-----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, Ic3bGupb2bsYNaj33Bb/61q/FsZbwhpCXJkMUJGV5MStnmYP3tn6Ze20htwxLl/q ZsFz4Wb1509gOwEoQiEc+Q== 0001031296-04-000074.txt : 20040315 0001031296-04-000074.hdr.sgml : 20040315 20040315123619 ACCESSION NUMBER: 0001031296-04-000074 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 44 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CLEVELAND ELECTRIC ILLUMINATING CO CENTRAL INDEX KEY: 0000020947 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 340150020 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-02323 FILM NUMBER: 04668523 BUSINESS ADDRESS: STREET 1: 76 SOUTH MAIN STREET STREET 2: C/O FIRSTENERGY CORP CITY: AKRON STATE: OH ZIP: 44308 BUSINESS PHONE: 2166229800 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENNSYLVANIA POWER CO CENTRAL INDEX KEY: 0000077278 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 250718810 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-03491 FILM NUMBER: 04668524 BUSINESS ADDRESS: STREET 1: 1 E WASHINGTON ST STREET 2: P O BOX 891 CITY: NEW CASTLE STATE: PA ZIP: 16103-0891 BUSINESS PHONE: 4126525531 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TOLEDO EDISON CO CENTRAL INDEX KEY: 0000352049 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 344375005 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-03583 FILM NUMBER: 04668522 BUSINESS ADDRESS: STREET 1: 76 SOUTH MAIN STREET CITY: AKRON STATE: OH ZIP: 43308 BUSINESS PHONE: 2166229800 FILER: COMPANY DATA: COMPANY CONFORMED NAME: OHIO EDISON CO CENTRAL INDEX KEY: 0000073960 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 340437786 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-02578 FILM NUMBER: 04668526 BUSINESS ADDRESS: STREET 1: 76 S MAIN ST CITY: AKRON STATE: OH ZIP: 44308 BUSINESS PHONE: 2163845100 FILER: COMPANY DATA: COMPANY CONFORMED NAME: JERSEY CENTRAL POWER & LIGHT CO CENTRAL INDEX KEY: 0000053456 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 210485010 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-03141 FILM NUMBER: 04668528 BUSINESS ADDRESS: STREET 1: 2800 POTTSVILLE PIKE CITY: READING STATE: PA ZIP: 19640-0001 BUSINESS PHONE: 6109293601 MAIL ADDRESS: STREET 1: C/O GPU ENERGY STREET 2: 2800 POTTSVILLE PIKE CITY: READING STATE: PA ZIP: 19640-0001 FILER: COMPANY DATA: COMPANY CONFORMED NAME: METROPOLITAN EDISON CO CENTRAL INDEX KEY: 0000065350 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 230870160 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-00446 FILM NUMBER: 04668527 BUSINESS ADDRESS: STREET 1: 2800 POTTSVILLE PIKE STREET 2: MUHLENBERG TOWNSHIP CITY: READING STATE: PA ZIP: 19640-0001 BUSINESS PHONE: 6109293601 MAIL ADDRESS: STREET 1: C/O ENERGY GPU ENERGY STREET 2: 2800 POTTERVILLE CITY: READING STATE: PA ZIP: 19640-0001 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENNSYLVANIA ELECTRIC CO CENTRAL INDEX KEY: 0000077227 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 250718085 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-03522 FILM NUMBER: 04668525 BUSINESS ADDRESS: STREET 1: 2800 POTTSVILLE PIKE READING STREET 2: MUHLENBERG TOWNSHIP CITY: BERKS COUNTY STATE: PA ZIP: 19640-0001 BUSINESS PHONE: 6109293601 MAIL ADDRESS: STREET 1: C/O GPU ENERGY STREET 2: 2800 POTTSVILLE PIKE CITY: READING STATE: PA ZIP: 19605-2459 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRSTENERGY CORP CENTRAL INDEX KEY: 0001031296 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 341843785 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 333-21011 FILM NUMBER: 04668529 BUSINESS ADDRESS: STREET 1: 76 SOUTH MAIN ST CITY: AKRON STATE: OH ZIP: 44308-1890 BUSINESS PHONE: 3303845100 MAIL ADDRESS: STREET 1: 76 SOUTH MAIN ST CITY: AKRON STATE: OH ZIP: 44308-1890 10-K 1 fe_10-k.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to _________________ Commission Registrant; State of Incorporation; I.R.S. Employer File Number Address; and Telephone Number Identification No. - ----------- ---------------------------------------- ------------------ 333-21011 FIRSTENERGY CORP. 34-1843785 (An Ohio Corporation) 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-2578 OHIO EDISON COMPANY 34-0437786 (An Ohio Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-2323 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY 34-0150020 (An Ohio Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-3583 THE TOLEDO EDISON COMPANY 34-4375005 (An Ohio Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-3491 PENNSYLVANIA POWER COMPANY 25-0718810 (A Pennsylvania Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-3141 JERSEY CENTRAL POWER & LIGHT COMPANY 21-0485010 (A New Jersey Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-446 METROPOLITAN EDISON COMPANY 23-0870160 (A Pennsylvania Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-3522 PENNSYLVANIA ELECTRIC COMPANY 25-0718085 (A Pennsylvania Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange Registrant Title of Each Class on Which Registered ---------- ------------------- ---------------------- FirstEnergy Corp. Common Stock, $0.10 par value New York Stock Exchange Ohio Edison Company Cumulative Preferred Stock, $100 par value: 3.90% Series All series registered on New 4.40% Series York Stock Exchange and 4.44% Series Chicago Stock Exchange 4.56% Series The Cleveland Electric Cumulative Serial Preferred Stock, without Illuminating Company par value: $7.40 Series A Both series registered on New Adjustable Rate, Series L York Stock Exchange The Toledo Edison Cumulative Preferred Stock, par value Company $100 per share: 4.25% Series American Stock Exchange Cumulative Preferred Stock, par value $25 per share: $2.365 Series All series registered on Adjustable Rate, Series A New York Stock Exchange Adjustable Rate, Series B First Mortgage Bonds: 8% Series due 2003 New York Stock Exchange Pennsylvania Power Cumulative Preferred Stock, $100 Company par value: 4.24% Series All series registered on 4.25% Series Philadelphia Stock Exchange 4.64% Series Jersey Central Power & Cumulative Preferred Stock, without Light Company par value: 4% Series New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes (X) No ( ) - -- 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 registrant's 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. (X) Indicate by check mark whether each registrant is an accelerated filer (as defined in Rule 12b-2 of the Act): Yes (X) No ( ) FirstEnergy Corp. - -- Yes ( ) No (X ) Ohio Edison Company, Pennsylvania Power Company, The Cleveland -- -- Electric Illuminating Company, The Toledo Edison Company, Jersey Central Power & Light Company, Metropolitan Edison Company, and Pennsylvania Electric Company State the aggregate market value of the common stock held by non-affiliates of the registrants: FirstEnergy Corp., $11,426,526,667 as of June 30, 2003; and for all other registrants, none. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: OUTSTANDING CLASS As of MARCH 15, 2004 ----- -------------------- FirstEnergy Corp., $0.10 par value 329,836,276 Ohio Edison Company, no par value 100 The Cleveland Electric Illuminating Company, no par value 79,590,689 The Toledo Edison Company, $5 par value 39,133,887 Pennsylvania Power Company, $30 par value 6,290,000 Jersey Central Power & Light Company, $10 par value 15,371,270 Metropolitan Edison Company, no par value 859,500 Pennsylvania Electric Company, $20 par value 5,290,596 FirstEnergy Corp. is the sole holder of Ohio Edison Company, The Cleveland Electric Illuminating Company, The Toledo Edison Company, Jersey Central Power & Light Company, Metropolitan Edison Company, and Pennsylvania Electric Company common stock; Ohio Edison Company is the sole holder of Pennsylvania Power Company common stock. Documents incorporated by reference (to the extent indicated herein): PART OF FORM 10-K INTO WHICH DOCUMENT DOCUMENT IS INCORPORTED -------- ---------------------------- FirstEnergy Corp. Annual Report to Stockholders for the fiscal year ended December 31, 2003 (Pages 6-85) Part II Proxy Statement for 2004 Annual Meeting of Stockholders to be held May 18, 2004 Part III This combined Form 10-K is separately filed by FirstEnergy Corp., Ohio Edison Company, Pennsylvania Power Company, The Cleveland Electric Illuminating Company, The Toledo Edison Company, Jersey Central Power & Light Company, Metropolitan Edison Company, and Pennsylvania Electric Company. Information contained herein relating to any individual registrant is filed by such registrant on its own behalf. No registrant makes any representation as to information relating to any other registrant, except that information relating to any of the seven FirstEnergy subsidiary registrants is also attributed to FirstEnergy. FORM 10-K TABLE OF CONTENTS Page Part I ---- Item 1. Business.................................................... 1 The Company............................................... 1 Divestitures- International Operations................................ 2 Generation Assets....................................... 2 Other Domestic Assets................................... 3 Risk Factors That May Affect Future Results............... 3 Risks Related to Our Business........................... 3 Risks Related to the Electric Utility Industry.......... 5 Utility Regulation........................................ 6 PUCO Rate Matters....................................... 7 NJBPU Rate Matters...................................... 8 PPUC Rate Matters....................................... 9 FERC Rate Matters....................................... 10 Regulatory Accounting................................... 10 Capital Requirements...................................... 10 Met-Ed Capital Trust and Penelec Capital Trust............ 12 Nuclear Regulation........................................ 13 Nuclear Insurance......................................... 14 Environmental Matters..................................... 15 Air Regulation.......................................... 15 Waste Disposal.......................................... 16 Water Regulation........................................ 17 Summary................................................. 17 Fuel Supply............................................... 17 System Capacity and Reserves.............................. 18 Regional Reliability...................................... 18 Competition............................................... 18 Research and Development.................................. 19 Executive Officers........................................ 20 FirstEnergy Website....................................... 21 Item 2. Properties.................................................. 21 Item 3. Legal Proceedings........................................... 22 Item 4. Submission of Matters to a Vote of Security Holders......... 22 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................................... 22 Item 6. Selected Financial Data..................................... 22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 22 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................... 22 Item 8. Financial Statements and Supplementary Data................. 22 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure......................... 23 Item 9A. Controls and Procedures..................................... 23 Part III Item 10. Directors and Executive Officers of the Registrant.......... 23 Item 11. Executive Compensation...................................... 24 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters................... 24 Item 13. Certain Relationships and Related Transactions.............. 24 Item 14. Principal Accounting Fees and Services...................... 24 Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K..................................... 25 PART I ITEM 1. BUSINESS The Company FirstEnergy Corp. was organized under the laws of the State of Ohio in 1996. FirstEnergy's principal business is the holding, directly or indirectly, of all of the outstanding common stock of its principal electric utility operating subsidiaries, Ohio Edison Company (OE), The Cleveland Electric Illuminating Company (CEI), Pennsylvania Power Company (Penn), The Toledo Edison Company (TE), American Transmission Systems, Incorporated (ATSI), Jersey Central Power & Light Company (JCP&L), Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec). These utility operating subsidiaries are referred to throughout as the "Companies." FirstEnergy's consolidated revenues are primarily derived from electric service provided by its utility operating subsidiaries and the revenues of its other principal subsidiaries: FirstEnergy Solutions Corp. (FES); FirstEnergy Facilities Services Group, LLC (FSG); MYR Group Inc. (MYR); MARBEL Energy Corporation (MARBEL); and First Communications, LLC. In addition, FirstEnergy holds all of the outstanding common stock of other direct subsidiaries including: FirstEnergy Properties, Inc., FirstEnergy Ventures Corp., FirstEnergy Nuclear Operating Company (FENOC), FirstEnergy Securities Transfer Company, GPU Diversified Holdings, LLC, GPU Telecom Services, Inc., GPU Nuclear, Inc.; and FirstEnergy Service Company (FESC). The Companies' combined service areas encompass approximately 37,200 square miles in Ohio, New Jersey and Pennsylvania. The areas they serve have a combined population of approximately 11.1 million. OE was organized under the laws of the State of Ohio in 1930 and owns property and does business as an electric public utility in that state. OE also has ownership interests in certain generating facilities located in the Commonwealth of Pennsylvania (see Item 2 - Properties). OE engages in the generation, distribution and sale of electric energy to communities in a 7,500 square mile area of central and northeastern Ohio. OE also engages in the sale, purchase and interchange of electric energy with other electric companies. The area it serves has a population of approximately 2.7 million. OE owns all of Penn's outstanding common stock. Penn was organized under the laws of the Commonwealth of Pennsylvania in 1930 and owns property and does business as an electric public utility in that state. Penn is also authorized to do business and owns property in the State of Ohio (see Item 2 - Properties). Penn furnishes electric service to communities in a 1,500 square mile area of western Pennsylvania. The area served by Penn has a population of approximately 0.3 million. CEI was organized under the laws of the State of Ohio in 1892 and does business as an electric public utility in that state. CEI engages in the generation, distribution and sale of electric energy in an area of approximately 1,700 square miles in northeastern Ohio. It also has ownership interests in certain generating facilities in Pennsylvania (see Item 2 - Properties). CEI also engages in the sale, purchase and interchange of electric energy with other electric companies. The area CEI serves has a population of approximately 1.9 million. TE was organized under the laws of the State of Ohio in 1901 and does business as an electric public utility in that state. TE engages in the generation, distribution and sale of electric energy in an area of approximately 2,500 square miles in northwestern Ohio. It also has interests in certain generating facilities in Pennsylvania and Michigan (see Item 2 - Properties). TE also engages in the sale, purchase and interchange of electric energy with other electric companies. The area TE serves has a population of approximately 0.8 million. ATSI was organized under the laws of the State of Ohio in 1998. ATSI owns transmission assets that were formerly owned by OE, CEI and TE (Ohio Companies) and Penn. ATSI owns and operates major, high-voltage transmission facilities, which consist of approximately 7,100 circuit miles (5,778 pole miles) of transmission lines with nominal voltages of 345 kilovolts (kV), 138 kV and 69 kV. There are 37 interconnections with six neighboring control areas. ATSI's transmission system offers gateways into the East through high capacity ties with Pennsylvania-New Jersey-Maryland Interconnection LLC (PJM) through Penelec, Duquesne Light Company and Allegheny Energy, Inc. into the North through multiple 345 kV high capacity ties with Michigan Electric Coordination Systems (MEC), and into the South through ties with American Electric Power Company, Inc. (AEP) and Dayton Power & Light Company (DPL). In addition, ATSI is the control area operator for the Ohio Companies and Penn service areas. ATSI plans, operates and maintains the transmission system in accordance with the requirements of the North American Electric Reliability Council and applicable regulatory agencies to ensure reliable service to FirstEnergy's customers (see FERC Rate Matters for a discussion of ATSI's participation in the Midwest Independent System Operator, Inc. (MISO)). JCP&L was organized under the laws of the State of New Jersey in 1925 and owns property and does business as an electric public utility in that state. JCP&L provides transmission and distribution services in northern, western and east central New Jersey. The area JCP&L serves has a population of approximately 2.5 million. 1 Met-Ed was organized under the laws of the Commonwealth of Pennsylvania in 1922 and owns property and does business as an electric public utility in that state. Met-Ed provides primarily transmission and distribution services in eastern and south central Pennsylvania. The area it serves has a population of approximately 1.2 million. Penelec was organized under the laws of the Commonwealth of Pennsylvania in 1919 and owns property and does business as an electric public utility in that state. Penelec provides transmission and distribution services in western, northern and south central Pennsylvania. The area it serves has a population of approximately 1.7 million. Penelec, as lessee of the property of its subsidiary, The Waverly Electric Light & Power Company, also serves a population of about 13,400 in Waverly, New York and its vicinity. FES was organized under the laws of the its State of Ohio in 1997 and provides energy-related products and services, and through its FirstEnergy Generation Corp. (FGCO) subsidiary, operates FirstEnergy's nonnuclear generation businesses. FSG is the parent company of several heating, ventilating, air conditioning and energy management companies; MYR is a utility infrastructure construction service company. MARBEL holds FirstEnergy's 50% owner interest in Great Lakes Energy Partners, LLC, an oil and natural gas exploration and production venture. First Communications, LLC provides telecommunication services (local and long-distance phone service). FESC provides legal, financial and other corporate support services to affiliated FirstEnergy companies. Divestitures International Operations FirstEnergy completed the divestiture of its international assets subsequent to December 31, 2003 with the sales of its remaining 20.1 percent interest in Avon (parent of Midlands Electricity in the United Kingdom) on January 16, 2004, and its 28.67 percent interest in Termobarranquilla S.A., Empresa de Servicios Publicos (TEBSA) and other related subsidiaries in Colombia on January 30, 2004. Avon, TEBSA and other international assets divested in 2003 and 2004 were acquired as part of FirstEnergy's November 2001 merger with the former GPU, Inc. As a result of these transactions, FirstEnergy no longer has ownership interests in international operating assets. The divestiture in 2003 of international operations in Bolivia and Argentina included the sale of FirstEnergy's wholly owned subsidiary, Guaracachi America, Inc., a holding company with a 50.001 percent interest in Empresa Guaracachi S.A. (EGSA), on December 11, 2003, and its ownership in GPU Empresa Distribuidora Electrica Regional S.A. (Emdersa) through the abandonment of its shares in Emdersa's parent company, GPU Argentina Holdings, Inc. on April 18, 2003. FirstEnergy was unsuccessful in selling of GPU's former Argentina operations and abandoned its interest in Emdersa in early 2003. A number of economic events occurred in Argentina that hindered FirstEnergy's ability to realize an acceptable value. These events included currency devaluation, restrictions on repatriation of cash, and the anticipation of future asset sales in that region by competitors. FirstEnergy reflected Emdersa's 2002 results of an after-tax loss of $87 million (including $109 million in currency transaction losses arising principally from U.S. dollar denominated debt) as discontinued operations in the Consolidated Statement of Income for the year ended December 31, 2002. FirstEnergy also recognized a currency translation adjustment (CTA) of $91 million in 2002 which reduced FirstEnergy's common stockholders' equity. This adjustment represented the impact of translating Emdersa's financial statements from its functional currency to the U.S. dollar for GAAP financial reporting. The abandonment was accomplished by relinquishing FirstEnergy's shares to the independent Board of Directors of GPU Argentina Holdings, relieving FirstEnergy of all rights and obligations relative to this business. As a result of the abandonment, FirstEnergy recognized a one-time, non-cash charge of $67 million, or $0.23 per share of common stock in the second quarter of 2003. This charge is the result of realizing the CTA losses through current period earnings ($90 million, or $0.30 per share), partially offset by the gain recognized from abandoning FirstEnergy's investment in Emdersa ($23 million, or $0.07 per share). Since FirstEnergy had previously recorded $90 million of CTA adjustments in Other Comprehensive Income (OCI), the net effect of the $67 million charge was an increase in common stockholders' equity of $23 million. The $67 million after-tax charge in 2003 does not include the expected income tax benefits related to the abandonment, which were fully reserved during the second quarter of 2003. FirstEnergy expects tax benefits of approximately $129 million, of which $50 million would increase net income in the period that it becomes probable those benefits will be realized. The remaining $79 million of tax benefits would reduce goodwill recognized in connection with the acquisition of GPU. Generation Assets In November 2001, FirstEnergy reached an agreement to sell four coal-fired power plants totaling 2,535 MW to NRG Energy Inc. On August 8, 2002, FirstEnergy notified NRG that it was canceling the agreement because NRG stated that it could not complete the transaction under the original terms of the 2 agreement. NRG filed voluntary bankruptcy petitions in May 2003; subsequently FirstEnergy reached an agreement for settlement of its claim against NRG. FirstEnergy sold its entire claim (including $32 million of cash proceeds received in December 2003) for $170 million in January 2004. Other Domestic Assets Other asset sales in 2003 included three FSG subsidiaries - Ancoma, Inc., a mechanical contracting company based in Rochester, New York, and Virginia-based Colonial Mechanical Corporation and Webb Technologies, Inc. - and a MARBEL subsidiary - Northeast Ohio Natural Gas Company. Risks Factors That May Affect Results Risks Related to Our Business FirstEnergy May Ultimately Incur Liability in Connection with the August 14, 2003 Regional Outage or the Restatement of Earnings On August 14, 2003, various states in the northeast United States and parts of southern Canada experienced a widespread power outage, which affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following causes: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy believes that the outage cannot be explained by events on any one utility's system. On March 1, 2004, the FirstEnergy companies filed, in accordance with a November 25, 2003 order from the PUCO, its plan for addressing certain issues identified by the Task Force in its interim report. In particular, the filing addressed upgrades to FENOC's control room computer hardware and software and enhancements to the training of control room operators. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the Federal Energy Regulatory Commission (FERC) ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron, Ohio areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. Various legal proceedings have been filed against FirstEnergy in connection with, among other things, the restatements in August 2003, by FirstEnergy and its Ohio utility subsidiaries of previously reported results, the August 14th power outage described above, and the extended outage at the Davis-Besse Nuclear Power Station. Depending upon the particular proceeding, the issues raised include alleged violations of federal securities laws, breaches of fiduciary duties under state law by FirstEnergy directors and officers, and damages as a result of one or more of the noted events. The securities cases have been consolidated into one action pending in federal court in Akron. The derivative actions filed in federal court likewise have been consolidated as a separate matter, also in federal court in Akron. There are also pending derivative actions in state court. FirstEnergy's Ohio utility subsidiaries also were named as respondents in two regulatory proceedings initiated at the Public Utility Commission of Ohio (PUCO) in response to complaints alleging failure to provide reasonable and adequate service stemming primarily from the August 14th power outage. FirstEnergy is vigorously defending these actions, but cannot predict the outcome of any of these proceedings or whether any further regulatory proceedings or legal actions may be instituted against them. In particular, if FirstEnergy were ultimately determined to have legal liability in connection with these proceedings, it could have a material adverse effect on our financial condition and results of operations. On September 11, 2003, FirstEnergy received an informal data request from the Securities and Exchange Commission (SEC) asking it to voluntarily provide information and documents related to the restatement of its 2002 annual financial statements. We have responded to the request, but are unable to predict the outcome of this or any of the other pending legal and regulatory proceedings discussed above. Changes in Commodity Prices Could Decrease Revenues from Power FirstEnergy Sells and Increase the Cost of Power We Buy While much of FirstEnergy's generation serves customers under retail rates set by regulatory bodies, FirstEnergy also purchases and sells electricity 3 in the competitive wholesale and retail markets. Increases in the costs of fuel for the generation facilities (particularly coal and natural gas) can affect FirstEnergy's profit margins in both competitive and non-competitive markets. Changes in the market prices of electricity, which are affected by changes in fuel costs and other factors, may impact FirstEnergy's financial results and financial position by increasing the amount FirstEnergy pays to purchase power to supply provider of last resort (PLR) obligations in Ohio and Pennsylvania. Electricity and fuel prices may fluctuate substantially over relatively short periods of time for a variety of reasons, including: o severe or unexpected weather or seasonality; o changes in electricity usage; o illiquidity in wholesale power and other markets; o transmission or transportation constraints, inoperability or inefficiencies; o availability of competitively priced alternative energy sources; o changes in supply and demand for energy commodities; o changes in power production capacity; o outages at our power production facilities or those of our competitors; o changes in production and storage levels of natural gas, lignite, coal, crude oil and refined products; o natural disasters, wars, acts of sabotage, terrorist acts, embargoes and other catastrophic events; and o federal, state and local energy environmental and other regulation and legislation. FirstEnergy's Facilities May Not Operate As Planned, Which May Increase Expenses or Decrease Revenues and Have an Adverse Effect on Financial Performance Operation of power plants and distribution facilities involves many risks, including the breakdown or failure of equipment or processes, accidents, labor disputes, and performance below expected levels. In addition, weather-related incidents and other natural disasters can disrupt generation, transmission and distribution delivery systems. Because FirstEnergy's transmission facilities are interconnected with those of third parties, the operation of its facilities may be adversely affected by unexpected or uncontrollable events occurring on the systems of such third parties. Operation of FirstEnergy's power plants below expected capacity levels could result in lost revenues or increased expenses, including higher maintenance costs that it may not be able to recover from customers. Unplanned outages may require it to incur significant replacement power costs. Moreover, if it were unable to perform under contractual obligations, penalties or liability for damages may result. A Downgrade in Credit Ratings Could Negatively Affect our Ability to Access Capital On December 23, 2003, Standard & Poor's (S&P) lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". Except for OE's senior secured issue rating, which was left unchanged, all other subsidiary ratings were lowered one notch as well. The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions in our ratings included uncertainty regarding the timing of the Ohio Rate Plan filing (see Utility Regulation), the pending final report on the August 14th power outage as previously discussed, the outcome of the remedial phase of litigation relating to the Sammis plant (see Environmental Matters), and the extended Davis-Besse outage and the related pending subpoena (see Progress Toward Davis-Besse Restart). S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of our credit ratings in December 2003 triggered cash and letter-of-credit collateral calls in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2 and downgraded the senior secured debt of JCP&L, Met-Ed 4 and Penelec to Baa1 from A2. Moody's also downgraded the preferred stock rating of JCP&L to Ba1 from Baa2 and the senior unsecured rating of Penelec to Baa2 from A2. The ratings of OE, CEI, TE and Penn were confirmed. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Risks Related to the Electric Utility Industry FirstEnergy is Subject to Complex and Changing Government Regulations that May Require Increased Expense and/or Changes in Business Strategy that Could Have a Negative Impact on our Results of Operations FirstEnergy is subject to comprehensive regulation by various federal, state and local regulatory agencies that significantly influences our operating environment. FirstEnergy is required to have numerous permits, approvals and certificates from the agencies that regulate our business. FirstEnergy believes the necessary permits, approvals and certificates have been obtained for our existing operations and that our business is conducted in accordance with applicable laws; however, we are unable to predict the impact on operating results from future regulatory activities of any of these agencies. Changes in or reinterpretations of existing laws or regulations or the imposition of new laws or regulations could require FirstEnergy to incur additional expenses or change the way we run our business, and therefore have an adverse impact on our results of operations. Restructuring and Deregulation in the Electric Utility Industry May Result in Increased Competition and Unrecoverable Costs that Could Adversely Affect FirstEnergy's Business and Results of Operations As a result of the actions taken by state legislative bodies over the last few years, major changes in the electric utility business have occurred and are continuing to take place in parts of the United States, including Ohio, Pennsylvania and New Jersey. These changes have resulted in fundamental alterations in the way integrated utilities conduct their business. Increased competition resulting from restructuring efforts could have a significant adverse financial impact on FirstEnergy and its subsidiaries and consequently on their results of operations. Increased competition could result in increased pressure to lower prices, including the price of electricity. Retail competition and the unbundling of regulated electric service could have a significant adverse financial impact on us due to potential impairment of assets, a loss of retail customers, lower profit margins or increased costs of capital. FirstEnergy cannot predict the extent and timing of entry by additional competitors into the electric markets. The FERC and U.S. Congress are also proposing significant changes in the structure and conduct of the electric utility industry. If the restructuring and deregulation efforts result in increased competition or unrecoverable costs, our business and results of operations may be adversely affected. FirstEnergy cannot predict the extent and timing of further efforts to restructure, deregulate or re-regulate FirstEnergy or the industry. FirstEnergy is Exposed to Risks of Nuclear Generation, Which Involve Issues and Uncertainties Relating to Health and Safety, Additional Capital Costs, the Adequacy of Insurance Coverage and Nuclear Plant Decommissioning FirstEnergy is subject to the risks of nuclear generation, including but not limited to the following: o the potential harmful effects on the environment and human health resulting from the operation of nuclear facilities and the storage, handling and disposal of radioactive materials; o limitations on the amounts and types of insurance commercially available to cover losses that might arise in connection with our nuclear operations or those of others in the United States; o uncertainties with respect to contingencies and assessment amounts if insurance coverage is inadequate; and o uncertainties with respect to the technological and financial aspects of decommissioning nuclear plants at the end of their licensed operation. The NRC has broad authority under federal law to impose licensing and safety-related requirements for the operation of nuclear generation facilities. In the event of non-compliance, the NRC has the authority to impose fines or shut down a unit, or both, depending upon its assessment of the severity of the situation, until compliance is achieved. Revised safety requirements promulgated 5 by the NRC could necessitate substantial capital expenditures at nuclear plants, including ours. Unlike our fossil plants, which have been leased to and operated by FGCO since 2001, new capital costs as well as fuel, operation and maintenance expenses for the nuclear plants continue to be borne by CEI, TE, OE and Penn. The Companies' respective interests in nuclear facilities are insured under Nuclear Electric Insurance Limited, or NEIL, policies issued for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. We have also obtained approximately $537 million of insurance coverage for replacement power costs for The Companies' respective interests in nuclear facilities. Under these policies, we can be assessed a maximum of approximately $29.1 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. FirstEnergy's Operating Results are Affected by Weather Conditions and May Fluctuate on a Seasonal and Quarterly Basis Weather conditions directly influence the demand for electric power. In FirstEnergy's service area, demand for power peaks during the hot summer months, with market prices also typically peaking at that time. As a result, overall operating results may fluctuate on a seasonal and quarterly basis. In addition, FirstEnergy has historically sold less power, and consequently received less revenue, when weather conditions are milder. Severe weather, such as tornadoes, hurricanes, storms and droughts, may cause outages and property damage which may require FirstEnergy to incur additional expenses that are generally not insured and that may not be recoverable from customers. The effect of the failure of FirstEnergy's facilities to operate as planned, as described above, would be particularly burdensome during a peak demand period. FirstEnergy's Costs of Compliance with Environmental Laws are Significant, and the Cost of Compliance with Future Environmental Laws Could Harm Cash Flow and Profitability FirstEnergy's subsidiaries' operations are subject to extensive federal, state and local environmental statutes, rules and regulations. Compliance with these legal requirements requires us to incur significant costs toward environmental monitoring, installation of pollution control equipment, emission fees, maintenance, upgrading, remediation and permitting at all of our facilities. These expenditures have been significant in the past and may increase in the future. If the cost of compliance with existing environmental regulations does increase, it could adversely affect FirstEnergy's business and results of operations, financial position and cash flows. Moreover, changes in environmental laws may materially increase FirstEnergy's costs of compliance or accelerate the timing of capital expenditures. Because of the deregulation of generation, FirstEnergy may not recover through rates additional costs incurred for such compliance. FirstEnergy's compliance strategy, although reasonably based on available information, may not successfully address the relevant standards and interpretations in the future. If FirstEnergy fails to comply with environmental laws and regulations, even if caused by factors beyond its control or new interpretations of longstanding requirements, that failure may result in the assessment of civil or criminal liability and fines. Utility Regulation As a registered public utility holding company, FirstEnergy is subject to regulation by the SEC under the Public Utility Holding Company Act of 1935 (1935 Act). The SEC has determined that the electric facilities of the Companies constitute a single integrated public utility system under the standards of the 1935 Act. The 1935 Act regulates FirstEnergy with respect to accounting, the issuance of securities, the acquisition and sale of utility assets, securities or any other interest in any business, and entering into, and performance of, service, sales and construction contracts among its subsidiaries, and certain other matters. The 1935 Act also limits the extent to which FirstEnergy may engage in nonutility businesses or acquire additional utility businesses. Each of the Companies' retail rates, conditions of service, issuance of securities and other matters are subject to regulation in the state in which each operates - - in Ohio by the PUCO, in New Jersey by the New Jersey Board of Public Utilities (NJBPU) and in Pennsylvania by the Pennsylvania Public Utility Commission (PPUC). With respect to their wholesale and interstate electric operations and rates, the Companies are subject to regulation, including regulation of their accounting policies and practices, by the FERC. Under Ohio law, municipalities may regulate rates, subject to appeal to the PUCO if not acceptable to the utility. In Ohio, New Jersey and Pennsylvania, laws applicable to electric industry deregulation included similar provisions which are reflected in the Companies' respective state regulatory plans: o allowing the Companies' electric customers to select their generation suppliers; o establishing PLR obligations to customers in the Companies' service areas; o allowing recovery of transition costs (sometimes referred to as stranded investment); o itemizing (unbundling) the price of electricity into its component elements - including generation, transmission, distribution and transition costs recovery charges; o deregulating the Companies' electric generation businesses; 6 o continuing regulation of the Companies' transmission and distribution systems; and o requiring corporate separation of regulated and unregulated business activities. PUCO Rate Matters In July 1999, Ohio's electric utility restructuring legislation, which allowed Ohio electric customers to select their generation suppliers beginning January 1, 2001, was signed into law. Among other things, the legislation provided for a 5% reduction on the generation portion of residential customers' bills and the opportunity to recover transition costs, including regulatory assets, from January 1, 2001 through December 31, 2005 (market development period). The period for the recovery of regulatory assets only can be extended up to December 31, 2010. The PUCO was authorized to determine the level of transition cost recovery, as well as the recovery period for the regulatory assets portion of those costs, in considering each Ohio electric utility's transition plan application. In July 2000, the PUCO approved FirstEnergy's transition plan for OE, CEI and TE (Ohio Companies) as modified by a settlement agreement with major parties to the transition plan. The application of SFAS 71, "Accounting for the Effects of Certain Types of Regulation" to OE's generation business and the nonnuclear generation businesses of CEI and