility will continue to receive from the customer, and 2) the market value of the freed-up energy net of a mitigation factor, which is a percentage reduction of the transition charge amount. The mitigation factor is designed to provide incentive for management to continue cost reduction efforts and generate new sources of revenue. 2) Utilities are provided the opportunity to lower their financing and capital costs through the issuance of "securitized" bonds; and 3) Utilities are permitted to seek rate relief in the event that the change in law leads to their return on equity falling below a specified minimum based on a prescribed test. The extent to which revenues are lowered will depend on a number of factors including future market prices for wholesale and retail energy, and load growth and demand levels in the current IP service territory. The impact on net income will depend on, among other things, the amount of revenues earned and the ongoing costs of doing business. In 1996, IP received approval from both the ICC and FERC to conduct an open access experiment beginning in 1996 and ending on December 31, 1999. The experiment allows certain industrial customers to purchase electricity and related services from other sources. Currently, 17 customers are participating in the experiment. Since inception, the experiment has cost IP approximately $11.2 million in lost revenue net of avoided fuel cost and variable operating expenses. This loss was partially offset by selling the surplus energy and capacity on the open market and by $2.7 million in transmission service charges. Accounting Matters Prior to the passage of HB 362, IP prepared its consolidated financial statements in accordance with FAS 71, "Accounting for the Effects of Certain Types of Regulation." Reporting under FAS 71 allows companies whose service obligations and prices are regulated to maintain on their balance sheets assets representing costs they expect to recover from customers, through inclusion of such costs in their future rates. In July 1997, the EITF concluded that application of FAS 71 accounting should be discontinued at the date of enactment of deregulation legislation for business segments for which a plan of deregulation has been established. The EITF further concluded that regulatory assets and liabilities that originated in the portion of the business being deregulated should be written off unless their recovery is specifically provided for through future cash flows from the regulated portion of the business. Because HB 362 provides for market-based pricing of electric generation services, IP discontinued application of FAS 71 for its generating segment. IP evaluated its regulatory assets and liabilities associated with its generation segment and determined that recovery of these costs was not probable through rates charged to transmission and distribution customers, the regulated portion of the business. IP wrote off generation-related regulatory assets and liabilities of approximately $195 million (net of income taxes) in December 1997. These net assets related to previously incurred costs that were expected to be collected through future revenues, including deferred costs for Clinton, unamortized losses on reacquired debt, recoverable income taxes and other generation-related regulatory assets. At December 31, 1997, IP's net investment in generation facilities was $3.5 billion and was reflected in "Utility Plant, at Original Cost" on IP's balance sheet. In addition, IP evaluated its generation segment plant investments to determine if they had been impaired as defined in FAS 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of." This evaluation determined that future revenues were expected to be sufficient to recover the costs of its generation segment plant investments and as a result, no plant write-downs were necessary. However, ultimate recovery depends on a number of factors and variables including market conditions and IP's ability to operate its generation assets efficiently. The provisions of HB 362 allow an acceleration in the rate at which any utility-owned assets are expensed without regulatory approval, provided such charges are consistent with generally accepted accounting principles. Under this legislation, up to an aggregate of $1.5 billion in additional expense for the generation-related assets could be accelerated through the year 2008. This reduction in the net book value of IP's generation-related assets should help position IP to operate competitively and profitably in the changing business environment. This accelerated charge would have a direct impact on earnings but not on cash flows. The FASB continues to review the accounting for liabilities related to closure and removal of long-lived assets, including decommissioning. See "Note 3 - - Commitments and Contingencies" for a discussion of decommissioning. See "Note 1 - Summary of Significant Accounting Policies" for a discussion of other accounting issues. Regulatory Matters In September 1996, a leak in a recirculation pump seal caused IP operations personnel to shut down Clinton. Clinton has not resumed operation. In January and again in June 1997, the NRC named Clinton among plants having a trend of declining performance. In June 1997, IP committed to conduct an ISA to thoroughly assess Clinton's performance. The ISA was conducted by a team of 30 individuals with extensive nuclear experience and no substantial previous involvement at Clinton. Their report concluded that the underlying reasons for the performance problems at Clinton were ineffective leadership throughout the organization in providing standards of excellence, complacency throughout the organization, barrier weaknesses and weaknesses in teamwork. In late October, a team commissioned by the NRC performed an evaluation to validate the ISA results. In December, this team concluded that the findings of the ISA accurately characterized Clinton's performance deficiencies and their causes. On January 5, 1998, IP and PECO announced an agreement under which PECO will provide management services for Clinton. Although a PECO team will help manage the plant, IP will continue to maintain the operating license for Clinton and retain ultimate oversight of the plant. PECO employees will assume senior positions at Clinton, but the plant will remain primarily staffed by IP employees. IP made this decision based on a belief that bringing in PECO's experienced management team would be the most efficient way to get Clinton back on line and operating at a superior level as quickly as possible. On January 21, 1998, the NRC placed Clinton on its Watch List of nuclear plants that require additional regulatory oversight because of declining performance. Twice a year the NRC evaluates the performance of nuclear power plants in the United States and identifies those which require additional regulatory oversight. Once placed on the Watch List a plant must demonstrate consistent improved performance before it is removed from the list. The NRC will monitor Clinton more closely than plants not on the Watch List. This may include increased inspections, additional required documentation, NRC-required approval of processes and procedures, and higher-level NRC oversight. The NRC has advised IP that it must submit a written report to the NRC at least two weeks prior to restarting Clinton, giving the agency reasonable assurance that IP's actions to correct recurring weaknesses in the corrective action program have been effective. After the report is submitted, the NRC staff plans to meet with IP's management to discuss the plant's readiness for restart. In March 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership, in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton. Soyland's title to the plant and directly related assets such as nuclear fuel was transferred to IP in May 1997. Soyland's nuclear decommissioning trust assets were transferred to IP in May 1997, consistent with IP's assumption of all of Soyland's ownership obligations including those related to decommissioning. The FERC approved an amended PCA between IP and Soyland in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least 10 years. The amended PCA provides that a contract cancellation fee will be paid by Soyland to IP in the event that a Soyland Cooperative member terminates its membership from Soyland. On May 31, 1997, three distribution cooperative members terminated membership by buying out of their long-term wholesale power contracts with Soyland. This action resulted in Soyland paying a fee of $20.8 million to IP in June 1997 to reduce its base capacity charges. Fee proceeds of $2.9 million were used to offset the costs of acquiring Soyland's share of Clinton with the remaining $17.9 million recorded as interchange revenue. In December 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million will be deferred and recognized as interchange revenue over the initial term of the PCA. The payment is contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. In September 1997, the ICC approved a petition filed by IP which stipulates customers will not be charged for certain additional costs of energy incurred as a result of Clinton being out of service. IP did not collect from its customers $36.3 million for higher-cost replacement power in 1997. IP will forego recovery of additional fuel costs as the Clinton outage continues into 1998. Under the petition, fuel costs charged to customers will be no higher than average 1995-1996 levels until Clinton is back in service operating at least at a 65% capacity factor for two consecutive months. Under HB 362, IP may choose to eliminate application of the UFAC. IP's base rates will still include a component for some level of recovery of fuel costs, but IP would not be able to pass through to customers increased costs of purchasing fuel, emission allowances, or replacement power. On elimination of the UFAC, base rates will include a fixed fuel-cost factor equivalent to the average 1995 - 1996 fuel cost levels. Future recovery of fuel costs is uncertain, as IP will decrease base electric rates to residential customers beginning in August 1998 and certain customers will be free to choose their electric generation suppliers beginning in October 1999. The extent to which fuel costs are recovered will depend on a number of factors including the future market prices for wholesale and retail energy, when Clinton returns to service, and whether IP elects to eliminate the UFAC. Year 2000 In November 1996, IP deployed a project team to coordinate the identification, evaluation, and implementation of changes to computer systems and applications necessary to achieve a year 2000 date conversion with no effect on customers or disruption to business operations. These actions are necessary to ensure that systems and applications will recognize and process coding for the year 2000 and beyond. Major areas of potential business impact have been identified and initial conversion efforts are underway. IP also is communicating with third parties with whom it does business to ensure continued business operations. The cost of achieving year 2000 compliance is estimated to be at least $14 million through 1999. Contingency plans for operating without year 2000 compliance have not been developed. Such activity will depend on assessment of progress. Project completion is planned for the fourth quarter of 1999. Enhanced Retirement In December 1994, IP announced plans for voluntary enhanced retirement and severance programs. During the fourth quarter of 1995, 727 employees accepted enhanced retirement or severance under these programs. The combined enhanced retirement and severance programs generated a pretax charge of $38 million against fourth quarter 1995 earnings. Consolidated Results of Operations Overview Earnings (loss) applicable to common stock were $(65) million for 1997, $206 million for 1996 and $156 million for 1995. The decrease in 1997 earnings compared to 1996 was due primarily to the extraordinary item related to discontinued application of FAS 71 for the generation segment, higher operation and maintenance expenses due to Clinton, higher power purchased costs due to Clinton and Wood River outages and an increase in uncollectible accounts expense. The increase in 1996 net income over 1995 was due primarily to the one-time charge in 1995 for the enhanced retirement and severance programs, lower operations expense due to the employment decrease and lower financing costs. The 1995 results include $(22.8) million net-of-tax for the enhanced retirement and severance programs and $(3.5) million for the carrying amount under consideration paid for preferred stock redeemed in December 1995. Regulators historically have determined IP's rates for electric service, the ICC at the retail level and the FERC at the wholesale level. The ICC determines IP's rates for gas service. These rates have been designed to recover the cost of service and allow shareholders the opportunity to earn a fair rate of return. As described under "Competition" above, Illinois electric deregulation legislation phases in a competitive marketplace for electric generation while maintaining cost-based regulation for electric delivery services and gas service, protecting the financial integrity of the company during the transition period. Future electric and natural gas sales, including interchange sales, will continue to be affected by an increasingly competitive marketplace, changes in the regulatory environment, increased transmission access, weather conditions, competing fuel sources, interchange market conditions, plant availability, fuel cost recoveries, customer conservation efforts and the overall economy. Electric Operations For the years 1995 through 1997, electric revenues including interchange increased 3.7% and the gross electric margin decreased 6.4% as follows: (Millions of dollars) 1997 1996 1995 Electric revenues $ 1,244.4 $ 1,202.9 $ 1,252.6 Interchange revenues 175.6 137.6 116.3 Fuel cost & power purchased (450.3) (313.3) (333.4) Electric margin $ 969.7 $ 1,027.2 $ 1,035.5 The components of annual changes in electric revenues were: (Millions of dollars) 1997 1996 1995 Price $ (11.5) $ (7.2) $ 13.3 Volume and other 9.7 6.4 42.7 Fuel cost recoveries 43.3 (48.9) 19.1 Revenue increase (decrease) $ 41.5 $ (49.7) $ 75.1 1997 Electric revenues excluding interchange sales increased 3.4%, primarily due to an increase in revenues under the UFAC and increased wheeling revenues. Interchange revenues increased 27.6% due to the receipt of an opt-out fee from Soyland per the amended PCA and increased interchange activity. Electric margin decreased primarily due to increased power purchased costs as a result of outages at the nuclear and fossil facilities. 