TE was discontinued with the issuance of the PUCO transition plan order, as described further below. Major provisions of the settlement agreement consisted of approval of recovery of generation-related transition costs as filed of $4.0 billion net of deferred income taxes (OE-$1.6 billion, CEI-$1.6 billion and TE-$0.8 billion) and transition costs related to regulatory assets as filed of $2.9 billion net of deferred income taxes (OE-$1.0 billion, CEI-$1.4 billion and TE-$0.5 billion), with recovery through no later than 2006 for OE, mid-2007 for TE and 2008 for CEI, except where a longer period of recovery is provided for in the settlement agreement. The generation-related transition costs include $1.4 billion, net of deferred income taxes, (OE-$1.0 billion, CEI-$0.2 billion and TE-$0.2 billion) of impaired generating assets recognized as regulatory assets as described further below, $2.4 billion, net of deferred income taxes, (OE-$1.2 billion, CEI-$0.4 billion and TE-$0.8 billion) of above market operating lease costs and $0.8 billion, net of deferred income taxes, (CEI-$0.5 billion and TE-$0.3 billion) of additional plant costs that were reflected on CEI's and TE's regulatory financial statements. Also as part of the settlement agreement, the Ohio Companies give preferred access over its subsidiaries to nonaffiliated marketers, brokers and aggregators to 1,120 megawatts (MW) of generation capacity through 2005 at established prices for sales to the Ohio Companies' retail customers. Customer prices are frozen through the five-year market development period, which runs through the end of 2005, except for certain limited statutory exceptions, including the 5% reduction referred to above. In February 2003, the Ohio Companies were authorized increases in annual revenues aggregating approximately $50 million (OE-$41 million, CEI-$4 million and TE-$5 million) to recover their higher tax costs resulting from the Ohio deregulation legislation. The Ohio Companies' customers choosing alternative suppliers receive an additional incentive applied to the shopping credit (generation component) of 45% for residential customers, 30% for commercial customers and 15% for industrial customers. The amount of the incentive is deferred for future recovery from customers. Subject to approval by the PUCO, recovery will be accomplished by extending the respective transition cost recovery period. On October 21, 2003, the Ohio Companies filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate supply and continuing our support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for the Ohio Companies' customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of the Ohio Companies' support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, FirstEnergy is requesting: o Extension of the transition cost amortization period for OE from 2006 to 2007; for CEI from 2008 to mid-2009 and for TE from mid-2007 to mid-2008; 7 o Deferral of interest costs on the accumulated shopping incentives and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates under certain limited conditions. On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004 and were completed on March 1, 2004. On February 23 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. NJBPU Rate Matters JCP&L's 2001 Final Decision and Order (Final Order) with respect to its rate unbundling, stranded cost and restructuring filings confirmed rate reductions set forth in its 1999 Summary Order, which had been in effect at increasing levels through July 2003. The Final Order also confirmed the establishment of a non-bypassable societal benefits charge (SBC) to recover costs which include nuclear plant decommissioning and manufactured gas plant remediation, as well as a non-bypassable market transition charge (MTC) primarily to recover stranded costs. The NJBPU has deferred making a final determination of the net proceeds and stranded costs related to prior generating asset divestitures until JCP&L's request for an Internal Revenue Service (IRS) ruling regarding the treatment of associated federal income tax benefits is acted upon. Should the IRS ruling support the return of the tax benefits to customers, there would be no effect on FirstEnergy's or JCP&L's net income since the contingency existed prior to the merger. In addition, the Final Order provided for the ability to securitize stranded costs associated with the divested Oyster Creek Nuclear Generating Station. Under NJBPU authorization in 2002, JCP&L issued through its wholly owned subsidiary, JCP&L Transition Funding LLC, $320 million of transition bonds (recognized on the Consolidated Balance Sheet) which securitized the recovery of these costs and which provided for a usage-based non-bypassable transition bond charge (TBC) and for the transfer of the bondable transition property to another entity. Prior to August 1, 2003, JCP&L's PLR obligation to provide basic generation service (BGS) to non-shopping customers was supplied almost entirely from contracted and open market purchases. JCP&L is permitted to defer for future collection from customers the amounts by which its costs of supplying BGS to non-shopping customers and costs incurred under nonutility generation (NUG) agreements exceed amounts collected through BGS and MTC rates. As of December 31, 2003, the accumulated deferred cost balance totaled approximately $440 million, after the charge discussed below. The NJBPU also allowed securitization of JCP&L's deferred balance to the extent permitted by law upon application by JCP&L and a determination by the NJBPU that the conditions of the New Jersey restructuring legislation are met. There can be no assurance as to the extent, if any, that the NJBPU will permit such securitization. Under New Jersey transition legislation, all electric distribution companies were required to file rate cases to determine the level of unbundled rate components to become effective August 1, 2003. JCP&L's two August 2002 rate filings requested increases in base electric rates of approximately $98 million annually and requested the recovery of deferred costs that exceeded amounts being recovered under the current MTC and SBC rates; one proposed method of recovery of these costs is the securitization of the deferred balance. This securitization methodology is similar to the Oyster Creek securitization discussed above. On July 25, 2003, the NJBPU announced its JCP&L base electric rate proceeding decision, which reduced JCP&L's annual revenues by approximately $62 million effective August 1, 2003. The NJBPU decision also provided for an interim return on equity of 9.5 percent on JCP&L's rate base for 6 to 12 months. During that period, JCP&L will initiate another proceeding to request recovery of additional costs incurred to enhance system reliability. In that proceeding, the NJBPU could increase the return on equity to 9.75 percent or decrease it to 9.25 percent, depending on its assessment of the reliability of JCP&L's service. Any reduction would be retroactive to August 1, 2003. The net revenue decrease from the NJBPU's decision consists of a $223 million decrease in the electricity delivery charge, a $111 million increase due to the August 1, 2003 expiration of annual customer credits previously mandated by the New Jersey transition legislation, a $49 million increase in the MTC tariff component, and a net $1 million increase in the SBC charge. The MTC allows for the recovery of $465 million in deferred energy costs over the next ten years on an interim basis, thus disallowing $153 million of the $618 million provided for in a preliminary settlement agreement between certain parties. As a result, JCP&L recorded charges to net income for the year ended December 31, 2003, aggregating $185 million ($109 million net of tax) consisting of the $153 million of disallowed deferred energy costs and other regulatory assets. JCP&L filed a motion for rehearing and reconsideration with the NJBPU on August 15, 2003 with respect to the following issues: (1) the disallowance of the $153 million deferred energy costs; (2) the reduced rate of return on equity; and (3) $42.7 million of disallowed costs to achieve merger savings. On October 10, 2003, the NJBPU held the motion in abeyance until the final NJBPU decision and order which is expected to be issued in the first quarter of 2004. 8 JCP&L's BGS obligation for the twelve month period beginning August 1, 2003 was auctioned in February 2003. The auction covered a fixed price bid (applicable to all residential and smaller commercial and industrial customers) and an hourly price bid (applicable to all large industrial customers) process. JCP&L sells all self-supplied energy (NUGs and owned generation) to the wholesale market with offsetting credits to its deferred energy balances. The BGS auction for the subsequent period was completed in February 2004. The NJBPU adjusted the generation component of JCP&L's retail rates on August 1, 2003 to reflect the results of the BGS auction. On July 5, 2003, JCP&L experienced a series of 34.5 kilo-volt sub-transmission line faults that resulted in outages on the New Jersey shore. The NJBPU instituted an investigation into these outages, and directed that a Special Reliability Master be hired to oversee the investigation. On December 8, 2003, the Special Reliability Master issued his Interim Report recommending that JCP&L implement a series of actions to improve reliability in the area affected by the outages. The NJBPU adopted the findings and recommendations of the Interim Report on December 17, 2003, and ordered JCP&L to implement the recommended actions on a staggered basis, with initial actions to be completed by March 31, 2004. JCP&L expects to spend $12.5 million implementing these actions during 2004. PPUC Rate Matters The PPUC authorized 1998 rate restructuring plans for Penn, Met-Ed and Penelec. In 2000, the PPUC disallowed a portion of the requested additional stranded costs above those amounts granted in Met-Ed's and Penelec's 1998 rate restructuring plan orders. The PPUC required Met-Ed and Penelec to seek an IRS ruling regarding the return of certain unamortized investment tax credits and excess deferred income tax benefits to customers. Similar to JCP&L's situation, if the IRS ruling ultimately supports returning these tax benefits to customers, there would be no effect to FirstEnergy's, Met-Ed's or Penelec's net income since the contingency existed prior to the merger. In June 2001, the PPUC approved the Settlement Stipulation with all of the major parties in the combined merger and rate proceedings which approved the merger and provided PLR deferred accounting treatment for energy costs, permitting Met-Ed and Penelec to defer, for future recovery, energy costs in excess of amounts reflected in their capped generation rates retroactive to January 1, 2001. This PLR deferral accounting procedure was later denied in a February 2002 Commonwealth Court of Pennsylvania decision. The court decision also affirmed the PPUC decision regarding the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. FirstEnergy established reserves in 2002 for Met-Ed's and Penelec's PLR deferred energy costs which aggregated $287.1 million, reflecting the potential adverse impact of the then pending Pennsylvania Supreme Court decision whether to review the Commonwealth Court decision. On April 2, 2003, the PPUC remanded the issue relating to merger savings to the Office of Administrative Law for hearings, directed Met-Ed and Penelec to file a position paper on the effect of the Commonwealth Court order on the Settlement Stipulation and allowed other parties to file responses to the position paper. Met-Ed and Penelec filed a letter with the Administrative Law Judge (ALJ) on June 11, 2003, voiding the Stipulation in its entirety and reinstating Met-Ed's and Penelec's restructuring settlement previously approved by the PPUC. On October 2, 2003, the PPUC issued an order concluding that the Commonwealth Court reversed the PPUC's June 20, 2001 order in its entirety. The PPUC directed Met-Ed and Penelec to file tariffs within thirty days of the order to reflect the competitive transition charge (CTC) rates and shopping credits that were in effect prior to the June 21, 2001 order to be effective upon one day's notice. In response to that order, Met-Ed and Penelec filed these supplements to their tariffs to become effective October 24, 2003. On October 8, 2003, Met-Ed and Penelec filed a petition for clarification relating to the October 2, 2003 order on two issues: to establish June 30, 2004 as the date to fully refund the NUG trust fund and to clarify that the ordered accounting treatment regarding the CTC rate/shopping credit swap should follow the ratemaking, and that the PPUC's findings would not impair their rights to recover all of their stranded costs. On October 9, 2003, ARIPPA (an intervenor in the proceedings) petitioned the PPUC to direct Met-Ed and Penelec to reinstate accounting for the CTC rate/shopping credit swap retroactive to January 1, 2002. Several other parties also filed petitions. On October 16, 2003, the PPUC issued a reconsideration order granting the date requested by Met-Ed and Penelec for the NUG trust fund refund, denying Met-Ed's and Penelec's other clarification requests and granting ARIPPA's petition with respect to the accounting treatment of the changes to the CTC rate/shopping credit swap. On October 22, 2003, Met-Ed and Penelec filed an Objection with the Commonwealth Court asking that the Court reverse the PPUC's finding that requires Met-Ed and Penelec to treat the stipulated CTC rates that were in effect from January 1, 2002 on a retroactive basis. Met-Ed and Penelec are considering filing an appeal to the Commonwealth Court on the PPUC orders as well. On October 27, 2003, a Commonwealth Court judge issued an Order denying Met-Ed's and Penelec's objection without explanation. Due to the vagueness of the Order, Met-Ed and Penelec, on October 31, 2003, filed an Application for Clarification with the judge. Concurrent with this filing, Met-Ed and Penelec, in order to preserve their rights, also filed with the Commonwealth Court both a Petition for Review of the PPUC's October 16 and October 22 Orders, and an application for reargument, if the judge, in his clarification order, indicates that Met-Ed's and Penelec's objection was intended to be denied on the merits. In addition to these findings, Met-Ed and Penelec, in compliance with the PPUC's Orders, filed revised PPUC quarterly 9 reports for the twelve months ended December 31, 2001 and 2002, and for the first two quarters of 2003, reflecting balances consistent with the PPUC's findings in their Orders. Effective September 1, 2002, Met-Ed and Penelec assigned their PLR responsibility to their FES affiliate through a wholesale power sale agreement. The PLR sale will be automatically extended for each successive calendar year unless any party elects to cancel the agreement by November 1 of the preceding year. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by Met-Ed and Penelec under their NUG contracts and other power contracts with nonaffiliated third party suppliers. This arrangement reduces Met-Ed's and Penelec's exposure to high wholesale power prices by providing power at a fixed price for their uncommitted PLR energy costs during the term of the agreement with FES. FES has hedged most of Met-Ed's and Penelec's unfilled PLR on-peak obligation through 2004 and a portion of 2005, the period during which deferred accounting was previously allowed under the PPUC's order. Met-Ed and Penelec are authorized to continue deferring differences between NUG contract costs and current market prices. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. Met-Ed, Penelec and Penn are currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March of 2004. On January 16, 2004, the PPUC initiated a formal investigation of Met-Ed's, Penelec's and Penn's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation, and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. FirstEnergy is unable to predict the outcome of the investigation or the impact of the PPUC order. FERC Rate Matters The Companies provide wholesale power and transmission service subject to the jurisdiction of the FERC. Following the FirstEnergy/GPU merger, the transmission facilities of JCP&L, Met-Ed and Penelec continue to be operated by PJM. PJM was approved by the FERC as a regional transmission organization (RTO) on December 20, 2002. Transmission service over the facilities of FirstEnergy's PJM operating companies is provided under the PJM Open Access Transmission Tariff. ATSI transferred operational control of its transmission facilities in the East Central Area Reliability Agreement (ECAR) area to the MISO RTO as part of GridAmerica, LLC, an independent transmission company. This transfer of control became effective on October 1, 2003. Transmission service over the facilities of ATSI is now provided under the MISO Open Access Transmission Tariff. A settlement of all rate matters related to ATSI's integration into MISO was filed with FERC on December 18, 2003 and is waiting decision by FERC. PJM and MISO were ordered by the FERC to develop a common market between the regions by October 31, 2004. The FERC also initiated a Section 206 investigation into the reasonableness of the "through-and-out" transmission rates charged by PJM and MISO. On November 17, 2003, the FERC issued orders directing MISO, PJM, and certain unaffiliated transmission owners in the Midwest to eliminate their transmission rates for point-to-point service effective April 1, 2004. A settlement judge has been appointed by the FERC to resolve compliance filings by the affected transmission providers. As part of the settlement process, the FERC extended the date for elimination of through-and-out rates until May 1, 2004. AEP, Commonwealth Edison, and other transmission owning utilities have appealed the FERC's November 17, 2003 orders to the federal court of appeals for the District of Columbia. Regulatory Accounting All of the Companies' regulatory assets (deferred costs) are expected to continue to be recovered under provisions of the Ohio transition plan and the respective Pennsylvania and New Jersey regulatory plans. The application of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation", has been discontinued with respect to the Companies' generation operations. Capital Requirements Capital expenditures for the Companies, FES and FirstEnergy's other subsidiaries for the years 2004 through 2006 excluding nuclear fuel, are shown 10 in the following table. Such costs include expenditures for the betterment of existing facilities and for the construction of generating capacity, facilities for environmental compliance, transmission lines, distribution lines, substations and other assets. Capital Expenditures Forecast 2003 ------------------------------ Actual 2004 2005-2006 Total ------ ---- --------- ----- (In millions) OE.................. $ 87 $110 $ 185 $ 295 Penn................ 46 64 79 143 CEI................. 114 92 183 275 TE.................. 71 50 91 141 JCP&L............... 125 146 300 446 Met-Ed.............. 44 55 113 168 Penelec............. 46 66 132 198 ATSI................ 18 23 43 66 FES................. 141 69 374 443 Other subsidiaries.. 100 38 87 125 ----- ---- ------- ------ Total............... $ 792 $713 $ 1,587 $2,300 Amounts shown above for 2004 and 2005-2006 include $45 million and $120 million, respectively, for the replacement of steam generators at the Beaver Valley Nuclear Power Plant. During the 2004-2006 period, maturities of, and sinking fund requirements for, long-term debt and preferred stock of FirstEnergy and its subsidiaries are: Preferred Stock and Long-Term Debt Redemption Schedule ---------------------------------- 2004 2005-2006 Total ---- --------- ----- (In millions) OE........................ $ 60 $ 180 $ 240 Penn...................... 64 4 68 CEI*...................... 289 2 291 TE........................ 230 -- 230 JCP&L..................... 176 275 451 Met-Ed.................... 40 181 221 Penelec................... 125 8 133 FirstEnergy............... 270 1,300 1,570 Other subsidiaries........ 4 18 22 ------ ------ ------ Total..................... $1,258 $1,968 $3,226 * CEI has an additional $22 million due to associated companies in 2005-2006. The Companies' and FES's respective investments for additional nuclear fuel, and nuclear fuel investment reductions as the fuel is consumed, during the 2004-2006 period are presented in the following table. The table also displays the Companies' operating lease commitments, net of capital trust cash receipts for the 2004-2006 period.
Nuclear Fuel Forecasts ---------------------------------------------------- Net New Investments Consumption Operating Lease Commitments ----------------------- ------------------------- ----------------------------- 2004 2005-2006 Total 2004 2005-2006 Total 2004 2005-2006 Total ---- --------- ----- ---- --------- ----- ---- --------- ----- (In millions) OE.................. $28 $20 $48 $25 $25 $50 $ 80 $163 $243 Penn................ 20 14 34 17 18 35 -- -- -- CEI................. 29 32 61 30 30 60 27 33 60 TE.................. 13 29 42 21 21 42 73 161 234 JCP&L............... -- -- -- -- -- -- 1 3 4 Met-Ed.............. -- -- -- -- -- -- 1 3 4 FES................. -- 138 138 -- 98 98 -- -- -- ------ ----- ----- ----- ----- ----- -------- ------- ------- Total............... $90 $233 $323 $93 $192 $285 $182 $363 $545
Short-term borrowings outstanding as of December 31, 2003, consisted of $372 million of bank borrowings (FirstEnergy-$280 million, OE-$22 million and TE-$70 million), and $150 million of OES Capital, Incorporated commercial paper. OES Capital is a wholly owned subsidiary of OE whose borrowings are secured by customer accounts receivable. OES Capital can borrow up to $170 million under a receivables financing agreement at rates based on certain bank commercial paper. FirstEnergy had $516 million available under $1.25 billion of revolving lines of credit as of December 31, 2003. FirstEnergy may borrow under its facility and could transfer any of its borrowings to affiliated companies. OE had $477 million of unused bank facilities as of December 31, 2003. An additional source of ongoing cash for FirstEnergy, as a holding company, is cash dividends from its subsidiaries. In 2003, the holding company received $864 million of cash dividends on common stock from its subsidiaries. 11 Based on their present plans, the Companies could provide for their cash requirements in 2004 from the following sources: funds to be received from operations; available cash and temporary cash investments as of December 31, 2003 (Company's nonutility subsidiaries-$85 million, OE-$2 million, CEI-$25 million, TE-$2 million); the issuance of long-term debt (for refunding purposes); and funds available under revolving credit arrangements. Cash and cash equivalents as of December 31, 2003 included $32 million received in December 2003 which was included in the NRG settlement claim sold in January 2004. The extent and type of future financings will depend on the need for external funds as well as market conditions, the maintenance of an appropriate capital structure and the ability of the Companies to comply with coverage requirements in order to issue first mortgage bonds and preferred stock. The Companies will continue to monitor financial market conditions and, where appropriate, may take advantage of economic opportunities to refund debt and preferred stock to the extent that their financial resources permit. The coverage requirements contained in the first mortgage indentures under which the Companies issue first mortgage bonds provide that, except for certain refunding purposes, the Companies may not issue first mortgage bonds unless applicable net earnings (before income taxes), calculated as provided in the indentures, for any period of twelve consecutive months within the fifteen calendar months preceding the month in which such additional bonds are issued, are at least twice annual interest requirements on outstanding first mortgage bonds, including those being issued. Under OE's first mortgage indenture, the availability of property additions is more restrictive than the earnings test at the present time and would limit the amount of first mortgage bonds issuable against property additions to $238 million. OE is currently able to issue approximately $1.4 billion principal amount of first mortgage bonds against previously retired bonds without the need to meet the above restrictions. Under Penn's first mortgage indenture, other requirements also apply and are more restrictive than the earnings test at the present time. Penn is currently able to issue $451 million principal amount of first mortgage bonds, with up to $237 million of such amount issuable against property additions; the remainder could be issued against previously retired bonds. CEI can issue approximately $1.1 billion principal amount of first mortgage bonds against a combination of previously retired bonds and property additions. TE cannot currently issue first mortgage bonds. JCP&L, Met-Ed and Penelec are able to issue $126 million, $189 million and $23 million principal amount, respectively, of first mortgage bonds. OE's, Penn's, TE's and JCP&L's respective articles of incorporation prohibit the sale of preferred stock unless applicable gross income, calculated as provided in the articles of incorporation, is equal to at least 1-1/2 times the aggregate of the annual interest requirements on indebtedness and annual dividend requirements on preferred stock outstanding immediately thereafter. Based upon earnings for 2003 an assumed dividend rate of 7.38% (OE and Penn) and 7.25% (JCP&L), and no additional indebtedness, OE, Penn and JCP&L would be permitted, under the earnings coverage test contained in their respective charters, to issue at least $2.4 billion, $244 million and $189 million of preferred stock, respectively; TE cannot currently issue preferred stock. There are no restrictions on the ability of CEI, Met-Ed and Penelec to issue preferred stock. To the extent that coverage requirements or market conditions restrict the Companies' abilities to issue desired amounts of first mortgage bonds or preferred stock, the Companies may seek other methods of financing. Such financings could include the sale of preferred and/or preference stock or of such other types of securities as might be authorized by applicable regulatory authorities which would not otherwise be sold and could result in annual interest charges and/or dividend requirements in excess of those that would otherwise be incurred. Met-Ed Capital Trust and Penelec Capital Trust In 1999, Met-Ed Capital Trust, a wholly owned subsidiary of Met-Ed, issued $100 million of trust preferred securities (Met-Ed Trust Preferred Securities) at 7.35%, due 2039. The sole assets of Met-Ed Capital Trust are the 7.35% Cumulative Preferred Securities of Met-Ed Capital II, L.P. (Met-Ed Partnership Preferred Securities) and its only revenues are the quarterly cash distributions it receives on the Met-Ed Partnership Preferred Securities. Each Met-Ed Trust Preferred Security represents a Met-Ed Partnership Preferred Security. Met-Ed Capital II, L.P. is a wholly-owned subsidiary of Met-Ed and the sponsor of Met-Ed Capital Trust. The sole assets of Met-Ed Capital II, L.P. are Met-Ed's 7.35% Subordinated Debentures, Series A, due 2039, which have an aggregate principal amount of $103.1 million. Distributions were made on the Trust Preferred Securities during 2003 in the aggregate amount of $7,350,000. Expenses of Met-Ed Trust for 2003 were approximately $5,000, all of which were paid by Met-Ed Preferred Capital II, Inc., the general partner of Met-Ed Capital II, L.P. The Trust Preferred Securities are issued in book-entry form only so that there is only one holder of record. Met-Ed has fully and unconditionally guaranteed the Met-Ed Partnership Preferred Securities, and, therefore, the Met-Ed Trust Preferred Securities. In 1999, Penelec Capital Trust, a wholly owned subsidiary of Penelec, issued $100 million of trust preferred securities (Penelec Trust Preferred Securities) at 7.34%, due 2039. The sole assets of Penelec Capital Trust are the 12 7.34% Cumulative Preferred Securities of Penelec Capital II, L.P. (Penelec Partnership Preferred Securities) and its only revenues are the quarterly cash distributions it receives on the Penelec Partnership Preferred Securities. Each Penelec Trust Preferred Security represents a Penelec Partnership Preferred Security. Penelec Capital II, L.P. is a wholly-owned subsidiary of Penelec and the sponsor of Penelec Capital Trust. The sole assets of Penelec Capital II, L.P. are Penelec's 7.34% Subordinated Debentures, Series A, due 2039, which have an aggregate principal amount of $103.1 million. Distributions were made on the Trust Preferred Securities during 2003 in the aggregate amount of $7,340,000. Expenses of Penelec Trust for 2003 were approximately $5,000, all of which were paid by Penelec Preferred Capital II, Inc., the general partner of Penelec Capital II, L.P. The Trust Preferred Securities are issued in book-entry form only so that there is only one holder of record. Penelec has fully and unconditionally guaranteed the Penelec Partnership Preferred Securities, and, therefore, the Penelec Trust Preferred Securities. Upon adoption of FIN 46R, "Consolidation of Variable Interest Entities", the limited partnerships and statutory business trusts discussed above are not consolidated on the financial statements of FirstEnergy, CEI, Met-Ed and Penelec as of December 31, 2003. Nuclear Regulation The construction, operation and decommissioning of nuclear generating units are subject to the regulatory jurisdiction of the Nuclear Regulatory Commission (NRC) including the issuance by it of construction permits, operating licenses, and possession only licenses for decommissioning reactors. The NRC's procedures with respect to the amendment of nuclear reactor operating licenses afford opportunities for interested parties to request adjudicatory hearings on health, safety and environmental issues subject to meeting NRC "standing" requirements. The NRC may require substantial changes in operation or the installation of additional equipment to meet safety or environmental standards, subject to the backfit rule requiring the NRC to justify such new requirements as necessary for the overall protection of public health and safety. The possibility also exists for modification, denial or revocation of licenses. As a result of the merger with GPU, FirstEnergy now owns the Three Mile Island Unit 2 (TMI-2) and the Saxton Nuclear Experimental Facility. Both facilities are in various stages of decommissioning. TMI-2 is in a post-defueling monitored storage condition, with decommissioning planned in 2014. Saxton is in the final stages of decommissioning, with license termination scheduled for the fourth quarter of 2004 and its final site restoration is scheduled for the end of 2004. Beaver Valley Unit 1 was placed in commercial operation in 1976, and its operating license expires in 2016. Davis-Besse was placed in commercial operation in 1977, and its operating license expires in 2017. Perry Unit 1 and Beaver Valley Unit 2 were placed in commercial operation in 1987, and their operating licenses expire in 2026 and 2027, respectively. Davis-Besse, which is operated by FENOC, began its scheduled refueling outage on February 16, 2002. The plant was originally scheduled to return to service by the end of March 2002. During the refueling outage, visual and ultrasonic testings were conducted on all 69 of the Control Rod Drive Mechanism penetration nozzles. This testing was performed to check for the kind of circular or circumferential cracking in these nozzles that had been found at some other plants similar in design and vintage to Davis-Besse. Based on the inspection and test results, five nozzles were scheduled for repair during the refueling outage. As repair work began on one of the nozzles, FENOC found corrosion in the reactor vessel head near some of the penetration holes, created by boric acid deposits from leaks in the nozzles. As a result, the NRC issued a confirmatory action letter stating that restart of the plant would be subject to prior NRC approval, and it established an Inspection Manual Chapter 0350 Oversight Panel to ensure close NRC oversight of Davis-Besse's corrective actions. In response to the reactor vessel head degradation, FENOC initiated a number of root cause analyses and other assessments, and established a Return to Service Plan to correct the causes and ensure a safe and reliable return to service. The Return to Service Plan included actions to: replace the reactor vessel head, inspect and correct other components in the containment that may have been affected by boric acid, review important systems and programs to ensure their readiness for restart, and improve management and human performance. FENOC has completed all of the actions under the Return to Service Plan and is currently implementing corrective actions and performing assessments for operations issues identified in the late 2003 and early 2004. On March 8, 2004, FENOC received NRC authorization to restart Davis-Besse. FENOC formally requested startup authorization at the February 12, 2004, NRC 0350 panel meeting in Port Clinton, Ohio. The plant will be restarted in a deliberate and controlled manner, with reactor operators incrementally increasing reactor power, stopping at the 50-percent and 100-percent power levels to test equipment and assess operational performance. Also, post-restart assessments will be conducted two weeks and one month after the plant reaches 100-percent power. Operators expect to reach full power by mid-March. The NRC granted restart authorization in an order containing several commitments for Davis-Besse. Those requirements include ongoing independent assessments of the site's operational performance, safety culture and safety conscious work environment, and corrective action and engineering programs for 13 five years, as well as visual inspection of the reactor head and lower vessel during the plant's mid-cycle outage, slated in about one year. In 2002, FENOC spent approximately $115 million in additional nuclear-related operation and maintenance costs, approximately $120 million in replacement power costs and approximately $63 million in capital expenditures related to the reactor head and restart. In 2003, FENOC spent approximately $93 million in additional nuclear-related operation and maintenance costs, approximately $196 million in replacement power costs and approximately $21 million in capital expenditures related to the reactor head and restart. For 2004, FENOC expects to spend approximately $10 million in additional nuclear-related operation and maintenance costs and approximately $15-20 million in replacement power costs per month during the remaining period of the outage. FENOC recently received a subpoena from a grand jury sitting in the United States District Court for the Northern District of Ohio, Eastern Division requesting the production of certain documents and records relating to the inspection and maintenance of the reactor vessel head at the Davis-Besse plant. We are unable to predict the outcome of this investigation. In addition, FENOC remains subject to possible civil enforcement action by the NRC in connection with the events leading to the Davis Besse outage. If it were ultimately determined that FirstEnergy has legal liability or is otherwise made subject to regulatory or civil enforcement action with respect to the Davis-Besse outage, it could have a material adverse effect on FirstEnergy's financial condition and results of operations. The NRC has promulgated and continues to promulgate orders and regulations related to the safe operation of nuclear power plants and standards for decommissioning clean-up and final license termination. The Companies cannot predict what additional orders and regulations (including post-September 11, 2001 security enhancements) may be promulgated, design changes required or the effect that any such regulations or design changes or additional clean-up standards for final site release, or the consideration thereof, may have upon their nuclear plants. Although the Companies have no reason to anticipate an accident at any of their nuclear plants, if such an accident did happen, it could have a material but currently undeterminable adverse effect on FirstEnergy's consolidated financial position. In addition, such an accident at any operating nuclear plant, whether or not owned by the Companies, could result in regulations or requirements that could affect the operation, licensing, or decommissioning of plants that the Companies do own with a consequent but currently undeterminable adverse impact, and could affect the Companies' abilities to raise funds in the capital markets. Nuclear Insurance The Price-Anderson Act limits the public liability which can be assessed with respect to a nuclear power plant to $10.9 billion (assuming 105 units licensed to operate) for a single nuclear incident, which amount is covered by: (i) private insurance amounting to $300 million; and (ii) $10.6 billion provided by an industry retrospective rating plan required by the NRC pursuant thereto. Under such retrospective rating plan, in the event of a nuclear incident at any unit in the United States resulting in losses in excess of private insurance, up to $100.6 million (but not more than $10 million per unit per year in the event of more than one incident) must be contributed for each nuclear unit licensed to operate in the country by the licensees thereof to cover liabilities arising out of the incident. Based on their present nuclear ownership and leasehold interests, the Companies' maximum potential assessment under these provisions would be $402.4 million (OE-$107.5 million, Penn-$84.5 million, CEI-$121.4 million and TE-$89.0 million) per incident but not more than $40.0 million (OE-$10.7 million, Penn-$8.4 million, CEI-$12.1 million and TE-$8.8 million) in any one year for each incident. In addition to the public liability insurance provided pursuant to the Price-Anderson Act, the Companies have also obtained insurance coverage in limited amounts for economic loss and property damage arising out of nuclear incidents. The Companies are members of NEIL which provides coverage (NEIL I) for the extra expense of replacement power incurred due to prolonged accidental outages of nuclear units. Under NEIL I, the Companies have policies, renewable yearly, corresponding to their respective nuclear interests, which provide an aggregate indemnity of up to approximately $1.182 billion (OE-$315 million, Penn-$222 million, CEI-$382 million and TE-$263 million) for replacement power costs incurred during an outage after an initial 12-week waiting period. Members of NEIL I pay annual premiums and are subject to assessments if losses exceed the accumulated funds available to the insurer. The Companies' present maximum aggregate assessment for incidents at any covered nuclear facility occurring during a policy year would be approximately $8.6 million (OE-$2.3 million, Penn-$1.6 million, CEI-$2.8 million and TE-$1.9 million). The Companies are insured as to their respective nuclear interests under property damage insurance provided by NEIL to the operating company for each plant. Under these arrangements, $2.75 billion of coverage for decontamination costs, decommissioning costs, debris removal and repair and/or replacement of property is provided. The Companies pay annual premiums for this coverage and are liable for retrospective assessments of up to approximately $55.5 million (OE-$14.9 million, Penn-$10.2 million, CEI-$17.7 million, TE-$12.0 million, JCP&L-$0.2 million, Met-Ed-$0.3 million and Penelec-$0.2 million) during a policy year. The Companies intend to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the 14 Companies' plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Companies' insurance policies, or to the extent such insurance becomes unavailable in the future, the Companies would remain at risk for such costs. The NRC requires nuclear power plant licensees to obtain minimum property insurance coverage of $1.06 billion or the amount generally available from private sources, whichever is less. The proceeds of this insurance are required to be used first to ensure that the licensed reactor is in a safe and stable condition and can be maintained in that condition so as to prevent any significant risk to the public health and safety. Within 30 days of stabilization, the licensee is required to prepare and submit to the NRC a cleanup plan for approval. The plan is required to identify all cleanup operations necessary to decontaminate the reactor sufficiently to permit the resumption of operations or to commence decommissioning. Any property insurance proceeds not already expended to place the reactor in a safe and stable condition must be used first to complete those decontamination operations that are ordered by the NRC. The Companies are unable to predict what effect these requirements may have on the availability of insurance proceeds to the Companies for the Companies' bondholders. Environmental Matters Various federal, state and local authorities regulate the Companies with regard to air and water quality and other environmental matters. The effects of compliance on the Companies with regard to environmental matters could have a material adverse effect on FirstEnergy's earnings and competitive position. These environmental regulations affect FirstEnergy's earnings and competitive position to the extent that its subsidiaries compete with companies that are not subject to such regulations and therefore do not bear the risk of costs associated with compliance, or failure to comply, with such regulations. Overall, FirstEnergy believes its subsidiaries are in material compliance with existing regulations but is unable to predict future change in regulatory policies and what, if any, the effects of such change would be. FirstEnergy estimates additional capital expenditures for environmental compliance of approximately $91 million for 2004 through 2006, which is included in the $2.3 billion of forecasted capital expenditures for 2004 through 2006. Additional estimated capital expenditures of $481 million relating to proposed environmental laws could be required after 2006. Clean Air Act Compliance FirstEnergy is required to meet federally approved sulfur dioxide (SO2) regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The Environmental Protection Agency (EPA) has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Companies cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. FirstEnergy is complying with SO2 reduction requirements under the Clean Air Act Amendments of 1990 by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or using emission allowances. NOx reductions required by the 1990 Amendments are being achieved through combustion controls and the generation of more electricity at lower-emitting plants. In September 1998, the EPA finalized regulations requiring additional NOx reductions from the Companies' Ohio and Pennsylvania facilities. The EPA's NOx Transport Rule imposes uniform reductions of NOx emissions (an approximate 85% reduction in utility plant NOx emissions from projected 2007 emissions) across a region of nineteen states (including Michigan, New Jersey, Ohio and Pennsylvania) and the District of Columbia based on a conclusion that such NOx emissions are contributing significantly to ozone pollution in the eastern United States. State Implementation Plans (SIP) must comply by May 31, 2004 with individual state NOx budgets established by the EPA. New Jersey and Pennsylvania submitted a SIP that required compliance with the NOx budgets at the Companies' New Jersey and Pennsylvania facilities by May 1, 2003. The Companies' New Jersey and Pennsylvania facilities complied with the NOx budgets in 2003 and all facilities will comply with the NOx budgets in 2004 and thereafter. Michigan and Ohio submitted a SIP that requires compliance with the NOx budgets at the Companies' Michigan and Ohio facilities by May 31, 2004. National Ambient Air Quality Standards In July 1997, the EPA promulgated changes in the National Ambient Air Quality Standard (NAAQS) for ozone and proposed a new NAAQS for fine particulate matter. On December 17, 2003, the EPA proposed the "Interstate Air Quality Rule" covering a total of 29 states (including New Jersey, Ohio and Pennsylvania) and the District of Columbia based on proposed findings that air pollution emissions from 29 eastern states and the District of Columbia significantly contribute to nonattainment of the NAAQS for fine particles and/or the "8-hour" ozone NAAQS in other states. The EPA has proposed the Interstate Air Quality Rule to "cap-and-trade" NOx and SO2 emissions in two phases (Phase I in 2010 and Phase II in 2015). According to the EPA, SO2 emissions would be reduced by approximately 3.6 million tons in 2010, across states covered by the rule, with reductions ultimately reaching more than 5.5 million tons annually. NOx emission reductions would measure about 1.5 million tons in 2010 and 1.8 million tons in 2015. The future cost of compliance with these proposed regulations may be substantial and will depend on whether and how they are ultimately implemented by the states in which the Companies operate affected facilities. 15 Mercury Emissions In December 2000, the EPA announced it would proceed with the development of regulations regarding hazardous air pollutants from electric power plants, identifying mercury as the hazardous air pollutant of greatest concern. On December 15, 2003, the EPA proposed two different approaches to reduce mercury emissions from coal-fired power plants. The first approach would require plants to install controls known as "maximum achievable control technologies" (MACT) based on the type of coal burned. According to the EPA, if implemented, the MACT proposal would reduce nationwide mercury emissions from coal-fired power plants by fourteen tons to approximately thirty-four tons per year. The second approach proposes a cap-and-trade program that would reduce mercury emissions in two distinct phases. Initially, mercury emissions would be reduced by 2010 as a "co-benefits" from implementation of SO2 and NOx emission caps under the EPA's proposed Interstate Air Quality Rule. Phase II of the mercury cap-and-trade program would be implemented in 2018 to cap nationwide mercury emissions from coal-fired power plants at fifteen tons per year. The EPA has agreed to choose between these two options and issue a final rule by December 15, 2004. The future cost of compliance with these regulations may be substantial. W. H. Sammis Plant In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a Compliance Order to nine utilities covering 44 power plants, including the W. H. Sammis Plant. In addition, the U.S. Department of Justice filed eight civil complaints against various investor-owned utilities, which included a complaint against OE and Penn in the U.S. District Court for the Southern District of Ohio. The NOV and complaint allege violations of the Clean Air Act based on operation and maintenance of the W. H. Sammis Plant dating back to 1984. The complaint requests permanent injunctive relief to require the installation of "best available control technology" and civil penalties of up to $27,500 per day of violation. On August 7, 2003, the United States District Court for the Southern District of Ohio ruled that 11 projects undertaken at the W. H. Sammis Plant between 1984 and 1998 required pre-construction permits under the Clean Air Act. The ruling concludes the liability phase of the case, which deals with applicability of Prevention of Significant Deterioration provisions of the Clean Air Act. The remedy phase, which is currently scheduled to be ready for trial beginning July 19, 2004, will address civil penalties and what, if any, actions should be taken to further reduce emissions at the plant. In the ruling, the Court indicated that the remedies it "may consider and impose involved a much broader, equitable analysis, requiring the Court to consider air quality, public health, economic impact, and employment consequences. The Court may also consider the less than consistent efforts of the EPA to apply and further enforce the Clean Air Act." The potential penalties that may be imposed, as well as the capital expenditures necessary to comply with substantive remedial measures that may be required, could have a material adverse impact on FirstEnergy's financial condition and results of operations. Management is unable to predict the ultimate outcome of this matter and no liability has been accrued as of December 31, 2003. Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but it failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. We cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Companies is lower than many regional competitors due to the Companies' diversified generation sources which includes low or non-CO2 emitting gas-fired and nuclear generators. Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. The Companies have been named as "potentially responsible parties" (PRPs) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved 16 are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Companies' proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. In addition, JCP&L has accrued liabilities for environmental remediation of former manufactured gas plants in New Jersey; those costs are being recovered by JCP&L through a non-bypassable societal benefits charge. The Companies have total accrued liabilities aggregating approximately $65 million as of December 31, 2003. Clean Water Act Various water quality regulations, the majority of which are the result of the federal Clean Water Act and its amendments, apply to the Companies' plants. In addition, Ohio, New Jersey and Pennsylvania have water quality standards applicable to the Companies' operations. As provided in the Clean Water Act, authority to grant federal National Pollutant Discharge Elimination System water discharge permits can be assumed by a state. Ohio, New Jersey and Pennsylvania have assumed such authority. Summary Environmental controls are still developing and require, in many instances, balancing the needs for additional quantities of energy in future years and the need to protect the environment. As a result, the Companies cannot now estimate the precise effect of existing and potential regulations and legislation upon any of their existing and proposed facilities and operations or upon their ability to issue additional first mortgage bonds under their respective mortgages. These mortgages contain covenants by the Companies to observe and conform to all valid governmental requirements at the time applicable unless in course of contest, and provisions which, in effect, prevent the issuance of additional bonds if there is a completed default under the mortgage. The provisions of each of the mortgages, in effect, also require, in the opinion of counsel for the respective Companies, that certification of property additions as the basis for the issuance of bonds or other action under the mortgages be accompanied by an opinion of counsel that the company certifying such property additions has all governmental permissions at the time necessary for its then current ownership and operation of such property additions. The Companies intend to contest any requirements they deem unreasonable or impossible for compliance or otherwise contrary to the public interest. Developments in these and other areas of regulation may require the Companies to modify, supplement or replace equipment and facilities, and may delay or impede the construction and operation of new facilities, at costs which could be substantial. Fuel Supply FirstEnergy currently has long-term coal contracts to provide approximately 17.4 million tons for the year 2004. The contracts are shared among the Companies based on various economic considerations. This contract coal is produced primarily from mines located in Pennsylvania, Kentucky, Wyoming and West Virginia. The contracts expire at various times through December 31, 2021. The Companies estimate their 2004 coal requirements to be approximately 18.7 million tons (OE - 6.4 million, Penn - 7.4 million, CEI - 3.6 million, and TE - 1.3 million) to be met from the long-term contracts discussed above and spot market purchases. See "Environmental Matters" for factors pertaining to meeting environmental regulations affecting coal-fired generating units. CEI, TE, OE and Penn have contracts for uranium material and conversion services through 2007. One supplier of natural uranium provided notice that it will not deliver under its contract for the year 2004. The Companies will cover this quantity of natural uranium from other contracts or other sources. The enrichment services are contracted for all of the enrichment requirements for nuclear fuel through 2006. A portion of enrichment requirements is also contracted through 2011. Fabrication services for fuel assemblies are contracted for the next three reloads for Beaver Valley Unit 1, the next two reloads for Beaver Valley Unit 2 (through approximately 2007 and 2006, respectively), the next reload for Davis-Besse (through approximately 2006) and through the operating license period for Perry (through approximately 2026). Davis-Besse fabrication contract also has an extension provision for services through about 2008. In addition to the existing commitments, the Companies intend to make additional arrangements for the supply of uranium and for the subsequent conversion, enrichment, fabrication, and waste disposal services. On-site spent fuel storage facilities are expected to be adequate for Perry through 2011; facilities at Beaver Valley Units 1 and 2 are expected to be adequate through 2015 and 2008, respectively. With the plant modifications completed in 2002, Davis-Besse has adequate storage through the remainder of its operating license period. After current on-site storage capacity is exhausted, additional storage capacity will have to be obtained either through plant modifications, interim off-site disposal, or permanent waste disposal facilities. The Federal Nuclear Waste Policy Act of 1982 provides for the construction of facilities for the permanent disposal of high-level nuclear wastes, including spent fuel from nuclear power plants operated by electric utilities. CEI, TE, OE and Penn have contracts with the U.S. Department of Energy (DOE) for the disposal of spent fuel for Beaver Valley, Davis-Besse and Perry. On February 15, 2002, President Bush approved the DOE's recommendation of Yucca Mountain for underground disposal of spent nuclear fuel from nuclear power plants and high level waste from U.S. defense programs. The approval by 17 President Bush enables the process to proceed to the licensing phase. Based on the DOE schedule published in the July 1999 Draft Environmental Impact Statement, the Yucca Mountain Repository is currently projected to start receiving spent fuel in 2010. The Companies intend to make additional arrangements for storage capacity as a contingency for further delays with the DOE acceptance of spent fuel for disposal past 2010. System Capacity and Reserves The 2003 net maximum hourly demand for each of the Companies was: OE-6,097 MW (including an additional 272 MW of firm power sales under a contract which extends through 2005) on August 21, 2003; Penn-952 MW (including an additional 63 MW of firm power sales under a contract which extends through 2005) on August 14, 2003; CEI-4,160 MW on June 26, 2003; TE-2,037 MW on August 25, 2003; JCP&L-5,645 MW on June 26, 2003; Met-Ed-2,506 MW on August 21, 2003; and Penelec-2,661 MW on January 23, 2003. JCP&L's load was auctioned off in the New Jersey BGS Auction, transferring the full 5,100 MW load obligation to other parties for the period through July 31, 2004. FES participated in the auction and won a segment of that load. Based on existing capacity plans, ongoing arrangements for firm purchase contracts, and anticipated term power sales and purchases, FirstEnergy has sufficient supply resources to meet load obligations. The current FirstEnergy capacity portfolio contains 13,387 MW of owned generation and approximately 1,600 MW of long-term purchases from non-utility generators. The Companies' sources of generation during 2003 were: Coal Nuclear ---- ------- OE.................... 76.5% 23.5% Penn.................. 42.0% 58.0% CEI................... 69.3% 30.7% TE.................... 64.0% 36.0% Total FirstEnergy..... 68.4% 31.6% Any remaining load obligations will be met through a mix of multi-year forward purchases, short-term forward purchases (less than one year) and spot market purchases. Regional Reliability The Companies participate with 24 other electric companies operating in nine states in ECAR, which was organized for the purpose of furthering the reliability of bulk power supply in the area through coordination of the planning and operation by the ECAR members of their bulk power supply facilities. The ECAR members have established principles and procedures regarding matters affecting the reliability of the bulk power supply within the ECAR region. Procedures have been adopted regarding: i) the evaluation and simulated testing of systems' performance; ii) the establishment of minimum levels of daily operating reserves; iii) the development of a program regarding emergency procedures during conditions of declining system frequency; and iv) the basis for uniform rating of generating equipment. Following the FirstEnergy/GPU merger, the transmission facilities of JCP&L, Met-Ed and Penelec continue to be operated by PJM. PJM is the organization responsible for the operation and control of the bulk electric power system throughout major portions of five Mid-Atlantic states and the District of Columbia. PJM is dedicated to meeting the reliability criteria and standards of the North American Electric Reliability Council and the Mid-Atlantic Area Council. Competition The Companies traditionally competed with other utilities for intersystem bulk power sales and for sales to municipalities and cooperatives. The Companies compete with suppliers of natural gas and other forms of energy in connection with their industrial and commercial sales and in the home climate control market, both with respect to new customers and conversions, and with all other suppliers of electricity. To date, there has been no substantial cogeneration by the Companies' customers. 18 As a result of the actions taken by state legislative bodies over the last few years, major changes in the electric utility business are occurring in parts of the United States, including Ohio, New Jersey and Pennsylvania where FirstEnergy's utility subsidiaries operate. These changes have resulted in fundamental alterations in the way traditional integrated utilities and holding company systems, like FirstEnergy, conduct their business. In accordance with the Ohio electric utility restructuring law under which Ohio electric customers could begin choosing their electric generation suppliers starting in January 2001, FirstEnergy has further aligned its business units to accommodate its retail strategy and participate in the competitive electricity marketplace in Ohio. The organizational changes deal with the unbundling of electric utility services and new ways of conducting business. Sales of electricity in deregulated markets are diversifying FirstEnergy's revenue sources through our competitive subsidiaries in areas outside of the Companies' franchise areas. This strategy has positioned FirstEnergy to compete in the northeast and mid-Atlantic region of the United States - the area targeted by FirstEnergy for growth. FirstEnergy's competitive segment participates in deregulated energy markets in Ohio, Pennsylvania, New Jersey and Michigan. Currently, FES is providing electric generation service to customers within those states. As additional states within the northeast and mid-Atlantic region of the United States become deregulated, FES is preparing to enter these markets. Competition in Ohio's electric generation began on January 1, 2001. FirstEnergy moved the operation of the generation portion of its business to its competitive business unit as reflected in its approved Ohio transition plan. The Companies continue to provide generation services to regulated franchise customers who have not chosen an alternative, competitive generation supplier, except in New Jersey where JCP&L's obligation to provide BGS has been removed through a transitional mechanism of auctioning the obligation (see "NJBPU Rate Matters"). In September 2002, Met-Ed and Penelec assigned their PLR responsibility to FES through a wholesale power sale agreement. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by Met-Ed and Penelec. The agreement will be automatically extended on an annual basis unless any party elects to cancel the agreement by November 1 of the preceding year (see "PPUC Rate Matters" for further discussion). The Ohio Companies and Penn obtain their generation through power supply agreements with FES. In addition to electric generation, FES is also competing in deregulated natural gas markets as well as offering other energy-related products and services. Research and Development The Companies participate in funding the Electric Power Research Institute (EPRI), which was formed for the purpose of expanding electric research and development under the voluntary sponsorship of the nation's electric utility industry - public, private and cooperative. Its goal is to mutually benefit utilities and their customers by promoting the development of new and improved technologies to help the utility industry meet present and future electric energy needs in environmentally and economically acceptable ways. EPRI conducts research on all aspects of electric power production and use, including fuels, generation, delivery, energy management and conservation, environmental effects and energy analysis. The major portion of EPRI research and development projects is directed toward practical solutions and their applications to problems currently facing the electric utility industry. In 2003, approximately 45% of the Companies' research and development expenditures were related to EPRI. 19 Executive Officers The executive officers are elected at the annual organization meeting of the Board of Directors, held immediately after the annual meeting of stockholders, and hold office until the next such organization meeting, unless the Board of Directors shall otherwise determine, or unless a resignation is submitted.
Position Held During Name Age Past Five Years Dates - ------------------ --- ------------------------------------------------------------- ------------- A. J. Alexander** 52 President and Chief Executive Officer 2004-present President and Chief Operating Officer 2001-2004 President 2000-2001 Executive Vice President and General Counsel *-2000 L. M. Cavalier 52 Vice President - Human Resources 2001-present President - Eastern Region *-2001 M. T. Clark 53 Senior Vice President - Strategic Planning and Operations 2004-present Vice President - Business Development 2000-2004 Managing Director - Business Development *-2000 D. S. Elliott 49 Senior Vice President - FirstEnergy Solutions 2001-present Vice President *-2001 C. E. Jones 48 Senior Vice President 2003-present Vice President - Regional Operations 2001-2003 President - Northern Region *-2001 K. J. Keough 44 Senior Vice President 2001-present Vice President - Business Planning & Ventures 1999-2001 Partner - McKinsey & Company *-1999 G. R. Leidich 53 President and Chief Nuclear Officer - FENOC 2003-present Executive Vice President - FENOC 2002-2003 Executive Vice President - Institute of Nuclear Power Operations *-2002 R. H. Marsh 53 Senior Vice President and Chief Financial Officer 2001-present Vice President and Chief Financial Officer *-2001 S. E. Morgan 53 President - JCP&L 2003-present Vice President - Energy Delivery 2002-2003 President - Central Region *-2002 G. L. Pipitone 53 Senior Vice President - Commodity Operations 2001-present Vice President *-2001 D. R. Schneider 42 Vice President - Fossil Operations 2001-present Plant Manager *-2001 C. B. Snyder 58 Senior Vice President 2001-present Executive Vice President - Corporate Affairs - GPU *-2001 L. L. Vespoli 44 Senior Vice President and General Counsel 2001-present Vice President and General Counsel 2000-2001 Associate General Counsel *-2000 H. L. Wagner 51 Vice President, Controller and Chief Accounting Officer 2001-present Controller and Chief Accounting Officer *-2001 T. M. Welsh 54 Senior Vice President 2004-present Vice President - Communications 2001-2004 Manager - Communications Services *-2001
Mrs. Vespoli and Messrs. Alexander, Marsh and Wagner are the executive officers, as noted above, of OE, Penn, CEI, TE, Met-Ed and Penelec. Mrs. Vespoli and Messrs. Marsh, Morgan and Wagner are the executive officers of JCP&L. * Indicates position held at least since January 1, 1999. ** Mr. Alexander was elected "Acting Chief Executive Officer" on December 22, 2003 when H. Peter Burg, the Chairman and Chief Executive Officer, began a medical leave of absence. Mr. Alexander was elected Chief Executive Officer effective January 20, 2004, succeeding Mr. Burg, who passed away on January 13, 2004. As of January 1, 2004, FirstEnergy's nonutility subsidiaries and the Companies had a total of 15,905 employees located in the United States as follows: FirstEnergy-2,677, OE-1,320, CEI-949, TE-446, Penn-201, JCP&L-1,557, Met-Ed-659, Penelec-887, ATSI-31, FES-2,078, FENOC-2,954, FSG-2,042, and First Communications - 104. 20 FirstEnergy Website Each of the registrant's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are also made available free of charge on or through FirstEnergy's internet website at www.firstenergycorp.com. These reports are posted on the website as soon as reasonably practicable after they are electronically filed with the SEC. ITEM 2. PROPERTIES The Companies' respective first mortgage indentures constitute, in the opinion of the Companies' counsel, direct first liens on substantially all of the respective Companies' physical property, subject only to excepted encumbrances, as defined in the indentures. See "Leases" and "Capitalization" notes to the respective financial statements for information concerning leases and financing encumbrances affecting certain of the Companies' properties. The Companies own, individually or together as tenants in common, and/or lease, the generating units in service as of March 1, 2004, shown on the table below.
Net Demonstrated Capacity (MW) --------------- OE Penn CEI TE JCP&L Met-Ed FES ----------- --------- ---------- ----------- ---------- ------- --------- Unit Total % MW % MW % MW % MW % MW % MW % MW ---- ----- - -- - -- - -- - -- - -- - -- - -- Plant - Location - ---------------- Coal-Fired Units - ---------------- Ashtabula-........ 5 244 -- -- -- -- 100.00% 244 -- -- -- -- -- -- -- -- Ashtabula, OH Bay Shore-........ 1-4 631 -- -- -- -- -- -- 100.00% 631 -- -- -- -- -- -- Toledo, OH R. E. Burger-..... 3-5 406 100.00% 406 -- -- -- -- -- -- -- -- -- -- -- -- Shadyside, OH Eastlake-Eastlake, OH 1-5 1,233 -- -- -- -- 100.00% 1,233 -- -- -- -- -- -- -- -- Lakeshore-........ 18 245 -- -- -- -- 100.00% 245 -- -- -- -- -- -- -- -- Cleveland, OH Bruce Mansfield-.. 1 780 60.00% 468 33.50% 261 6.50% 51 -- -- -- -- -- -- -- -- Shippingport, PA 2 780 43.06% 336 9.36% 73 30.28%(a) 236 17.30%(a) 135 -- -- -- -- -- -- 3 800 49.34% 395 6.28% 50 24.47% 196 19.91% 159 -- -- -- -- -- -- W. H. Sammis-..... 1-6 1,620 100.00% 1,620 -- -- -- -- -- -- -- -- -- -- -- -- Stratton, OH... 7 600 48.00% 288 20.80% 125 31.20% 187 -- -- -- -- -- -- -- -- ------ ----- ---- ----- ----- --- ----- ----- Total........ 7,339 3,513 509 2,392 925 -- -- -- ------ ----- ---- ------ ----- --- ----- ----- Nuclear Units - ------------- Beaver Valley-.... 1 821 35.00% 287 65.00% 534 -- -- -- -- -- -- -- -- -- -- Shippingport, PA 2 831 41.88%(b) 348 13.74% 114 24.47% 203 19.91%(c) 166 -- -- -- -- -- -- Davis-Besse-...... 1 883 -- -- -- -- 51.38% 454 48.62% 429 -- -- -- -- -- -- Oak Harbor, OH Perry-............ 1 1,260 30.00%(b) 378 5.24% 66 44.85% 565 19.91% 251 -- -- -- -- -- -- N. Perry Village, OH ------ ----- ----- ----- ----- ---- ---- ----- Total........ 3,795 1,013 714 1,222 846 -- -- -- ------ ----- ----- ----- ----- ---- ---- ----- Oil/Gas-Fired/ Pumped Storage Units - -------------------- Richland-Defiance, OH 1-3 42 -- -- -- -- -- -- 100.00% 42 -- -- -- -- -- -- 4-6 390 -- -- -- -- -- -- -- -- -- -- -- -- 100.00% 390 Seneca-Warren, PA. 1-3 435 -- -- -- -- 100.00% 435 -- -- -- -- -- -- -- -- Sumpter-Sumpter Twp., MI 1-4 340 -- -- -- -- -- -- -- -- -- -- -- -- 100.00% 340 West Lorain....... 1-1 120 100.00% 120 -- -- -- -- -- -- -- -- -- -- -- -- Lorain, OH..... 2-6 425 -- -- -- -- -- -- -- -- -- -- -- -- 100.00% 425 Yard's Creek-Blairstown Twp., NJ....... 1-3 200 -- -- -- -- -- -- -- -- 50% 200 -- -- -- -- Other............. 301 109 19 33 35 86 19 ------ ----- ----- ----- ---- ---- ---- ----- Total........ 2,253 229 19 468 77 286 19 1,155 ------- ----- ----- ----- ----- ---- ---- ----- 13,387 4,755 1,242 4,082 1,848 286 19 1,155 Total........ ====== ===== ===== ===== ===== -=== ==== ===== Notes: (a) CEI's interests consist of 1.68% owned and 28.60% leased and TE's interests are leased. (b) OE's interests consist of 20.22% owned and 21.66% leased for Beaver Valley Unit 2; and 17.42% owned (representing portion leased from a wholly owned subsidiary of OE) and 12.58% leased for Perry. (c) TE's interests consist of 1.65% owned and 18.26% leased.
Prolonged outages of existing generating units might make it necessary for the Companies, depending upon the demand for electric service upon their system, to use to a greater extent than otherwise, less efficient and less economic generating units, or purchased power, and in some cases may require the reduction of load during peak periods under the Companies' interruptible programs, all to an extent not presently determinable. The Companies' generating plants and load centers are connected by a transmission system consisting of elements having various voltage ratings ranging from 23 kV to 345 kV. The Companies' overhead and underground transmission lines aggregate 14,944 pole miles. 21 The Companies' electric distribution systems include 112,709 miles of overhead pole line and underground conduit carrying primary, secondary and street lighting circuits. They own substations with a total installed transformer capacity of 91,822,000 kilovolt-amperes. The transmission facilities that are owned and operated by ATSI also interconnect with those of AEP, DPL, Duquesne, Allegheny, MEC and Penelec. The transmission facilities of JCP&L, Met-Ed and Penelec are physically interconnected and are operated on an integrated basis as part of the PJM RTO. FirstEnergy's distribution and transmission systems as of December 31, 2003, consist of the following: Substation Distribution Transmission Transformer Lines Lines Capacity ------------ ------------ ------------ (Miles) (kV-amperes) OE.................... 29,064 550 9,679,000 Penn.................. 5,548 44 1,777,000 CEI................... 24,729 2,144 9,937,000 TE.................... 1,445 223 3,586,000 JCP&L................. 18,219 2,106 21,154,000 Met-Ed................ 14,235 1,407 9,985,000 Penelec............... 19,469 2,690 13,182,000 ATSI.................. -- 5,780 22,522,000 ------- ------ ---------- Total................. 112,709 14,944 91,822,000 FirstEnergy's subsidiary, MARBEL Energy, holds a 50% ownership interest in Great Lakes Energy Partners, LLC, an oil and natural gas exploration and production venture. The joint venture in Great Lakes includes interests in more than 7,700 oil and natural gas wells, drilling rights to nearly one million acres, proved reserves of 450 billion cubic feet equivalent of natural gas and oil and 5,000 miles of pipelines in the Appalachian Basin. ITEM 3. LEGAL PROCEEDINGS Reference is made to Note 7, Commitments, Guarantees and Contingencies, of the Notes to Consolidated Financial Statements contained in Item 8 for a description of certain legal proceedings involving FirstEnergy, OE, CEI, TE, Penn, JCP&L, Met-Ed and Penelec. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this item for FirstEnergy is included on page 5 of FirstEnergy's 2003 Annual Report to Stockholders (Exhibit 13). The information required for OE, CEI, TE, Penn, JCP&L, Met-Ed and Penelec is not applicable because they are wholly owned subsidiaries. ITEM 6. SELECTED FINANCIAL DATA ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required for items 6 through 8 is incorporated herein by reference to Selected Financial Data, Management's Discussion and Analysis of Results of Operations and Financial Condition, and Financial Statements included on the pages shown in the following table in the respective company's 2003 Annual Report to Stockholders (Exhibit 13). Item 6 Item 7 Item 7A Item 8 ------ ------ ------- ------ FirstEnergy.............. 5 6-38 26-29 39-85 OE....................... 1 2-13 7 14-39 Penn..................... 1 2-10 6 11-30 CEI...................... 1 2-13 7 14-39 TE....................... 1 2-12 6-7 13-37 JCP&L.................... 1 2-12 6-7 13-33 Met-Ed................... 1 2-12 6-7 13-34 Penelec.................. 1 2-12 5-7 13-34 22 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Each registrant's Chief Executive Officer and Chief Financial Officer have reviewed and evaluated such registrant's disclosure controls and procedures, as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e), as of the end date covered by this report. Based upon this evaluation, the respective Chief Executive Officer and Chief Financial Officer concluded that, except as described below, such registrant's disclosure controls and procedures are effective. During the fourth quarter of 2003, management identified expenses recognized during the first three quarters of 2003 related to activities that should have been recorded as capital expenditures as a result of untimely table updates in the registrants' automated work management system and inconsistent application of the allocation of costs to capital projects in the registrants' work management system. Management believes that this condition, which has been defined as a material weakness, was attributable to employee training and process changes that were not uniformly applied in connection with the registrants' recent implementation of a new Enterprise Resource Planning system. As a result, the quarterly financial results for JCP&L, Penelec and TE have been restated in each registrant's respective annual reports. As discussed below, management has corrected this condition by strengthening the registrants' internal control procedures. (b) Changes in Internal Controls During the quarter ended December 31, 2003, management implemented the following measures to correct the condition discussed above: 1. Increased training of field employees regarding the proper accounting for capital and expense projects; 2. Established procedures to ensure that tables within the registrants' automated work management system are updated on a timely basis; and 3. Reconfigured the registrants' automated work management system to identify the proper allocation of capital and expense projects. Except for the changes noted above, there were no other changes in the registrants' internal controls over the financial reporting that have materially affected, or are reasonably likely to materially affect, the registrants' internal control over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT FirstEnergy The information required by Item 10, with respect to Identification of FirstEnergy's Directors and with respect to reports required to be filed under Section 16 of the Securities Exchange Act of 1934, is incorporated herein by reference to FirstEnergy's 2004 Proxy Statement filed with the SEC pursuant to Regulation 14A and, with respect to Identification of Executive Officers, to "Part I, Item 1. Business - Executive Officers" herein. The Board of Directors has determined that Robert Loughhead, an independent director, is the audit committee financial expert. FirstEnergy makes available on its website at http://www.firstenergycorp.com/ir its Corporate Governance Policies and the charters for each of the following committees of the Board of Directors: Audit; Corporate Governance; Compensation; Finance; and Nuclear. The Corporate Governance Policies and Board committee charters are also available in print upon written request to David Whitehead, Corporate Secretary, FirstEnergy Corp., 76 South Main Street, Akron, OH 44308-1890. FirstEnergy has adopted a Code of Business Conduct, which applies to all employees, including the Chief Executive Officer, the Chief Financial Officer and the Chief Accounting Officer. In addition, the Board of Directors 23 has its own Code of Business Conduct. These Codes can be found on our website provided in the previous paragraph or upon written request to the Corporate Secretary. OE, Penn, CEI, TE, JCP&L, Met-Ed and Penelec -------------------------------------------- A. J. Alexander, R. H. Marsh and L. L. Vespoli are the Directors of OE, Penn, CEI, TE, Met-Ed and Penelec. Information concerning these individuals is shown in the "Executive Officers" section of Item 1. S. E. Morgan, C. E. Jones, L. L. Vespoli, B. S. Ewing, M. A. Julian, G. E. Persson and S. C. Van Ness are the Directors of JCP&L. Mr. Ewing has served as FirstEnergy Service Company's Vice President - Energy Delivery since 2003. From 1999 to 2003, Mr. Ewing served as Director of Operations Services - Northern Region. Mr. Julian has served as FirstEnergy Service Company's Vice President - - Energy Delivery since 2003. From 2001 to 2003, Mr. Julian served as Director of Energy Delivery Technical Services. He was Director of Operations Services - Northern Region from 2000 to 2001 and Director of Operations Support Services - Central Region from 1999-2000. Mrs. Persson has served in the New Jersey Division of Consumer Affairs Elder Fraud Investigation Unit since 1999. She previously served as liaison (Special Assistant Director) between the New Jersey Division of Consumer Affairs and various state boards. Prior to 1995, she was owner and President of Business Dynamics Associates of Red Bank, NJ. Mrs. Persson is a member of the United States Small Business Administration National Advisory Board, the New Jersey Small Business Advisory Council, the Board of Advisors of Brookdale Community College and the Board of Advisors of Georgian Court College. Mr. Van Ness has been Of Counsel in the firm of Hubert, Van Ness, Cayci and Goodell, LP of Princeton, NJ since 1998. Prior to that he was affiliated with the law firm of Pico, Mack, Kennedy, Jaffe, Perrella and Yoskin of Trenton, NJ since 1990. He is also a director of The Prudential Insurance Company of America. Information concerning the other Directors of JCP&L is shown in the "Executive Officers" section of Item 1. ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS FirstEnergy, OE, CEI, TE, Penn, JCP&L, Met-Ed and Penelec - ----------------------------------------------------------- The information required by Items 11, 12 and 13 is incorporated herein by reference to FirstEnergy's 2004 Proxy Statement filed with the SEC pursuant to Regulation 14A. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES A summary of the audit and audit-related fees rendered by PricewaterhouseCoopers LLP for the years ended December 31, 2003 and 2002 are as follows: Audit Fees (1) Audit Related Fees (2) -------------------- ----------------------- Company 2003 2002 2003 2002 ---------------------- ------- -------- -------- --------- (In thousands) OE.................... $ 676 $ 427 $ 58 $ -- CEI................... 806 332 54 -- TE.................... 684 258 48 -- Penn.................. 230 168 18 -- JCP&L................. 402 310 28 -- Met-Ed................ 377 241 22 -- Penelec............... 275 241 22 -- Other subsidiaries.... 983 948 182 89 ------- ------- -------- --------- Total FirstEnergy $ 4,433 $ 2,925 $ 432 $ 89 ======= ======= ======== ========= (1) Professional services rendered for the audits of FirstEnergy's annual financial statements and reviews of financial statements included in FirstEnergy's Quarterly Reports on Form 10-Q and for services in connection with statutory and regulatory filings or engagements, including comfort letters and consents for financings and filings made with the SEC. 24 (2) Assurance and related services principally related to: (i) audits of employee benefit plans; (ii) consultation to ensure appropriate accounting and reporting in connection with FIN 46 and the Ohio Rate Plan (OE, CEI and TE); and (iii) assistance with Sarbanes-Oxley. Tax Fees The aggregate fees billed to FirstEnergy for the fiscal years ended December 31, 2003 and December 31, 2002 for professional services rendered by PricewaterhouseCoopers LLP for tax-related services were $0 and $263,673, respectively. All Other Fees There were no additional fees billed by PricewaterhouseCoopers LLP for the fiscal year ended December 31, 2003. The aggregate fees billed by PricewaterhouseCoopers LLP for the fiscal year ended December 31, 2002 for services rendered to FirstEnergy other than the Audit Fees, Audit-Related Fees and Tax Fees included above were $661,167. These fees principally related to services provided prior to PricewaterhouseCoopers LLP being engaged as FirstEnergy's independent auditor. PricewaterhouseCoopers LLP no longer provides this type of service for FirstEnergy or any of its affiliates. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements Included in Part II of this report and incorporated herein by reference to the respective company's 2003 Annual Report to Stockholders (Exhibit 13 below) at the pages indicated.