1996 Electric revenues excluding interchange sales decreased 4.0%, primarily due to reduction in revenues under the UFAC. Volume changes by customer class were insignificant, as kwh sales to ultimate consumers (excluding interchange sales and wheeling) decreased .3%. Interchange revenues increased 18.3% as a result of higher plant availability in the first half of the year. 1995 The 6.4% increase in electric revenues was primarily due to a 1.9% increase in kwh sales to ultimate consumers (excluding interchange sales and wheeling). Volume increases resulted from higher residential sales (4.8%) and higher commercial sales (8.2%) due to an improving economy and warmer summer temperatures compared to 1994. Industrial sales remained essentially unchanged from 1994. Interchange revenues increased $6.3 million (5.8%) as a result of increased sales opportunities. The cost of meeting IP's system requirements was reflected in fuel costs for electric plants and power purchased. Changes in these costs are detailed below: (Millions of dollars) 1997 1996 1995 Fuel for electric plants Volume and other $ (37.7) $ 15.4 $ 9.8 Price (8.5) (12.0) (35.5) Emission allowances 12.3 .8 18.5 Fuel cost recoveries 18.2 (30.0) 14.5 (15.7) (25.8) 7.3 Power purchased 152.7 5.7 6.9 Total increase (decrease) $ 137.0 $ (20.1) $ 14.2 Weighted average system generating fuel cost ($/MWH) $ 12.06 $ 11.01 $ 11.41 System load requirements, generating unit availability, fuel prices, purchased power prices, resale of energy to other utilities, emission allowance costs and fuel cost recovery through UFAC caused changes in these costs. Changes in factors affecting the cost of fuel for electric generation are below: 1997 1996 1995 Increase (decrease) in generation (25.4)% 5.4% .7% Generation mix Coal and other 100% 78% 73% Nuclear 0% 22% 27% 1997 The cost of fuel decreased 6.3% and electric generation decreased 25.4%. The decrease in fuel cost was primarily attributable to decreased generation and a favorable price variance. These factors were partially offset by effects of the UFAC and increased emission allowance costs. Power purchased increased $152.7 million primarily due to Clinton and Wood River being out of service. 1996 The cost of fuel decreased 9.4% and electric generation increased 5.4%. The decrease in fuel cost was primarily attributable to the effects of the UFAC, as well as a favorable price variance. These factors were partially offset by an increase in fuel cost due to the increase in generation. Power purchased increased $5.7 million primarily due to the extended Clinton outage. Clinton's equivalent availability and generation were lower than in 1995 due to that outage. 1995 The cost of fuel increased 2.8% and electric generation increased .7%. The increase in fuel cost was attributable to the effects of the UFAC, the increase in higher-cost fossil generation and the cost of emission allowances. Clinton's equivalent availability and generation were lower in 1995 as compared to 1994 due to the scheduled refueling and maintenance outage. Clinton returned to service April 29, 1995, after completing its fifth refueling and maintenance outage, which began March 12, 1995. Power purchased increased $6.9 million. Gas Operations For the years 1995 through 1997, gas revenues including transportation increased 29.9%, while the gross margin on gas revenues increased 9.3% as follows: (Millions of dollars) 1997 1996 1995 Gas revenues $ 345.2 $ 341.4 $ 264.5 Gas cost (207.7) (202.6) (138.8) Transportation revenues 8.7 6.8 8.0 Gas margin $ 146.2 $ 145.6 $ 133.7 (Millions of therms) Therms sold 537 703 588 Therms transported 309 251 273 Total consumption 846 954 861 Changes in the cost of gas purchased for resale were: (Millions of dollars) 1997 1996 1995 Gas purchased for resale Cost $ 8.0 $ 49.0 $ (43.5) Volume (30.0) 8.5 25.3 Gas cost recoveries 27.1 6.3 (15.4) Total increase (decrease) $ 5.1 $ 63.8 $ (33.6) Average cost per therm delivered $ .28 $ .267 $ .201 The 1997 increase in gas costs was due to slightly higher prices from suppliers and effects of the UGAC, offset by a decrease in volume. The 1996 increase in gas costs was primarily due to higher prices from suppliers and the effects of the UGAC. The 1995 decrease in the cost of gas purchased was due to lower gas prices caused by unusually warm winter weather nationwide. Also contributing to the higher gas margins in 1995 was the 6.1% increase in gas base rates approved by the ICC in April 1994. Other Expenses A comparison of significant increases (decreases) in other operating expenses, maintenance and depreciation for the last three years is presented in the following table: (Millions of dollars) 1997 1996 1995 Other operating expenses $ 40.6 $ (9.8) $ (.3) Maintenance 12.0 (.3) 10.4 Depreciation and amortization 8.8 3.5 7.2 The increase in operating and maintenance expenses for 1997 is primarily due to increased company and contractor labor at the nuclear and fossil plants. An increase in uncollectible accounts expense and disposal of surplus inventory also contributed to the increase. The decrease in operating expenses for 1996 is due primarily to the savings from the enhanced retirement and severance program, partially offset by the costs of the extended Clinton outage and increased amortization of MGP site expenses. The ICC approved tariff riders in March 1996 that resulted in the current recognition of MGP site remediation costs in operating expenses. The 1996 increase amounted to $5.5 million. This increase is offset by increased revenues collected under the riders. The increase in maintenance expenses for 1995 is primarily due to the refueling and maintenance outage at Clinton. The increases in depreciation and amortization for each of the three years were due to increases in utility plant balances. Other Income and Deductions - Net The 1997 decrease of $2.1 million in Other Income and Deductions, Net is due primarily to 1996 accruals recorded for the planned disposition of property. The 1996 increase was due primarily to a decrease in the credit for allocated income taxes. The 1995 change in Other Income and Deductions, Net was negligible. Interest Charges Interest charges, including AFUDC, decreased $2.8 million in 1997, decreased $15.5 million in 1996, and increased $3.6 million in 1995. The 1997 decrease is primarily due to the continued benefits of IP refinancing efforts and capitalization reductions partially offset by increased IP short-term borrowings and lower AFUDC. The 1996 decrease was due to lower short-term interest rates and the impact of IP refinancing efforts and capitalization reduction during 1996. The 1995 increase was due to increased short-term borrowings at higher interest rates. Inflation Inflation, as measured by the Consumer Price Index, was 2.3%, 3.3%, and 2.5% in 1997, 1996, and 1995, respectively. IP recovers historical rather than current plant costs in its regulated rates. Liquidity and Capital Resources Dividends On December 10, 1997, IP declared the quarterly common stock dividend for the first quarter of 1998. On December 11, 1996, IP increased the quarterly common stock dividend by 11% declaring the common stock dividend for the first quarter of 1997. On December 13, 1995, IP increased the quarterly common stock dividend 12%, declaring the common stock dividend for the first quarter of 1996. Capital Resources and Requirements IP needs cash for operating expenses, interest and dividend payments, debt and certain preferred stock retirements and construction programs. To meet these needs, IP has used internally generated funds and external financings, including the issuance of debt and revolving lines of credit. The timing and amount of external financings depend primarily on economic and financial market conditions, cash needs and capitalization ratio objectives. IP cash flows from operations during 1997 provided sufficient working capital to meet ongoing operating requirements, to service existing common and IP preferred stock dividends and debt requirements and to meet all of IP's construction requirements. Additionally, IP expects that future cash flows will enable it to meet operating requirements and continue to service IP's existing debt, preferred stock dividends, IP's sinking fund requirements and all of IP's anticipated construction requirements. Continued sufficiency of cash flows for these purposes will depend on a number of factors and variables, including market conditions, business expenses and the ability to compete. To a significant degree, the availability and cost of external financing depend on the financial health of the company seeking those funds. Security ratings are an indication of a company's financial position and may affect the cost of securities, as well as the willingness of investors to invest in these securities. The current ratings of IP's securities by three principal securities rating agencies are as follows: Standard Duff & Moody's & Poor's Phelps First/New mortgage bonds Baa1 BBB BBB+ Preferred stock baa2 BBB- BBB- Commercial paper P-2 A-2 D-2 Under current market conditions, these ratings would afford IP the ability to issue additional securities through external financing. IP has adequate short-term and intermediate-term bank borrowing capacity. Based on its 1993 revised standards for review of utility business and financial risks, S&P placed IP, along with approximately one-third of the industry, in a "somewhat below average" category. In April 1994, S&P lowered IP's mortgage bond rating to BBB from BBB+. In August 1995, S&P revised its ratings outlook from stable to positive. In February 1996, Moody's also revised its ratings outlook from stable to positive. Moody's upgraded IP's securities on July 1, 1996. The rating for mortgage bonds was raised from Baa2 to Baa1, while preferred stock ratings went from baa3 to baa2. Duff & Phelps has indicated that it expects IP's ratings to remain stable, reflecting a modestly strengthening financial profile characterized by good cash flow and an average business risk profile. For the years 1997, 1996 and 1995, changes in long-term debt and preferred stock, including normal maturities and elective redemptions, were as follows: (Millions of dollars) 1997 1996 1995 Long-term debt $ (11) $(154) $ (5) Preferred stock (39) 71 (135) Total decrease $ (50) $ (83) $(140) The amounts shown in the preceding table for debt retirements do not include all mortgage sinking fund requirements. IP generally has met these requirements by pledging property additions as permitted under IP's 1943 Mortgage and Deed of Trust and the 1992 New Mortgage. For additional information, see "Note 8 - Long-Term Debt" an d "Note 9 - Preferred Stock." During 1997, IP redeemed $34.9 million (all of the remaining) Adjustable Rate Series A serial preferred stock. IP also redeemed $4.2 million of various issues of serial preferred stock. In addition, $10.5 million of medium-term notes matured and were retired. During the year IP issued $150 million of Adjustable Rate Pollution Control Revenue Bonds, due April 1, 2032. The proceeds were used on June 2, 1997, to retire $150 million of IP's 7 5/8% Pollution Control First Mortgage Bonds due 2016. During 1996, IP redeemed $2.2 million of Adjustable Rate Series A serial preferred stock, $20.5 million (all of the remaining) Adjustable Rate Series B serial preferred stock and $6.7 million of 7.75% serial preferred stock. During the year, IP also retired $62.9 million of 8.75% First Mortgage Bonds due 2021, $6 million of 8% New Mortgage Bonds due 2023 and $23 million of 7.5% New Mortgage Bonds due 2025. The $40 million of 5.85% First Mortgage Bonds matured and were retired. In addition, $21.5 million of medium-term notes matured and were retired. In February 1995, IP redeemed $12 million of 8.00% mandatorily redeemable serial preferred stock. In May 1995, IP redeemed the remaining $24 million of 8.00% mandatorily redeemable serial preferred stock. In March 1995, IP redeemed $.2 million of 7.56% serial preferred stock and $3 million of 8.24% serial preferred stock. In August 1995, IP redeemed $5 million of 8.75% First Mortgage Bonds. In December 1995, IP redeemed $34.7 million of 8.00% serial preferred stock, $33.6 million of 7.56% serial preferred stock and $27 million of 8.24% serial preferred stock. IPFI is a statutory business trust in which IP serves as sponsor. IPFI issued $100 million of TOPrS at 8% (4.8% after-tax rate) in January 1996. The TOPrS were issued by IPFI, which invested the proceeds in an equivalent amount of IP subordinated debentures due in 2045. The proceeds were used by IP to repay short-term indebtedness on varying dates on or before March 1, 1996. IP incurred the indebtedness in December 1995 to redeem $95.3 million (principal value) of higher-cost outstanding preferred stock of IP. In 1992, IP executed a general obligation mortgage (New Mortgage) to replace, over time, IP's 1943 Mortgage and Deed of Trust (First Mortgage). Both mortgages are secured by liens on substantially all of IP's properties. A corresponding issue of First Mortgage bonds, under the First Mortgage, secures any bonds issued under the New Mortgage. In October 1997, at a special bondholders meeting, the 1943 First Mortgage was amended to be generally consistent with the New Mortgage. The New Mortgage provides IP with increased financial flexibility. At December 31, 1997, based on the most restrictive earnings test contained in the New Mortgage, IP could issue approximately $800 million of additional New Mortgage bonds for other than refunding purposes. Also at December 31, 1997, the unused portion of IP total bank lines of credit was $354 million. The amount of available IP unsecured borrowing capacity totaled $168 million at December 31, 1997. On February 12, 1997, the IP Board of Directors approved a change to the Articles of Incorporation to remove the limitation on the amount of unsecured debt that IP can issue. The change will be voted on by the preferred stockholders at a special meeting planned to be held in 1998. Under HB 362, IP may issue transitional funding instruments for up to 25% of its December 31, 1996, capitalization on or after August 1, 1998. IP is continuing to review its refinancing plans but could issue up to $864 million of transitional funding instruments on or after August 1, 1998, under this provision. In addition, IP would be eligible to issue up to an additional $864 million of transition funding instruments on or after August 1, 1999. Of the proceeds from the issuance of transitional funding instruments, 80% or more must be used to retire and repurchase IP debt and equity while 20% or less can be used to fund certain other transition costs. Construction expenditures for the years 1995 through 1997 were approximately $620.5 million, including $17.5 million of AFUDC. IP estimates that it will spend approximately $225 million for construction expenditures in 1998. IP construction expenditures for the period 1998-2002 are expected to total about $1 billion. Additional expenditures may be required during this period to accommodate transitional expenditures related to a competitive environment, environmental compliance costs and system upgrades, which cannot be determined at this time. IP's capital expenditures for the years 1998 through 2002, in addition to its construction expenditures, are expected to include $129 million for nuclear fuel and $291 million for mandatory debt retirement. See "Note 3 - Commitments and Contingencies" for additional information. Internal cash generation will meet substantially all construction and capital requirements. Environmental Matters See "Note 3 - Commitments and Contingencies" for a discussion of environmental matters that impact or could potentially impact IP. Tax Matters See "Note 6 - Income Taxes" for a discussion of effective tax rates and other tax issues. Illinois Power Company RESPONSIBILITY FOR INFORMATION The consolidated financial statements and all information in this annual report are the responsibility of management. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the consolidated financial statements. In the opinion of management, the consolidated financial statements fairly reflect Illinois Power's financial position, results of operations and cash flows. Illinois Power believes that its accounting and internal accounting control systems are maintained so that these systems provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition and that the financial records are reliable for preparing the consolidated financial statements. The consolidated financial statements have been audited by Illinois Power's independent accountants, Price Waterhouse LLP, in accordance with generally accepted auditing standards. Such standards include the evaluation of internal accounting controls to establish a basis for developing the scope of the examination of the consolidated financial statements. In addition to the use of independent accountants, Illinois Power maintains a professional staff of internal auditors who conduct financial, procedural and special audits. To assure their independence, both Price Waterhouse LLP and the internal auditors have direct access to the Audit Committee of the Board of Directors. The Audit Committee is composed of members of the Board of Directors who are not active or retired employees of Illinois Power. The Audit Committee meets with Price Waterhouse LLP and the internal auditors and makes recommendations to the Board of Directors concerning the appointment of the independent accountants and services to be performed. Additionally, the Audit Committee meets with Price Waterhouse LLP to discuss the results of their annual audit, Illinois Power's internal accounting controls and financial reporting matters. The Audit Committee meets with the internal auditors to assess the internal audit work performed, including tests of internal accounting controls. Larry D. Haab Chairman, President and Chief Executive Officer Larry F. Altenbaumer Senior Vice President and Chief Financial Officer Illinois Power Company REPORT OF INDEPENDENT ACCOUNTANTS PRICE WATERHOUSE LLP To the Board of Directors and Shareholders of Illinois Power Company In our opinion, the consolidated financial statements of Illinois Power Company and its subsidiaries appearing on pages a-11 through a-31 of this report present fairly, in all material respects, the financial position of Illinois Power Company and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of Illinois Power's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 1 to the consolidated financial statements, Illinois Power discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulations," for its generation segment of the business in December 1997. Price Waterhouse LLP St. Louis, Missouri February 12, 1998 Illinois Power Company CONSOLIDATED STATEMENTS OF INCOME (Millions of dollars) For the Years Ended December 31, 1997 1996 1995 Operating Revenues Electric $ 1,244.4 $ 1,202.9 $ 1,252.6 Electric interchange 175.6 137.6 116.3 Gas 353.9 348.2 272.5 Total 1,773.9 1,688.7 1,641.4 Operating Expenses and Taxes Fuel for electric plants 232.4 248.1 273.9 Power purchased 217.9 65.2 59.5 Gas purchased for resale 207.7 202.6 138.8 Other operating expenses 290.5 249.9 259.7 Maintenance 111.7 99.7 100.0 Enhanced retirement and severance - - 37.8 Depreciation and amortization 198.8 190.0 186.5 General taxes 133.8 131.3 135.0 Income taxes 102.4 140.5 125.8 Total 1,495.2 1,327.3 1,317.0 Operating income 278.7 361.4 324.4 Other Income and Deductions, Net (4.2) (6.3) .3 Income before interest charges 274.5 355.1 324.7 Interest Charges Interest expense 128.7 133.0 148.0 Allowance for borrowed funds used during construction (5.0) (6.5) (6.0) Total 123.7 126.5 142.0 Net income before extraordinary item 150.8 228.6 182.7 Extraordinary item net of income tax benefit of $118.0 million (Note 1) (195.0) - - Net income (loss) (44.2) 228.6 182.7 Less - Preferred dividend requirements 21.5 22.3 23.7 Plus - Carrying amount over (under) consideration paid for redeemed preferred stock .2 (.7) (3.5) Net income (loss) applicable to common stock $ (65.5) $ 205.6 $ 155.5
See notes to consolidated financial statements which are an integral part of these statements. Illinois Power company CONSOLIDATED BALANCE SHEETS (Millions of dollars) December 31, 1997 1996 Assets Utility Plant, at original cost Electric (includes construction work in progress of $214.3 million and $212.5 million, respectively) $ 6,690.4 $ 6,335.4 Gas (includes construction work in progress of $10.7 million and $21.2 million, respectively) 663.0 646.1 7,353.4 6,981.5 Less - accumulated depreciation 2,808.1 2,419.7 4,545.3 4,561.8 Nuclear fuel in process 6.3 5.3 Nuclear fuel under capital lease 126.7 96.4 4,678.3 4,663.5 Investments and Other Assets 5.9 14.5 Current Assets Cash and cash equivalents 17.8 12.5 Accounts receivable (less allowance for doubtful accounts of $5.5 million and $3.0 million, respectively) Service 115.6 138.8 Other 16.6 51.1 Accrued unbilled revenue 86.3 106.0 Materials and supplies, at average cost Fossil fuel 12.6 7.9 Gas in underground storage 29.3 27.2 Operating materials 75.4 77.1 Prepayments and other 61.2 23.7 414.8 444.3 Deferred Charges Deferred Clinton costs - 103.9 Recoverable income taxes - 101.3 Other 192.5 241.0 192.5 446.2 $ 5,291.5 $ 5,568.5 Capital and Liabilities Capitalization Common stock - No par value, 100,000,000 shares authorized; 75,643,937 shares issued, stated at $ 1,424.6 $ 1,424.6 Retained earnings 89.5 245.9 Less - Capital stock expense 7.3 8.2 Less - 9,428,645 and 3,410,897 shares of common stock in treasury, respectively, at cost 207.7 86.2 Total common stock equity 1,299.1 1,576.1 Preferred stock 57.1 96.2 Mandatorily redeemable preferred stock 197.0 197.0 Long-term debt 1,617.5 1,636.4 Total capitalization 3,170.7 3,505.7 Current Liabilities Accounts payable 102.7 149.7 Notes payable 376.8 310.0 Long-term debt and lease obligations maturing within one year 87.5 47.7 Dividends declared 22.9 24.7 Taxes accrued 27.5 46.0 Interest accrued 33.0 34.3 Other 78.7 43.1 729.1 655.5 Deferred Credits Accumulated deferred income taxes 980.6 1,048.0 Accumulated deferred investment tax credits 208.3 215.5 Other 202.8 143.8 1,391.7 1,407.3 $ 5,291.5 $ 5,568.5
(Commitments and Contingencies Note 3) See notes to consolidated financial statements which are an integral part of these statements. Illinois Power company CONSOLIDATED STATEMENTS OF CASH FLOWS (Millions of dollars) For the Years Ended December 31, 1997 1996 1995 Cash Flows from Operating Activities Net income (loss) $ (44.2) $ 228.6 $ 182.7 Items not requiring (providing) cash - 202.1 195.3 190.0 Depreciation and amortization (5.0) (6.5) (6.0) Allowance for funds used during construction 29.4 64.2 42.0 Deferred income taxes - - 37.8 Enhanced retirement and severance 195.0 - - Extraordinary item Changes in assets and liabilities - 57.7 (35.2) 38.7 Accounts and notes receivable 19.7 (16.9) (10.2) Accrued unbilled revenue (5.1) (1.2) 22.8 Materials and supplies (31.2) 29.8 (14.0) Accounts payable .3 (14.8) (10.1) Interest accrued and other, net 418.7 443.3 473.7 Net cash provided by operating activities Cash Flows from Investing Activities (223.9) (187.3) (209.3) Construction expenditures 5.0 6.5 6.0 Allowance for funds used during construction 27.8 5.0 (7.5) Other investing activities (191.1) (175.8) (210.8) Net cash used in investing activities Cash Flows from Financing Activities (114.6) (107.9) (100.5) Dividends on common stock and preferred stock (121.5) (18.9) (67.3) Repurchase of common stock Redemptions - (164.1) (355.8) (213.6) Short-term debt (160.8) (153.7) (5.2) Long-term debt (39.0) (29.5) (134.5) Preferred stock Issuances - 231.0 306.2 209.5 Short-term debt 150.0 - - Long-term debt - 100.0 - Preferred stock (3.3) .3 5.1 Other financing activities (222.3) (259.3) (306.5) Net cash used in financing activities 5.3 8.2 (43.6) Net change in cash and cash equivalents 12.5 4.3 47.9 Cash and cash equivalents at beginning of year $ 17.8 $ 12.5 $ 4.3 Cash and cash equivalents at end of year
Illinois Power company CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (Millions of dollars) For the Years Ended December 31, 1997 1996 1995 Balance at beginning of year $ 245.9 $ 129.6 $ 51.1 Net income (loss) before dividends and carrying amount adjustment (44.2) 228.6 182.7 201.7 358.2 233.8 Less - Dividends - Preferred stock 21.7 22.6 23.6 Common stock 90.7 86.6 77.1 Investment transfer to Illinova - 2.4 - Plus - Carrying amount over (under) consideration paid for redeemed preferred stock .2 (.7) (3.5) (112.2) (112.3) (104.2) Balance at end of year $ 89.5 $ 245.9 $ 129.6
See notes to consolidated financial statements which are an integral part of these statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies Principles of Consolidation IP is a subsidiary of Illinova, a holding company. IP is engaged in the generation, transmission, distribution and sale of electric energy and the distribution, transportation and sale of natural gas in the state of Illinois. The consolidated financial statements include the accounts of IP, a combination electric and gas utility, Illinois Power Capital, L.P. and IPFI. See "Note 9 - Preferred Stock" for additional information. All significant intercompany balances and transactions have been eliminated from the consolidated financial statements. Preparation of financial statements in conformity with generally accepted accounting principles requires the use of management's estimates. Actual results could differ from those estimates. Regulation IP is subject to regulation by the ICC and the FERC. Prior to the passage of HB 362, IP prepared its consolidated financial statements in accordance with FAS 71, "Accounting for the Effects of Certain Types of Regulation." Reporting under FAS 71 allows companies whose service obligations and prices are regulated to maintain on their balance sheets assets which represent costs they expect to recover from customers through inclusion of such costs in their future rates. In July 1997, the EITF concluded that application of FAS 71 accounting should be discontinued at the date of enactment of deregulation legislation for business segments for which a plan of deregulation has been established. The EITF further concluded that regulatory assets and liabilities that originated in the portion of the business being deregulated should be written off unless their recovery is specifically provided for through future cash flows from the regulated portion of the business. Because HB 362 provides for market-based pricing of electric generation services, IP discontinued application of FAS 71 for its generating segment in December 1997 when HB 362 was signed by Illinois Governor Edgar. IP evaluated its regulatory assets and liabilities associated with its generation segment and determined that recovery of these costs was not probable through rates charged to transmission and distribution customers, the regulated portion of its business. Therefore, IP wrote off generation-related regulatory assets and liabilities of approximately $195 million (net of income taxes) in December 1997. These net assets related to previously incurred costs that had been expected to be collected through future revenues, including deferred Clinton post construction costs, unamortized losses on reacquired debt, recoverable income taxes and other generation-related regulatory assets. At December 31, 1997, IP's net investment in generation facilities was $3.5 billion and was included in "Utility Plant, at Original Cost" on IP's Consolidated Balance Sheets. IP's principal accounting policies are: Regulatory Assets Regulatory assets represent probable future revenues to IP associated with certain costs that are expected to be recovered from customers through the ratemaking process. Significant regulatory assets are as follows: (Millions of dollars) 1997 1996 Deferred Clinton post-construction costs $ - $ 103.9 Recoverable income taxes $ - $ 101.3 Unamortized losses on reacquired debt $ 32.3 $ 87.7 Manufactured-gas plant site cleanup costs $ 64.8 $ 69.1 DOE decontamination and decommissioning fees $ 6.3 $ 5.4 Utility Plant The cost of additions to utility plant and replacements for retired property units is capitalized. Cost includes labor, materials, and an allocation of general and administrative costs, plus AFUDC as described below. Maintenance and repairs, including replacement of minor items of property, are charged to maintenance expense as incurred. When depreciable property units are retired, the original cost and dismantling charges, less salvage value, are charged to accumulated depreciation. Allowance for