First- Energy OE Penn CEI TE JCP&L Met-Ed Penelec ------ -- ---- --- -- ----- ------ ------- Report of Independent Auditors.................................... 3-4 40-41 31-32 40 38 34-35 35-36 35-36 Statements of Income-Three Years Ended December 31, 2003.......... 39 14 11 14 13 13 13 13 Balance Sheets-December 31, 2003 and 2002......................... 40 15 12 15 14 14 14 14 Statements of Capitalization-December 31, 2003 and 2002........... 41-44 16-17 13 16-17 15-16 15 15 15 Statements of Common Stockholders' Equity-Three Years Ended December 31, 2003........................................ 45 18 14 18 17 16 16 16 Statements of Preferred Stock-Three Years Ended December 31, 2003. 46 18 14 18 17 16 16 16 Statements of Cash Flows-Three Years Ended December 31, 2003...... 47 19 15 19 18 17 17 17 Statements of Taxes-Three Years Ended December 31, 2003........... 48 20 16 20 19 18 18 18 Notes to Financial Statements..................................... 49-85 21-39 17-30 21-39 20-37 19-33 19-34 19-34
25 2. Financial Statement Schedules Included in Part IV of this report:
First- Energy OE Penn CEI TE JCP&L Met-Ed Penelec ------ -- ---- --- -- ----- ------ ------- Report of Independent Auditors.......................... 59-60 61-62 65-66 63 64 67-68 69-70 71-72 Schedule - Three Years Ended December 31, 2003: II - Consolidated Valuation and Qualifying Accounts..... 73 74 77 75 76 78 79 80
Schedules other than the schedule listed above are omitted for the reason that they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto. 3. Exhibits - FirstEnergy Exhibit Number - ------- 3-1 -- Articles of Incorporation constituting FirstEnergy Corp.'s Articles of Incorporation, dated September 17, 1996. (September 17, 1996 Form 8-K, Exhibit C) 3-1(a) -- Amended Articles of Incorporation of FirstEnergy Corp. (Registration No. 333-21011, Exhibit (3)-1) 3-2 -- Regulations of FirstEnergy Corp. (September 17, 1996 Form 8-K, Exhibit D) 3-2(a) -- FirstEnergy Corp. Amended Code of Regulations. (Registration No. 333-21011, Exhibit (3)-2) 4-1 -- Rights Agreement (December 1, 1997 Form 8-K, Exhibit 4.1) 4-2 -- FirstEnergy Corp. to The Bank of New York, Supplemental Indenture, dated November 7, 2001. (2001 Form 10-K, Exhibit 4-2) 10-1 -- FirstEnergy Corp. Executive and Director Incentive Compensation Plan, revised November 15, 1999. (1999 Form 10-K, Exhibit 10-1) 10-2 -- Amended FirstEnergy Corp. Deferred Compensation Plan for Directors, revised November 15, 1999. (1999 Form 10-K, Exhibit 10-2) 10-3 -- Employment, severance and change of control agreement between FirstEnergy Corp. and executive officers. (1999 Form 10-K, Exhibit 10-3) 10-4 -- FirstEnergy Corp. Supplemental Executive Retirement Plan, amended January 1, 1999. (1999 Form 10-K, Exhibit 10-4) 10-5 -- FirstEnergy Corp. Executive Incentive Compensation Plan. (1999 Form 10-K, Exhibit 10-5) 10-6 -- Restricted stock agreement between FirstEnergy Corp. and A. J. Alexander. (1999 Form 10-K, Exhibit 10-6) 10-7 -- FirstEnergy Corp. Executive and Director Incentive Compensation Plan. (1998 Form 10-K, Exhibit 10-1) 10-8 -- Amended FirstEnergy Corp. Deferred Compensation Plan for Directors, amended February 15, 1999. (1998 Form 10-K, Exhibit 10-2) 10-9 -- Restricted stock agreement between FirstEnergy Corp. and . A. J. Alexander. (2000 Form 10-K, Exhibit 10-9) 10-10 -- Restricted stock agreement between FirstEnergy Corp. and H. P. Burg. (2000 Form 10-K, Exhibit 10-10) 10-11 -- Stock option agreement between FirstEnergy Corp. and officers dated November 22, 2000. (2000 Form 10-K, Exhibit 10-11) 10-12 -- Stock option agreement between FirstEnergy Corp. and officers dated March 1, 2000. (2000 Form 10-K, Exhibit 10-12) 26 Exhibit Number - ------ 10-13 -- Stock option agreement between FirstEnergy Corp. and director dated January 1, 2000. (2000 Form 10-K, Exhibit 10-13) 10-14 -- Stock option agreement between FirstEnergy Corp. and two directors dated January 1, 2001. (2000 Form 10-K, Exhibit 10-14) 10-15 -- Executive and Director Incentive Compensation Plan dated May 15, 2001. (2001 Form 10-K, Exhibit 10-15) 10-16 -- Amended FirstEnergy Corp. Deferred Compensation Plan for Directors, revised September 18, 2000. (2001 Form 10-K, Exhibit 10-16) 10-17 -- Stock Option Agreements between FirstEnergy Corp. and Officers dated May 16, 2001. (2001 Form 10-K, Exhibit 10-17) 10-18 -- Restricted Stock Agreements between FirstEnergy Corp. and Officers dated February 20, 2002. (2001 Form 10-K, Exhibit 10-18) 10-19 -- Stock Option Agreements between FirstEnergy Corp. and One Director dated January 1, 2002. (2001 Form 10-K, Exhibit 10-19) 10-20 -- FirstEnergy Corp. Executive Deferred Compensation Plan. (2001 Form 10-K, Exhibit 10-20) 10-21 -- Executive Incentive Compensation Plan-Tier 2. (2001 Form 10-K, Exhibit 20-21) 10-22 -- Executive Incentive Compensation Plan-Tier 3. (2001 Form 10-K, Exhibit 20-22) 10-23 -- Executive Incentive Compensation Plan-Tier 4. (2001 Form 10-K, Exhibit 10-23) 10-24 -- Executive Incentive Compensation Plan-Tier 5. (2001 Form 10-K, Exhibit 10-24) 10-25 -- Amendment to GPU, Inc. 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries, effective April 5, 2001. (2001 Form 10-K, Exhibit 10-25) 10-26 -- Form of Amendment, effective November 7, 2001, to GPU, Inc. 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries, Deferred Remuneration Plan for Outside Directors of GPU, Inc., and Retirement Plan for Outside Directors of GPU, Inc. (2001 Form 10-K, Exhibit 10-26) 10-27 -- GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group, Inc. Employees. (2001 Form 10-K, Exhibit 10-27) 10-28 -- Executive and Director Stock Option Agreement dated June 11, 2002. (2002 Form 10-K, Exhibit 10-28). 10-29 -- Director Stock Option Agreement. (2002 Form 10-K, Exhibit 10-29). 10-30 -- Executive and Director Executive Incentive Compensation Plan, Amendment dated May 21, 2002. (2002 Form 10-K, Exhibit 10-30). 10-31 -- Directors Deferred Compensation Plan, Revised Nov. 19, 2002. (2002 Form 10-K, Exhibit 10-31). 10-32 -- Executive Incentive Compensation Plan 2002. (2002 Form 10-K, Exhibit 10-32). 10-33 -- GPU, Inc. 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries as amended and restated to reflect amendments through June 3, 1999. (1999 Form 10-K, Exhibit 10-V, File No. 1-6047, GPU, Inc.) 10-34 -- Form of 1998 Stock Option Agreement under the GPU, Inc. 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries. (1997 Form 10-K, Exhibit 10-Q, File No. 1-6047, GPU, Inc.) 10-35 -- Form of 1999 Stock Option Agreement under the GPU, Inc. 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries. (1999 Form 10-K, Exhibit 10-W, File No. 1-6047, GPU, Inc.) 10-36 -- Form of 2000 Stock Option Agreement under the GPU, Inc. 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries. (2000 Form 10-K, Exhibit 10-W, File No. 1-6047, GPU, Inc.) 27 Exhibit Number - ------ 10-37 -- Deferred Remuneration Plan for Outside Directors of GPU, Inc. as amended and restated effective August 8, 2000. (2000 Form 10-K, Exhibit 10-O, File No. 1-6047, GPU, Inc.) 10-38 -- Retirement Plan for Outside Directors of GPU, Inc. as amended and restated as of August 8, 2000. (2000 Form 10-K, Exhibit 10-N, File No. 1-6047, GPU, Inc.) 10-39 -- Forms of Estate Enhancement Program Agreements entered into by certain former GPU directors. (1999 Form 10-K, Exhibit 10-JJ, File No. 1-6047, GPU, Inc.) (A) 12.1 -- Consolidated fixed charge ratios. (A) 13 -- FirstEnergy 2003 Annual Report to Stockholders. (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with the SEC.) (A) 21 -- List of Subsidiaries of the Registrant at December 31, 2003. (A) 23 -- Consent of Independent Accountants. (A) 31.1 -- Certification of chief executive officer, as adopted pursuant to Rule 13a-15(e)/15d-15(e) (FirstEnergy, OE, CEI, TE, Penn, Met-Ed and Penelec). (A) 31.2 -- Certification of chief financial officer, as adopted pursuant to Rule 13a-15(e)/15d-15(e) (FirstEnergy, OE, CEI, TE, Penn, Met-Ed and Penelec). (A) 32.1 -- Certification of chief executive officer and chief financial officer, pursuant to 18 U.S.C.ss.1350 (FirstEnergy, OE, CEI, TE, Penn, Met-Ed and Penelec). (A) Provided herein in electronic format as an exhibit. (B) 3.Exhibits - Ohio Edison 2-1 -- Agreement and Plan of Merger, dated as of September 13, 1996, between Ohio Edison Company (OE) and Centerior Energy Corporation. (September 17, 1996 Form 8-K, Exhibit 2-1) 3-1 -- Amended Articles of Incorporation, Effective June 21, 1994, constituting OE's Articles of Incorporation. (1994 Form 10-K, Exhibit 3-1) 3-2 -- Amended and Restated Code of Regulations, amended March 15, 2002. (2001 Form 10-K, Exhibit 3-2) (B) 4-1 -- Indenture dated as of August 1, 1930 between OE and Bankers Trust Company, (now the Bank of New York), as Trustee, as amended and supplemented by Supplemental Indentures: Dated as of File Reference Exhibit No. ----------- -------------- ----------- March 3, 1931 2-1725 B1, B-1(a),B-1(b) November 1, 1935 2-2721 B-4 January 1, 1937 2-3402 B-5 September 1, 1937 Form 8-A B-6 June 13, 1939 2-5462 7(a)-7 August 1, 1974 Form 8-A, August 28, 1974 2(b) July 1, 1976 Form 8-A, July 28, 1976 2(b) December 1, 1976 Form 8-A, December 15, 1976 2(b) June 15, 1977 Form 8-A, June 27, 1977 2(b) Supplemental Indentures: September 1, 1944 2-61146 2(b)(2) April 1, 1945 2-61146 2(b)(2) September 1, 1948 2-61146 2(b)(2) May 1, 1950 2-61146 2(b)(2) January 1, 1954 2-61146 2(b)(2) May 1, 1955 2-61146 2(b)(2) August 1, 1956 2-61146 2(b)(2) March 1, 1958 2-61146 2(b)(2) April 1, 1959 2-61146 2(b)(2) June 1, 1961 2-61146 2(b)(2) 28 Exhibit Number - ------ Dated as of File Reference Exhibit No. ----------- -------------- ----------- September 1, 1969 2-34351 2(b)(2) May 1, 1970 2-37146 2(b)(2) September 1, 1970 2-38172 2(b)(2) June 1, 1971 2-40379 2(b)(2) August 1, 1972 2-44803 2(b)(2) September 1, 1973 2-48867 2(b)(2) May 15, 1978 2-66957 2(b)(4) February 1, 1980 2-66957 2(b)(5) April 15, 1980 2-66957 2(b)(6) June 15, 1980 2-68023 (b)(4)(b)(5) October 1, 1981 2-74059 (4)(d) October 15, 1981 2-75917 (4)(e) February 15, 1982 2-75917 (4)(e) July 1, 1982 2-89360 (4)(d) March 1, 1983 2-89360 (4)(e) March 1, 1984 2-89360 (4)(f) September 15, 1984 2-92918 (4)(d) September 27, 1984 33-2576 (4)(d) November 8, 1984 33-2576 (4)(d) December 1, 1984 33-2576 (4)(d) December 5, 1984 33-2576 (4)(e) January 30, 1985 33-2576 (4)(e) February 25, 1985 33-2576 (4)(e) July 1, 1985 33-2576 (4)(e) October 1, 1985 33-2576 (4)(e) January 15, 1986 33-8791 (4)(d) May 20, 1986 33-8791 (4)(d) June 3, 1986 33-8791 (4)(e) October 1, 1986 33-29827 (4)(d) August 25, 1989 33-34663 (4)(d) February 15, 1991 33-39713 (4)(d) May 1, 1991 33-45751 (4)(d) May 15, 1991 33-45751 (4)(d) September 15, 1991 33-45751 (4)(d) April 1, 1992 33-48931 (4)(d) June 15, 1992 33-48931 (4)(d) September 15, 1992 33-48931 (4)(e) April 1, 1993 33-51139 (4)(d) June 15, 1993 33-51139 (4)(d) September 15, 1993 33-51139 (4)(d) November 15, 1993 1-2578 (4)(2) April 1, 1995 1-2578 (4)(2) May 1, 1995 1-2578 (4)(2) July 1, 1995 1-2578 (4)(2) June 1, 1997 1-2578 (4)(2) April 1, 1998 1-2578 (4)(2) June 1, 1998 1-2578 (4)(2) September 29, 1999 1-2578 (4)(2) April 1, 2000 1-2578 (4)(2)(a) April 1, 2000 1-2578 (4)(2)(b) June 1, 2001 1-2578 (A) February 1, 2003 1-2578 4(2) (A) March 1, 2003 1-2578 4(2) (A) August 1, 2003 1-2578 4(2) (B) 4-2 -- General Mortgage Indenture and Deed of Trust dated as of January 1, 1998 between OE and the Bank of New York, as Trustee. Registration No. 333-05277, Exhibit 4(g)) Dated as of File Reference Exhibit No. ----------- -------------- ----------- (A) February 1, 2003 1-2578 4-2 (A) March 1, 2003 1-2578 4-2 (A) August 1, 2003 1-2578 4-2 29 Exhibit Number - ------ (A) 4-3 -- Indenture dated as of April 1, 2003 between OE and The Bank of New York, as Trustee. 10-1 -- Administration Agreement between the CAPCO Group dated as of September 14, 1967. (Registration No. 2-43102, Exhibit 5(c)(2) 10-2 -- Amendment No. 1 dated January 4, 1974 to Administration Agreement between the CAPCO Group dated as of September 14, 1967. (Registration No. 2-68906, Exhibit 5(c)(3)) 10-3 -- Transmission Facilities Agreement between the CAPCO Group dated as of September 14, 1967. (Registration No. 2-43102, Exhibit 5(c)(3)) 10-4 -- Amendment No. 1 dated as of January 1, 1993 to Transmission Facilities Agreement between the CAPCO Group dated as of September 14, 1967. (1993 Form 10-K, Exhibit 10-4) 10-5 -- Agreement for the Termination or Construction of Certain Agreements effective September 1, 1980 among the CAPCO Group. (Registration No. 2-68906, Exhibit 10-4) 10-6 -- Amendment dated as of December 23, 1993 to Agreement for the Termination or Construction of Certain Agreements effective September 1, 1980 among the CAPCO Group. (1993 Form 10-K, Exhibit 10-6) 10-7 -- CAPCO Basic Operating Agreement, as amended September 1, 1980. (Registration No. 2-68906, Exhibit 10-5) 10-8 -- Amendment No. 1 dated August 1, 1981, and Amendment No. 2 dated September 1, 1982 to CAPCO Basic Operating Agreement, as amended September 1, 1980. (September 30, 1981 Form 10-Q, Exhibit 20-1 and 1982 Form 10-K, Exhibit 19-3, respectively) 10-9 -- Amendment No. 3 dated July 1, 1984 to CAPCO Basic Operating Agreement, as amended September 1, 1980. (1985 Form 10-K, Exhibit 10-7) 10-10 -- Basic Operating Agreement between the CAPCO Companies as amended October 1, 1991. (1991 Form 10-K, Exhibit 10-8) 10-11 -- Basic Operating Agreement between the CAPCO Companies as amended January 1, 1993. (1993 Form 10-K, Exhibit 10-11) 10-12 -- Memorandum of Agreement effective as of September 1, 1980 among the CAPCO Group. (1982 Form 10-K, Exhibit 19-2) 10-13 -- Operating Agreement for Beaver Valley Power Station Units Nos. 1 and 2 as Amended and Restated September 15, 1987, by and between the CAPCO Companies. (1987 Form 10-K, Exhibit 10-15) 10-14 -- Construction Agreement with respect to Perry Plant between the CAPCO Group dated as of July 22, 1974. (Registration No. 2-52251 of Toledo Edison Company, Exhibit 5(yy)) 10-15 -- Amendment No. 3 dated as of October 31, 1980 to the Bond Guaranty dated as of October 1, 1973, as amended, with respect to the CAPCO Group. (Registration No. 2-68906 of Pennsylvania Power Company, Exhibit 10-16) 10-16 -- Amendment No. 4 dated as of July 1, 1985 to the Bond Guaranty dated as October 1, 1973, as amended, by the CAPCO Companies to National City Bank as Bond Trustee. (1985 Form 10-K, Exhibit 10-30) 10-17 -- Amendment No. 5 dated as of May 1, 1986, to the Bond Guaranty by the CAPCO Companies to National City Bank as Bond Trustee. (1986 Form 10-K, Exhibit 10-33) 10-18 -- Amendment No. 6A dated as of December 1, 1991, to the Bond Guaranty dated as of October 1, 1973, by The Cleveland Electric Illuminating Company, Duquesne Light Company, Ohio Edison Company, Pennsylvania Power Company, The Toledo Edison Company to National City Bank, as Bond Trustee. (1991 Form 10-K, Exhibit 10-33) 10-19 -- Amendment No. 6B dated as of December 30, 1991, to the Bond Guaranty dated as of October 1, 1973 by The Cleveland Electric Illuminating Company, Duquesne Light Company, Ohio Edison Company, Pennsylvania Power Company, The Toledo Edison Company to National City Bank, as Bond Trustee. (1991 Form 10-K, Exhibit 10-34) 30 Exhibit Number - ------ 10-20 -- Bond Guaranty dated as of December 1, 1991, by The Cleveland Electric Illuminating Company, Duquesne Light Company, Ohio Edison Company, Pennsylvania Power Company, The Toledo Edison Company to National City Bank, as Bond Trustee. (1991 Form 10-K, Exhibit 10-35) 10-21 -- Memorandum of Understanding dated March 31, 1985 among the CAPCO Companies. (1985 Form 10-K, Exhibit 10-35) (C) 10-22 -- Ohio Edison System Executive Supplemental Life Insurance Plan. (1995 Form 10-K, Exhibit 10-44) (C) 10-23 -- Ohio Edison System Executive Incentive Compensation Plan. (1995 Form 10-K, Exhibit 10-45.) (C) 10-24 -- Ohio Edison System Restated and Amended Executive Deferred Compensation Plan. (1995 Form 10-K, Exhibit 10-46.) (C) 10-25 -- Ohio Edison System Restated and Amended Supplemental Executive Retirement Plan. (1995 Form 10-K, Exhibit 10-47.) (C) 10-26 -- Severance pay agreement between Ohio Edison Company and W. R. Holland. (1995 Form 10-K, Exhibit 10-48.) (C) 10-27 -- Severance pay agreement between Ohio Edison Company and H. P. Burg. (1995 Form 10-K, Exhibit 10-49.) (C) 10-28 -- Severance pay agreement between Ohio Edison Company and A. J. Alexander. (1995 Form 10-K, Exhibit 10-50.) (C) 10-29 -- Severance pay agreement between Ohio Edison Company and J. A. Gill. (1995 Form 10K, Exhibit 10-51.) (D) 10-30 -- Participation Agreement dated as of March 16, 1987 among Perry One Alpha Limited Partnership, as Owner Participant, the Original Loan Participants listed in Schedule 1 Hereto, as Original Loan Participants, PNPP Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee and Ohio Edison Company, as Lessee. (1986 Form 10-K, Exhibit 28-1.) (D) 10-31 -- Amendment No. 1 dated as of September 1, 1987 to Participation Agreement dated as of March 16, 1987 among Perry One Alpha Limited Partnership, as Owner Participant, the Original Loan Participants listed in Schedule 1 thereto, as Original Loan Participants, PNPP Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company (now The Bank of New York), as Indenture Trustee, and Ohio Edison Company, as Lessee. (1991 Form 10-K, Exhibit 10-46.) (D) 10-32 -- Amendment No. 3 dated as of May 16, 1988 to Participation Agreement dated as of March 16, 1987, as amended among Perry One Alpha Limited Partnership, as Owner Participant, PNPP Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee, and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-47.) (D) 10-33 -- Amendment No. 4 dated as of November 1, 1991 to Participation Agreement dated as of March 16, 1987 among Perry One Alpha Limited Partnership, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1991 Form 10-K, Exhibit 10-47.) (D) 10-34 -- Amendment No. 5 dated as of November 24, 1992 to Participation Agreement dated as of March 16, 1987, as amended, among Perry One Alpha Limited Partnership, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company as Lessee. (1992 Form 10-K, Exhibit 10-49.) 31 Exhibit Number - ------ (D) 10-35 -- Amendment No. 6 dated as of January 12, 1993 to Participation Agreement dated as of March 16, 1987 among Perry One Alpha Limited Partnership, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-50.) (D) 10-36 -- Amendment No. 7 dated as of October 12, 1994 to Participation Agreement dated as of March 16, 1987 as amended, among Perry One Alpha Limited Partnership, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-54.) (D) 10-37 -- Facility Lease dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee, with Perry One Alpha Limited Partnership, Lessor, and Ohio Edison Company, Lessee. (1986 Form 10-K, Exhibit 28-2.) (D) 10-38 -- Amendment No. 1 dated as of September 1, 1987 to Facility Lease dated as of March 16, 1997 between The First National Bank of Boston, as Owner Trustee, Lessor and Ohio Edison Company, Lessee. (1991 Form 10-K, Exhibit 10-49.) (D) 10-39 -- Amendment No. 2 dated as of November 1, 1991, to Facility Lease dated as of March 16, 1987, between The First National Bank of Boston, as Owner Trustee, Lessor and Ohio Edison Company, Lessee. (1991 Form 10-K, Exhibit 10-50.) (D) 10-40 -- Amendment No. 3 dated as of November 24, 1992 to Facility Lease dated as March 16, 1987 as amended, between The First National Bank of Boston, as Owner Trustee, with Perry One Alpha Limited partnership, as Owner Participant and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-54.) (D) 10-41 -- Amendment No. 4 dated as of January 12, 1993 to Facility Lease dated as of March 16, 1987 as amended, between, The First National Bank of Boston, as Owner Trustee, with Perry One Alpha Limited Partnership, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-59.) (D) 10-42 -- Amendment No. 5 dated as of October 12, 1994 to Facility Lease dated as of March 16, 1987 as amended, between, The First National Bank of Boston, as Owner Trustee, with Perry One Alpha Limited Partnership, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-60.) (D) 10-43 -- Letter Agreement dated as of March 19, 1987 between Ohio Edison Company, Lessee, and The First National Bank of Boston, Owner Trustee under a Trust dated March 16, 1987 with Chase Manhattan Realty Leasing Corporation, required by Section 3(d) of the Facility Lease. (1986 Form 10-K, Exhibit 28-3.) (D) 10-44 -- Ground Lease dated as of March 16, 1987 between Ohio Edison Company, Ground Lessor, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with the Owner Participant, Tenant. (1986 Form 10-K, Exhibit 28-4.) (D) 10-45 -- Trust Agreement dated as of March 16, 1987 between Perry One Alpha Limited Partnership, as Owner Participant, and The First National Bank of Boston. (1986 Form 10-K, Exhibit 28-5.) (D) 10-46 -- Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of March 16, 1987 with Perry One Alpha Limited Partnership, and Irving Trust Company, as Indenture Trustee. (1986 Form 10-K, Exhibit 28-6.) (D) 10-47 -- Supplemental Indenture No. 1 dated as of September 1, 1987 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of March 16, 1987 between The First National Bank of Boston as Owner Trustee and Irving Trust Company (now The Bank of New York), as Indenture Trustee. (1991 Form 10-K, Exhibit 10-55.) 32 Exhibit Number - ------ (D) 10-48 -- Supplemental Indenture No. 2 dated as of November 1, 1991 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee and The Bank of New York, as Indenture Trustee. (1991 Form 10-K, Exhibit 10-56.) (D) 10-49 -- Tax Indemnification Agreement dated as of March 16, 1987 between Perry One, Inc. and PARock Limited Partnership as General Partners and Ohio Edison Company, as Lessee. (1986 Form 10-K, Exhibit 28-7.) (D) 10-50 -- Amendment No. 1 dated as of November 1, 1991 to Tax Indemnification Agreement dated as of March 16, 1987 between Perry One, Inc. and PARock Limited Partnership and Ohio Edison Company. (1991 Form 10-K, Exhibit 10-58.) (D) 10-51 -- Amendment No. 2 dated as of January 12, 1993 to Tax Indemnification Agreement dated as of March 16, 1987 between Perry One, Inc. and PARock Limited Partnership and Ohio Edison Company. (1994 Form 10-K, Exhibit 10-69.) (D) 10-52 -- Amendment No. 3 dated as of October 12, 1994 to Tax Indemnification Agreement dated as of March 16, 1987 between Perry One, Inc. and PARock Limited Partnership and Ohio Edison Company. (1994 Form 10-K, Exhibit 10-70.) (D) 10-53 -- Partial Mortgage Release dated as of March 19, 1987 under the Indenture between Ohio Edison Company and Bankers Trust Company, as Trustee, dated as of the 1st day of August 1930. (1986 Form 10-K, Exhibit 28-8.) (D) 10-54 -- Assignment, Assumption and Further Agreement dated as of March 16, 1987 among The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Perry One Alpha Limited Partnership, The Cleveland Electric Illuminating Company, Duquesne Light Company, Ohio Edison Company, Pennsylvania Power Company and Toledo Edison Company. (1986 Form 10-K, Exhibit 28-9.) (D) 10-55 -- Additional Support Agreement dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Perry One Alpha Limited Partnership, and Ohio Edison Company. (1986 Form 10-K, Exhibit 28-10.) (D) 10-56 -- Bill of Sale, Instrument of Transfer and Severance Agreement dated as of March 19, 1987 between Ohio Edison Company, Seller, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Perry One Alpha Limited Partnership. (1986 Form 10-K, Exhibit 28-11.) (D) 10-57 -- Easement dated as of March 16, 1987 from Ohio Edison Company, Grantor, to The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Perry One Alpha Limited Partnership, Grantee. (1986 Form 10-K, File Exhibit 28-12.) 10-58 -- Participation Agreement dated as of March 16, 1987 among Security Pacific Capital Leasing Corporation, as Owner Participant, the Original Loan Participants listed in Schedule 1 Hereto, as Original Loan Participants, PNPP Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee and Ohio Edison Company, as Lessee. (1986 Form 10-K, as Exhibit 28-13.) 10-59 -- Amendment No. 1 dated as of September 1, 1987 to Participation Agreement dated as of March 16, 1987 among Security Pacific Capital Leasing Corporation, as Owner Participant, The Original Loan Participants Listed in Schedule 1 thereto, as Original Loan Participants, PNPP Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee and Ohio Edison Company, as Lessee. (1991 Form 10-K, Exhibit 10-65.) 10-60 -- Amendment No. 4 dated as of November 1, 1991, to Participation Agreement dated as of March 16, 1987 among Security Pacific Capital Leasing Corporation, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1991 Form 10-K, Exhibit 10-66.) 33 Exhibit Number - ------ 10-61 -- Amendment No. 5 dated as of November 24, 1992 to Participation Agreement dated as of March 16, 1987 as amended among Security Pacific Capital Leasing Corporation, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNNP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-71.) 10-62 -- Amendment No. 6 dated as of January 12, 1993 to Participation Agreement dated as of March 16, 1987 as amended among Security Pacific Capital Leasing Corporation, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-80.) 10-63 -- Amendment No. 7 dated as of October 12, 1994 to Participation Agreement dated as of March 16, 1987 as amended among Security Pacific Capital Leasing Corporation, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-81.) 10-64 -- Facility Lease dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee, with Security Pacific Capital Leasing Corporation, Lessor, and Ohio Edison Company, as Lessee. (1986 Form 10-K, Exhibit 28-14.) 10-65 -- Amendment No. 1 dated as of September 1, 1987 to Facility Lease dated as of March 16, 1987 between The First National Bank of Boston as Owner Trustee, Lessor and Ohio Edison Company, Lessee. (1991 Form 10-K, Exhibit 10-68.) 10-66 -- Amendment No. 2 dated as of November 1, 1991 to Facility Lease dated as of March 16, 1987 between The First National Bank of Boston as Owner Trustee, Lessor and Ohio Edison Company, Lessee. 1991 Form 10-K, Exhibit 10-69.) 10-67 -- Amendment No. 3 dated as of November 24, 1992 to Facility Lease dated as of March 16, 1987, as amended, between, The First National Bank of Boston, as Owner Trustee, with Security Pacific Capital Leasing Corporation, as Owner Participant and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-75.) 10-68 -- Amendment No. 4 dated as of January 12, 1993 to Facility Lease dated as of March 16, 1987 as amended between, The First National Bank of Boston, as Owner Trustee, with Security Pacific Capital Leasing Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-76.) 10-69 -- Amendment No. 5 dated as of October 12, 1994 to Facility Lease dated as of March 16, 1987 as amended between, The First National Bank of Boston, as Owner Trustee, with Security Pacific Capital Leasing Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-87.) 10-70 -- Letter Agreement dated as of March 19, 1987 between Ohio Edison Company, as Lessee, and The First National Bank of Boston, as Owner Trustee under a Trust, dated as of March 16, 1987, with Security Pacific Capital Leasing Corporation, required by Section 3(d) of the Facility Lease. (1986 Form 10-K, Exhibit 28-15.) 10-71 -- Ground Lease dated as of March 16, 1987 between Ohio Edison Company, Ground Lessor, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Perry One Alpha Limited Partnership, Tenant. (1986 Form 10-K, Exhibit 28-16.) 10-72 -- Trust Agreement dated as of March 16, 1987 between Security Pacific Capital Leasing Corporation, as Owner Participant, and The First National Bank of Boston. (1986 Form 10-K, Exhibit 28-17.) 34 Exhibit Number - ------ 10-73 -- Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Security Pacific Capital Leasing Corporation, and Irving Trust Company, as Indenture Trustee. (1986 Form 10-K, Exhibit 28-18.) 10-74 -- Supplemental Indenture No. 1 dated as of September 1, 1987 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee and Irving Trust Company (now The Bank of New York), as Indenture Trustee. (1991 Form 10-K, Exhibit 10-74.) 10-75 -- Supplemental Indenture No. 2 dated as of November 1, 1991 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee and The Bank of New York, as Indenture Trustee. (1991 Form 10-K, Exhibit 10-75.) 10-76 -- Tax Indemnification Agreement dated as of March 16, 1987 between Security Pacific Capital Leasing Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1986 Form 10-K, Exhibit 28-19.) 10-77 -- Amendment No. 1 dated as of November 1, 1991 to Tax Indemnification Agreement dated as of March 16, 1987 between Security Pacific Capital Leasing Corporation and Ohio Edison Company. (1991 Form 10-K, Exhibit 10-77.) 10-78 -- Amendment No. 2 dated as of January 12, 1993 to Tax Indemnification Agreement dated as of March 16, 1987 between Security Pacific Capital Leasing Corporation and Ohio Edison Company. (1994 Form 10-K, Exhibit 10-96.) 10-79 -- Amendment No. 3 dated as of October 12, 1994 to Tax Indemnification Agreement dated as of March 16, 1987 between Security Pacific Capital Leasing Corporation and Ohio Edison Company. (1994 Form 10-K, Exhibit 10-97.) 10-80 -- Assignment, Assumption and Further Agreement dated as of March 16, 1987 among The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Security Pacific Capital Leasing Corporation, The Cleveland Electric Illuminating Company, Duquesne Light Company, Ohio Edison Company, Pennsylvania Power Company and Toledo Edison Company. (1986 Form 10-K, Exhibit 28-20.) 10-81 -- Additional Support Agreement dated as of March 16, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Security Pacific Capital Leasing Corporation, and Ohio Edison Company. (1986 Form 10-K, Exhibit 28-21.) 10-82 -- Bill of Sale, Instrument of Transfer and Severance Agreement dated as of March 19, 1987 between Ohio Edison Company, Seller, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Security Pacific Capital Leasing Corporation, Buyer. (1986 Form 10-K, Exhibit 28-22.) 10-83 -- Easement dated as of March 16, 1987 from Ohio Edison Company, Grantor, to The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of March 16, 1987, with Security Pacific Capital Leasing Corporation, Grantee. (1986 Form 10-K, Exhibit 28-23.) 10-84 -- Refinancing Agreement dated as of November 1, 1991 among Perry One Alpha Limited Partnership, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee, The Bank of New York, as Collateral Trust Trustee, The Bank of New York, as New Collateral Trust Trustee and Ohio Edison Company, as Lessee. (1991 Form 10-K, Exhibit 10-82.) 10-85 -- Refinancing Agreement dated as of November 1, 1991 among Security Pacific Leasing Corporation, as Owner Participant, PNPP Funding Corporation, as Funding Corporation, PNPP II Funding Corporation, as New Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee, The Bank of New York, as Collateral Trust Trustee, The Bank of New York as New Collateral Trust Trustee and Ohio Edison Company, as Lessee. (1991 Form 10-K, Exhibit 10-83.) 35 Exhibit Number - ------ 10-86 -- Ohio Edison Company Master Decommissioning Trust Agreement for Perry Nuclear Power Plant Unit One, Perry Nuclear Power Plant Unit Two, Beaver Valley Power Station Unit One and Beaver Valley Power Station Unit Two dated July 1, 1993. (1993 Form 10-K, Exhibit 10-94.) 10-87 -- Nuclear Fuel Lease dated as of March 31, 1989, between OES Fuel, Incorporated, as Lessor, and Ohio Edison Company, as Lessee. (1989 Form 10-K, Exhibit 10-62.) 10-88 -- Receivables Purchase Agreement dated as November 28, 1989, as amended and restated as of April 23, 1993, between OES Capital, Incorporated, Corporate Asset Funding Company, Inc. and Citicorp North America, Inc. (1994 Form 10-K, Exhibit 10-106.) 10-89 -- Guarantee Agreement entered into by Ohio Edison Company dated as of January 17, 1991. (1990 Form 10-K, Exhibit 10-64.) 10-90 -- Transfer and Assignment Agreement among Ohio Edison Company and Chemical Bank, as trustee under the OE Power Contract Trust. (1990 Form 10-K, Exhibit 10-65.) 10-91 -- Renunciation of Payments and Assignment among Ohio Edison Company, Monongahela Power Company, West Penn Power Company, and the Potomac Edison Company dated as of January 4, 1991. (1990 Form 10-K, Exhibit 10-66.) 10-92 -- Transfer and Assignment Agreement dated May 20, 1994 among Ohio Edison Company and Chemical Bank, as trustee under the OE Power Contract Trust. (1994 Form 10-K, Exhibit 10-110.) 10-93 -- Renunciation of Payments and Assignment among Ohio Edison Company, Monongahela Power Company, West Penn Power Company, and the Potomac Edison Company dated as of May 20, 1994. (1994 Form 10-K, Exhibit 10-111.) 10-94 -- Transfer and Assignment Agreement dated October 12, 1994 among Ohio Edison Company and Chemical Bank, as trustee under the OE Power Contract Trust. (1994 Form 10-K, Exhibit 10-112.) 10-95 -- Renunciation of Payments and Assignment among Ohio Edison Company, Monongahela Power Company, West Penn Power Company, and the Potomac Edison Company dated as of October 12, 1994. (1994 Form 10-K, Exhibit 10-113.) (E) 10-96 -- Participation Agreement dated as of September 15, 1987, among Beaver Valley Two Pi Limited Partnership, as Owner Participant, the Original Loan Participants listed in Schedule 1 Thereto, as Original Loan Participants, BVPS Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee and Ohio Edison Company as Lessee. (1987 Form 10-K, Exhibit 28-1.) (E) 10-97 -- Amendment No. 1 dated as of February 1, 1988, to Participation Agreement dated as of September 15, 1987, among Beaver Valley Two Pi Limited Partnership, as Owner Participant, the Original Loan Participants listed in Schedule 1 Thereto, as Original Loan Participants, BVPS Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee and Ohio Edison Company, as Lessee. (1987 Form 10-K, Exhibit 28-2.) (E) 10-98 -- Amendment No. 3 dated as of March 16, 1988 to Participation Agreement dated as of September 15, 1987, as amended, among Beaver Valley Two Pi Limited Partnership, as Owner Participant, BVPS Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-99.) (E) 10-99 -- Amendment No. 4 dated as of November 5, 1992 to Participation Agreement dated as of September 15, 1987, as amended, among Beaver Valley Two Pi Limited Partnership, as Owner Participant, BVPS Funding Corporation, BVPS II Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-100.) 36 Exhibit Number - ------ (E) 10-100 -- Amendment No. 5 dated as of September 30, 1994 to Participation Agreement dated as of September 15, 1987, as amended, among Beaver Valley Two Pi Limited Partnership, as Owner Participant, BVPS Funding Corporation, BVPS II Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-118.) (E) 10-101 -- Facility Lease dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee, with Beaver Valley Two Pi Limited Partnership, Lessor, and Ohio Edison Company, Lessee. (1987 Form 10-K, Exhibit 28-3.) (E) 10-102 -- Amendment No. 1 dated as of February 1, 1988, to Facility Lease dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee, with Beaver Valley Two Pi Limited Partnership, Lessor, and Ohio Edison Company, Lessee. (1987 Form 10-K, Exhibit 28-4.) (E) 10-103 -- Amendment No. 2 dated as of November 5, 1992, to Facility Lease dated as of September 15, 1987, as amended, between The First National Bank of Boston, as Owner Trustee, with Beaver Valley Two Pi Limited Partnership, as Owner Participant, and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-103.) (E) 10-104 -- Amendment No. 3 dated as of September 30, 1994 to Facility Lease dated as of September 15, 1987, as amended, between The First National Bank of Boston, as Owner Trustee, with Beaver Valley Two Pi Limited Partnership, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-122.) (E) 10-105 -- Ground Lease and Easement Agreement dated as of September 15, 1987, between Ohio Edison Company, Ground Lessor, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of September 15, 1987, with Beaver Valley Two Pi Limited Partnership, Tenant. (1987 Form 10-K, Exhibit 28-5.) (E) 10-106 -- Trust Agreement dated as of September 15, 1987, between Beaver Valley Two Pi Limited Partnership, as Owner Participant, and The First National Bank of Boston. (1987 Form 10-K, Exhibit 28-6.) (E) 10-107 -- Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987, with Beaver Valley Two Pi Limited Partnership, and Irving Trust Company, as Indenture Trustee. (1987 Form 10-K, Exhibit 28-7.) (E) 10-108 -- Supplemental Indenture No. 1 dated as of February 1, 1988 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of September 15, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with Beaver Valley Two Pi Limited Partnership and Irving Trust Company, as Indenture Trustee. (1987 Form 10-K, Exhibit 28-8.) (E) 10-109 -- Tax Indemnification Agreement dated as of September 15, 1987, between Beaver Valley Two Pi Inc. and PARock Limited Partnership as General Partners and Ohio Edison Company, as Lessee. (1987 Form 10-K, Exhibit 28-9.) (E) 10-110 -- Amendment No. 1 dated as of November 5, 1992 to Tax Indemnification Agreement dated as of September 15, 1987, between Beaver Valley Two Pi Inc. and PARock Limited Partnership as General Partners and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-128.) (E) 10-111 -- Amendment No. 2 dated as of September 30, 1994 to Tax Indemnification Agreement dated as of September 15, 1987, between Beaver Valley Two Pi Inc. and PARock Limited Partnership as General Partners and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-129.) (E) 10-112 -- Tax Indemnification Agreement dated as of September 15, 1987, between HG Power Plant, Inc., as Limited Partner and Ohio Edison Company, as Lessee. (1987 Form 10-K, Exhibit 28-10.) 37 Exhibit Number - ------ (E) 10-113 -- Amendment No. 1 dated as of November 5, 1992 to Tax Indemnification Agreement dated as of September 15, 1987, between HG Power Plant, Inc., as Limited Partner and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-131.) (E) 10-114 -- Amendment No. 2 dated as of September 30, 1994 to Tax Indemnification Agreement dated as of September 15, 1987, between HG Power Plant, Inc., as Limited Partner and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-132.) (E) 10-115 -- Assignment, Assumption and Further Agreement dated as of September 15, 1987, among The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of September 15, 1987, with Beaver Valley Two Pi Limited Partnership, The Cleveland Electric Illuminating Company, Duquesne Light Company, Ohio Edison Company, Pennsylvania Power Company and Toledo Edison Company. (1987 Form 10-K, Exhibit 28-11.) (E) 10-116 -- Additional Support Agreement dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of September 15, 1987, with Beaver Valley Two Pi Limited Partnership, and Ohio Edison Company. (1987 Form 10-K, Exhibit 28-12.) (F) 10-117 -- Participation Agreement dated as of September 15, 1987, among Chrysler Consortium Corporation, as Owner Participant, the Original Loan Participants listed in Schedule 1 Thereto, as Original Loan Participants, BVPS Funding Corporation as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee and Ohio Edison Company, as Lessee. (1987 Form 10-K, Exhibit 28-13.) (F) 10-118 -- Amendment No. 1 dated as of February 1, 1988, to Participation Agreement dated as of September 15, 1987, among Chrysler Consortium Corporation, as Owner Participant, the Original Loan Participants listed in Schedule 1 Thereto, as Original Loan Participants, BVPS Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee, and Ohio Edison Company, as Lessee. (1987 Form 10-K, Exhibit 28-14.) (F) 10-119 -- Amendment No. 3 dated as of March 16, 1988 to Participation Agreement dated as of September 15, 1987, as amended, among Chrysler Consortium Corporation, as Owner Participant, BVPS Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee, and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-114.) (F) 10-120 -- Amendment No. 4 dated as of November 5, 1992 to Participation Agreement dated as of September 15, 1987, as amended, among Chrysler Consortium Corporation, as Owner Participant, BVPS Funding Corporation, BVPS II Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-115.) (F) 10-121 -- Amendment No. 5 dated as of January 12, 1993 to Participation Agreement dated as of September 15, 1987, as amended, among Chrysler Consortium Corporation, as Owner Participant, BVPS Funding Corporation, BVPS II Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-139.) (F) 10-122 -- Amendment No. 6 dated as of September 30, 1994 to Participation Agreement dated as of September 15, 1987, as amended, among Chrysler Consortium Corporation, as Owner Participant, BVPS Funding Corporation, BVPS II Funding Corporation, The First National Bank of Boston, as Owner Trustee, The Bank of New York, as Indenture Trustee and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-140.) (F) 10-123 -- Facility Lease dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee, with Chrysler Consortium Corporation, Lessor, and Ohio Edison Company, as Lessee. (1987 Form 10-K, Exhibit 28-15.) 38 Exhibit Number - ------ (F) 10-124 -- Amendment No. 1 dated as of February 1, 1988, to Facility Lease dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee, with Chrysler Consortium Corporation, Lessor, and Ohio Edison Company, Lessee. (1987 Form 10-K, Exhibit 28-16.) (F) 10-125 -- Amendment No. 2 dated as of November 5, 1992 to Facility Lease dated as of September 15, 1987, as amended, between The First National Bank of Boston, as Owner Trustee, with Chrysler Consortium Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-118.) (F) 10-126 -- Amendment No. 3 dated as of January 12, 1993 to Facility Lease dated as of September 15, 1987, as amended, between The First National Bank of Boston, as Owner Trustee, with Chrysler Consortium Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1992 Form 10-K, Exhibit 10-119.) (F) 10-127 -- Amendment No. 4 dated as of September 30, 1994 to Facility Lease dated as of September 15, 1987, as amended, between The First National Bank of Boston, as Owner Trustee, with Chrysler Consortium Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-145.) (F) 10-128 -- Ground Lease and Easement Agreement dated as of September 15, 1987, between Ohio Edison Company, Ground Lessor, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of September 15, 1987, with Chrysler Consortium Corporation, Tenant. (1987 Form 10-K, Exhibit 28-17.) (F) 10-129 -- Trust Agreement dated as of September 15, 1987, between Chrysler Consortium Corporation, as Owner Participant, and The First National Bank of Boston. (1987 Form 10-K, Exhibit 28-18.) (F) 10-130 -- Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of September 15, 1987, with Chrysler Consortium Corporation and Irving Trust Company, as Indenture Trustee. (1987 Form 10-K, Exhibit 28-19.) (F) 10-131 -- Supplemental Indenture No. 1 dated as of February 1, 1988 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease dated as of September 15, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with Chrysler Consortium Corporation and Irving Trust Company, as Indenture Trustee. (1987 Form 10-K, Exhibit 28-20.) (F) 10-132 -- Tax Indemnification Agreement dated as of September 15, 1987, between Chrysler Consortium Corporation, as Owner Participant, and Ohio Edison Company, Lessee. (1987 Form 10-K, Exhibit 28-21.) (F) 10-133 -- Amendment No. 1 dated as of November 5, 1992 to Tax Indemnification Agreement dated as of September 15, 1987, between Chrysler Consortium Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-151.) (F) 10-134 -- Amendment No. 2 dated as of January 12, 1993 to Tax Indemnification Agreement dated as of September 15, 1987, between Chrysler Consortium Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-152.) (F) 10-135 -- Amendment No. 3 dated as of September 30, 1994 to Tax Indemnification Agreement dated as of September 15, 1987, between Chrysler Consortium Corporation, as Owner Participant, and Ohio Edison Company, as Lessee. (1994 Form 10-K, Exhibit 10-153.) (F) 10-136 -- Assignment, Assumption and Further Agreement dated as of September 15, 1987, among The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of September 15, 1987, with Chrysler Consortium Corporation, The Cleveland Electric Illuminating Company, Duquesne Light Company, Ohio Edison Company, Pennsylvania Power Company, and Toledo Edison Company. (1987 Form 10-K, Exhibit 28-22.) (F) 10-137 -- Additional Support Agreement dated as of September 15, 1987, between The First National Bank of Boston, as Owner Trustee under a Trust Agreement, dated as of September 15, 1987, with Chrysler Consortium Corporation, and Ohio Edison Company. (1987 Form 10-K, Exhibit 28-23.) 39 Exhibit Number - ------ 10-138 -- Operating Agreement dated March 10, 1987 with respect to Perry Unit No. 1 between the CAPCO Companies. (1987 Form 10-K, Exhibit 28-24.) 10-139 -- Operating Agreement for Bruce Mansfield Units Nos. 1, 2 and 3 dated as of June 1, 1976, and executed on September 15, 1987, by and between the CAPCO Companies. (1987 Form 10-K, Exhibit 28-25.) 10-140 -- Operating Agreement for W. H. Sammis Unit No. 7 dated as of September 1, 1971 by and between the CAPCO Companies. (1987 Form 10-K, Exhibit 28-26.) 10-141 -- OE-APS Power Interchange Agreement dated March 18, 1987, by and among Ohio Edison Company and Pennsylvania Power Company, and Monongahela Power Company and West Penn Power Company and The Potomac Edison Company. (1987 Form 10-K, Exhibit 28-27.) 10-142 -- OE-PEPCO Power Supply Agreement dated March 18, 1987, by and among Ohio Edison Company and Pennsylvania Power Company and Potomac Electric Power Company. (1987 Form 10-K, Exhibit 28-28.) 10-143 -- Supplement No. 1 dated as of April 28, 1987, to the OE-PEPCO Power Supply Agreement dated March 18, 1987, by and among Ohio Edison Company, Pennsylvania Power Company, and Potomac Electric Power Company. (1987 Form 10-K, Exhibit 28-29.) 10-144 -- APS-PEPCO Power Resale Agreement dated March 18, 1987, by and among Monongahela Power Company, West Penn Power Company, and The Potomac Edison Company and Potomac Electric Power Company. (1987 Form 10-K, Exhibit 28-30.) (A) 12.2 -- Consolidated fixed charge ratios. (A) 13.1 -- OE 2003 Annual Report to Stockholders (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with the SEC.) (A) 21.1 -- List of Subsidiaries of the Registrant at December 31, 2003. (A) 23.1 -- Consent of Independent Accountants. (A) Provided herein in electronic format as an exhibit. (B) Pursuant to paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, OE has not filed as an exhibit to this Form 10-K any instrument with respect to long-term debt if the total amount of securities authorized thereunder does not exceed 10% of the total assets of OE and its subsidiaries on a consolidated basis, but hereby agrees to furnish to the SEC on request any such instruments. (C) Management contract or compensatory plan contract or arrangement filed pursuant to Item 601 of Regulation S-K. (D) Substantially similar documents have been entered into relating to three additional Owner Participants. (E) Substantially similar documents have been entered into relating to five additional Owner Participants. (F) Substantially similar documents have been entered into relating to two additional Owner Participants. Note: Reports of OE on Forms 10-Q and 10-K are on file with the SEC under number 1-2578. Pursuant to Rule 14a - 3 (10) of the Securities Exchange Act of 1934, the Company will furnish any exhibit in this Report upon the payment of the Company's expenses in furnishing such exhibit. 3. Exhibits - Penn 3-1 -- Amended and Restated Articles of Incorporation, as amended March 15, 2002. (2001 Form 10-K, Exhibit 3-1) 40 Exhibit Number - ------ 3-2 -- Amended and Restated By-Laws of Penn, as amended March 15, 2002. (2001 Form 10-K, Exhibit 3-2) 4-1* -- Indenture dated as of November 1, 1945, between Penn and The First National Bank of the City of New York (now Citibank, N.A.), as Trustee, as supplemented and amended by Supplemental Indentures dated as of May 1, 1948, March 1, 1950, February 1, 1952, October 1, 1957, September 1, 1962, June 1, 1963, June 1, 1969, May 1, 1970, April 1, 1971, October 1, 1971, May 1, 1972, December 1, 1974, October 1, 1975, September 1, 1976, April 15, 1978, June 28, 1979, January 1, 1980, June 1, 1981, January 14, 1982, August 1, 1982, December 15, 1982, December 1, 1983, September 6, 1984, December 1, 1984, May 30, 1985, October 29, 1985, August 1, 1987, May 1, 1988, November 1, 1989, December 1, 1990, September 1, 1991, May 1, 1992, July 15, 1992, August 1, 1992, and May 1, 1993, July 1, 1993, August 31, 1993, September 1, 1993, September 15, 1993, October 1, 1993, November 1, 1993, and August 1, 1994. (Physically filed and designated as Exhibits 2(b)(1)-1 through 2(b)(1)-15 in Registration Statement File No. 2-60837; as Exhibits 2(b)(2), 2(b)(3), and 2(b)(4) in Registration Statement File No. 2-68906; as Exhibit 4-2 in Form 10-K for 1981 File No. 1-3491; as Exhibit 19-1 in Form 10-K for 1982 File No. 1-3491; as Exhibit 19-1 in Form 10-K for 1983 File No. 1-3491; as Exhibit 19-1 in Form 10-K for 1984 File No. 1-3491; as Exhibit 19-1 in Form 10-K for 1985 File No. 1-3491; as Exhibit 19-1 in Form 10-K for 1987 File No. 1-3491; as Exhibit 19-1 in Form 10-K for 1988 File No. 1-3491; as Exhibit 19 in Form 10-K for 1989 File No. 1-3491; as Exhibit 19 in Form 10-K for 1990 File No. 1-3491; as Exhibit 19 in Form 10-K for 1991 File No. 1-3491; as Exhibit 19-1 in Form 10-K for 1992 File No. 1-3491; as Exhibit 4-2 in Form 10-K for 1993 File No. 1-3491; and as Exhibit 4-2 in Form 10-K for 1994 File No. 1-3491.) 4-2 -- Supplemental Indenture dated as of September 1, 1995, between Penn and Citibank, N.A., as Trustee. (1995 Form 10-K, Exhibit 4-2.) 4-3 -- Supplemental Indenture dated as of June 1, 1997, between Penn and Citibank, N.A., as Trustee. (1997 Form 10-K, Exhibit 4-3.) 4-4 -- Supplemental Indenture dated as of June 1, 1998, between Penn and Citibank, N. A., as Trustee. (1998 Form 10-K, Exhibit 4-4.) 4-5 -- Supplemental Indenture dated as of September 29, 1999, between Penn and Citibank, N.A., as Trustee. (1999 Form 10-K, Exhibit 4-5.) 4-6 -- Supplemental Indenture dated as of November 15, 1999, between Penn and Citibank, N.A., as Trustee. (1999 Form 10-K, Exhibit 4-6.) 4-7 -- Supplemental Indenture dated as of June 1, 2001. (2001 Form 10-K, Exhibit 4-7) 10-1 -- Administration Agreement between the CAPCO Group dated as of September 14, 1967. (Registration Statement of Ohio Edison Company, File No. 2-43102, Exhibit 5(c)(2).) 10-2 -- Amendment No. 1 dated January 4, 1974 to Administration Agreement between the CAPCO Group dated as of September 14, 1967. (Registration Statement No. 2-68906, Exhibit 5 (c)(3).) 10-3 -- Transmission Facilities Agreement between the CAPCO Group dated as of September 14, 1967. (Registration Statement of Ohio Edison Company, File No. 2-43102, Exhibit 5 (c)(3).) 10-4 -- Amendment No. 1 dated as of January 1, 1993 to Transmission Facilities Agreement between the CAPCO Group dated as of September 14, 1967. (1993 Form 10-K, Exhibit 10-4, Ohio Edison Company.) 10-5 -- Agreement for the Termination or Construction of Certain Agreements effective September 1, 1980 among the CAPCO Group. (Registration Statement No. 2-68906, Exhibit 10-4.) - ----------------------------- * Pursuant to paragraph (b)(4)(iii) (A) of Item 601 of Regulation S-K, Penn has not filed as an exhibit to this Form 10-K any instrument with respect to long-term debt if the total amount of securities authorized thereunder does not exceed 10% of the total assets of Penn, but hereby agrees to furnish to the Commission on request any such instruments. 41 Exhibit Number - ------ 10-6 -- Amendment dated as of December 23, 1993 to Agreement for the Termination or Construction of Certain Agreements effective September 1, 1980 among the CAPCO Group. (1993 Form 10-K, Exhibit 10-6, Ohio Edison Company.) 10-7 -- CAPCO Basic Operating Agreement, as amended September 1, 1980. (Registration Statement No. 2-68906, as Exhibit 10-5.) 10-8 -- Amendment No. 1 dated August 1, 1981 and Amendment No. 2 dated September 1, 1982, to CAPCO Basic Operating Agreement as amended September 1, 1980. (September 30, 1981 Form 10-Q, Exhibit 20-1 and 1982 Form 10-K, Exhibit 19-3, File No. 1-2578, of Ohio Edison Company.) 10-9 -- Amendment No. 3 dated as of July 1, 1984, to CAPCO Basic Operating Agreement as amended September 1, 1980. (1985 Form 10-K, Exhibit 10-7, File No. 1-2578, of Ohio Edison Company.) 10-10 -- Basic Operating Agreement between the CAPCO Companies as amended October 1, 1991. (1991 Form 10-K, Exhibit 10-8, File No. 1-2578, of Ohio Edison Company.) 10-11 -- Basic Operating Agreement between the CAPCO Companies as amended January 1, 1993. (1993 Form 10-K, Exhibit 10-11, Ohio Edison.) 10-12 -- Memorandum of Agreement effective as of September 1, 1980, among the CAPCO Group. (1991 Form 10-K, Exhibit 19-2, Ohio Edison Company.) 10-13 -- Operating Agreement for Beaver Valley Power Station Units Nos. 1 and 2 as Amended and Restated September 15, 1987, by and between the CAPCO Companies. (1987 Form 10-K, Exhibit 10-15, File No. 1-2578, of Ohio Edison Company.) 10-14 -- Construction Agreement with respect to Perry Plant between the CAPCO Group dated as of July 22, 1974. (Registration Statement of Toledo Edison Company, File No. 2-52251, as Exhibit 5 (yy).) 10-15 -- Memorandum of Understanding dated as of March 31, 1985, among the CAPCO Companies. (1985 Form 10-K, Exhibit 10-35, File No. 1-2578, Ohio Edison Company.) (B) 10-16 -- Ohio Edison System Executive Supplemental Life Insurance Plan. (1995 Form 10-K, Exhibit 10-44, File No. 1-2578, Ohio Edison Company.) (B) 10-17 -- Ohio Edison System Executive Incentive Compensation Plan. (1995 Form 10-K, Exhibit 10-45, File No. 1-2578, Ohio Edison Company.) (B) 10-18 -- Ohio Edison System Restated and Amended Executive Deferred Compensation Plan. (1995 Form 10-K, Exhibit 10-46, File No. 1-2578, Ohio Edison Company.) (B) 10-19 -- Ohio Edison System Restated and Amended Supplemental Executive Retirement Plan. (1995 Form 10-K, Exhibit 10-47, File No. 1-2578, Ohio Edison Company.) 10-20 -- Operating Agreement for Perry Unit No. 1 dated March 10, 1987, by and between the CAPCO Companies. (1987 Form 10-K, Exhibit 28-24, File No. 1-2578, Ohio Edison Company.) 10-21 -- Operating Agreement for Bruce Mansfield Units Nos. 1, 2 and 3 dated as of June 1, 1976, and executed on September 15, 1987, by and between the CAPCO Companies. (1987 Form 10-K, Exhibit 28-25, File No. 1-2578, Ohio Edison Company.) 10-22 -- Operating Agreement for W. H. Sammis Unit No. 7 dated as of September 1, 1971, by and between the CAPCO Companies. (1987 Form 10-K, Exhibit 28-26, File No. 1-2578, Ohio Edison Company.) 10-23 -- OE-APS Power Interchange Agreement dated March 18, 1987, by and among Ohio Edison Company and Pennsylvania Power Company, and Monongahela Power Company and West Penn Power Company and The Potomac Edison Company. (1987 Form 10-K, Exhibit 28-27, File No. 1-2578, of Ohio Edison Company.) 42 Exhibit Number - ------ 10-24 -- OE-PEPCO Power Supply Agreement dated March 18, 1987, by and among Ohio Edison Company and Pennsylvania Power Company and Potomac Electric Power Company. (1987 Form 10-K, Exhibit 28-28, File No. 1-2578, of Ohio Edison Company.) 10-25 -- Supplement No. 1 dated as of April 28, 1987, to the OE-PEPCO Power Supply Agreement dated March 18, 1987, by and among Ohio Edison Company, Pennsylvania Power Company and Potomac Electric Power Company. (1987 Form 10-K, Exhibit 28-29, File No. 1-2578, of Ohio Edison Company.) 10-26 -- APS-PEPCO Power Resale Agreement dated March 18, 1987, by and among Monongahela Power Company, West Penn Power Company, and The Potomac Edison Company and Potomac Electric Power Company. (1987 Form 10-K, Exhibit 28-30, File No. 1-2578, of Ohio Edison Company.) 10-27 -- Pennsylvania Power Company Master Decommissioning Trust Agreement for Beaver Valley Power Station and Perry Nuclear Power Plant dated as of April 21, 1995. (Quarter ended June 30, 1995 Form 10-Q, Exhibit 10, File No. 1-3491.) 10-28 -- Nuclear Fuel Lease dated as of March 31, 1989, between OES Fuel, Incorporated, as Lessor, and Pennsylvania Power Company, as Lessee. (1989 Form 10-K, Exhibit 10-39, File No. 1-3491.) (A) 12.5 -- Fixed Charge Ratios (A) 13.4 -- Penn 2003 Annual Report to Stockholders. (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with the Securities and Exchange Commission.) (A) 23.2 -- Consent of Independent Accountants. (A) Provided herein in electronic format as an exhibit. (B) -- Management contract or compensatory plan contract or arrangement filed pursuant to Item 601 of Regulation S-K. Pursuant to Rule 14a-3(10) of the Securities Exchange Act of 1934, the Company will furnish any exhibit in this Report upon the payment of the Company's expenses in furnishing such exhibit. 3. Exhibits - Common Exhibits to CEI and TE Exhibit Number 2(a) -- Agreement and Plan of Merger between Ohio Edison and Centerior Energy dated as of September 13, 1996 (Exhibit (2)-1, Form S-4 File No. 333-21011, filed by FirstEnergy). 2(b) -- Merger Agreement by and among Centerior Acquisition Corp., FirstEnergy and Centerior (Exhibit (2)-3, Form S-4 File No. 333-21011, filed by FirstEnergy). 4(a) -- Rights Agreement (Exhibit 4, June 25, 1996 Form 8-K, File Nos. 1-9130, 1-2323 and 1-3583). 4(b)(1) -- Form of Note Indenture between Cleveland Electric, Toledo Edison and The Chase Manhattan Bank, as Trustee dated as of June 13, 1997 (Exhibit 4(c), Form S-4 File No. 333-35931, filed by Cleveland Electric and Toledo Edison). 4(b)(2) -- Form of First Supplemental Note Indenture between Cleveland Electric, Toledo Edison and The Chase Manhattan Bank, as Trustee dated as of June 13, 1997 (Exhibit 4(d), Form S-4 File No. 333-35931, filed by Cleveland Electric and Toledo Edison). 10b(1)(a) -- CAPCO Administration Agreement dated November 1, 1971, as of September 14, 1967, among the CAPCO Group members regarding the organization and procedures for implementing the objectives of the CAPCO Group (Exhibit 5(p), Amendment No. 1, File No. 2-42230, filed by Cleveland Electric). 43 Exhibit Number - ------ 10b(1)(b) -- Amendment No. 1, dated January 4, 1974, to CAPCO Administration Agreement among the CAPCO Group members (Exhibit 5(c)(3), File No. 2-68906, filed by Ohio Edison). 10b(2) -- CAPCO Transmission Facilities Agreement dated November 1, 1971, as of September 14, 1967, among the CAPCO Group members regarding the installation, operation and maintenance of transmission facilities to carry out the objectives of the CAPCO Group (Exhibit 5(q), Amendment No. 1, File No. 2-42230, filed by Cleveland Electric). 10b(2)(1) -- Amendment No. 1 to CAPCO Transmission Facilities Agreement, dated December 23, 1993 and effective as of January 1, 1993, among the CAPCO Group members regarding requirements for payment of invoices at specified times, for payment of interest on non-timely paid invoices, for restricting adjustment of invoices after a four-year period, and for revising the method for computing the Investment Responsibility charge for use of a member's transmission facilities (Exhibit 10b(2)(1), 1993 Form 10-K, File Nos. 1-9130, 1-2323 and 1-3583). 10b(3) -- CAPCO Basic Operating Agreement As Amended January 1, 1993 among the CAPCO Group members regarding coordinated operation of the members' systems (Exhibit 10b(3), 1993 Form 10-K, File Nos. 1-9130, 1-2323 and 1-3583). 10b(4) -- Agreement for the Termination or Construction of Certain Agreement By and Among the CAPCO Group members, dated December 23, 1993 and effective as of September 1, 1980 (Exhibit 10b(4), 1993 Form 10-K, File Nos. 1-9130, 1-2323 and 1-3583). 10b(5) -- Construction Agreement, dated July 22, 1974, among the CAPCO Group members and relating to the Perry Nuclear Plant (Exhibit 5 (yy), File No. 2-52251, filed by Toledo Edison). 10b(6) -- Contract, dated as of December 5, 1975, among the CAPCO Group members for the construction of Beaver Valley Unit No. 2 (Exhibit 5 (g), File No. 2-52996, filed by Cleveland Electric). 10b(7) -- Amendment No. 1, dated May 1, 1977, to Contract, dated as of December 5, 1975, among the CAPCO Group members for the construction of Beaver Valley Unit No. 2 (Exhibit 5(d)(4), File No. 2-60109, filed by Ohio Edison). 10d(1)(a) -- Form of Collateral Trust Indenture among CTC Beaver Valley Funding Corporation, Cleveland Electric, Toledo Edison and Irving Trust Company, as Trustee (Exhibit 4(a), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(1)(b) -- Form of Supplemental Indenture to Collateral Trust Indenture constituting Exhibit 10d(1)(a) above, including form of Secured Lease Obligation bond (Exhibit 4(b), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(1)(c) -- Form of Collateral Trust Indenture among Beaver Valley II Funding Corporation, The Cleveland Electric Illuminating Company and The Toledo Edison Company and The Bank of New York, as Trustee (Exhibit (4)(a), File No. 33-46665, filed by Cleveland Electric and Toledo Edison). 10d(1)(d) -- Form of Supplemental Indenture to Collateral Trust Indenture constituting Exhibit 10d(1)(c) above, including form of Secured Lease Obligation Bond (Exhibit (4)(b), File No. 33-46665, filed by Cleveland Electric and Toledo Edison). 10d(2)(a) -- Form of Collateral Trust Indenture among CTC Mansfield Funding Corporation, Cleveland Electric, Toledo Edison and IBJ Schroder Bank & Trust Company, as Trustee (Exhibit 4(a), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(2)(b) -- Form of Supplemental Indenture to Collateral Trust Indenture constituting Exhibit 10d(2)(a) above, including forms of Secured Lease Obligation bonds (Exhibit 4(b), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(3)(a) -- Form of Facility Lease dated as of September 15, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with the limited partnership Owner Participant named therein, Lessor, and Cleveland Electric and Toledo Edison, Lessee (Exhibit 4(c), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 44 Exhibit Number - ------ 10d(3)(b) -- Form of Amendment No. 1 to Facility Lease constituting Exhibit 10d(3)(a) above (Exhibit 4(e), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(4)(a) -- Form of Facility Lease dated as of September 15, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with the corporate Owner Participant named therein, Lessor, and Cleveland Electric and Toledo Edison, Lessees (Exhibit 4(d), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(4)(b) -- Form of Amendment No. 1 to Facility Lease constituting Exhibit 10d(4)(a) above (Exhibit 4(f), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(5)(a) -- Form of Facility Lease dated as of September 30, 1987 between Meridian Trust Company, as Owner Trustee under a Trust Agreement dated as of September 30, 1987 with the Owner Participant named therein, Lessor, and Cleveland Electric and Toledo Edison, Lessees (Exhibit 4(c), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(5)(b) -- Form of Amendment No. 1 to the Facility Lease constituting Exhibit 10d(5)(a) above (Exhibit 4(f), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(6)(a) -- Form of Participation Agreement dated as of September 15, 1987 among the limited partnership Owner Participant named therein, the Original Loan Participants listed in Schedule 1 thereto, as Original Loan Participants, CTC Beaver Valley Fund Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee, and Cleveland Electric and Toledo Edison, as Lessees (Exhibit 28(a), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(6)(b) -- Form of Amendment No. 1 to Participation Agreement constituting Exhibit 10d(6)(a) above (Exhibit 28(c), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(7)(a) -- Form of Participation Agreement dated as of September 15, 1987 among the corporate Owner Participant named therein, the Original Loan Participants listed in Schedule 1 thereto, as Owner Loan Participants, CTC Beaver Valley Funding Corporation, as Funding Corporation, The First National Bank of Boston, as Owner Trustee, Irving Trust Company, as Indenture Trustee, and Cleveland Electric and Toledo Edison, as Lessees (Exhibit 28(b), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(7)(b) -- Form of Amendment No. 1 to Participation Agreement constituting Exhibit 10d(7)(a) above (Exhibit 28(d), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(8)(a) -- Form of Participation Agreement dated as of September 30, 1987 among the Owner Participant named therein, the Original Loan Participants listed in Schedule II thereto, as Owner Loan Participants, CTC Mansfield Funding Corporation, Meridian Trust Company, as Owner Trustee, IBJ Schroder Bank & Trust Company, as Indenture Trustee, and Cleveland Electric and Toledo Edison, as Lessees (Exhibit 28(a), File No. 33-0128, filed by Cleveland Electric and Toledo Edison). 