Funds Used During Construction The FERC Uniform System of Accounts defines AFUDC as the net costs for the period of construction of borrowed funds used for construction purposes and a reasonable rate on other funds when so used. AFUDC is capitalized as a component of construction work in progress by those business segments applying the provisions of FAS 71. In 1997, 1996 and 1995, the pre-tax rate used for all construction projects was 5.6%, 5.8% and 6.5%, respectively. Although cash is not currently realized from the allowance, it is realized under the ratemaking process over the service life of the related property through increased revenues resulting from a higher rate base and higher depreciation expense. Non-regulated business segments capitalize interest under the guidelines in FAS 34, "Capitalization of Interest Cost." Depreciation For financial statement purposes, IP depreciates the various classes of depreciable property over their estimated useful lives by applying composite rates on a straight-line basis. In 1997, 1996 and 1995, provisions for depreciation were 2.8%, 2.8% and 2.8%, respectively, of the average depreciable cost for Clinton. Provisions for depreciation for all other electric plant were 2.8%, 2.6% and 2.6% in 1997, 1996 and 1995, respectively. Provisions for depreciation of gas utility plant, as a percentage of the average depreciable cost, were 3.3%, 3.9% and 3.9% in 1997, 1996 and 1995, respectively. Amortization of Nuclear Fuel IP leases nuclear fuel from the Fuel Company under a capital lease. Amortization of nuclear fuel (including related financing costs) is determined on a unit of production basis. A provision for spent fuel disposal costs is charged to fuel expense based on kwh generated. See "Note 3 - Commitments and Contingencies" for discussion of decommissioning and nuclear fuel disposal costs. Unamortized Debt Discount, Premium and Expense Discount, premium and expense associated with long-term debt are amortized over the lives of the related issues. Costs related to refunded debt for business segments under the provisions of FAS 71 are amortized over the lives of the related new debt issues or the remaining life of the old debt if no new debt is issued. Costs related to refunded debt for the generating segment are expensed when incurred. Revenue and Energy Cost IP records revenue for services provided but not yet billed to more closely match revenues with expenses. Unbilled revenues represent the estimated amount customers will be billed for service delivered from the time meters were last read to the end of the accounting period. Operating revenues include related taxes that have been billed to customers in the amount of $71 million in 1997, $68 million in 1996 and $66 million in 1995. The costs of fuel for the generation of electricity, purchased power and gas purchased for resale are recovered from customers pursuant to the electric fuel and purchased gas adjustment clauses. Accordingly, allowable energy costs that are to be passed on to customers in a subsequent accounting period are deferred. The recovery of costs deferred under these clauses is subject to review and approval by the ICC. In September 1997, IP filed a petition with the ICC that stipulated customers will not be charged for certain additional costs of energy incurred as a result of Clinton being out of service. During 1997, as a result of this stipulation, IP did not collect $36.3 million of fuel costs. IP will also forego recovery of additional fuel costs in 1998 for the duration of the Clinton outage. Under the petition, fuel costs charged to customers will be no higher than average 1995-1996 levels until Clinton is back in service operating at least at a 65% capacity factor for two consecutive months. Income Taxes Deferred income taxes result from temporary differences between book income and taxable income, and the tax bases of assets and liabilities on the balance sheet. The temporary differences relate principally to plant in service and depreciation. Investment tax credits used to reduce federal income taxes have been deferred and are being amortized to income over the service life of the property that gave rise to the credits. IP is included in Illinova's consolidated federal income tax return. Income taxes are allocated to the individual companies based on their respective taxable income or loss. See "Note 6 - Income Taxes" for additional discussion. Preferred Dividend Requirements Preferred dividend requirements reflected in the Consolidated Statements of Income are recorded on the accrual basis. Consolidated Statements of Cash Flows Cash and cash equivalents include cash on hand and temporary investments purchased with an initial maturity of three months or less. Capital lease obligations not affecting cash flows increased by $30 million, $31 million and $19 million during 1997, 1996 and 1995, respectively. Income taxes and interest paid are as follows: Years ended December 31, (Millions of dollars) 1997 1996 1995 Income taxes $ 94.3 $ 65.9 $ 65.7 Interest $ 140.0 $ 147.4 $ 152.4 Interest Rate Cap Generally, premiums paid for purchased interest rate cap agreements are being amortized to interest expense over the terms of the caps. Unamortized premiums are included in Current Assets, "Prepayments and other," in the Consolidated Balance Sheets. Amounts to be received under the cap agreements are accrued and recognized as a reduction in interest expense. Transactions with Illinova In addition to transfers of capital reflected in the Consolidated Statements of Retained Earnings, IP provided approximately $122 million, $81 million and $34 million in funds to Illinova for operations and investments during 1997, 1996 and 1995, respectively. Illinova is paying IP interest on these funds at a rate equal to that which Illinova would have paid had it used a currently outstanding line of credit. In addition, Illinova and IP have recorded an intercompany payable and receivable, respectively, for approximately $10.2 million, $14.3 million and $18.4 million in 1997, 1996 and 1995, respectively, in order to recognize the effect on the Employees' Stock Ownership Plan of the conversion of IP common stock to Illinova common stock concurrent with the formation of Illinova. This was a noncash transaction. See "Note 10 - Common Stock and Retained Earnings" for additional information. New Pronouncements The FASB issued FAS 128, "Earnings Per Share" in February 1997, effective for financial statements issued after December 15, 1997. FAS 128 establishes standards for computing and presenting EPS and replaces the presentation of primary EPS and fully diluted EPS with a presentation of basic EPS and diluted EPS, respectively. No new requirements are imposed on IP by FAS 128. The FASB issued FAS 129, "Disclosure of Information about Capital Structure" in February 1997, effective for financial statements for periods ending after December 15, 1997. FAS 129 establishes standards for disclosing information about an entity's capital structure and contains no change in disclosure requirements for entities that were previously subject to the requirements of Accounting Principles Board Opinions 10 and 15 and FAS 47. No new requirements are imposed on IP by FAS 129. The FASB issued FAS 130, "Reporting Comprehensive Income" in June 1997, effective for fiscal years beginning after December 15, 1997. FAS 130 establishes standards for reporting and display of comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements. IP continues to analyze FAS 130 and does not expect it to have a significant impact on its financial statements presentation. The FASB issued FAS 131, "Disclosures about Segments of an Enterprise and Related Information" in June 1997, effective for periods beginning after December 15, 1997. FAS 131 supersedes FAS 14, "Financial Reporting for Segments of a Business Enterprise." FAS 131 establishes standards for the way public business enterprises report financial and descriptive information about their reportable operating segments in their financial statements. Generally, financial information is required to be reported on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments. IP continues to evaluate the provisions of FAS 131 and determine the impact of the revised disclosure requirements on its 1998 financial statements. Note 2 - Clinton Power Station Clinton Operations In September 1996, a leak in a recirculation pump seal caused IP operations personnel to shut down Clinton. Clinton has not resumed operation. In January and again in June 1997, the NRC named Clinton among plants having a trend of declining performance. In June 1997, IP committed to conduct an ISA to thoroughly assess Clinton's performance. The ISA was conducted by a team of 30 individuals with extensive nuclear experience and no substantial previous involvement at Clinton. Their report concluded that the underlying reasons for the performance problems at Clinton were ineffective leadership throughout the organization in providing standards of excellence, complacency throughout the organization, barrier weaknesses and weaknesses in teamwork. In late October, a team commissioned by the NRC performed an evaluation to validate the ISA results. In December, this team concluded that the findings of the ISA accurately characterized Clinton's performance deficiencies and their causes. In September 1997, the NRC advised IP that it must submit a written report to the NRC at least two weeks prior to restarting Clinton, giving the agency reasonable assurance that IP's actions to correct recurring weaknesses in the corrective action program have been effective. After the report is submitted, the NRC staff plans to meet with IP's management to discuss the plant's readiness for restart. In November 1997, Larry Haab, Chief Executive Officer of IP, publicly pledged to address the findings of the ISA, to improve Clinton, and provide the resources necessary to restart the plant. Further, in January 1998, IP and PECO announced an agreement under which PECO will provide management services for Clinton. The new management team initially will consist of nine people in key positions, including chief nuclear officer and plant manager. Although a PECO team will help manage the plant, IP will continue to maintain the operating license for Clinton and retain ultimate oversight of the plant. The plant will remain staffed primarily by IP employees. PECO operates two stations, Limerick and Peach Bottom, each with two boiling water reactors similar to the one at Clinton. Although PECO's Peach Bottom Station was a troubled plant that experienced a two-year outage, it was turned around, and both plants have set performance records for long operating runs and short refueling outages, receiving excellent performance ratings from the NRC and the Institute of Nuclear Power Operations. On January 21, 1998, the NRC placed Clinton on its Watch List. Nuclear plants are placed on the Watch List when the NRC believes additional regulatory oversight is required because of declining performance. Clinton will remain on the Watch List until consistent improved performance is demonstrated. During the period Clinton remains on the Watch List, the NRC will monitor it more closely than plants not on the Watch List. This may include increased inspections, additional required documentation, NRC-required approval of processes and procedures and higher-level NRC oversight. Transfer of Soyland's Ownership Share to IP In March 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton. Soyland's title to the plant and directly related assets such as nuclear fuel was transferred to IP in May 1997. Soyland's nuclear decommissioning trust assets were transferred to IP in May 1997, consistent with IP's assumption of all of Soyland's ownership obligations, including those related to decommissioning. The FERC approved an amended PCA in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least 10 years. The amended PCA provides that a contract cancellation fee be paid by Soyland to IP in the event that a Soyland member terminates its membership from Soyland. In May 1997, three distribution cooperative members terminated membership by buying out of their long-term wholesale power contracts with Soyland. As a result, Soyland paid a fee of $20.8 million to IP in June 1997. Fee proceeds of $2.9 million were used to offset the costs of acquiring Soyland's share of Clinton with the remaining $17.9 million recorded as interchange revenue. In December 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million will be deferred and recognized as interchange revenue over the initial term of the PCA. The payment is contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. Clinton Cost and Risks Clinton was placed in service in 1987 and represents approximately 20.3% of IP's installed generation capacity. The investment in Clinton represented approximately 57% of IP's total assets at December 31, 1997. See "Note 1 - Summary of Significant Accounting Policies" for additional information. IP's Clinton-related costs represented 38% of its total 1997 other operating, maintenance and depreciation expenses. Clinton's equivalent availability was 0%, 66% and 76% for 1997, 1996 and 1995, respectively. Ownership of an operating nuclear generating unit exposes IP to significant risks, including increased and changing regulatory, safety and environmental requirements and the uncertain future cost of closing and dismantling the unit. IP expects to be allowed to continue to operate Clinton; however, if any unforeseen or unexpected developments would prevent it from doing so, IP would be materially adversely affected. See "Note 3 - Commitments and Contingencies" for additional information. Note 3 - Commitments and Contingencies Commitments IP estimates that it will spend approximately $225 million for construction expenditures in 1998. IP construction expenditures for the period 1998-2002 are expected to total about $1 billion. Additional expenditures may be required during this period to accommodate transitional expenditures related to a competitive environment, environmental compliance costs and system upgrades, which cannot be determined at this time. IP's capital expenditures for the years 1998 through 2002, in addition to its construction expenditures, are expected to include $129 million for nuclear fuel and $291 million for mandatory debt retirement. In addition, IP has substantial commitments for the purchase of coal under long-term contracts. Estimated coal contract commitments for 1998 through 2002 are $619 million (excluding price escalation provisions). Total coal purchases for 1997, 1996 and 1995 were $181 million, $184 million and $168 million, respectively. IP has contracts with various natural gas suppliers and interstate pipelines to provide natural gas supply, transportation and leased storage. Estimated committed natural gas, transportation and leased storage costs (including pipeline transition costs) for 1998 through 2002 total $56 million. Total natural gas purchased for 1997, 1996 and 1995 was $185 million, $207 million and $150 million, respectively. IP's estimated nuclear fuel commitments for Clinton are approximately $11 million for uranium concentrates through 2001, $3 million for conversion services through 2002, $35 million for enrichment services through 1999 and $232 million for fabrication services through 2019. IP is committed to purchase approximately $20 million of emission allowances through 1999. IP anticipates that all gas-related costs will be recoverable under IP's UGAC. See the subcaption "Fuel Cost Recovery" below for discussion of the UFAC. Fuel Cost Recovery On September 29, 1997, the ICC approved an IP petition that stipulates customers will not be charged for certain additional costs of energy incurred as a result of Clinton being out of service. Under the petition, fuel costs charged to customers will be no higher than average 1995 - 1996 levels until Clinton is back in service operating at least at a 65% capacity factor for two consecutive months. See "Note 2 - Clinton Power Station" for additional information about Clinton. As a result of Illinois deregulation legislation, IP may choose to eliminate application of the UFAC. IP's base rates would still include a component for some level of recovery of fuel costs, but IP would not be able to pass through to customers increased costs of purchasing fuel, emission allowances or replacement power. On elimination of the UFAC, base rates will include a fixed fuel cost factor equivalent to the average 1995 - 1996 fuel cost levels. Future recovery of fuel costs is uncertain, as IP will decrease base electric rates to residential customers beginning August 1998 and certain customers will be free to choose their electric generation suppliers beginning in October 1999. The extent to which fuel costs are recovered will depend on a number of factors including the future market prices for wholesale and retail energy, when Clinton returns to service, and whether IP elects to eliminate the UFAC. Insurance IP maintains insurance for certain losses involving the operation of Clinton. For physical damage to the plant, IP's insurance program has two layers: 1) a primary layer of $500 million provided by nuclear insurance pools; and 2) an excess coverage layer of $1.1 billion provided by an industry-owned mutual insurance company for a total coverage of $1.6 billion. In the event of an accident with an estimated cost of reactor stabilization and site decontamination exceeding $100 million, NRC regulations require that insurance proceeds be dedicated and used first to return the reactor to, and maintain it in, a safe and stable condition, and second to decontaminate the reactor station site. The insurers also provide coverage for the shortfall in the Decommissioning Trust Fund caused by the premature decommissioning of the reactor due to an accident. In the event insurance limits are not exhausted by the above, the remaining coverage will be applied to property damage and a portion of the value of the undamaged property. In addition, while IP has no reason to anticipate a serious nuclear accident at Clinton, if such an incident should occur, the claims for property damage and other costs could materially exceed the limits of current or available insurance coverage. In the event of an extended shutdown of Clinton due to accidental property damage, IP also purchases approximately $1.5 million per week of business interruption insurance coverage through an industry-owned mutual insurance company. This insurance does not provide coverage until Clinton has been out of service for 21 weeks. All United States nuclear reactor licensees are subject to the Price-Anderson Act. This act currently limits public liability for a nuclear incident to $8.9 billion. Private insurance covers the first $200 million. Retrospective premium assessments against each licensed nuclear reactor in the United States provide excess coverage. Currently, the liability to these nuclear reactor licensees for such an assessment would be up to $79.3 million per incident, not including premium taxes which may be applicable, payable in annual installments of not more than $10 million. A Master Worker Policy covers worker tort claims alleging bodily injury, sickness or disease due to the nuclear energy hazard for workers whose initial radiation exposure occurred on or after January 1, 1988. The policy has an aggregate limit of $200 million that applies to the commercial nuclear industry as a whole. A provision provides for automatic reinstatement of policy limits up to an additional $200 million. IP may be subject to other risks that may not be insurable, or the amount of insurance carried to offset the various risks may not be sufficient to meet potential liabilities and losses. There is also no assurance that IP will be able to maintain insurance coverage at its present level. Under those circumstances, such losses or liabilities may have a substantial adverse effect on IP's financial position. Decommissioning and Nuclear Fuel Disposal IP is responsible for the costs of decommissioning Clinton and for spent nuclear fuel disposal costs. In May 1997, consistent with IP's assumption of all of Soyland's ownership obligations of Clinton, Soyland's nuclear decommissioning trust assets were transferred to IP. Future decommissioning costs related to Soyland's former share of Clinton will be provided through the PCA between Soyland and IP. IP is collecting future decommissioning costs for the remaining portion of Clinton through its electric rates based on an ICC-approved formula that allows IP to adjust rates annually for changes in decommissioning cost estimates. Illinois deregulation legislation provides for the continued recovery of decommissioning costs from IP's delivery customers. IP concluded a site-specific study in 1996 to estimate the costs of dismantlement, removal and disposal of Clinton. This study resulted in projected decommissioning costs of $538 million (1996 dollars) or $969 million (2026 dollars, assuming a 2% inflation factor). Regulatory approval of this increased decommissioning cost level was received in August 1997. This estimate is the basis used for funding decommissioning costs through rates charged to IP's customers and through the PCA with Soyland. External decommissioning trusts, as prescribed under Illinois law and authorized by the ICC, accumulate funds for the future decommissioning of Clinton based on the expected service life of the plant. For the years 1997, 1996 and 1995, IP contributed $5.3 million, $3.9 million and $5.0 million, respectively, to its external nuclear decommissioning trust funds. The balances in these nuclear decommissioning funds at December 31, 1997 and 1996, were $62.5 million and $41.4 million, respectively. Decommissioning funds are recorded as assets on the balance sheet. A decommissioning liability approximately equivalent to trust assets is also recorded. IP recognizes earnings and expenses from the trust fund as changes in its assets and liabilities relating to these funds occur. The FASB is reviewing the accounting for closure and removal costs of long-lived assets. Changes to current electric utility industry accounting practices for decommissioning may result in recording the estimated total cost for decommissioning as a liability and an increase to plant balances, depreciating the increased plant balances, and reporting trust fund income from the external decommissioning trusts as investment income rather than as a reduction to decommissioning expense. Based on current information, management believes that these changes will not have an adverse effect on results of operations due to existing and anticipated future ability to recover decommissioning costs through rates. Under the Nuclear Waste Policy Act of 1982, the DOE is responsible for the permanent storage and disposal of spent nuclear fu el. The DOE currently charges one mill ($0.001) per net kwh (one dollar per MWH) generated and sold for future disposal of spent fuel. IP is recovering these charges through rates. In 1996, the District of Columbia Circuit Court of Appeals issued an order, at the request of nuclear-owning utilities and state regulatory agencies, confirming DOE's unconditional obligation to take responsibility for spent nuclear fuel commencing in 1998, even if it has no permanent repository at that time. Notwithstanding this decision, which the DOE did not appeal, the DOE has indicated to all nuclear utilities that it may experience delay in performance. The impact of any such delay on IP will depend on many factors, including the duration of such delay and the cost and feasibility of interim, on-site storage. Environmental Matters Clean Air Act To comply with the SO2 emission reduction requirements of Phase I (1995 - 1999) of the Acid Rain Program of the 1990 Clean Air Act Amendments, IP continues to purchase emission allowances. An emission allowance is the authorization by the U.S. EPA to emit one ton of SO2. The ICC approved IP's Phase I Acid Rain Compliance Plan in September 1993, and IP is continuing to implement that plan. IP has acquired sufficient emission allowances to meet most of its anticipated needs for 1998 and 1999 and will purchase the remainder on the spot market. In 1993, the Illinois General Assembly passed and the governor signed legislation authorizing, but not requiring, the ICC to permit expenditures and revenues from emission allowance purchases and sales to be included in rates charged to customers as a cost of fuel. In December 1994, the ICC approved the recovery of emission allowance costs through the UFAC. See the subcaption "Fuel Cost Recovery" above for discussion of the UFAC. IP's compliance plan will defer, until at least 2000, any need for scrubbers or other capital projects associated with SO2 emission reductions. Phase II (2000 and beyond) SO2 emission reduction requirements of the Acid Rain Program could require additional actions and may result in capital expenditures and the purchase of emission allowances. To comply with the Phase I NOx emission reduction requirements of the acid rain provisions of the Clean Air Act, IP installed low-NOx burners at Baldwin Unit 3 and Vermilion Unit 2. On November 29, 1994, the Phase I NOx rules were remanded to the U.S. EPA. On April 13, 1995, the U.S. EPA reinstated, with some modifications, the Phase I NOx rules effective January 1, 1996. IP was positioned to comply with these revised rules without additional modifications to any of its generating plants. The U.S. EPA issued revised Phase II NOx emission limits on December 10, 1996. IP has prepared a Phase II Compliance Plan. Litigation over the scope and legality of these Phase II NOx limits precludes a precise quantification of anticipated capital costs for compliance; however, capital expenditures for IP's NOx Compliance Plan are expected to be $100 million prior to the year 2000. The majority of this investment will be directed to Baldwin Units 1 and 2 and will occur in conjunction with replacement of the air heaters on these units. In addition, regulators are continuing to examine potential approaches for compliance with current federal ozone air quality standards. On November 7, 1997, the U.S. EPA proposed air pollution rules which would require substantial reductions of NOx emissions in Illinois and 21 other states. The proposal would require the installation of NOx controls by September 2002. This proposal is expected to be finalized by November 1998 with Illinois utility reduction requirements specified in 1999. Preliminary cost estimates to comply with the proposed NOx limitations are $130 to $150 million beyond what is already needed to comply with the NOx requirements of Phase II of the Acid Rain Program. The legality of this proposal along with its technical feasibility is expected to be challenged by a number of utilities and utility groups, including IP. Global Warming On December 11, 1997, international negotiations to reduce greenhouse gas emissions concluded with the adoption of the Kyoto Protocol. This Protocol requires the United States to reduce greenhouse gas emissions to 7% below 1990 levels during the years 2008 through 2012 and to make further reductions thereafter. This Protocol must be ratified by the United States Senate. United States Senate Resolution 98 (passed 95-0) indicates the Senate would not ratify an agreement that fails to involve all countries or would damage the United States economy. Ratification will be a major political issue as the Protocol does not contain key elements that Senate Resolution 98 said would be necessary for ratification. It is anticipated that ratification will be delayed until after 1998. IP will face major changes in how it generates electricity if the Kyoto Protocol is ratified, or if the Protocol's reduction goals are incorporated into other environmental regulations. IP would have to repower some generating units and change from coal to natural gas in other units to reduce greenhouse gas emissions. IP estimates that compliance with these proposed regulations may require significant capital outlays and annual operating expenses which could have a material adverse impact on IP. Manufactured-Gas Plant IP's estimated liability for MGP site remediation is $65 million. This amount represents IP's current best estimate of the costs that it will incur in remediation of the 24 MGP sites for which it is responsible. Because of the unknown and unique characteristics at each site, IP cannot presently determine its ultimate liability for remediation of the sites. IP is currently recovering MGP site remediation through tariff riders approved by the ICC. Accordingly, IP has recorded a regulatory asset on its balance sheet totaling $65 million as of December 31, 1997. Management expects that cleanup costs will be fully recovered from IP's customers. To offset the burden imposed on its customers, IP has initiated