10d(8)(b) -- Form of Amendment No. 1 to the Participation Agreement constituting Exhibit 10d(8)(a) above (Exhibit 28(b), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(9) -- Form of Ground Lease dated as of September 15, 1987 between Toledo Edison, Ground Lessor, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with the Owner Participant named therein, Tenant (Exhibit 28(e), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(10) -- Form of Site Lease dated as of September 30, 1987 between Toledo Edison, Lessor, and Meridian Trust Company, as Owner Trustee under a Trust Agreement dated as of September 30, 1987 with the Owner Participant named therein, Tenant (Exhibit 28(c), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 45 Exhibit Number - ------ 10d(11) -- Form of Site Lease dated as of September 30, 1987 between Cleveland Electric, Lessor, and Meridian Trust Company, as Owner Trustee under a Trust Agreement dated as of September 30, 1987 with the Owner Participant named therein, Tenant (Exhibit 28(d), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(12) -- Form of Amendment No. 1 to the Site Leases constituting Exhibits 10d(10) and 10d(11) above (Exhibit 4(f), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(13) -- Form of Assignment, Assumption and Further Agreement dated as of September 15, 1987 among The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with the Owner Participant named therein, Cleveland Electric, Duquesne, Ohio Edison, Pennsylvania Power and Toledo Edison (Exhibit 28(f), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(14) -- Form of Additional Support Agreement dated as of September 15, 1987 between The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with the Owner Participant named therein, and Toledo Edison (Exhibit 28(g), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(15) -- Form of Support Agreement dated as of September 30, 1987 between Meridian Trust Company, as Owner Trustee under a Trust Agreement dated as of September 30, 1987 with the Owner Participant named therein, Toledo Edison, Cleveland Electric, Duquesne, Ohio Edison and Pennsylvania Power (Exhibit 28(e), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(16) -- Form of Indenture, Bill of Sale, Instrument of Transfer and Severance Agreement dated as of September 30, 1987 between Toledo Edison, Seller, and The First National Bank of Boston, as Owner Trustee under a Trust Agreement dated as of September 15, 1987 with the Owner Participant named therein, Buyer (Exhibit 28(h), File No. 33-18755, filed by Cleveland Electric and Toledo Edison). 10d(17) -- Form of Bill of Sale, Instrument of Transfer and Severance Agreement dated as of September 30, 1987 between Toledo Edison, Seller, and Meridian Trust Company, as Owner Trustee under a Trust Agreement dated as of September 30, 1987 with the Owner Participant named therein, Buyer (Exhibit 28(f), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(18) -- Form of Bill of Sale, Instrument of Transfer and Severance Agreement dated as of September 30, 1987 between Cleveland Electric, Seller, and Meridian Trust Company, as Owner Trustee under a Trust Agreement dated as of September 30, 1987 with the Owner Participant named therein, Buyer (Exhibit 28(g), File No. 33-20128, filed by Cleveland Electric and Toledo Edison). 10d(19) -- Forms of Refinancing Agreement, including exhibits thereto, among the Owner Participant named therein, as Owner Participant, CTC Beaver Valley Funding Corporation, as Funding Corporation, Beaver Valley II Funding Corporation, as New Funding Corporation, The Bank of New York, as Indenture Trustee, The Bank of New York, as New Collateral Trust Trustee, and The Cleveland Electric Illuminating Company and The Toledo Edison Company, as Lessees (Exhibit (28)(e)(i), File No. 33-46665, filed by Cleveland Electric and Toledo Edison). 10d(20)(a) -- Form of Amendment No. 2 to Facility Lease among Citicorp Lescaman, Inc., Cleveland Electric and Toledo Edison (Exhibit 10(a), Form S-4 File No. 333-47651, filed by Cleveland Electric). 10d(20)(b) -- Form of Amendment No. 3 to Facility Lease among Citicorp Lescaman, Inc., Cleveland Electric and Toledo Edison (Exhibit 10(b), Form S-4 File No. 333-47651, filed by Cleveland Electric). 10d(21)(a) -- Form of Amendment No. 2 to Facility Lease among US West Financial Services, Inc., Cleveland Electric and Toledo Edison (Exhibit 10(c), Form S-4 File No. 333-47651, filed by Cleveland Electric). 10d(21)(b) -- Form of Amendment No. 3 to Facility Lease among US West Financial Services, Inc., Cleveland Electric and Toledo Edison (Exhibit 10(d), Form S-4 File No. 333-47651, filed by Cleveland Electric). 46 Exhibit Number - ------ 10d(22) -- Form of Amendment No. 2 to Facility Lease among Midwest Power Company, Cleveland Electric and Toledo Edison (Exhibit 10(e), Form S-4 File No. 333-47651, filed by Cleveland Electric). 10e(1) -- Centerior Energy Corporation Equity Compensation Plan (Exhibit 99, Form S-8, File No. 33-59635). 3. Exhibits - Cleveland Electric Illuminating (CEI) 3a -- Amended Articles of Incorporation of CEI, as amended, effective May 28, 1993 (Exhibit 3a, 1993 Form 10-K, File No. 1-2323). 3b -- Regulations of CEI, dated April 29, 1981, as amended effective October 1, 1988 and April 24, 1990 (Exhibit 3b, 1990 Form 10-K, File No. 1-2323). 3c -- Amended and Restated Code of Regulations, dated March 15, 2002. (B)4b(1) -- Mortgage and Deed of Trust between CEI and Guaranty Trust Company of New York (now The Chase Manhattan Bank (National Association)), as Trustee, dated July 1, 1940 (Exhibit 7(a), File No. 2-4450). Supplemental Indentures between CEI and the Trustee, supplemental to Exhibit 4b(1), dated as follows: 4b(2) -- July 1, 1940 (Exhibit 7(b), File No. 2-4450). 4b(3) -- August 18, 1944 (Exhibit 4(c), File No. 2-9887). 4b(4) -- December 1, 1947 (Exhibit 7(d), File No. 2-7306). 4b(5) -- September 1, 1950 (Exhibit 7(c), File No. 2-8587). 4b(6) -- June 1, 1951 (Exhibit 7(f), File No. 2-8994). 4b(7) -- May 1, 1954 (Exhibit 4(d), File No. 2-10830). 4b(8) -- March 1, 1958 (Exhibit 2(a)(4), File No. 2-13839). 4b(9) -- April 1, 1959 (Exhibit 2(a)(4), File No. 2-14753). 4b(10) -- December 20, 1967 (Exhibit 2(a)(4), File No. 2-30759). 4b(11) -- January 15, 1969 (Exhibit 2(a)(5), File No. 2-30759). 4b(12) -- November 1, 1969 (Exhibit 2(a)(4), File No. 2-35008). 4b(13) -- June 1, 1970 (Exhibit 2(a)(4), File No. 2-37235). 4b(14) -- November 15, 1970 (Exhibit 2(a)(4), File No. 2-38460). 4b(15) -- May 1, 1974 (Exhibit 2(a)(4), File No. 2-50537). 4b(16) -- April 15, 1975 (Exhibit 2(a)(4), File No. 2-52995). 4b(17) -- April 16, 1975 (Exhibit 2(a)(4), File No. 2-53309). 4b(18) -- May 28, 1975 (Exhibit 2(c), June 5, 1975 Form 8-A, File No. 1-2323). 4b(19) -- February 1, 1976 (Exhibit 3(d)(6), 1975 Form 10 K, File No. 1-2323). 4b(20) -- November 23, 1976 (Exhibit 2(a)(4), File No. 2-57375). 4b(21) -- July 26, 1977 (Exhibit 2(a)(4), File No. 2-59401). 4b(22) -- September 7, 1977 (Exhibit 2(a)(5), File No. 2-67221). 4b(23) -- May 1, 1978 (Exhibit 2(b), June 30, 1978 Form 10-Q, File No. 1-2323). 4b(24) -- September 1, 1979 (Exhibit 2(a), September 30, 1979 Form 10-Q, File No. 1-2323). 4b(25) -- April 1, 1980 (Exhibit 4(a)(2), September 30, 1980 Form 10-Q, File No. 1-2323). 4b(26) -- April 15, 1980 (Exhibit 4(b), September 30, 1980 Form 10-Q, File No. 1-2323). 4b(27) -- May 28, 1980 (Exhibit 2(a)(4), Amendment No. 1, File No. 2-67221). 4b(28) -- June 9, 1980 (Exhibit 4(d), September 30, 1980 Form 10-Q, File No. 1-2323). 4b(29) -- December 1, 1980 (Exhibit 4(b)(29), 1980 Form 10-K, File No. 1-2323). 4b(30) -- July 28, 1981 (Exhibit 4(a), September 30, 1981, Form 10-Q, File No. 1-2323). 4b(31) -- August 1, 1981 (Exhibit 4(b), September 30, 1981, Form 10-Q, File No. 1-2323). 4b(32) -- March 1, 1982 (Exhibit 4(b)(3), Amendment No. 1, File No. 2-76029). 4b(33) -- July 15, 1982 (Exhibit 4(a), September 30, 1982 Form 10-Q, File No. 1-2323). 4b(34) -- September 1, 1982 (Exhibit 4(a)(1), September 30, 1982 orm 10-Q, File No. 1-2323). 4b(35) -- November 1, 1982 (Exhibit (a)(2), September 30, 1982 Form 10-Q, File No. 1-2323). 4b(36) -- November 15, 1982 (Exhibit 4(b)(36), 1982 Form 10-K, File No. 1-2323). 47 Exhibit Number - ------ 4b(37) -- May 24, 1983 (Exhibit 4(a), June 30, 1983 Form 10-Q, File No. 1-2323). 4b(38) -- May 1, 1984 (Exhibit 4, June 30, 1984 Form 10-Q, File No. 1-2323). 4b(39) -- May 23, 1984 (Exhibit 4, May 22, 1984 Form 8-K, File No. 1-2323). 4b(40) -- June 27, 1984 (Exhibit 4, June 11, 1984 Form 8-K, File No. 1-2323). 4b(41) -- September 4, 1984 (Exhibit 4b(41), 1984 Form 10-K, File No. 1-2323). 4b(42) -- November 14, 1984 (Exhibit 4b(42), 1984 Form 10 K, File No. 1-2323). 4b(43) -- November 15, 1984 (Exhibit 4b(43), 1984 Form 10-K, File No. 1-2323). 4b(44) -- April 15, 1985 (Exhibit 4(a), May 8, 1985 Form 8-K, File No. 1-2323). 4b(45) -- May 28, 1985 (Exhibit 4(b), May 8, 1985 Form 8-K, File No. 1-2323). 4b(46) ---August 1, 1985 (Exhibit 4, September 30, 1985 Form 10-Q, File No. 1-2323). File No. 1-2323). 4b(48) -- November 1, 1985 (Exhibit 4, January 31, 1986 Form 8-K, File No. 1-2323). 4b(49) -- April 15, 1986 (Exhibit 4, March 31, 1986 Form 10-Q, ile No. 1-2323). 4b(50) -- May 14, 1986 (Exhibit 4(a), June 30, 1986 Form 10-Q, File No. 1-2323). 4b(51) -- May 15, 1986 (Exhibit 4(b), June 30, 1986 Form 10-Q, File No. 1-2323). 4b(52) -- February 25, 1987 (Exhibit 4b(52), 1986 Form 10-K, File No. 1-2323). 4b(53) -- October 15, 1987 (Exhibit 4, September 30, 1987 Form 10-Q, File No. 1-2323). 4b(54) -- February 24, 1988 (Exhibit 4b(54), 1987 Form 10-K, File No. 1-2323). 4b(55) -- September 15, 1988 (Exhibit 4b(55), 1988 Form 10-K, File No. 1-2323). 4b(56) -- May 15, 1989 (Exhibit 4(a)(2)(i), File No. 33-32724). 4b(57) -- June 13, 1989 (Exhibit 4(a)(2)(ii), File No. 33-32724). 4b(58) -- October 15, 1989 (Exhibit 4(a)(2)(iii), File No. 33-32724). 4b(59) -- January 1, 1990 (Exhibit 4b(59), 1989 Form 10-K, File No. 1-2323). 4b(60) -- June 1, 1990 (Exhibit 4(a). September 30, 1990 Form 10-Q, File No. 1-2323). 4b(61) -- August 1, 1990 (Exhibit 4(b), September 30, 1990 Form 10-Q, File No. 1-2323). 4b(62) -- May 1, 1991 (Exhibit 4(a), June 30, 1991 Form 10-Q, File No. 1-2323). 4b(63) -- May 1, 1992 (Exhibit 4(a)(3), File No. 33-48845). 4b(64) -- July 31, 1992 (Exhibit 4(a)(3), File No. 33-57292). 4b(65) -- January 1, 1993 (Exhibit 4b(65), 1992 Form 10-K, File No. 1-2323). 4b(66) -- February 1, 1993 (Exhibit 4b(66), 1992 Form 10-K, File No. 1-2323). 4b(67) -- May 20, 1993 (Exhibit 4(a), July 14, 1993 Form 8-K, File No. 1-2323). 4b(68) -- June 1, 1993 (Exhibit 4(b), July 14, 1993 Form 8-K, File No. 1-2323). 4b(69) -- September 15, 1994 (Exhibit 4(a), September 30, 1994 Form 10-Q, File No. 1-2323). 4b(70) -- May 1, 1995 (Exhibit 4(a), September 30, 1995 Form 10-Q, File No. 1-2323). 4b(71) -- May 2, 1995 (Exhibit 4(b), September 30, 1995 Form 10-Q, File No. 1-2323). 4b(72) -- June 1, 1995 (Exhibit 4(c), September 30, 1995 Form 10-Q, File No. 1-2323). 4b(73) -- July 15, 1995 (Exhibit 4b(73), 1995 Form 10-K, File No. 1-232). 4b(74) -- August 1, 1995 (Exhibit 4b(74), 1995 Form 10-K, File No. 1-2323). 4b(75) -- June 15, 1997 (Exhibit 4(a), Form S-4 File No. 333-35931, filed by Cleveland Electric and Toledo Edison). 4b(76) -- October 15, 1997 (Exhibit 4(a), Form S-4 File No. 333-47651, filed by Cleveland Electric). 4b(77) -- June 1, 1998 (Exhibit 4b(77), Form S-4 File No. 333-72891). 4b(78) -- October 1, 1998 (Exhibit 4b(78), Form S-4 File No. 333-72891). 4b(79) -- October 1, 1998 (Exhibit 4b(79), Form S-4 File No. 333-72891). 4b(80) -- February 24, 1999 (Exhibit 4b(80), Form S-4 File No. 333-72891). 4b(81) -- September 29, 1999. (Exhibit 4b(81), 1999 Form 10-K, File No. 1-2323). 4b(82) -- January 15, 2000. (Exhibit 4b(82), 1999 Form 10-K, File No. 1-2323). 4b(83) -- May 15, 2002 (Exhibit 4b(83), 2002 Form 10-K, Fil File No. 1-2323). 4d -- Form of Note Indenture between Cleveland Electric and The Chase Manhattan Bank, as Trustee dated as of October 24, 1997 (Exhibit 4(b), Form S-4 File No. 333-47651, filed by Cleveland Electric). 4d(1) -- Form of Supplemental Note Indenture between Cleveland Electric and The Chase Manhattan Bank, as Trustee dated as of October 24, 1997 (Exhibit 4(c), Form S-4 File No. 333-47651, filed by Cleveland Electric). (A) 4-1 -- Indenture dated as of December 1, 2003 between CEI and JPMorgan Chase Bank, as Trustee. 48 Exhibit Number - ------ 10-1 -- Administration Agreement between the CAPCO Group dated as of September 14, 1967. (Registration No. 2-43102, Exhibit 5(c)(2).) 10-2 -- Amendment No. 1 dated January 4, 1974 to Administration Agreement between the CAPCO Group dated as of September 14, 1967. (Registration No. 2-68906, Exhibit 5(c)(3).) 10-3 -- Transmission Facilities Agreement between the CAPCO Group dated as of September 14, 1967. (Registration No. 2-43102, Exhibit 5(c)(3).) 10-4 -- Amendment No. 1 dated as of January 1, 1993 to Transmission Facilities Agreement between the CAPCO Group dated as of September 14, 1967. (1993 Form 10-K, Exhibit 10-4.) 10-5 -- Agreement for the Termination or Construction of Certain Agreements effective September 1, 1980, October 15, 1997 (Exhibit 4(a), Form S-4 File No. 333-47651, filed by Cleveland Electric). (A)12.3 -- Consolidated fixed charge ratios. (A)13.2 -- CEI 2003 Annual Report to Stockholders. (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with the SEC.) (A)21.2 -- List of Subsidiaries of the Registrant at December 31, 2003. (A) Provided herein in electronic format as an exhibit. (B) -- Pursuant to paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, CEI has not filed as an exhibit to this Form 10-K any instrument with respect to long-term debt if the total amount of securities authorized thereunder does not exceed 10% of the total assets of CEI, but hereby agrees to furnish to the Commission on request any such instruments. 3. Exhibits - Toledo Edison (TE) Exhibit Number 3a -- Amended Articles of Incorporation of TE, as amended effective October 2, 1992 (Exhibit 3a, 1992 Form 10-K, File No. 1-3583). 3b -- Amended and Restated Code of Regulations, dated March 15, 2002. (2001 Form 10-K, Exhibit 3b) (B)4b(1) b-- Indenture, dated as of April 1, 1947, between TE and The Chase National Bank of the City of New York (now The Chase Manhattan Bank (National Association)) (Exhibit 2(b), File No. 2-26908). 4b(2) -- September 1, 1948 (Exhibit 2(d), File No. 2-26908). 4b(3) -- April 1, 1949 (Exhibit 2(e), File No. 2-26908). 4b(4) -- December 1, 1950 (Exhibit 2(f), File No. 2-26908). 4b(5) -- March 1, 1954 (Exhibit 2(g), File No. 2-26908). 4b(6) -- February 1, 1956 (Exhibit 2(h), File No. 2-26908). 4b(7) -- May 1, 1958 (Exhibit 5(g), File No. 2-59794). 4b(8) -- August 1, 1967 (Exhibit 2(c), File No. 2-26908). 4b(9) -- November 1, 1970 (Exhibit 2(c), File No. 2-38569). 4b(10) -- August 1, 1972 (Exhibit 2(c), File No. 2-44873). 4b(11) -- November 1, 1973 (Exhibit 2(c), File No. 2-49428). 4b(12) -- July 1, 1974 (Exhibit 2(c), File No. 2-51429). 4b(13) -- October 1, 1975 (Exhibit 2(c), File No. 2-54627). 4b(14) -- June 1, 1976 (Exhibit 2(c), File No. 2-56396). 4b(15) -- October 1, 1978 (Exhibit 2(c), File No. 2-62568). 4b(16) -- September 1, 1979 (Exhibit 2(c), File No. 2-65350). 4b(17) -- September 1, 1980 (Exhibit 4(s), File No. 2-69190). 4b(18) -- October 1, 1980 (Exhibit 4(c), File No. 2-69190). 4b(19) -- April 1, 1981 (Exhibit 4(c), File No. 2-71580). 49 Exhibit Number - ------ 4b(20) -- November 1, 1981 (Exhibit 4(c), File No. 2-74485). 4b(21) -- June 1, 1982 (Exhibit 4(c), File No. 2-77763). 4b(22) -- September 1, 1982 (Exhibit 4(x), File No. 2-87323). 4b(23) -- April 1, 1983 (Exhibit 4(c), March 31, 1983, Form 10-Q, File No. 1-3583). 4b(24) -- December 1, 1983 (Exhibit 4(x), 1983 Form 10-K, File No. 1-3583). 4b(25) -- April 1, 1984 (Exhibit 4(c), File No. 2-90059). 4b(26) -- October 15, 1984 (Exhibit 4(z), 1984 Form 10-K, File No. 1-3583). 4b(27) -- October 15, 1984 (Exhibit 4(aa), 1984 Form 10-K, File No. 1-3583). 4b(28) -- August 1, 1985 (Exhibit 4(dd), File No. 33-1689). 4b(29) -- August 1, 1985 (Exhibit 4(ee), File No. 33-1689). 4b(30) -- December 1, 1985 (Exhibit 4(c), File No. 33-1689). 4b(31) -- March 1, 1986 (Exhibit 4b(31), 1986 Form 10-K, File No. 1-3583). 4b(32) -- October 15, 1987 (Exhibit 4, September 30, 1987 Form 10-Q, File No. 1-3583). 4b(33) -- September 15, 1988 (Exhibit 4b(33), 1988 Form 10-K, File No. 1-3583). 4b(34) -- June 15, 1989 (Exhibit 4b(34), 1989 Form 10-K, File No. 1-3583). 4b(35) -- October 15, 1989 (Exhibit 4b(35), 1989 Form 10-K, File No. 1-3583). 4b(36) -- May 15, 1990 (Exhibit 4, June 30, 1990 Form 10-Q, File No. 1-3583). 4b(37) -- March 1, 1991 (Exhibit 4(b), June 30, 1991 Form 10-Q, File No. 1-3583). 4b(38) -- May 1, 1992 (Exhibit 4(a)(3), File No. 33-48844). 4b(39) -- August 1, 1992 (Exhibit 4b(39), 1992 Form 10-K, File No. 1-3583). 4b(40) -- October 1, 1992 (Exhibit 4b(40), 1992 Form 10-K, File No. 1-3583). 4b(41) -- January 1, 1993 (Exhibit 4b(41), 1992 Form 10-K, File No. 1-3583). 4b(42) -- September 15, 1994 (Exhibit 4(b), September 30, 1994 Form 10-Q, File No. 1-3583). No. 1-3583). 4b(44) -- June 1, 1995 (Exhibit 4(e), September 30, 1995 Form 10-Q, File No. 1-3583). 4b(45) -- July 14, 1995 (Exhibit 4(f), September 30, 1995 Form 10-Q, File No. 1-3583). 4b(46) -- July 15, 1995 (Exhibit 4(g), September 30, 1995 Form 10-Q, File No. 1-3583). 4b(47) -- August 1, 1997 (Exhibit 4b(47), 1998 Form 10-K, Fil No. 1-3583). 4b(48) -- June 1, 1998 (Exhibit 4b (48), 1998 Form 10-K, File No. 1-3583). 4b(49) -- January 15, 2000 (Exhibit 4b(49), 1999 Form 10-K, File No 1-3583). 4b(50) -- May 1, 2000 (Exhibit 4b(50), 2000 Form 10-K, File No. 1-3583). 4b(51) -- September 1, 2000 (Exhibit 4b(51), 2002 Form 10-K, File No. 1-3583). 4b(52) -- October 1, 2002 (Exhibit 4b(52), 2002 Form 10-K, File No. 1-3583). (A) 4b(53) -- April 1, 2003 (Exhibit 4b(53). (A) 12.4 -- Consolidated fixed charge ratios. (A) 13.3 -- TE 2003 Annual Report to Stockholders. (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with the SEC.) (A) 21.3 -- List of Subsidiaries of the Registrant at December 31, 2003. (A) Provided herein in electronic format as an exhibit. (B) -- Pursuant to paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, TE has not filed as an exhibit to this Form 10-K any instrument with respect to long-term debt if the total amount of securities authorized thereunder does not exceed 10% of the total assets of TE, but hereby agrees to furnish to the Commission on request any such instruments. 3. Exhibits - Combined Exhibits for JCP&L, Met-Ed and Penelec Exhibit Number 3-A -- Restated Certificate of Incorporation of JCP&L, as amended - Incorporated by reference to Exhibit 3-A, 1990 Annual Report on Form 10-K, SEC File No. 1-3141. 3-A-1 -- Certificate of Amendment to Restated Certificate of Incorporation of JCP&L, dated June 19, 1992 - Incorporated by reference to Exhibit A-2(a), Certificate Pursuant to Rule 24, SEC File No. 70-7949. 50 Exhibit Number - ------ 3-A-2 -- Certificate of Amendment to Restated Certificate of Incorporation of JCP&L, dated June 19, 1992 - Incorporated by reference to Exhibit A-2(a)(i), Certificate Pursuant to Rule 24, SEC File No. 70-7949. 3-B -- By-Laws of JCP&L, as amended May 25, 1993 - Incorporated by reference to Exhibit 3-B, 1993 Annual Report on Form 10-K, SEC File No. 1-3141. 3-C -- Restated Articles of Incorporation of Met-Ed, dated March 8, 1999 - Incorporated by reference to Exhibit 3-E, 1999 Annual Report on Form 10-K, SEC File No. 1-446. 3-D -- By-Laws of Met-Ed as amended May 16, 2000. 3-E -- Restated Articles of Incorporation of Penelec, dated March 8, 1999 - Incorporated by reference to Exhibit 3-G, 1999 Annual Report on Form 10-K, SEC File No. 1-3522. 3-F -- By-Laws of Penelec as amended May 16, 2000. 4-A -- Indenture of JCP&L, dated March 1, 1946, between JCP&L and United States Trust Company of New York, Successor Trustee, as amended and supplemented by eight supplemental indentures dated December 1, 1948 through June 1, 1960 - Incorporated by reference to JCP&L's Instruments of Indebtedness Nos. 1 to 7, inclusive, and 9 and 10 filed as part of Amendment No. 1 to 1959 Annual Report of GPU on Form U5S, SEC File Nos. 30-126 and 1-3292. 4-A-1 -- Ninth Supplemental Indenture of JCP&L, dated November 1, 1962 - Incorporated by reference to Exhibit 2-C, Registration No. 2-20732. 4-A-2 -- Tenth Supplemental Indenture of JCP&L, dated October 1, 1963 - Incorporated by reference to Exhibit 2-C, Registration No. 2-21645. 4-A-3 -- Eleventh Supplemental Indenture of JCP&L, dated October 1, 1964 - Incorporated by reference to Exhibit 5-A-3, Registration No. 2-59785. 4-A-4 -- Twelfth Supplemental Indenture of JCP&L, dated November 1, 1965 - Incorporated by reference to Exhibit 5-A-4, Registration No. 2-59785. 4-A-5 -- Thirteenth Supplemental Indenture of JCP&L, dated August 1, 1966 - Incorporated by reference to Exhibit 4-C, Registration No. 2-25124. 4-A-6 -- Fourteenth Supplemental Indenture of JCP&L, dated September 1, 1967 - Incorporated by reference to Exhibit 5-A-6, Registration No. 2-59785. 4-A-7 -- Fifteenth Supplemental Indenture of JCP&L, dated October 1, 1968 - Incorporated by reference to Exhibit 5-A-7, Registration No. 2-59785. 4-A-8 -- Sixteenth Supplemental Indenture of JCP&L, dated October 1, 1969 - Incorporated by reference to Exhibit 5-A-8, Registration No. 2-59785. 4-A-9 -- Seventeenth Supplemental Indenture of JCP&L, dated June 1, 1970 - Incorporated by reference to Exhibit 5-A-9, Registration No. 2-59785. 4-A-10 -- Eighteenth Supplemental Indenture of JCP&L, dated December 1, 1970 - Incorporated by reference to Exhibit 5-A-10, Registration No. 2-59785. 4-A-11 -- Nineteenth Supplemental Indenture of JCP&L, dated February 1, 1971 - Incorporated by reference to Exhibit 5-A-11, Registration No. 2-59785. 4-A-12 -- Twentieth Supplemental Indenture of JCP&L, dated November 1, 1971 - Incorporated by reference to Exhibit 5-A-12, Registration No. 2-59875. 4-A-13 -- Twenty-first Supplemental Indenture of JCP&L, dated August 1, 1972 - Incorporated by reference to Exhibit 5-A-13, Registration No. 2-59785. 51 Exhibit Number - ------ 4-A-14 -- Twenty-second Supplemental Indenture of JCP&L, dated August 1, 1973 - Incorporated by reference to Exhibit 5-A-14, Registration No. 2-59785. 4-A-15 -- Twenty-third Supplemental Indenture of JCP&L, dated October 1, 1973 - Incorporated by reference to Exhibit A-15, Registration No. 2-59785. 4-A-16 -- Twenty-fourth Supplemental Indenture of JCP&L, dated December 1, 1973 - Incorporated by reference to Exhibit 5-A-16, Registration No. 2-59785. 4-A-17 -- Twenty-fifth Supplemental Indenture of JCP&L, dated November 1, 1974 - Incorporated by reference to Exhibit 5-A-17, Registration No. 2-59785. 4-A-18 -- Twenty-sixth Supplemental Indenture of JCP&L, dated March 1, 1975 - Incorporated by reference to Exhibit 5-A-18, Registration No. 2-59785. 4-A-19 -- Twenty-seventh Supplementa Indenture of JCP&L, dated July 1, 1975 - Incorporated by reference to Exhibit 5-A-19, Registration No. 2-59785. 4-A-20 -- Twenty-eighth Supplemental Indenture of JCP&L, dated October 1, 1975 - Incorporated by reference to Exhibit 5-A-20, Registration No. 2-59785. 4-A-21 -- Twenty-ninth Supplemental Indenture of JCP&L, dated February 1, 1976 - Incorporated by reference to Exhibit 5-A-21, Registration No. 2-59785. 4-A-22 -- Supplemental Indenture No. 29A of JCP&L, dated May 31, 1976 - Incorporated by reference to Exhibit 5-A-22, Registration No. 2-59785. 4-A-23 -- Thirtieth Supplemental Indenture of JCP&L, dated June 1, 1976 - Incorporated by reference to Exhibit 5-A-23, Registration No. 2-59785. 4-A-24 -- Thirty-first Supplemental Indenture of JCP&L, dated May 1, 1977 - Incorporated by reference to Exhibit 5-A-24, Registration No. 2-59785. 4-A-25 -- Thirty-second Supplemental Indenture of JCP&L, dated January 20, 1978 - Incorporated by reference to Exhibit 5-A-25, Registration No. 2-60438. 4-A-26 -- Thirty-third Supplemental Indenture of JCP&L, dated January 1, 1979 - Incorporated by reference to Exhibit A-20(b), Certificate Pursuant to Rule 24, SEC File No. 70-6242. 4-A-27 -- Thirty-fourth Supplemental Indenture of JCP&L, dated June 1, 1979 - Incorporated by reference to Exhibit A-28, Certificate Pursuant to Rule 24, SEC File No. 70-6290. 4-A-28 -- Thirty-sixth Supplemental Indenture of JCP&L, dated October 1, 1979 - Incorporated by reference to Exhibit A-30, Certificate Pursuant to Rule 24, SEC File No. 70-6354. 4-A-29 -- Thirty-seventh Supplemental Indenture of JCP&L, dated September 1, 1984 - Incorporated by reference to Exhibit A-1(cc), Certificate Pursuant to Rule 24, SEC File No. 70-7001. 4-A-30 -- Thirty-eighth Supplemental Indenture of JCP&L, dated July 1, 1985 - Incorporated by reference to Exhibit A-1(dd), Certificate Pursuant to Rule 24, SEC File No. 70-7109. 4-A-31 -- Thirty-ninth Supplemental Indenture of JCP&L, dated April 1, 1988 - Incorporated by reference to Exhibit A-1(a), Certificate Pursuant to Rule 24, SEC File No. 70-7263. 4-A-32 -- Fortieth Supplemental Indenture of JCP&L, dated June 14, 1988 - Incorporated by reference to Exhibit A-1(ff), Certificate Pursuant to Rule 24, SEC File No. 70-7603. 4-A-33 -- Forty-first Supplemental Indenture of JCP&L, dated April 1, 1989 - Incorporated by reference to Exhibit A-1(gg), Certificate Pursuant to Rule 24, SEC File No. 70-7603. 4-A-34 -- Forty-second Supplemental Indenture of JCP&L, dated July 1, 1989 - Incorporated by reference to Exhibit A-1(hh), Certificate Pursuant to Rule 24, SEC File No. 70-7603. 52 Exhibit Number - ------ 4-A-35 -- Forty-third Supplemental Indenture of JCP&L, dated March 1, 1991 - Incorporated by reference to Exhibit 4-A-35, Registration No. 33-45314. 4-A-36 -- Forty-fourth Supplemental Indenture of JCP&L, dated March 1, 1992 - Incorporated by reference to Exhibit 4-A-36, Registration No. 33-49405. 4-A-37 -- Forty-fifth Supplemental Indenture of JCP&L, dated October 1, 1992 - Incorporated by reference to Exhibit 4-A-37, Registration No. 33-49405. 4-A-38 -- Forty-sixth Supplemental Indenture of JCP&L, dated April 1, 1993 - Incorporated by reference to Exhibit C-15, 1992 Annual Report of GPU on Form U5S, SEC File No. 30-126. 4-A-39 -- Forty-seventh Supplemental Indenture of JCP&L, dated April 10, 1993 - Incorporated by reference to Exhibit C-16, 1992 Annual Report of GPU on Form U5S, SEC File No. 30-126. 4-A-40 -- Forty-eighth Supplemental Indenture of JCP&L, dated April 15, 1993 - Incorporated by reference to Exhibit C-17, 1992 Annual Report of GPU on Form U5S, SEC File No. 30-126. 4-A-41 -- Forty-ninth Supplemental Indenture of JCP&L, dated October 1, 1993 - Incorporated by reference to Exhibit C-18, 1993 Annual Report of GPU on Form U5S, SEC File No. 30-126. 4-A-42 -- Fiftieth Supplemental Indenture of JCP&L, dated August 1, 1994 - Incorporated by reference to Exhibit C-19, 1994 Annual Report of GPU on Form U5S, SEC File No. 30-126. 4-A-43 -- Fifty-first Supplemental Indenture of JCP&L, dated August 15, 1996 - Incorporated by reference to Exhibit 4-A-43, 1996 Annual Report on Form 10-K, SEC File No. 1-6047. 4-A-44 -- Fifty-second Supplemental Indenture of JCP&L, dated July 1, 1999 - Incorporated by reference to Exhibit 4-B-44, Registration No. 333-88783. 4-A-45 -- Fifty-third Supplemental Indenture of JCP&L, dated November 1, 1999 - Incorporated by reference to Exhibit 4-A-45, 1999 Annual Report on Form 10-K, SEC File No. 1-3141. 4-A-46 -- Subordinated Debenture Indenture of JCP&L, dated May 1, 1995 - Incorporated by reference to Exhibit A-8(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495. 4-A-47 -- Fifty-fourth Supplemental Indenture of JCP&L, dated November 7, 2001. 4-B -- Indenture of Met-Ed, dated November 1, 1944, between Met-Ed and United States Trust Company of New York, Successor Trustee, as amended and supplemented by fourteen supplemental indentures dated February 1, 1947 through May 1, 1960 - Incorporated by reference to Met-Ed's Instruments of Indebtedness Nos. 1 to 14 inclusive, and 16, filed as part of Amendment No. 1 to 1959 Annual Report of GPU on Form U5S, SEC File Nos. 30-126 and 1-3292. 4-B-1 -- Supplemental Indenture of Met-Ed, dated December 1, 1962 - Incorporated by reference to Exhibit 2-E(1), Registration No. 2-59678. 4-B-2 -- Supplemental Indenture of Met-Ed, dated March 20, 1964 - Incorporated by reference to Exhibit 2-E(2), Registration No. 2-59678. 4-B-3 -- Supplemental Indenture of Met-Ed, dated July 1, 1965 - Incorporated by reference to Exhibit 2-E(3), Registration No. 2-59678. 4-B-4 -- Supplemental Indenture of Met-Ed, dated June 1, 1966 - Incorporated by reference to Exhibit 2-B-4, Registration No. 2-24883. 4-B-5 -- Supplemental Indenture of Met-Ed, dated March 22, 1968 - Incorporated by reference to Exhibit 4-C-5, Registration No. 2-29644. 4-B-6 -- Supplemental Indenture of Met-Ed, dated September 1, 1968 - Incorporated by reference to Exhibit 2-E(6), Registration No. 2-59678. 53 Exhibit Number - ------ 4-B-7 -- Supplemental Indenture of Met-Ed, dated August 1, 1969 - Incorporated by reference to Exhibit 2-E(7), Registration No. 2-59678. 4-B-8 -- Supplemental Indenture of Met-Ed, dated November 1, 1971 - Incorporated by reference to Exhibit 2-E(8), Registration No. 2-59678. 4-B-9 -- Supplemental Indenture of Met-Ed, dated May 1, 1972 - Incorporated by reference to Exhibit 2-E(9), Registration No. 2-59678. 4-B-10 -- Supplemental Indenture of Met-Ed, dated December 1, 1973 - Incorporated by reference to Exhibit 2-E(10), Registration No. 2-59678. 4-B-11 -- Supplemental Indenture of Met-Ed, dated October 30, 1974 - Incorporated by reference to Exhibit 2-E(11), Registration No. 2-59678. 4-B-12 -- Supplemental Indenture of Met-Ed, dated October 31, 1974 - Incorporated by reference to Exhibit 2-E(12), Registration No. 2-59678. 4-B-13 -- Supplemental Indenture of Met-Ed, dated March 20, 1975 - Incorporated by reference to Exhibit 2-E(13), Registration No. 2-59678. 4-B-14 -- Supplemental Indenture of Met-Ed, dated September 25, 1975 - Incorporated by reference to Exhibit 2-E(15), Registration No. 2-59678. 4-B-15 -- Supplemental Indenture of Met-Ed, dated January 12, 1976 - Incorporated by reference to Exhibit 2-E(16), Registration No. 2-59678. 4-B-16 -- Supplemental Indenture of Met-Ed, dated March 1, 1976 - Incorporated by reference to Exhibit 2-E(17), Registration No. 2-59678. 4-B-17 -- Supplemental Indenture of Met-Ed, dated September 28, 1977 - Incorporated by reference to Exhibit 2-E(18), Registration No. 2-62212. 4-B-18 -- Supplemental Indenture of Met-Ed, dated January 1, 1978 - Incorporated by reference to Exhibit 2-E(19), Registration No. 2-62212. 4-B-19 -- Supplemental Indenture of Met-Ed, dated September 1, 1978 - Incorporated by reference to Exhibit 4-A(19), Registration No. 33-48937. 4-B-20 -- Supplemental Indenture of Met-Ed, dated June 1, 1979 - Incorporated by reference to Exhibit 4-A(20), Registration No. 33-48937. 4-B-21 -- Supplemental Indenture of Met-Ed, dated January 1, 1980 - Incorporated by reference to Exhibit 4-A(21), Registration No. 33-48937. 4-B-22 -- Supplemental Indenture of Met-Ed, dated September 1, 1981 - Incorporated by reference to Exhibit 4-A(22), Registration No. 33-48937. 4-B-23 -- Supplemental Indenture of Met-Ed, dated September 10, 1981 - Incorporated by reference to Exhibit 4-A(23), Registration No. 33-48937. 4-B-24 -- Supplemental Indenture of Met-Ed, dated December 1, 1982 - Incorporated by reference to Exhibit 4-A(24), Registration No. 33-48937. 4-B-25 -- Supplemental Indenture of Met-Ed, dated September 1, 1983 - Incorporated by reference to Exhibit 4-A(25), Registration No. 33-48937. 4-B-26 -- Supplemental Indenture of Met-Ed, dated September 1, 1984 - Incorporated by reference to Exhibit 4-A(26), Registration No. 33-48937. 4-B-27 -- Supplemental Indenture of Met-Ed, dated March 1, 1985 - Incorporated by reference to Exhibit 4-A(27), Registration No. 33-48937. 54 Exhibit Number - ------ 4-B-28 -- Supplemental Indenture of Met-Ed, dated September 1, 1985 - Incorporated by reference to Exhibit 4-A(28), Registration No. 33-48937. 4-B-29 -- Supplemental Indenture of Met-Ed, dated June 1, 1988 - Incorporated by reference to Exhibit 4-A(29), Registration No. 33-48937. 4-B-30 -- Supplemental Indenture of Met-Ed, dated April 1, 1990 - Incorporated by reference to Exhibit 4-A(30), Registration No. 33-48937. 4-B-31 -- Amendment dated May 22, 1990 to Supplemental Indenture of Met-Ed, dated April 1, 1990 - Incorporated by reference to Exhibit 4-A(31), Registration No. 33-48937. 4-B-32 -- Supplemental Indenture of Met-Ed, dated September 1, 1992 - Incorporated by reference to Exhibit 4-A(32)(a), Registration No. 33-48937. 4-B-33 -- Supplemental Indenture of Met-Ed, dated December 1, 1993 - Incorporated by reference to Exhibit C-58, 1993 Annual Report of GPU on Form U5S, SEC File No. 30-126. 4-B-34 -- Supplemental Indenture of Met-Ed, dated July 15, 1995 - Incorporated by reference to Exhibit 4-B-35, 1995 Annual Report on Form 10-K, SEC File No. 1-446. 4-B-35 -- Supplemental Indenture of Met-Ed, dated August 15, 1996 - Incorporated by reference to Exhibit 4-B-35, 1996 Annual Report on Form 10-K, SEC File No. 1-446. 4-B-36 -- Supplemental Indenture of Met-Ed, dated May 1, 1997 - Incorporated by reference to Exhibit 4-B-36, 1997 Annual Report on Form 10-K, SEC File No. 1-446. 4-B-37 -- Supplemental Indenture of Met-Ed, dated July 1, 1999 - Incorporated by reference to Exhibit 4-B-38, 1999 Annual Report on Form 10-K, SEC File No. 1-446. 4-B-38 -- Indenture between Met-Ed and United States Trust Company of New York, dated May 1, 1999 - Incorporated by reference to Exhibit A-11(a), Certificate Pursuant to Rule 24, SEC File No. 70-9329. 4-B-39 -- Senior Note Indenture between Met-Ed and United States Trust Company of New York, dated July 1, 1999 Incorporated by reference to Exhibit C-154 to GPU, Inc.'s Annual Report on Form U5S for the year 1999, SEC File No. 30-126. 