litigation against a number of insurance carriers. Any settlement proceeds or damages recovered from the carriers will continue to be credited to IP's customers through the tariff rider mechanism which the ICC previously approved. Electric and Magnetic Fields The possibility that exposure to EMF emanating from power lines, household appliances and other electric sources may result in adverse health effects continues to be the subject of litigation and governmental, medical and media attention. Litigants also have claimed that EMF concerns justify recovery from utilities for the loss in value of real property exposed to power lines, substations and other such sources of EMF. The number of EMF cases has declined in the last few years as more national and international science commissions have concluded that an EMF health risk has not been established. Additional research is being conducted to attempt to resolve continuing scientific uncertainties. On July 3, 1997, President Clinton signed legislation extending the National EMF Research and Public Information Dissemination Program through 1998. Research results, policy decisions and public information developments will continue into 1999. It is too soon to tell what, if any, impact these actions may have on IP's financial position. IP continues its commitment to address customer and employee concerns related to the EMF issue. Other Legal Proceedings IP is involved in legal or administrative proceedings before various courts and agencies with respect to matters occurring in the ordinary course of business, some of which involve substantial amounts of money. Management believes that the final disposition of these proceedings will not have a material adverse effect on the consolidated financial position or the results of operations. Accounts Receivable IP sells electric energy and natural gas to residential, commercial and industrial customers throughout Illinois. At December 31, 1997, 72%, 17% and 11% of "Accounts receivable - Service" were from residential, commercial and industrial customers, respectively. IP maintains reserves for potential credit losses and such losses have been within management's expectations. During 1997, IP increased its reserve for doubtful accounts from $3.0 million to $5.5 million. Contingencies Soyland In March 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton. The FERC approved an amended PCA in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least 10 years (the initial term of the PCA) and includes a provision that allows Soyland to pay its base capacity charges in advance. The amended PCA also provides that a contract cancellation fee will be paid by Soyland to IP in the event that a Soyland Cooperative member terminates its membership from Soyland. In May 1997, three distribution cooperative members terminated their membership by buying out of their respective long-term wholesale power contracts with Soyland. As a result, Soyland paid a fee of $20.8 million to IP in June 1997 to reduce its future base capacity charges. In December, 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million will be deferred and recognized as interchange revenue over the initial term of the PCA. The payment will be contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. Nuclear Fuel Lease See "Note 7 - Capital Leases" for discussion of contingencies related to IP's nuclear fuel lease. Internal Revenue Service Audit The Internal Revenue Service is currently auditing IP's federal income tax returns for the years 1991 through 1993. At this time, the outcome of the audit cannot be determined; however, management does not expect that the results will have a material adverse effect on IP's financial position or results of operations. For a detailed discussion of income taxes, see "Note 6 - Income Taxes." Note 4 - Lines of Credit and Short-Term Loans IP has total lines of credit represented by bank commitments amounting to $354 million, all of which were unused at December 31, 1997. These lines of credit are renewable in May 1998, August 1998 and May 2002. These bank commitments support the amount of commercial paper outstanding at any time, limited only by the amount of unused bank commitments, and are available to support other IP activities. IP pays facility fees up to .10% per annum on $350 million of the total lines of credit, regardless of usage. The interest rate on borrowings under these agreements is, at IP's option, based upon the lending banks' reference rate, their Certificate of Deposit rate, the borrowing rate of key banks in the London interbank market or competitive bid. IP has letters of credit totaling $206 million and pays fees up to .45% per annum on the unused amount of credit. In addition, IP and the Fuel Company each have a short-term financing option to obtain funds not to exceed $30 million. IP and the Fuel Company pay no fees for this uncommitted facility and funding is subject to availability upon request. For the years 1997, 1996 and 1995, IP had short-term borrowings consisting of bank loans, commercial paper, extendible floating rate notes and other short-term debt outstanding at various times as follows: (Millions of dollars, except rates) 1997 1996 1995 Short-term borrowings at December 31, $ 376.8 $ 310.0 $ 359.6 Weighted average interest rate at December 31, 6.0% 5.7% 6.0% Maximum amount outstanding at any month end $ 376.8 $ 310.0 $ 359.6 Average daily borrowings outstanding during the year $ 284.4 $ 261.9 $ 306.5 Weighted average interest rate during the year 5.8% 5.6% 6.2% Interest rate cap agreements are used to reduce the potential impact of increases in interest rates on floating-rate debt. IP has two variable rate interest rate cap agreements covering up to $114.6 million of commercial paper. These agreements entitle IP to receive from a counterparty on a quarterly basis the amount, if any, by which IP's interest payments on a nominal amount of commercial paper exceed the interest rate set by the cap. On December 31, 1997, the cap rates were set at 7.75% and 8.0% while the current market rate available to IP was 5.8%. IP also has a $50 million interest rate swap in effect through October 1998 where IP pays 5.92% and receives the LIBOR variable rate, payable quarterly. Note 5 - Facilities Agreements On March 13, 1997, the NRC issued an order approving transfer to IP of the Clinton operating license related to Soyland's 13.2% ownership obligations in connection with the transfer from Soyland to IP of all of Soyland's interest in Clinton pursuant to an agreement reached in 1996. Soyland's title to the plant and directly related assets such as nuclear fuel was transferred to IP on May 1, 1997. Soyland's nuclear decommissioning trust assets were transferred to IP on May 19, 1997, consistent with IP's assumption of all of Soyland's ownership obligations including those related to decommissioning. The FERC approved an amended PCA between Soyland and IP in July 1997. The amended PCA obligates Soyland to purchase all of its capacity and energy needs from IP for at least 10 years. The amended PCA provides that a contract cancellation fee will be paid by Soyland to IP in the event that a Soyland member terminates its membership in Soyland. In May 1997, three distribution cooperative members terminated their membership by buying out of their respective long-term wholesale power contracts with Soyland. This action resulted in Soyland paying a fee of $20.8 million to IP in June 1997 to reduce its future base capacity charges. Fee proceeds of $2.9 million were used to offset the costs of acquiring Soyland's share of Clinton with the remaining $17.9 million recorded as interchange revenue. In December 1997, Soyland signed a letter of intent to pay in advance the remainder of its base capacity charges in the PCA. The fee of approximately $70 million will be deferred and recognized as interchange revenue over the initial term of the PCA. The payment will be contingent on Soyland obtaining the necessary financing and regulatory approvals in 1998. Note 6 - Income Taxes Deferred tax assets and liabilities were comprised of the following: Balances as of December 31, (Millions of dollars) 1997 1996 Deferred tax assets: Current: Misc. book/tax recognition differences $ 11.2 $ 7.7 Noncurrent: Depreciation and other property related 46.2 42.0 Alternative minimum tax 156.8 198.5 Tax credit and net operating loss carryforward - 32.8 Unamortized investment tax credit 116.9 120.9 Misc. book/tax recognition differences 40.3 65.8 360.2 460.0 Total deferred tax assets $ 371.4 $ 467.7 Deferred tax liabilities: Current: Misc. book/tax recognition differences $ .9 $ 11.3 Noncurrent: Depreciation and other property related 1,348.0 1,350.1 Deferred Clinton costs - 58.2 Misc. book/tax recognition differences (7.1) 99.7 1,340.9 1,508.0 Total deferred tax liabilities $ 1,341.8 $ 1,519.3 Income taxes included in the Consolidated Statements of Income consist of the following components: Years Ended December 31, (Millions of dollars) 1997 1996 1995 Current taxes- Included in operating expenses and taxes $ 72.7 $ 79.2 $ 98.6 Included in other income and deductions (.7) (14.5) (20.3) Total current taxes 72.0 64.7 78.3 Deferred taxes- Included in operating expenses and taxes Property related differences 9.2 60.4 62.2 Alternative minimum tax 41.7 1.1 2.9 Gain/loss on reacquired debt .4 (1.6) (1.9) Net operating loss carryforward - - (.2) Enhanced retirement and severance .5 2.6 (15.0) Misc. book/tax recognition differences (16.7) 6.1 (13.9) Included in other income and deductions Property related differences (.4) 10.2 9.7 Misc. book/tax recognition differences 1.5 1.7 2.2 Total deferred taxes 36.2 80.5 46.0 Deferred investment tax credit-net Included in operating expenses and taxes (7.3) (7.3) (6.9) Total investment tax credit (7.3) (7.3) (6.9) Total income taxes from continuing operations $ 100.9 $ 137.9 $ 117.4 Income tax - Extraordinary item Current tax expense (17.8) - - Deferred tax expense (100.2) - - Total extraordinary item (118.0) - - Total income taxes $ (17.1) $ 137.9 $ 117.4 The reconciliations of income tax expense to amounts computed by applying the statutory tax rate to reported pretax income from continuing operations for the period are set below: Years Ended December 31, (Millions of dollars) 1997 1996 1995 Income tax expense at the federal statutory tax rate $ 88.1 $ 128.3 $ 105.0 Increases/(decreases) in taxes resulting from- State taxes, net of federal effect 11.8 13.7 14.0 Investment tax credit amortization (7.3) (7.3) (6.9) Depreciation not normalized 11.3 9.4 7.4 Interest expense on preferred securities (6.9) (6.9) (3.7) Other-net 3.9 .7 1.6 Total income taxes from continuing operations $ 100.9 $ 137.9 $ 117.4 Combined federal and state effective income tax rates were 40.1%, 37.6% and 39.1% for the years 1997, 1996 and 1995, respectively. IP is subject to the provisions of the Alternative Minimum Tax System. As a result, IP has an Alternative Minimum Tax credit carryforward at December 31, 1997, of approximately $156.8 million. This credit can be carried forward indefinitely to offset future regular income tax liabilities in excess of the tentative minimum tax. The Internal Revenue Service is currently auditing IP's consolidated federal income tax returns for the years 1991 through 1993. At this time, the outcome of the audit cannot be determined; however, the results of the audit are not expected to have a material adverse effect on IP's consolidated financial position or results of operations. Because of the passage of HB 362, IP's electric generation business no longer meets the criteria for application of FAS 71. As required by FAS 101, "Regulated Enterprises - Accounting for the Discontinuation of Application of FASB Statement No. 71", the income tax effects of the write-off of regulatory assets and liabilities related to electric generation are reflected in the extraordinary item for the cumulative effect of a change in accounting principle. Note 7 - Capital Leases The Fuel Company, which is 50% owned by IP, was formed in 1981 for the purpose of leasing nuclear fuel to IP for Clinton. Lease payments are equal to the Fuel Company's cost of fuel as consumed (including related financing and administrative costs). Billings under the lease agreement during 1997, 1996 and 1995 were $4 million, $35 million and $41 million, respectively, including financing costs of $4 million, $5 million and $7 million, respectively. IP is required to pay financing costs whether or not fuel is consumed. IP is obligated to make subordinated loans to the Fuel Company at any time the obligations of the Fuel Company that are due and payable exceed the funds available to the Fuel Company. Lease terms stipulate that in the event that Clinton is out of service for 24 consecutive months, IP will be obligated to purchase Clinton's incore nuclear fuel for $62 million from the Fuel Company. IP has an obligation for nuclear fuel disposal costs of leased nuclear fuel. See "Note 3 - Commitments and Contingencies" for discussion of decommissioning and nuclear fuel disposal costs. Nuclear fuel lease payments are included with "Fuel for electric plants" on IP's Consolidated Statements of Income. At December 31, 1997 and 1996, current obligations under capital lease for nuclear fuel are $18.7 million and $36.9 million, respectively. Over the next five years estimated payments under capital leases are as follows: (Millions of dollars) 1998 $ 23.5 1999 44.3 2000 23.9 2001 21.5 2002 16.7 Thereafter 12.8 142.7 Less-Interest 16.0 Total $ 126.7 Note 8 - Long-Term Debt (Millions of dollars) December 31, 1997 1996 First mortgage bonds- 6 1/2% series due 1999 $ 72.0 $ 72.0 6.60% series due 2004 (Pollution Control Series A) 6.3 6.5 7.95% series due 2004 72.0 72.0 6% series due 2007 (Pollution Control Series B) 18.7 18.7 7 5/8% series due 2016 (Pollution Control Series F, G and H) - 150.0 8.30% series due 2017 (Pollution Control Series I) 33.8 33.8 7 3/8% series due 2021 (Pollution Control Series J) 84.7 84.7 8 3/4% series due 2021 57.1 57.1 5.70% series due 2024 (Pollution Control Series K) 35.6 35.6 7.40% series due 2024 (Pollution Control Series L) 84.1 84.1 Total first mortgage bonds 464.3 614.5 New mortgage bonds- 6 1/8% series due 2000 40.0 40.0 5 5/8% series due 2000 110.0 110.0 6 1/2% series due 2003 100.0 100.0 6 3/4% series due 2005 70.0 70.0 8% series due 2023 229.0 229.0 7 1/2% series due 2025 177.0 177.0 Adjustable rate series due 2028 (Pollution Control Series M, N and O) 111.8 111.8 Adjustable rate series due 2032 (Pollution Control Series P, Q and R) 150.0 - Total new mortgage bonds 987.8 837.8 Total mortgage bonds 1,452.1 1,452.3 Medium-term notes, series A 68.0 78.5 Variable rate long-term debt due 2017 75.0 75.0 Total other long-term debt 143.0 153.5 1,595.1 1,605.8 Unamortized discount on debt (16.8) (18.1) Total long-term debt excluding capital lease obligations 1,578.3 1,587.7 Obligations under capital leases 126.7 96.4 1,705.0 1,684.1 Long-term debt and lease obligations maturing within one year (87.5) (47.7) Total long-term debt $ 1,617.5 $ 1,636.4
In April 1997, IP refinanced $150 million of 7 5/8% First Mortgage Bonds due 2016 as Adjustable Rate New Mortgage Bonds due 2032. In 1989 and 1991, IP issued a series of fixed rate medium-term notes. At December 31, 1997, these notes had interest rates ranging from 9% to 9.31% and will mature at various dates in 1998. Interest rates on variable rate long-term debt due 2017 are adjusted weekly and ranged from 4.35% to 4.6% at December 31, 1997. For the years 1998, 1999, 2000, 2001 and 2002, IP has long-term debt maturities and cash sinking fund requirements in the aggregate of (in millions) $68.8, $72.8, $150.8, $.8 and $.8, respectively. These amounts exclude capital lease requirements. See "Note 7 - Capital Leases." At December 31, 1997, the aggregate total of unamortized debt expense and unamortized loss on reacquired debt was approximately $50.4 million. In 1992, IP executed a new general obligation mortgage (New Mortgage) to replace, over time, IP's 1943 Mortgage and Deed of Trust (First Mortgage). Both mortgages are secured by liens on substantially all of IP's properties. A corresponding issue of First Mortgage bonds, under the First Mortgage, secures any bonds issued under the New Mortgage. In October 1997, at a special bondholders meeting, the 1943 First Mortgage was amended to be generally consistent with the New Mortgage. The remaining balance of net bondable additions at December 31, 1997, was approximately $1.8 billion. Note 9 - Preferred Stock (Millions of dollars) December 31, 1997 1996 Serial Preferred Stock, cumulative, $50 par value- Authorized 5,000,000 shares; 1,139,110 and 1,221,700 shares outstanding, respectively Series Shares Redemption Prices 4.08% 283,290 $ 51.50 $ 14.1 $ 15.0 4.26% 136,000 51.50 6.8 7.5 4.70% 176,000 51.50 8.8 10.0 4.42% 134,400 51.50 6.7 7.5 4.20% 167,720 52.00 8.4 9.0 7.75% 241,700 50.00 after July 1, 2003 12.1 12.1 Net premium on preferred stock .2 .2 Total Preferred Stock, $50 par value $ 57.1 $ 61.3 Serial Preferred Stock, cumulative, without par value- Authorized 5,000,000 shares; 0 and 698,200 shares outstanding, respectively Series Shares Redemption Prices A - - $ - $ 34.9 Total Preferred Stock, without par value $ - $ 34.9 Preference Stock, cumulative, without par value- Authorized 5,000,000 shares; none outstanding - - Total Serial Preferred Stock, Preference Stock and Preferred Securities $ 57.1 $ 96.2 Company Obligated Mandatorily Redeemable Preferred Securities of: Illinois Power Capital, L.P. Monthly Income Preferred Securities, cumulative, $25 liquidation preference- 3,880,000 shares authorized and outstanding $ 97.0 $ 97.0 Illinois Power Financing I Trust Originated Preferred Securities, cumulative, $25 liquidation preference- 4,000,000 shares authorized and outstanding 100.0 100.0 Total Mandatorily Redeemable Preferred Stock $ 197.0 $ 197.0
Serial Preferred Stock ($50 par value) is redeemable at the option of IP in whole or in part at any time with not less than 30 days and not more than 60 days notice by publication. The MIPS are redeemable at the option in whole or in part on or after October 6, 1999 with not less than 30 days and not more than 60 days notice by publication. The TOPrS mature on January 31, 2045 and may be redeemed in whole or in part at any time on or after January 31, 2001. Quarterly dividend rates for Serial Preferred Stock, Series A, are determined based on market interest rates of certain U.S. Treasury securities. Dividends paid in 1997 and 1996 were $.75 per share per quarter. Illinois Power Capital, L.P., is a limited partnership in which IP serves as a general partner. Illinois Power Capital issued (1994) $97 million of tax-advantaged MIPS at 9.45% (5.67% after-tax rate) with a liquidation preference of $25 per share. IP consolidates the accounts of Illinois Power Capital. Illinois Power Financing I is a statutory business trust in which IP serves as sponsor. IPFI issued (1996) $100 million of TOPrS at 8% (4.8% after-tax rate). IP consolidates the accounts of IPFI. On September 29, 1997, IP issued a notice of redemption to all holders of its Adjustable Rate Series A Preferred Stock. All 698,200 shares outstanding were redeemed on November 1, 1997, at the price of $50 per share. In 1997, IP redeemed $4.2 million of various issues of Serial Preferred Stock. The carrying amount was $.2 million over consideration paid and was recorded in equity and included in Net income applicable to common stock. Note 10 - Common Stock and Retained Earnings On May 31, 1994, common shares of IP began trading as common shares of Illinova. Illinova is the sole shareholder of IP common stock. In 1997, IP repurchased 6,017,748 shares of its common stock from Illinova. In 1996 and 1995, IP repurchased 714,811 shares and 2,696,086 shares, respectively, of its common stock from Illinova. Under Illinois law, such shares may be held as treasury stock and treated as authorized but unissued, or may be canceled by resolution of the Board of Directors. IP holds the common stock as treasury stock and deducts it from common equity at the cost of the shares. IP employees participate in an ESOP that includes an incentive compensation feature which is tied to achievement of specified corporate performance goals. This arrangement began in 1991 when IP loaned $35 million to the Trustee of the Plans, which used the loan proceeds to purchase 2,031,445 shares of IP's common stock on the open market. The loan and common shares were converted to Illinova instruments with the formation of Illinova in May 1994. These shares are held in a suspense account under the Plans and are being distributed to the accounts of participating employees as the loan is repaid by the Trustee with funds contributed by IP, together with dividends on the shares acquired with the loan proceeds. IP financed the loan with funds borrowed under its bank credit agreements. For the year ended December 31, 1997, 91,282 common shares were allocated to salaried employees and 83,418 shares to employees covered under the Collective Bargaining Agreement through the matching contribution feature of the ESOP arrangement. Under the incentive compensation feature, 70,720 common shares were allocated to employees for the year ended December 31, 1997. During 1997, IP contributed $5.0 million to the ESOP and, using the shares allocated method, recognized $3.3 million of expense. Interest paid on the ESOP debt was approximately $1.3 million in 1997 and dividends used for debt service were approximately $2.3 million. In 1992, the Board of Directors adopted and the shareholders approved a Long-Term Incentive Compensation Plan (the Plan) for officers or employee members of the Board, but excluding directors who are not officers or employees. The types of awards that may be granted under the Plan are restricted stock, incentive stock options, non-qualified stock options, stock appreciation rights, dividend equivalents and other stock-based awards. The Plan provides that any one or more types of awards may be granted for up to 1,500,000 shares of Illinova's common stock. The following table outlines the activity under this plan at December 31, 1997. Of the options granted in 1992, 1993, 1994 and 1995 in the table below, 7,500, 10,500, 4,400 and 6,500 options, respectively, have been forfeited and are not exercisable. An additional 20,000 options were exercised in January 1998. Year Options Grant Year Expiration Options Granted Granted Price Exercisable Date Exercised 1992 62,000 $ 23 3/8 1996 6/10/01 38,000 1993 73,500 $ 24 1/4 1997 6/09/02 - 1994 82,650 $ 20 7/8 1997 6/08/03 - 1995 69,300 $ 24 7/8 1998 6/14/04 - 1996 80,500 $ 29 3/4 1999 2/07/05 - 1997 82,000 $ 26 1/8 2000 2/12/07 - In October 1995, the FASB issued FAS 123, "Accounting for Stock-Based Compensation" effective for fiscal years beginning after December 15, 1995. Based on the current and anticipated use of stock options, the impact of FAS 123 is not material on the current period and is not envisioned to be material in any future period. IP continues to account for its stock options in accordance with Accounting Principle Board Opinion No. 25. The provisions of Supplemental Indentures to IP's General Mortgage Indenture and Deed of Trust contain certain restrictions with respect to the declaration and payment of dividends. IP was not limited by any of these restrictions at December 31, 1997. Under the Restated Articles of Incorporation, common stock dividends are subject to the preferential rights of the holders of preferre d and preference stock. Note 11 -Pension and Other Benefit Costs Illinova offers certain benefit plans to the employees of all of its subsidiaries. IP is sponsor and administrator of all of the benefit plans. IP is reimbursed by the other Illinova subsidiaries for their share of the expenses of the benefit plans. The discussion and amounts below represent the plans in total, including the amounts attributable to the other subsidiaries. IP has defined-benefit pension plans covering all officers and employees. Benefits are based on years of service and compensation. IP's funding policy is to contribute annually at least the minimum amount required by government funding standards, but not more than can be deducted for federal income tax purposes. Pension costs, a portion of which have been capitalized for 1997, 1996 and 1995, include the following components: Years Ended December 31, (Million of dollars) 1997 1996 1995 Service cost on benefits earned during the year $ 10.1 $ 10.2 $ 10.4 Interest cost on projected benefit obligation 27.9 26.8 23.6 Return on plan assets (95.6) (42.2) (58.3) Net amortization and deferral 61.5 9.4 29.6 Effect of enhanced retirement program - - 15.7 Net periodic pension cost $ 3.9 $ 4.2 $ 21.0 The estimated funded status of the plans at December 31, 1997 and 1996, using discount rates of 7.5% and 8.0%, respectively, and future compensation increases of 4.5% was as follows: Balances as of December 31, (Millions of dollars) 1997 1996 Actuarial present value of: Vested benefit obligation $ (329.7) $ (291.7) Accumulated benefit obligation (350.6) (312.5) Projected benefit obligation (412.8) (361.5) Plan assets at fair value 432.1 357.2 Funded status 19.3 (4.3) Unrecognized net (gain)/loss (39.1) (13.8) Unrecognized net asset at transition (26.1) (30.3) Unrecognized prior service cost 17.4 19.3 Accrued pension cost included in deferred credits $ (28.5) $ (29.1) The plans' assets consist primarily of common stocks, fixed income securities, cash equivalents, alternative investments and real estate. The actuarial present values of accumulated plan benefits at January 1, 1997 and 1996, were $375 million and $361 million, respectively, including vested benefits of $353 million and $337 million, respectively. The pension cost for 1997, 1996 and 1995 was calculated using a discount rate of 8.0%, 7.75% and 8.75%, respectively; future compensation increases of 4.5% for 1997, 1996 and 1995; and a return on assets of 9.5% for 1997 and 1996, and 9.0% for 1995. The unrecognized net asset at transition and the unrecognized prior service cost are amortized on a straight-line basis over the average remaining service period of employees who are expected to receive benefits under the plan. IP made cash contributions of $5 million in 1997, $6 million in 1996 and $2 million in 1995. IP provides health care and life insurance benefits to certain retired employees, including their eligible dependents, who attain specified ages and years of service under the terms of the defined-benefit plans. Postretirement benefits, a portion of which have been capitalized, for 1997 and 1996 included the following components: Years Ended December 31, (Millions of dollars) 1997 1996 Service cost on benefits earned during the year $ 1.9 $ 2.2 Interest cost on projected benefit obligation 5.9 6.1 Return on plan assets (8.0) (5.9) Amortization of unrecognized transition obligation 7.4 6.4 Net periodic postretirement benefit cost $ 7.2 $ 8.8 The net periodic postretirement benefit cost in the preceding table includes amortization of the previously unrecognized accumulated postretirement benefit obligation, which was $41.4 million and $44.2 million as of January 1, 1997 and 1996, respectively, over 20 years on a straight-line basis. IP has established two separate trusts for those retirees who were subject to a collectively bargained agreement and all other retirees to fund retiree health care and life insurance benefits. IP's funding policy is to contribute annually an amount at least equal to the revenues collected for the amount of postretirement benefit costs allowed in rates. The plan assets consist of common stocks and fixed income securities at December 31, 1997 and 1996. The estimated funded status of the plans at December 31, 1997 and 1996, using weighted average discount rates of 7.0% and 8.0%, respectively, and a return on assets of 9.0%, was as follows: Balances as of December 31, (Millions of dollars) 1997 1996 Accumulated postretirement benefit obligation Current retirees $ (51.1) $ (49.6) Current employees - fully eligible (5.5) (3.5) Current employees - not fully eligible (32.8) (28.6) Total benefit obligation (89.4) (81.7) Plan assets at fair value 49.7 34.4 Funded status (39.7) (47.3) Unrecognized transition obligation 38.7 41.4 Unrecognized net (gain)/loss (6.3) (7.1) Accrued postretirement benefit cost included in deferred credits $ (7.3) $ (13.0) The pre-65 health-care-cost trend rate decreases from 7.1% to 5.5% over nine years and the post-65 health-care-cost trend rate is level at 1.5%. A 1.0% increase in each future year's assumed health-care-cost trend rates increases the service and interest cost from $7.8 million to $8.7 million and the accumulated postretirement benefit obligation from $89.4 million to $99.9 million. Note 12 - Segments of Business Illinois Power Company is a public utility engaged in the generation, transmission, distribution and sale of electric energy, and the distribution, transportation and sale of natural gas. The following is a summary of operations: (Millions of dollars) 1997 1996 1995 Total Total Total Electric Gas Company Electric Gas Company Electric Gas Company Operation information - Operating revenues $ 1,420.0 $ 353.9 $ 1,773.9 $ 1,340.5 $ 348.2 $ 1,688.7 $ 1,368.9 $ 272.5 $ 1,641.4 Operating expenses, excluding provision for income taxes 1,081.3 311.5 1,392.8 886.2 300.5 1,186.7 946.2 245.0 1,191.2 Pre-tax operating income 338.7 42.4 381.1 454.3 47.7 502.0 422.7 27.5 450.2 AFUDC 4.9 .1 5.0 6.3 .2 6.5 5.5 .5 6.0 Pre-tax operating income, including AFUDC $ 343.6 $ 42.5 $ 386.1 $ 460.6 $ 47.9 $ 508.5 $ 428.2 $ 28.0 $ 456.2 Other deductions, net 5.7 9.0 8.1 Interest charges 128.7 133.0 148.0 Provision for income taxes 100.9 137.9 117.4 Net income 150.8 228.6 182.7 Extraordinary item (net of taxes) (195.0) - - Preferred dividend requirements (21.5) (22.3) (23.7) Carrying value over (under) consideration paid for redeemed preferred stock .2 (.7) (3.5) Net income (loss) applicable to common stock $(65.5) $205.6 $155.5 Other information - Depreciation 171.5 $ 24.1 $ 195.6 $ 164.0 $ 22.5 $ 186.5 $ 161.4 $ 21.6 $183.0 Capital expenditures $ 201.3 $ 22.6 $ 223.9 $ 164.0 $ 23.3 $ 187.3 $ 185.7 $ 23.6 $209.3 Investment information - Identifiable assets* $4,508.1 $ 453.8 4,961.9 $ 4,577.1 $ 481.9 $ 5,059.0 $ 4,580.4 $ 446.3 $5,026.7 Nonutility plant and other investments 5.7 14.3 16.2 Assets utilized for overall operations 323.9 495.2 524.3 Total assets $5,291.5 $5,568.5 $5,567.2