4-B-40 -- First Supplemental Indenture between Met-Ed and United States Trust Company of New York, dated August 1, 2000 - Incorporated by reference to Exhibit 4-A, June 30, 2000 Quarterly Report on Form 10-Q, SEC File No. 1-446. 4-B-41 -- Supplemental Indenture of Met-Ed, dated May 1, 2001. (A) 4-B-42 -- Supplemental Indenture of Met-Ed, dated March 1,2003. 4-C -- Mortgage and Deed of Trust of Penelec, dated January 1, 1942, between Penelec and United States Trust Company of New York, Successor Trustee, and indentures supplemental thereto dated March 7, 1942 through May 1, 1960 - Incorporated by reference to Penelec's Instruments of Indebtedness Nos. 1-20, inclusive, filed as a part of Amendment No. 1 to 1959 Annual Report of GPU on Form U5S, SEC File Nos. 30-126 and 1-3292. 4-C-1 -- Supplemental Indentures to Mortgage and Deed of Trust of Penelec, dated May 1, 1961 through December 1, 1977 - Incorporated by reference to Exhibit 2-D(1) to 2-D(19), Registration No. 2-61502. 4-C-2 -- Supplemental Indenture of Penelec, dated June 1, 1978 - Incorporated by reference to Exhibit 4-A(2), Registration No. 33-49669. 4-C-3 -- Supplemental Indenture of Penelec, dated June 1, 1979 - Incorporated by reference to Exhibit 4-A(3), Registration No. 33-49669. 55 Exhibit Number - ------ 4-C-4 -- Supplemental Indenture of Penelec, dated September 1, 1984 - Incorporated by reference to Exhibit 4-A(4), Registration No. 33-49669. 4-C-5 -- Supplemental Indenture of Penelec, dated December 1, 1985 - Incorporated by reference to Exhibit 4-A(5), Registration No. 33-49669. 4-C-6 -- Supplemental Indenture of Penelec, dated December 1, 1986 - Incorporated by reference to Exhibit 4-A(6), Registration No. 33-49669. 4-C-7 -- Supplemental Indenture of Penelec, dated May 1, 1989 - Incorporated by reference to Exhibit 4-A(7), Registration No. 33-49669. 4-C-8 -- Supplemental Indenture of Penelec, dated December 1, 1990 - Incorporated by reference to Exhibit 4-A(8), Registration No. 33-45312. 4-C-9 -- Supplemental Indenture of Penelec, dated March 1, 1992 - Incorporated by reference to Exhibit 4-A(9), Registration No. 33-45312. 4-C-10 -- Supplemental Indenture of Penelec, dated June 1, 1993 - Incorporated by reference to Exhibit C-73, 1993 Annual Report of GPU on Form U5S, SEC File No. 30-126. 4-C-11 -- Supplemental Indenture of Penelec, dated November 1, 1995 - Incorporated by reference to Exhibit 4-C-11, 1995 Annual Report on Form 10-K, SEC File No.1-3522. 4-C-12 -- Supplemental Indenture of Penelec, dated August 15, 1996 - Incorporated by reference to Exhibit 4-C-12, 1996 Annual Report on Form 10-K, SEC File No. 1-3522. 4-C-13 -- Senior Note Indenture between Penelec and United States Trust Company of New York, dated April 1, 1999 - Incorporated by reference to Exhibit 4-C-13, 1999 Annual Report on Form 10-K, SEC File No. 1-3522. 4-C-14 -- Indenture between Penelec and United States Trust Company of New York, dated June 1, 1999 - Incorporated by reference to No. 70-9327. 4-C-15 -- First Supplemental Indenture between Penelec and United States Trust Company of New York, dated August 1, 2000 - Incorporated by reference to Exhibit 4-B, June 30, 2000 Quarterly Report on Form 10-Q, SEC File No. 1-3522. 4-C-16 -- Supplemental Indenture of Penelec, dated May 1, 2001. 4-C-17 -- Supplemental Indenture No. 1 of Penelec, dated May 1, 2001. 4-D -- Amended and Restated Limited Partnership Agreement of JCP&L Capital, L.P., dated May 11, 1995 - Incorporated by reference to Exhibit A-5(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495. 4-E -- Action Creating Series A Preferred Securities of JCP&L Capital, L.P., dated May 11, 1995 - Incorporated by reference to Exhibit A-6(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495. 4-F -- Payment and Guarantee Agreement of JCP&L, dated May 18, 1995 - Incorporated by reference to Exhibit B-1(a), Certificate Pursuant to Rule 24, SEC File No. 70-8495. 4-G -- Payment and Guarantee Agreement of Met-Ed, dated May 28, 1999 - Incorporated by reference to Exhibit B-1(a), Certificate Pursuant to Rule 24, SEC No. 70-9329. 4-H -- Amendment No. 1 to Payment and Guarantee Agreement of Met-Ed, dated November 23, 1999 - Incorporated by reference to Exhibit 4-H, 1999 Annual Report on Form 10-K, SEC File No. 1-446. 4-I -- Payment and Guarantee Agreement of Penelec, dated June 16, 1999 - Incorporated by reference to Exhibit B-1(a), Certificate Pursuant to Rule 24, SEC File No. 70-9327. 56 Exhibit Number - ------ 4-J -- Amendment No. 1 to Payment and Guarantee Agreement of Penelec, dated November 23, 1999 - Incorporated by reference to Exhibit 4-J, 1999 Annual Report on Form 10-K, SEC File No. 1-3522. * 10-A -- Deferred Remuneration Plan for Outside Directors of Jersey Central Power & Light Company, as amended and restated effective August 8, 2000. (2000 Form 10-K, Exhibit 10-H, File No. 1-3141, Jersey Central Power & Light Company.) 10-B -- Form of Amendment, effective November 7, 2001, to Deferred Remuneration Plan for Outside Directors of Jersey Central Power and Light Company. (A) 12.6 -- Consolidated fixed charge ratios - JCP&L. (A) 12.7 -- Consolidated fixed charge ratios - Met-Ed. (A) 12.8 -- Consolidated fixed charge ratios - Penelec. (A) 13.5 -- JCP&L 2003 Annual Report to Stockholders (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with SEC.) (A) 13.6 -- Met-Ed 2003 Annual Report to Stockholders (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with SEC.) (A) 13.7 -- Penelec 2003 Annual Report to Stockholders (Only those portions expressly incorporated by reference in this Form 10-K are to be deemed "filed" with SEC.) (A) 21.4 -- List of Subsidiaries of JCP&L at December 31, 2003. (A) 21.5 -- List of Subsidiaries of Met-Ed at December 31, 2003. (A) 21.6 -- List of Subsidiaries of Penelec at December 31, 2003. (A) 23.3 - Consent of Independent Accountants - Penelec. (A) 31.2 - Certification of chief financial officer, as adopted pursuan t to Rule 13a-15(e)/15d-15(e). (A) 31.3 - Certification of chief executive officer, as adopted pursuant to Rule 13a-15(e)/15d-15(e). (A) 32.2 - Certification of chief executive officer and chief financial officer, pursuant to 18 U.S.C. Section 1350. (A) Provided here in electronic format as an exhibit. (b) Reports on Form 8-K FirstEnergy- FirstEnergy filed the following eight reports on Form 8-K since September 30, 2003: A report dated November 13, 2003 reported the announcement of a settlement agreement of FirstEnergy's claim against NRG Energy for the cancellation of a generating plants sale. A report dated November 21, 2003 reported FirstEnergy received a subpoena for Davis-Besse related matters. A report dated December 22, 2003 reported FirstEnergy Chief Executive Officer H. Peter Burg on extended medical leave. A report dated December 23, 2003 reported Standard and Poor's lowers credit ratings for FirstEnergy and subsidiaries. A report dated January 13, 2004 reported FirstEnergy Chief Executive Officer H. Peter Burg passed away. A report dated January 20, 2004 reported Anthony J. Alexander elected as FirstEnergy Chief Executive Officer and George M. Smart elected as FirstEnergy Chairman of the Board of Directors. A report dated February 9, 2004 reported Moody's lowered debt ratings for FirstEnergy and subsidiaries. A report dated March 8, 2004 reported that FirstEnergy began Davis-Besse restart with NRC authorization. 57 OE OE filed the following five reports on Form 8-K since September 30, 2003: A report dated December 22, 2003 reported FirstEnergy Chief Executive Officer H. Peter Burg on extended medical leave. A report dated December 23, 2003 reported Standard and Poor's lowers credit ratings for FirstEnergy and subsidiaries. A report dated January 13, 2004 reported FirstEnergy Chief Executive Officer H. Peter Burg passed away. A report dated January 20, 2004 reported Anthony J. Alexander elected as FirstEnergy Chief Executive Officer and George M. Smart elected as FirstEnergy Chairman of the Board of Directors. A report dated February 9, 2004 reported Moody's lowered debt ratings for FirstEnergy and subsidiaries. CEI and TE CEI and TE each filed the following nine reports on Form 8-K since September 30, 2003: A report dated October 21, 2003 reported the filing of a proposed rate stabilization plan with the PUCO. A report dated November 13, 2003 reported the announcement of a settlement agreement of FirstEnergy's claim against NRG Energy for the cancellation of a generating plants sale. A report dated November 21, 2003 reported FirstEnergy received a subpoena for Davis-Besse related matters. A report dated December 22, 2003 reported FirstEnergy Chief Executive Officer H. Peter Burg on extended medical leave. A report dated December 23, 2003 reported Standard and Poor's lowers credit ratings for FirstEnergy and subsidiaries. A report dated January 13, 2004 reported FirstEnergy Chief Executive Officer H. Peter Burg passed away. A report dated January 20, 2004 reported Anthony J. Alexander elected as FirstEnergy Chief Executive Officer and George M. Smart elected as FirstEnergy Chairman of the Board of Directors. A report dated February 9, 2004 reported Moody's lowered debt ratings for FirstEnergy and subsidiaries. A report dated March 8, 2004 reported that FirstEnergy began Davis-Besse restart with NRC authorization. Penn, JCP&L, Met-Ed and Penelec Penn, JCP&L, Met-Ed and Penelec filed the following five reports on Form 8-K since September 30, 2003: A report dated December 22, 2003 reported Chief Executive Officer H. Peter Burg on extended medical leave. A report dated December 23, 2003 reported Standard and Poor's lowers credit ratings for FirstEnergy and subsidiaries. A report dated January 13, 2004 reported FirstEnergy Chief Executive Officer H. Peter Burg passed away. A report dated January 20, 2004 reported Anthony J. Alexander elected as FirstEnergy Chief Executive Officer and George M. Smart elected as FirstEnergy Chairman of the Board of Directors. A report dated February 9, 2004 reported Moody's lowered debt ratings for FirstEnergy and subsidiaries. 58 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of FirstEnergy Corp.: Our audits of the consolidated financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of FirstEnergy Corp. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules for the years ended December 31, 2003 and 2002 listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The financial statement schedule of FirstEnergy Corp. for the year ended December 31, 2001 was audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on the financial statement schedule in their report dated March 18, 2002. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 59 The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of FirstEnergy Corp.: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements included in FirstEnergy Corp.'s Annual Report to Stockholders incorporated by reference in this Form 10-K and have issued our report thereon dated March 18, 2002. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule of consolidated valuation and qualifying accounts listed in Item 14 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 60 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of Ohio Edison Company: Our audits of the consolidated financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of Ohio Edison Company (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules for the years ended December 31, 2003 and 2002 listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The financial statement schedule of Ohio Edison Company for the year ended December 31, 2001 was audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on the financial statement schedule in their report dated March 18, 2002. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 61 The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Ohio Edison Company: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements included in Ohio Edison Company's Annual Report to Stockholders incorporated by reference in this Form 10-K and have issued our report thereon dated March 18, 2002. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule of consolidated valuation and qualifying accounts listed in Item 14 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 62 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of The Cleveland Electric Illuminating Company: Our audits of the consolidated financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of The Cleveland Electric Illuminating Company (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 63 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of The Toledo Edison Company: Our audits of the consolidated financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of The Toledo Edison Company (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 64 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of Pennsylvania Power Company: Our audits of the financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of Pennsylvania Power Company (which report and financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules for the years ended December 31, 2003 and 2002 listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. The financial statement schedule of Pennsylvania Power Company for the year ended December 31, 2001 was audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on the financial statement schedule in their report dated March 18, 2002. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 65 The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Pennsylvania Power Company: We have audited, in accordance with auditing standards generally accepted in the United States, the financial statements included in Pennsylvania Power Company's Annual Report to Stockholders incorporated by reference in this Form 10-K and have issued our report thereon dated March 18, 2002. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule of valuation and qualifying accounts listed in Item 14 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 66 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of Jersey Central Power & Light Company: Our audits of the consolidated financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of Jersey Central Power & Light Company (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules for the years ended December 31, 2003 and 2002 listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The financial statement schedule of Jersey Central Power & Light Company for the year ended December 31, 2001 was audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on the financial statement schedule in their report dated March 18, 2002. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 67 The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Jersey Central Power & Light Company: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements as of December 31, 2001 and for the periods from January 1, 2001 to November 6, 2001 and from November 7, 2001 to December 31, 2001, included in Jersey Central Power & Light Company's Annual Report to Stockholders incorporated by reference in this Form 10-K and have issued our report thereon dated March 18, 2002. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule of consolidated valuation and qualifying accounts listed in Item 14 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. The information included in this schedule for the year ended December 31, 2001 has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. The consolidated financial statements as of December 31, 2000 and for each of the two years in the period ended December 31, 2000, together with the related information included in this schedule, were audited by other auditors whose report dated January 31, 2001, expressed an unqualified opinion. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 68 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of Metropolitan Edison Company: Our audits of the consolidated financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of Metropolitan Edison Company (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules for the years ended December 31, 2003 and 2002 listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The financial statement schedule of Metropolitan Edison Company for the year ended December 31, 2001 was audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on the financial statement schedule in their report dated March 18, 2002. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 69 The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Metropolitan Edison Company: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements as of December 31, 2001 and for the periods from January 1, 2001 to November 6, 2001 and from November 7, 2001 to December 31, 2001, included in Metropolitan Edison Company's Annual Report to Stockholders incorporated by reference in this Form 10-K and have issued our report thereon dated March 18, 2002. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule of consolidated valuation and qualifying accounts listed in Item 14 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. The information included in this schedule for the year ended December 31, 2001 has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. The consolidated financial statements as of December 31, 2000 and for each of the two years in the period ended December 31, 2000, together with the related information included in this schedule, were audited by other auditors whose report dated January 31, 2001, expressed an unqualified opinion. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 70 Report of Independent Auditors on Financial Statement Schedules To the Stockholders and Board of Directors of Pennsylvania Electric Company: Our audits of the consolidated financial statements referred to in our report dated February 25, 2004 appearing in the 2003 Annual Report to Stockholders of Pennsylvania Electric Company (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules for the years ended December 31, 2003 and 2002 listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The financial statement schedule of Pennsylvania Electric Company for the year ended December 31, 2001 was audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on the financial statement schedule in their report dated March 18, 2002. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 71 The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Pennsylvania Electric Company: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements as of December 31, 2001 and for the periods from January 1, 2001 to November 6, 2001 and from November 7, 2001 to December 31, 2001, included in Pennsylvania Electric Company's Annual Report to Stockholders incorporated by reference in this Form 10-K and have issued our report thereon dated March 18, 2002. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule of consolidated valuation and qualifying accounts listed in Item 14 is the responsibility of the Company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. The information included in this schedule for the year ended December 31, 2001 has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. The consolidated financial statements as of December 31, 2000 and for each of the two years in the period ended December 31, 2000, together with the related information included in this schedule, were audited by other auditors whose report dated January 31, 2001, expressed an unqualified opinion. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 72 SCHEDULE II FIRSTENERGY CORP. CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions --------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance ----------- --------- --------- ---------- ---------- ------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts - customers......... $ 52,514 $63,535 $15,966 (a) $81,768 (c) $ 50,247 ========= ======= ======= ======= ========= - other............. $ 12,851 $ 6,516 $10,002 (a) $11,086 $ 18,283 ========= ======= ======= ======= ========= Loss carryforward tax valuation reserve...................... $ 482,061 $29,575 $50,503 $91,326 (d) $ 470,813 ========= ======= ======= ======= ========= Year Ended December 31, 2002: Accumulated provision for uncollectible accounts - customers......... $ 65,358 $43,601 $ 5,637 (a) $62,082(c) $ 52,514 ========= ======= ======== ======= ========= - other............. $ 7,947 $ 4,316 $ 4,089 $ 3,501 $ 12,851 ========= ======= ======= ======= ========= Loss carryforward tax valuation reserve...................... $ 459,170 $17,500 $ 5,391 $ -- $482,061 ========= ======= ======== ======= ======== Year Ended December 31, 2001: Accumulated provision for uncollectible accounts - customers......... $ 32,251 $27,805 $ 41,071(a)(b) $35,769(c) $ 65,358 ========= ======= ======== ======= ========= - other............. $ 4,035 $3,912 $ -- $ -- $ 7,947 ========= ======= ======== ======= ========= Loss carryforward tax valuation reserve (Unaudited).......... $ -- $ -- $459,170 $ -- $ 459,170 ========= ======= ======== ======= ========= - --------------------- (a) Represents recoveries and reinstatements of accounts previously written off. (b) Represents amount assumed from the former GPU companies as of November 7, 2001, the effective date of the merger. (c) Represents the write-off of accounts considered to be uncollectible. (d) Includes a reclassification of a valuation allowance to a contingent liability. 73
SCHEDULE II OHIO EDISON COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 Additions --------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance ----------- --------- --------- -------- ---------- ------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts - customers...... $ 5,240 $18,157 $4,384 (a) $19,034 (b) $ 8,747 ======== ======= ====== ======= ======= - other.......... $ 1,000 $ 1,282 $ -- $ -- $ 2,282 ======== ======= ====== ======= ======= Year Ended December 31, 2002: Accumulated provision for uncollectible accounts - customers...... $ 4,522 $12,792 $2,777(a) $14,851 $ 5,240 ======== ======= ====== ======= ======= - other.......... $ 1,000 $ -- $ -- $ -- $ 1,000 ======== ======= ====== ======= ======= Year Ended December 31, 2001: Accumulated provision for uncollectible accounts - customers...... $ 11,777 $16,460 $2,401(a) $26,116 $ 4,522 ======== ======= ====== ======= ======= - other.......... $ 1,000 $ -- $ -- $ -- $ 1,000 ======== ======= ====== ======= ======= - -------------------- (a) Represents recoveries and reinstatements of accounts previously written off. (b) Represents the write-off of accounts considered to be uncollectible. 74
SCHEDULE II THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions --------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance ----------- --------- --------- --------- ---------- ------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts.................. $1,015 $ 765 $ -- $ 15 $1,765 ====== ======= ====== ===== ====== Year Ended December 31, 2002: Accumulated provision for uncollectible accounts.................. $1,015 $ -- $ -- $ -- $1,015 ====== ========== ====== ====== ====== Year Ended December 31, 2001: Accumulated provision for uncollectible accounts.................. $1,000 $ 15 $ -- $ -- $1,015 ====== ======== ====== ====== ====== 75
SCHEDULE II THE TOLEDO EDISON COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions --------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance --------- --------- -------- ---------- -------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts.................. $ 2 $1,160 $ 712 (c) $ 1,840 (c) $ 34 ======== ====== ======= ======= ======== Year Ended December 31, 2002: Accumulated provision for uncollectible accounts.................. $ 2 $ -- $ -- $ -- $ 2 ======== ====== ======= ======= ======== Year Ended December 31, 2001: Accumulated provision for uncollectible accounts.................. $ -- $ 2 $ -- $ -- $ 2 ======== ====== ======= ======= ======== - -------------------- (a) Represents recoveries and reinstatements of accounts previously written off. (b) Represents the write-off of accounts considered to be uncollectible. 76
SCHEDULE II PENNSYLVANIA POWER COMPANY VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions ----------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance --------- --------- --------- ---------- ------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts - customers...... $ 702 $1,931 $ 664(a) $2,528 $ 769 ======== ====== ====== ====== ======= - other.......... $ -- $ 102 $ -- $ -- $ 102 ======== ====== ====== ====== ======= Year Ended December 31, 2002: Accumulated provision for uncollectible accounts - customers...... $ 619 $1,808 $ 333 (a) $2,058(b) $ 702 ====== ====== ===== ====== ===== Year Ended December 31, 2001: Accumulated provision for uncollectible accounts - customers...... $ 628 $1,172 $ 311 (a) $1,492(b) $ 619 ====== ====== ===== ====== ===== - -------------------- (a) Represents recoveries and reinstatements of accounts previously written off. (b) Represents the write-off of accounts considered to be uncollectible. 77
SCHEDULE II JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions --------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance ----------- --------- --------- -------- ---------- ------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts - customers...... $ 4,509 $ 7,867 $2,991 (a) $11,071(b) $ 4,296 ======== ======== ====== ====== ======= - other.......... $ -- $ 1,183 $ -- $ -- $ 1,183 ======== ======== ====== ======= ======= Year Ended December 31, 2002: Accumulated provision for uncollectible accounts - customers...... $ 12,923 $ 9,057 $1,305 (a) $18,776(b) $ 4,509 ======== ======== ====== ======= ======= Year Ended December 31, 2001: Accumulated provision for uncollectible accounts - customers Nov. 7-Dec. 31, 2001 $ 12,858 $ 1,869 $ 57 (a) $ 1,861(b) $12,923 ======== ======== ======== ======= ======= Jan. 1-Nov. 6, 2001 $ 21,479 $ 390 $1,778 (a) $10,789(b) $12,858 ======== ======== ====== ======= ======= - -------------------- () Represents recoveries and reinstatements of accounts previously written off. (b) Represents the write-off of accounts considered to be uncollectible. 78
SCHEDULE II METROPOLITAN EDISON COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions --------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance --------- --------- -------- ---------- ------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts - customers...... $ 4,810 $ 8,617 $4,595 (a) $13,079(b) $ 4,943 ======= ======= ====== ======= ======== - other.......... $ -- $ 68 $ -- $ -- $ 68 ======= ======= ====== ======= ======== Year Ended December 31, 2002: Accumulated provision for uncollectible accounts - customers...... $12,271 $ 3,332 $ 851 (a) $11,644(b) $ 4,810 ======= ======= ====== ======= ======== Year Ended December 31, 2001: Accumulated provision for uncollectible accounts - customers Nov. 7-Dec. 31, 2001 $11,244 $ 2,669 $ 78 (a) $ 1,720(b) $ 12,271 ======= ======= ====== ======= ======== ____________________________________________________________________________________________________________________ Jan. 1-Nov. 6, 2001 $13,004 $ 7,354 $ 743 (a) $ 9,857(b) $ 11,244 ======= ======= ====== ======= ======== - -------------------- (a) Represents recoveries and reinstatements of accounts previously written off. (b) Represents the write-off of accounts considered to be uncollectible. 79
SCHEDULE II PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions --------------------- Charged Beginning Charged to Other Ending Description Balance to Income Accounts Deductions Balance --------- --------- --------- ---------- -------- (In thousands) Year Ended December 31, 2003: Accumulated provision for uncollectible accounts - customers...... $ 6,216 $ 9,287 $3,995 (a) $13,665(b) $ 5,833 ======== ======== ====== ======= ======== - other.......... $ -- $ 399 $ -- $ -- $ 399 ======== ======== ====== ======= ======== Year Ended December 31, 2002: Accumulated provision for uncollectible accounts - customers...... $ 14,719 $ 2,991 $ 704 (a) $12,198(b) $ 6,216 ======== ======== ====== ======= ======== Year Ended December 31, 2001: Accumulated provision for uncollectible accounts - customers Nov. 7-Dec. 31, 2001 $ 13,509 $ 3,686 $ 83 (a) $ 2,559(b) $ 14,719 ======== ======== ====== ======= ======== - -------------------------------------------------------------------------------------------------------------------- Jan. 1-Nov. 6, 2001 $ 14,851 $ 10,833 $1,069 (a) $13,244(b) $ 13,509 ======== ======= ====== ======= ======== - -------------------- (a) Represents recoveries and reinstatements of accounts previously written off. (b) Represents the write-off of accounts considered to be uncollectible. 80