Note 13 - Fair Value of Financial Instruments 1997 1996 Carrying Fair Carrying Fair (Millions of dollars) Value Value Value Value Nuclear decommissioning trust funds $ 62.5 $ 62.5 $ 41.4 $ 41.4 Cash and cash equivalents 17.8 17.8 12.5 12.5 Mandatorily redeemable preferred stock 197.0 202.7 197.0 199.3 Long-term debt 1,578.3 1,627.6 1,587.7 1,629.3 Notes payable 376.8 376.8 310.0 310.0 The following methods and assumptions were used to estimate the fair value of each class of financial instruments listed in the table above: Nuclear Decommissioning Trust Funds The fair values of available-for-sale marketable debt securities and equity investments held by the Nuclear Decommissioning Trust are based on quoted market prices at the reporting date for those or similar investments. Cash and Cash Equivalents The carrying amount of cash and cash equivalents approximates fair value due to the short maturity of these instruments. Mandatorily Redeemable Preferred Stock and Long-Term Debt The fair value of mandatorily redeemable preferred stock and long-term debt is estimated based on the quoted market prices for similar issues or by discounting expected cash flows at the rates currently offered for debt of the same remaining maturities, as advised by IP's bankers. Notes Payable The carrying amount of notes payable approximates fair value due to the short maturity of these instruments. Note 14 - Quarterly Consolidated Financial Information and Common Stock Data (unaudited) (Millions of dollars) First Quarter Second Quarter Third Quarter Fourth Quarter 1997 1997 1997 1997 Operating revenues $ 472.8 $ 415.3 $ 497.1 $ 388.7 Operating income 88.9 82.6 101.8 5.4 Net income (loss) before extraordinary item 55.0 51.4 71.9 (27.5) Net income (loss) after extraordinary item 55.0 51.4 71.9 (222.5) Net income (loss) applicable to common stock 49.5 46.0 67.5 (228.5) Cash dividends declared on common stock 23.5 23.2 22.2 22.2 Cash dividends paid on common stock 23.5 23.5 23.2 22.2 First Quarter Second Quarter Third Quarter Fourth Quarter 1996 1996 1996 1996 Operating revenues $ 446.7 $ 365.7 $ 458.4 $ 417.9 Operating income 88.1 74.9 133.3 65.1 Net income 49.1 48.7 100.6 30.2 Net income applicable to common stock 43.5 42.5 94.8 24.8 Cash dividends declared on common stock 21.2 21.2 21.2 23.5 Cash dividends paid on common stock 21.2 21.2 21.2 21.2
Illinois Power Company SELECTED CONSOLIDATED FINANCIAL DATA (Millions of dollars) 1997 1996 1995 1994 1993 1987 Operating revenues Electric $ 1,244.4 $ 1,202.9 $ 1,252.6 $ 1,177.5 $ 1,135.6 $ 910.8 Electric interchange 175.6 137.6 116.3 110.0 130.8 92.4 Gas 353.9 348.2 272.5 302.0 314.8 308.7 Total operating revenues $1,773.9 $1,688.7 $ 1,641.4 $ 1,589.5 $ 1,581.2 $ 1,311.9 Extraordinary item net of income tax benefit $ (195.0) $ - $ - $ - $ - $ - Net income (loss) after extraordinary item $ (44.2) $ 228.6 $ 182.7 $ 180.3 $ (56.1) $ 289.6 Effective income tax rate 40.1% 37.6% 39.1% 38.4% (72.4)% 19.1% Net income (loss) applicable to common stock $ (65.5) $ 205.6 $ 155.5 $ 161.8 $ (82.2) $ 251.9 Cash dividends declared on common stock $ 91.1 $ 87.1 $ 77.9 $ 49.1 $ 30.2 $ 178.5 Cash dividends paid on common stock 92.4 84.8 75.3 60.5 60.5 176.2 Total assets $ 5,291.5 $ 5,568.5 $ 5,567.2 $ 5,595.8 $ 5,445.1 $ 5,922.7 Capitalization Common stock equity $ 1,299.1 $ 1,576.1 $ 1,478.1 $ 1,466.0 $ 1,342.8 $ 1,841.4 Preferred stock 57.1 96.2 125.6 224.7 303.7 315.2 Mandatorily redeemable preferred stock 197.0 197.0 97.0 133.0 48.0 160.0 Long-term debt 1,617.5 1,636.4 1,739.3 1,946.1 1,926.3 2,279.2 Total capitalization $3,170.7 $3,505.7 $ 3,440.0 $ 3,769.8 $ 3,620.8 $ 4,595.8 Retained earnings (deficit) $ 89.5 $ 245.9 $ 129.6 $ 51.1 $ (71.0) $ 554.8 Capital expenditures $ 223.9 $ 187.3 $ 209.3 $ 193.7 $ 277.7 $ 263.5 Cash flows from operations $ 418.7 $ 443.3 $ 473.7 $ 280.2 $ 396.6 $ 232.3 AFUDC as a percent of earnings applicable to common stock (7.6)% 3.2% 3.9% 5.7% N/A 80.2% Ratio of earnings to fixed charges 1.24 3.40 2.77 2.73 .80 2.51
Illinois Power Company SELECTED STATISTICS 1997 1996 1995 1994 1993 1987 Electric Sales in KWH (Millions) Residential 4,734 4,782 4,754 4,537 4,546 4,241 Commercial 3,943 3,894 3,804 3,517 3,246 2,862 Industrial 8,403 8,493 8,670 8,685 8,120 7,323 Other 426 367 367 536 337 910 Sales to ultimate consumers 17,506 17,536 17,595 17,275 16,249 15,336 Interchange 7,230 5,454 4,444 4,837 6,015 3,682 Wheeling 3,253 928 642 622 569 - Total electric sales 27,989 23,918 22,681 22,734 22,833 19,018 Electric Revenues (Millions) Residential 489 $ 483 $ 500 $ 471 $ 463 $ 352 Commercial 325 318 321 295 269 209 Industrial 376 360 392 378 360 325 Other 40 38 37 30 40 25 Revenues from ultimate consumers 1,230 1,199 1,250 1,174 1,132 911 Interchange 176 138 116 110 131 92 Wheeling 14 4 3 3 3 - Total electric revenues $1,420 $ 1,341 $ 1,369 $ 1,287 $ 1,266 $ 1,003 Gas Sales in Therms (Millions) Residential $ 343 427 356 359 371 332 Commercial 147 177 144 144 148 137 Industrial 47 99 88 81 78 96 Sales to ultimate consumers 537 703 588 584 597 565 Transportation of customer-owned gas 309 251 273 262 229 327 Total gas sold and transported 846 954 861 846 826 892 Interdepartmental sales 19 9 21 5 7 5 Total gas delivered 865 963 882 851 833 897 Gas Revenues (Millions) Residential $ 238 $ 216 $ 173 $ 192 $ 200 $ 192 Commercial 77 79 60 66 68 66 Industrial 20 40 24 31 34 34 Revenues from ultimate consumers 335 335 257 289 302 292 Transportation of customer-owned gas 9 7 8 9 8 15 Miscellaneous 10 6 7 4 5 2 Total gas revenues $ 354 $ 348 $ 272 $ 302 $ 315 $ 309 System peak demand (native load) in kw (thousands) 3,532 3,492 3,667 3,395 3,415 3,083 Firm peak demand (native load) in kw (thousands) 3,469 3,381 3,576 3,232 3,254 2,923 Net generating capability in kw (thousands) 3,289 4,148 3,862 4,121 4,045 3,400 Electric customers (end of year) 580,257 549,957 529,966 553,869 554,270 542,848 Gas customers (end of year) 405,710 389,223 374,299 388,170 394,379 384,091 Employees (end of year) 3,655 3,635 3,559 4,350 4,540 4,616
500 south 27th street, decatur, illinois 62521 n http://www.illinova.com unlocking the power 1997 This entire report is printed on recycled paper EX-21 17 EX-21 Exhibit 21(a) Subsidiaries of Illinova Corporation and Illinois Power Company State or Jurisdiction Name of Incorporation - ---- --------------------- Illinova Corporation Illinois Illinois Power Company Illinois IP Gas Supply Company Illinois Illinois Power Fuel Company (1) Illinois Illinois Power Capital, L.P. (2) Delaware Illinois Power Financing I Delaware Illinova Generating Company Illinois Electric Energy, Inc. (3) Illinois Illinova Resource Recovery, Inc. (formerly IPG Canfield Co.) Illinois IGC Krishnapatnam Company (formerly IPG Dominguez Co.) Illinois IPG Eastern, Inc. Illinois IPG Ferndale, Inc. Illinois IPG Frederickson, Inc. Illinois IGC Solutions, Inc. (formerly IPG LAP Cogen, Inc.) Illinois IGC Grimes Frontier, Inc. (formerly IPG Panorama Co.) Illinois IPG Paris, Inc. Illinois IPG Western, Inc. Illinois IGC Acquisition Co. (formerly IPG Aztec Co.) Illinois IGC Brazos, Inc. Illinois IGC Development Company Illinois IGC International, Inc. Cayman Islands IGC Grimes County, Inc. (formerly IGC Sub Co., Inc.) Illinois White Oak Energy Investors, Inc. Illinois ECI Energy, Ltd. (4) Delaware North American Energy Services Co. (5) Washington IGC ELCO Partnership, LLC (6) Cayman Islands IGC Jamaica Partnership, LLC (7) Cayman Islands IGC International II, Inc. Cayman Islands IGC Flores Partnership, LLC (8) Cayman Islands IGC Flores Partnership II, LLC (9) Cayman Islands FIG Leasing International, Inc. (10) Cayman Islands FIG Leasing International III, Inc. (11) Cayman Islands FIG Equipment, LLC (12) Cayman Islands IGC Aguaytia Partners, LLC (13) Cayman Islands IGC Mauritius Holding Company (formerly IGC-ABC Shanghai Co.)(14) Mauritius Illinova ZJ XC Company (15) Mauritius IGC Mauritius International Company (16) Mauritius IGC Uch, LLC (17) Cayman Islands Operaciones de Arequipa, LLC (18) Cayman Islands Tenaska-Illinova Generating Inter- national, LLC (19) Cayman Islands Fuerza Electrica de Latinoamerica,LLC (20) Cayman Islands IGC (Encoe), LLC Cayman Islands IGC Vietnam Development, Inc. Cayman Islands IGC STI Guna Company (21) Mauritius COE (UK) Corp. (22) Connecticut COE (Gencoe) Corp. (23) Connecticut Charter Oak (Paris), Inc. (24) Connecticut Illinova Energy Partners, Inc. Delaware Tenaska Marketing Ventures (25) Nebraska Illinova Insurance Company Vermont (1) Illinois Power Company owns 50% of the common stock of Illinois Power Fuel Company. (2) Illinois Power Company is the general partner in Illinois Power Capital, L.P., with a 3% equity ownership share. Illinois Power Capital is consolidated in the accounts of Illinois Power Company. (3) Illinova Generating Company owns 20% of the common stock of EEI. (4) Illinova Generating Company owns 47.5% of the voting common stock of ECI Energy, Ltd. (5) Illinova Generating Company owns 50% of the common stock of North American Energy Services Company. (6) IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International II Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of IGC ELCO Partnership, LLC. (7) IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of IGC Jamaica Partnership, LLC. (8) IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of IGC Flores Partnership, LLC. (9) IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of IGC Flores Partnership II, LLC. (10) IGC Flores Partnership, LLC (a subsidiary of IGC International, Inc. and IGC International II, Inc.) owns 51% of the common stock of FIG Leasing International, LLC. (11) IGC Flores Partnership, LLC (a subsidiary of IGC International, Inc. and IGC International II, Inc.) owns 51% of the common stock of FIG Leasing International III, Inc. (12) IGC Flores Partnership, LLC (a subsidiary of IGC International, Inc. and IGC International II, Inc.) owns 50% of the common stock of FIG Equipment, LLC. (13) IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of IGC Aguaytia Partners, LLC. (14) IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 100% of the equity of IGC Mauritius Holding Company Ltd. (15) IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 100% of the equity of Illinova ZJ XC Company. (16) IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 100% of the equity of IGC Mauritius International Company. (17) IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of IGC Uch, LLC. (18) IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of Operaciones de Arequipa, LLC. (19) IGC Uch, LLC (a subsidiary of IGC International, Inc. and IGC International II, Inc.)owns 50% of the voting common stock of Tenaska-Illinova Generating International, LLC. (20) IGC International, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 99% and IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 1% of the common stock of Fuerza Electrica de Latinoamerica, LLC. (21) IGC International II, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 100% the equity IGC STI Guna Company. (22) IGC (Encoe), LLC (a wholly-owned subsidiary of Illinova Generating Company) owns 79.9% and COE (Gencoe) Corp. (owned 49% by IGC (Encoe), LLC) owns 20.1% of the common stock of COE (UK) Corp. (23) IGC (Encoe), LLC (a wholly-owned subsidiary of Illinova Generating Company) owns 49% of the common stock of COE (Gencoe) Corp. (24) IPG Paris, Inc. (a wholly-owned subsidiary of Illinova Generating Company) owns 100% of the common stock of Charter Oak (Paris), Inc. (25) Illinova Energy Partners, Inc. owns 50% of the equity of Tenaska Marketing Ventures. EX-23 18 EX-23 Exhibit 23 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-22068), the Registration Statement on Form S-8 (No. 33-60278), the Registration Statement on Form S-8 (No. 33-66124), the Prospectus constituting part of the Registration Statement on Form S-3 (No. 33-25699), the Prospectus constituting part of the Registration Statement on Form S-3 (No. 333-03011), and the Prospectus constituting part of the Registration Statement on Form S-3 (No. 333-17847) of our report dated February 12, 1998, appearing on page A-10 of the Annual Report to Shareholders in the Appendix to the Illinova Corporation Proxy Statement which is incorporated in this Annual Report on Form 10-K. /s/ Price Waterhouse LLP Price Waterhouse LLP March 10, 1998 EX-27 19 FDS --
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET, INCOME STATEMENT AND CASH FLOW STATEMENT OF ILLINOIS POWER COMPANY AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE BALANCE SHEET,INCOME STATEMENT AND CASH FLOW STATEMENT OF ILLINOIS POWER COMPANY. 0000049816 ILLINOIS POWER COMPANY 0 0 1,000,000 DEFAULT YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 PER-BOOK 4678 6 415 193 0 5292 1210 0 89 1299 197 57 1509 106 0 271 69 0 108 19 1657 5292 1774 102 1393 1495 279 (4) 275 124 (44) 22 (66) 92 110 419 0 0
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