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. FIRSTENERGY CORP. BY /s/ Anthony J. Alexander ---------------------------------------- Anthony J. Alexander President and Chief Executive Officer Date: March 15, 2004 81 SIGNATURES 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 and on the date indicated: /s/George M. Smart /s/Anthony J. Alexander - -------------------------------- --------------------------------------- George M. Smart Anthony J. Alexander Chairman of the Board President and Chief Executive Officer and Director (Principal Executive Officer) /s/Richard H. Marsh /s/Harvey L. Wagner - -------------------------------- --------------------------------------- Richard H. Marsh Harvey L. Wagner Senior Vice President and Vice President, Controller and Chief Financial Officer Chief Accounting Officer (Principal Financial Officer) (Principal Accounting Officer) /s/Paul T. Addison - -------------------------------- --------------------------------------- Paul T. Addison Robert N. Pokewaldt Director Director /s/William T. Cottle /s/Paul J. Powers - -------------------------------- --------------------------------------- William T. Cottle Paul J. Powers Director Director /s/Carol A. Cartwright /s/Catherine A. Rein - -------------------------------- --------------------------------------- Carol A. Cartwright Catherine A. Rein Director Director /s/Robert B. Heisler, Jr. /s/Robert C. Savage - -------------------------------- --------------------------------------- Robert B. Heisler, Jr. Robert C. Savage Director Director /s/Robert L. Loughhead /s/Jesse T. Williams, Sr. - -------------------------------- --------------------------------------- Robert L. Loughhead Jesse T. Williams, Sr. Director Director /s/Russell W. Maier /s/Patricia K. Woolf - -------------------------------- --------------------------------------- Russell W. Maier Patricia K. Woolf Director Director - -------------------------------- /s/John M. Pietruski John M. Pietruski Director Date: March 15, 2004 82 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. OHIO EDISON COMPANY BY /s/ Anthony J. Alexander ----------------------------- Anthony J. Alexander President Date: March 15, 2004 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 and on the date indicated: /s/ Anthony J. Alexander /s/Richard H. Marsh - ----------------------------------- --------------------------------------- Anthony J. Alexander Richard H. Marsh President and Director Senior Vice President and Director (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/Leila L. Vespoli - ----------------------------------- --------------------------------------- Harvey L. Wagner Leila L. Vespoli Vice President and Controller Senior Vice President and Director (Principal Accounting Officer) Date: March 15, 2004 83 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. THE CLEVELAND ELECTRIC ILLUMINATING COMPANY BY /s/ Anthony J. Alexander ---------------------------- Anthony J. Alexander President Date: March 15, 2004 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 and on the date indicated: /s/ Anthony J. Alexander /s/Richard H. Marsh - ---------------------------------- --------------------------------------- Anthony J. Alexander Richard H. Marsh President and Director Senior Vice President and Director (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/Leila L. Vespoli - ---------------------------------- ------------------------------------ Harvey L. Wagner Leila L. Vespoli Vice President and Controller Senior Vice President and Director (Principal Accounting Officer) Date: March 15, 2004 84 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. THE TOLEDO EDISON COMPANY BY /s/ Anthony J. Alexander -------------------------- Anthony J. Alexander President Date: March 15, 2004 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 and on the date indicated: /s/ Anthony J. Alexander /s/Richard H. Marsh - ---------------------------------- ------------------------------------- Anthony J. Alexander Richard H. Marsh President and Director Senior Vice President and Director (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/Leila L. Vespoli - ---------------------------------- ------------------------------------- Harvey L. Wagner Leila L. Vespoli Vice President and Controller Senior Vice President and Director (Principal Accounting Officer) Date: March 15, 2004 85 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. JERSEY CENTRAL POWER & LIGHT COMPANY BY /s/ Stephen E. Morgan -------------------------------- Stephen E. Morgan President Date: March 15, 2004 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 and on the date indicated: /s/ Stephen E. Morgan s/Richard H. Marsh - ---------------------------------- --------------------------------------- Stephen E. Morgan Richard H. Marsh President and Director Senior Vice President (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/Leila L. Vespoli - ---------------------------------- --------------------------------------- Harvey L. Wagner Leila L. Vespoli Vice President and Controller Senior Vice President and Director (Principal Accounting Officer) /s/ Charles E. Jones /s/Stanley C. Van Ness - ---------------------------------- --------------------------------------- Charles E. Jones Stanley C. Van Ness Director Director /s/ Gelorma E. Persson /s/Mark A. Julian - ---------------------------------- --------------------------------------- Gelorma E. Persson Mark A. Julian Director Director - ---------------------------------- /s/ Bradley S. Ewing Bradley S. Ewing Director Date: March 15, 2004 86 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. METROPOLITAN EDISON COMPANY BY /s/ Anthony J. Alexander ----------------------------- Anthony J. Alexander President Date: March 15, 2004 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 and on the date indicated: /s/ Anthony J. Alexander /s/Richard H. Marsh - ----------------------------------- -------------------------------------- Anthony J. Alexander Richard H. Marsh President and Director Senior Vice President and Director (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/Leila L. Vespoli - ----------------------------------- -------------------------------------- Harvey L. Wagner Leila L. Vespoli Vice President and Controller Senior Vice President and Director (Principal Accounting Officer) Date: March 15, 2004 87 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. PENNSYLVANIA ELECTRIC COMPANY BY /s/ Anthony J. Alexander ------------------------------- Anthony J. Alexander President Date: March 15, 2004 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 and on the date indicated: /s/ Anthony J. Alexander /s/Richard H. Marsh - ---------------------------------- -------------------------------------- Anthony J. Alexander Richard H. Marsh President and Director Senior Vice President and Director (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/Leila L. Vespoli - ---------------------------------- -------------------------------------- Harvey L. Wagner Leila L. Vespoli Vice President and Controller Senior Vice President and Director (Principal Accounting Officer) Date: March 15, 2004 88 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. PENNSYLVANIA POWER COMPANY BY /s/ Anthony J. Alexander ------------------------------- Anthony J. Alexander President Date: March 15, 2004 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 and on the date indicated: /s/ Anthony J. Alexander /s/Richard H. Marsh - ------------------------------------- -------------------------------------- Anthony J. Alexander Richard H. Marsh President and Director Senior Vice President and Director (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/Leila L. Vespoli - ------------------------------------- -------------------------------------- Harvey L. Wagner Leila L. Vespoli Vice President and Controller Senior Vice President and Director (Principal Accounting Officer) Date: March 15, 2004 89 EX-10 3 fe_ex10-1.txt EXHIBIT 10-1 EXEC & DIR ICP NSO FirstEnergy Corp. ---------------- Executive and Directors Incentive Compensation Plan --------------------------------------------------- Non-Qualifying Stock Option (NSO) Agreement ------------------------------------------- Option No.: 17A Number of Options Granted: NSOs Option Price: $__.__ per share Option Closing Date: April 23, 2003 This Option Agreement ("Agreement") is entered into as of the 1st day of March, 2003, between FirstEnergy Corp., and ("Optionee") and is not in lieu of salary or any other compensation for services. For the purposes of this plan, the term "Company" or "FE" means FirstEnergy Corp. or its subsidiaries, singularly or collectively. SECTION ONE - AWARD On February 17, 1998, the Board of Directors ("Board") of FE adopted the FE Executive and Director Incentive Compensation Plan ("Plan"), which was approved and amended by the common stock shareholders. As of the date of this Agreement, per the terms of the Plan, FE grants to the Optionee an option ("Option") to purchase the above number of shares of FE Common Stock ("Shares") at the option price reflected above. All Grants are considered NSOs, not subject to the provisions of section 422 of the Internal Revenue Code. SECTION TWO - GENERAL TERMS This Agreement is subject to the following terms and conditions, many of which are described in greater detail in the Plan. Please consult the Plan document for further information. Vesting Provisions These Options will become vested over a four-year period, in 25 percent increments, as reflected in the table below, unless they become exercisable sooner per the Termination of Employment table: Vesting Date Amount Vested March 1, 2004 25% March 1, 2005 50% March 1, 2006 75% March 1, 2007 100% 1 Expiration These Options expire on March 1, 2013 at 2:00 PM, Akron time unless the Options expire earlier due to termination of employment (or 2:00 PM on the last business day prior to such date, if the date falls on a Saturday, Sunday, or other day when the FirstEnergy General Office is closed). Termination of Employment
- ------------------------------------------------------------------------------------------------------------------------ Event of Optionee's Termination Vesting When Options Expire Further Information ------------------------------- ------- ------------------- -------------------- of Employment ------------------------------- - ------------------------------------------------------------------------------------------------------------------------ Retirement (including early Vesting continues per Options expire on As defined under 6.8 of retirement) vesting schedule March 1, 2013 the Plan - ------------------------------------------------------------------------------------------------------------------------ Disability Vesting continues per Options expire on As defined under 6.8 of vesting schedule March 1, 2013 the Plan - ------------------------------------------------------------------------------------------------------------------------ Death (including death after 100% vesting upon date All options expire the Shares exercisable by retirement, disability, or Other of death earlier of one year after the beneficiary (as Terminations other than for Cause) date of death or designated under expiration of the grant Article 12 of the Plan, or by will or by the laws of descent and distribution) - ------------------------------------------------------------------------------------------------------------------------ For "Cause" Vesting stops upon date All vested and unvested Termination for Cause of termination options are immediately is defined in section forfeited back to the 2.1.6 of the Plan Company - ------------------------------------------------------------------------------------------------------------------------ Other Separation (including Vesting stops upon date All unvested options are You may be subject to resignation) of termination immediately forfeited the "Forfeiture and back to the Company. All Recovery" provisions vested options expire the below. earlier of 90 days after you leave the Company or expiration of the grant - ------------------------------------------------------------------------------------------------------------------------
Change in Control In the event of a Change in Control (as defined in section 2.1.7 of the Plan), all options under this Agreement become immediately exercisable as of the date of the Change in Control, and the provisions under the section entitled "Forfeiture and Recovery" shall not apply. Forfeiture and Recovery If it is determined, in the sole discretion of the Compensation Committee (the "Committee") of the FirstEnergy Board of Directors or its delegate, that the Optionee has breached any of the covenants below, and unless such breach has been waived by the Committee or its delegate in writing, all outstanding Options shall be immediately forfeited back to FE, and any profits resulting from the exercise of Options realized in the twelve (12) months preceding the date of termination through the date of the breach shall be immediately returned to FE. 2 During the term of his/her employment with the Company and for a period of twenty-four (24) months following termination of employment for any reason, including without limitation, termination by mutual agreement, the Optionee expressly covenants and agrees that he/she will not at any time for himself/herself or on behalf of any other person, firm, association or other entity do any of the following: 1. Participate or engage, by virtue of being employed or otherwise, directly or indirectly, in the business of selling, servicing, and/or manufacturing products, supplies or services of the kind, nature or description of those sold by the Company except pursuant to his/her employment with the Company; 2. Directly participate or engage, on the behalf of other parties, in the purchase of products, supplies or services of the kind, nature or description of those sold by the Company except pursuant to his/her employment with the Company; 3. Solicit, divert, take away or attempt to take away any of the Company's Customers or the business or patronage of any such Customers of the Company; 4. Solicit, entice, lure, employ or endeavor to employ any of the Company's employees; 5. Divulge to others or use to his/her own benefit any confidential information obtained during the course of his/her employment with Company relative to sales, services, processes, methods, machines, manufacturers, compositions, ideas, improvements, patents, trademarks, or inventions belonging to or relating to the affairs of Company; or 6. Divulge to others or use to his/her own benefit any trade secrets belonging to the Company obtained during the course of his/her employment or of which he/she became aware during the course of his/her employment with the Company. The term "Customer" shall mean any person, firm, association, corporation or other entity to which the Optionee or the Company has sold the Company's products or services within the twenty-four (24) month period immediately preceding the termination of Optionee's employment with the Company or to which the Optionee or the Company is in the process of selling its products or services, or to which the Optionee or the Company has submitted a bid, or is in the process of submitting a bid to sell the Company's products or services. FE may offset any amount owed against any compensation due to the Optionee or against any amounts otherwise due and distributable to the Optionee from any benefit plan of FE in which the Optionee has participated, in accordance with the terms of such benefit plan. Should it be necessary for FE to initiate legal action to recover any amounts due, FE shall be entitled to recover from Optionee, in addition to such amounts due, all costs, including reasonable attorneys fees, incurred as a result of such legal action. Effect on the Employment Relationship Nothing in this Agreement guarantees employment with the Company, nor does it confer any special rights or privileges to the Optionee as to the terms of employment. Adjustments In the event of any merger, reorganization, consolidation, recapitalization, separation, liquidation, stock dividend, stock split, combination, distribution, or other change in corporate structure of FE affecting the Common Stock, the Committee will adjust the number and class of securities in this option in a manner determined appropriate to prevent dilution or diminution of the Option under this Agreement. 3 Administration 1. This Agreement is governed by the laws of the State of Ohio without giving effect to the principles of the conflicts of laws. 2. The terms and conditions of this Option may be modified by the Committee: (a) In any case permitted by the terms of the Plan or this Option, (b) with the written consent of the Optionee, and/or (c) without the consent of the Optionee if the amendment is either not adverse to the interests of the Optionee or is required by law. 3. The administration of this Agreement and the Plan will be performed in accordance with Article 3 of the Plan. All determinations and decisions made by the Committee, the Board, or any delegate of the Committee as to the provisions of the Plan shall be final, conclusive, and binding on all persons. 4. Except as provided otherwise herein, the terms of this Agreement are governed at all times by the official text of the Plan and in no way alter or modify the Plan. 5. If a term is capitalized but not defined in this Agreement, it has the meaning given to it in the Plan. 6. To the extent a conflict exists between the terms of this Agreement and the provisions of the Plan, the provisions of the Plan shall govern. SECTION THREE - METHODS OF EXERCISING THE OPTION Notification to Exercise To exercise an option, the Optionee must submit to the Administrator of the Plan the information below either on a form provided by FE, a broker form, or a blank sheet of paper: 1. Number of shares being purchased, 2. The grant price, 3. The form of payment, 4. A statement of intention to exercise, 5. The signature of the Optionee, (or legal representative in the case of death or disability), and 6. Any representations or disclosures required by any applicable securities law. Method of Payment Payment for the transaction and associated brokerage fees may be made through the following methods: 1. Cash Exercise -- Delivering cash equal to the cost of the exercise. 2. Stock Swap Exercise -- Surrendering certificates of FE stock previously acquired having a Fair Market Value at the time of the exercise equal to the amount of the exercise, and, if necessary, a small amount of cash, not to exceed the price of one (1) share of stock. 3. Cashless Exercise-- Using the net proceeds from the immediate sale of stock to pay for the exercise of the Option, as directed in the written notification to exercise the option. 4 A combination of any of the above based upon Plan administrative rules. Withholding Tax FE shall have the right to deduct, withhold, or require the Optionee to surrender an amount sufficient to satisfy federal (including FICA and Medicare), state, and/or local taxes required by law to be withheld for any exercise. SECTION FOUR - TRANSFER OF OPTION The Option is not transferable during the life of the Optionee. Only the Optionee shall have the right to exercise an option, unless deceased, at which time the option may be exercised by the Optionee's beneficiary (as designated under Article 12 of the Plan or by will or by the laws of descent and distribution). FirstEnergy Corp. By _____________________________ Corporate Secretary I acknowledge receipt of this NSO Agreement and I accept and agree with the terms and conditions stated above. -------------------------------- (Signature of Optionee) - --------------------- (Date) (This is 's grant under the FE Stock Option Program.) NSO Option Agreement Grant 14A - Normal (no name).doc 02/18/03 5 EX-12 4 fe_ex12-1.txt FE FIXED CHARGE RATIO EXHIBIT 12.1 FIRSTENERGY CORP. CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, ------------------------------------------------------------------- 1999 2000 2001 2002 2003 ---------- ---------- ---------- ---------- ---------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items ......................... $ 568,299 $ 598,970 $ 654,946 $ 632,667 $ 421,996 Interest and other charges, before reduction for amounts capitalized...................................... 585,648 556,194 591,192 982,617 843,553 Provision for income taxes................................. 394,827 376,802 474,457 524,059 405,959 Interest element of rentals charged to income (a).......... 279,519 271,471 258,561 246,416 247,222 ---------- ---------- ---------- ---------- ---------- Earnings as defined...................................... $1,828,293 $1,803,437 $1,979,156 $2,385,759 $1,918,730 ========== ========== ========== ========== ========== FIXED CHARGES AS DEFINED IN REGULATION S-K: Interest expense........................................... $ 509,169 $ 493,473 $ 519,131 $ 906,970 $ 801,184 Subsidiaries' preferred stock dividend requirements........ 76,479 62,721 72,061 75,647 42,369 Adjustments to subsidiaries' preferred stock dividends to state on a pre-income tax basis....................... 44,829 32,098 41,349 28,321 22,552 Interest element of rentals charged to income (a).......... 279,519 271,471 258,561 246,416 247,222 ---------- ---------- ---------- ---------- ---------- Fixed charges as defined................................. $ 909,996 $ 859,763 $ 891,102 $1,257,354 $1,113,327 ========== ========== ========== ========== ========== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES ................................................... 2.01 2.10 2.22 1.90 1.72 ==== ==== ==== ==== ==== - -------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rntal expense where no readily defined interest element can be determined. 90
EX-13 5 fe_ex13.txt FE ANNUAL REPORT MANAGEMENT REPORT The consolidated financial statements were prepared by the management of FirstEnergy Corp., who takes responsibility for their integrity and objectivity. The statements were prepared in conformity with accounting principles generally accepted in the United States and are consistent with other financial information appearing elsewhere in this report. PricewaterhouseCoopers LLP, independent auditors, have expressed an unqualified opinion on the Company's 2003 consolidated financial statements. The Company's internal auditors, who are responsible to the Audit Committee of the Board of Directors, review the results and performance of operating units within the Company for adequacy, effectiveness and reliability of accounting and reporting systems, as well as managerial and operating controls. The Audit Committee consists of six independent directors whose duties include: consideration of the adequacy of the internal controls of the Company and the objectivity of financial reporting; inquiry into the number, extent, adequacy and validity of regular and special audits conducted by independent auditors and the internal auditors; and reporting to the Board of Directors the Committee's findings and any recommendation for changes in scope, methods or procedures of the auditing functions. The Committee is directly responsible for appointing the Company's independent auditors (subject to shareholder approval) and is charged with reviewing and approving all services performed for the Company by the independent auditors and for reviewing the related fees. The Committee reviews the independent auditors' internal quality control procedures and reviews all relationships between the independent auditors and the Company, in order to assess the auditors' independence. The Committee also reviews management's programs to monitor compliance with the Company's policies on business ethics and risk management. The Committee establishes procedures to receive and respond to complaints received by the Company regarding accounting, internal accounting controls, or auditing matters and allows for the confidential, anonymous submission of concerns by employees. The Audit Committee held ten meetings in 2003. Richard H. Marsh Senior Vice President and Chief Financial Officer Harvey L. Wagner Vice President, Controller and Chief Accounting Officer 2 Report of Independent Auditors To the Stockholders and Board of Directors of FirstEnergy Corp.: In our opinion, the accompanying consolidated balance sheets and consolidated statements of capitalization and the related consolidated statements of income, common stockholders' equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of FirstEnergy Corp. and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. The consolidated financial statements of FirstEnergy Corp. and subsidiaries for the year ended December 31, 2001, prior to the revisions described in Notes 2(F), 2(L) and 8, were audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on those financial statements in their report dated March 18, 2002. As discussed in Note 2(L) to the consolidated financial statements, the Company changed its method of accounting for goodwill as of January 1, 2002. As discussed in Note 2(F) to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003. As discussed in Note 9 to the consolidated financial statements, the Company changed its method of accounting for the consolidation of variable interest entities as of December 31, 2003. As discussed above, the consolidated financial statements of FirstEnergy Corp. and subsidiaries for the year ended December 31, 2001 were audited by other independent auditors who have ceased operations. As described in Note 2(L) to the consolidated financial statements, the financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of January 1, 2002. As described in Note 2(F) to the consolidated financial statements, the financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, which was adopted by the Company as of January 1, 2003. As described in Note 8 to the consolidated financial statements, the Company changed the composition of its reportable segments in 2002. We audited the transitional disclosures described in Notes 2(F) and 2(L) and the adjustments that were applied to restate the 2001 reportable segments disclosures discussed in Note 8. In our opinion, such adjustments to the reportable segments disclosures are appropriate and have been properly applied and the transitional disclosures for 2001 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 consolidated financial statements of the Company other than with respect to such transitional disclosures and adjustments to the reportable segments disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 3 The following report is a copy of a report previously issued by Arthur Andersen LLP (Andersen). This report has not been reissued by Andersen and Andersen did not consent to the incorporation by reference of this report into any of the Company's registration statements. As discussed in Note 2(L) to the consolidated financial statements, the Company has revised its consolidated financial statements for the year ended December 31, 2001 to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." As discussed in Note 2(F) to the consolidated financial statements, the Company has revised its consolidated financial statements for the year ended December 31, 2001 to include the transitional disclosures required by Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations." Additionally, as discussed in Note 8 to the consolidated financial statements, the Company has revised its consolidated financial statements for the year ended December 31, 2001 to reflect changes in the composition of its reportable segments adopted in 2002. The Andersen report does not extend to these changes. The revisions to the 2001 financial statements related to these transitional disclosures and the revisions that were applied to restate the 2001 reportable segments disclosures were reported on by PricewaterhouseCoopers LLP, as stated in their report appearing herein. REPORT OF PREVIOUS INDEPENDENT PUBLIC ACCOUNTANTS TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF FIRSTENERGY CORP.: We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of FirstEnergy Corp. (an Ohio corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, common stockholders' equity, preferred stock, cash flows and taxes for each of the three years in the period ended December 31, 2001. 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 in accordance with auditing standards generally accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of FirstEnergy Corp. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. As explained in Note 1 to the consolidated financial statements, effective January 1, 2001, the Company changed its method of accounting for derivative instruments and hedging activities by adopting Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002 4
FIRSTENERGY CORP. SELECTED FINANCIAL DATA For the Years Ended December 31, 2003 2002* 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------------- (In thousands, except per share amounts) Revenues....................................... $12,307,407 $12,047,348 $ 7,999,362 $ 7,028,961 $ 6,319,647 -------------------------------------------------------------------- Income Before Discontinued Operations and Cumulative Effect of Accounting Changes. $ 421,996 $ 632,667 $ 654,946 $ 598,970 $ 568,299 -------------------------------------------------------------------- Net Income..................................... $ 422,764 $ 552,804 $ 646,447 $ 598,970 $ 568,299 -------------------------------------------------------------------- Basic Earnings per Share of Common Stock: Before Discontinued Operations and Cumulative Effect of Accounting Changes... $1.39 $2.16 $2.85 $2.69 $2.50 After Discontinued Operations and Cumulative Effect of Accounting Changes... $1.39 $1.89 $2.82 $2.69 $2.50 -------------------------------------------------------------------- Diluted Earnings per Share of Common Stock: Before Discontinued Operations and Cumulative Effect of Accounting Changes... $1.39 $2.15 $2.84 $2.69 $2.50 After Discontinued Operations and Cumulative Effect of Accounting Changes... $1.39 $1.88 $2.81 $2.69 $2.50 -------------------------------------------------------------------- Dividends Declared per Share of Common Stock... $1.50 $1.50 $1.50 $1.50 $1.50 -------------------------------------------------------------------- Total Assets................................... $32,909,948 $34,386,353 $37,351,513 $17,941,294 $18,224,047 ------------------------------------------------------------------- Capitalization as of December 31: Common Stockholders' Equity................. $ 8,289,341 $ 7,050,661 $ 7,398,599 $ 4,653,126 $ 4,563,890 Preferred Stock: Not Subject to Mandatory Redemption....... 335,123 335,123 480,194 648,395 648,395 Subject to Mandatory Redemption........... -- 428,388 594,856 161,105 256,246 Long-Term Debt.............................. 9,789,066 10,872,216 12,865,352 5,742,048 6,001,264 -------------------------------------------------------------------- Total Capitalization...................... $18,413,530 $18,686,388 $21,339,001 $11,204,674 $11,469,795 ==================================================================== * See Note 2(I) regarding reclassification of discontinued operations.
PRICE RANGE OF COMMON STOCK The Common Stock of FirstEnergy Corp.is listed on the New York Stock Exchange under the symbol "FE" and is traded on other registered exchanges. 2003 2002 - --------------------------------------------------------------------------- First Quarter High-Low......... $35.19 $27.04 $39.12 $30.30 Second Quarter High-Low........ 38.90 30.57 35.12 31.61 Third Quarter High-Low......... 38.75 25.82 34.78 24.85 Fourth Quarter High-Low........ 35.95 31.66 33.85 25.60 Yearly High-Low................ 38.90 25.82 39.12 24.85 - --------------------------------------------------------------------------- Prices are based on reports published in The Wall Street Journal for New York ----------------------- Stock Exchange Composite Transactions. HOLDERS OF COMMON STOCK There were 153,020 and 152,288 holders of 329,836,276 shares of FirstEnergy's Common Stock as of December 31, 2003 and January 31, 2004, respectively. Information regarding retained earnings available for payment of cash dividends is given in Note 5(A). 5 FIRSTENERGY CORP. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the continuing availability and operation of generating units, inability of the Davis-Besse Nuclear Power Station to restart (including because of an inability to obtain a favorable final determination from the Nuclear Regulatory Commission) in early 2004, the inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage, a denial of or material change to the Company's Application related to its Rate Stabilization Plan, and other similar factors. FIRSTENERGY'S BUSINESS FirstEnergy Corp. is a registered public utility holding company headquartered in Akron, Ohio that provides regulated and competitive energy services (see Results of Operations - Business Segments). Our vision is to become the leading retail energy and related services provider in the northeast and mid-Atlantic region of the United States. Our eight electric utility operating companies (EUOC) comprise the nation's fifth largest investor-owned electric system, serving 4.4 million customers within 36,100 square miles of Ohio, Pennsylvania and New Jersey.
Transmission and Distribution Services Area Served Customers Served -------------------------------------- ----------- ---------------- Ohio Edison Company (OE) Central and northeastern Ohio 1,019,280 Pennsylvania Power Company (Penn) Western Pennsylvania 155,929 The Cleveland Electric Illuminating Company (CEI) Northeastern Ohio 752,537 The Toledo Edison Company (TE) Northwestern Ohio 307,893 Jersey Central Power & Light Company (JCP&L) Northern, western and east central New Jersey 1,049,547 Metropolitan Edison Company (Met-Ed) Eastern Pennsylvania 516,536 Pennsylvania Electric Company (Penelec) Western Pennsylvania 585,089 American Transmission Systems, Incorporated (ATSI) Service areas of OE, Penn, CEI and TE
Competitive services are principally provided by FirstEnergy Solutions Corp. (FES), FirstEnergy Facilities Services Group, LLC (FSG), MARBEL Energy Corporation, MYR Group, Inc., and our majority owned First Communications, LLC. Through its 50% interest in Great Lakes Energy Partners, LLC, MARBEL is involved in the exploration and production of oil and natural gas, and transmission and marketing of natural gas. Other subsidiaries provide a wide range of services, including heating, ventilating, air-conditioning, refrigeration, process piping, plumbing, electrical and facility control systems and high-efficiency electrotechnologies. Telecommunication services are also provided - local and long-distance phone service is provided to more than 65,000 customers. While competitive revenues have increased since 2001, regulated energy services continue to provide, in aggregate, the majority of FirstEnergy's revenues and earnings. Beginning in 2001, Ohio utilities that offered both competitive and regulated retail electric services were required to implement a corporate separation plan approved by the Public Utilities Commission of Ohio (PUCO) - one which provided a clear separation between regulated and competitive operations. FES provides competitive retail energy services while the EUOC provide regulated transmission and distribution services. FirstEnergy Generation Corp. 6 (FGCO), a wholly owned subsidiary of FES, leases fossil and hydroelectric plants from the EUOC and operates those plants. Under the terms of the current corporate separation plan, the transfer of ownership of EUOC non-nuclear generating assets to FGCO would be substantially completed by the end of the Ohio market development period. All of the EUOC power supply requirements for the Ohio Companies (OE, CEI, and TE) and Penn are provided by FES to satisfy their provider of last resort (PLR) obligations, as well as their grandfathered wholesale contracts. FirstEnergy acquired international assets in the merger with GPU, Inc. in November 2001. GPU Capital, Inc. and its subsidiaries had provided electric distribution services in foreign countries (see Results of Operations - Discontinued Operations). GPU Power, Inc. and its subsidiaries owned and operated generation facilities in foreign countries. As of January 30, 2004, all of the international operations had been divested (see Note 3) because those assets were not consistent with the role we envision for FirstEnergy in the energy industry. ORDERLY TRANSITION OF LEADERSHIP On January 13, 2004, FirstEnergy Chairman and Chief Executive Officer H. Peter Burg, passed away. Mr. Burg had taken a leave of absence beginning December 22, 2003, to undergo treatment for leukemia. At that time, the Board of Directors of FirstEnergy named President and Chief Operating Officer Anthony J. Alexander acting Chief Executive Officer. On January 20, 2004, the Board of Directors elected Mr. Alexander President and Chief Executive Officer, and also elected George M. Smart as Chairman. Mr. Smart was elected to Ohio Edison Company's Board of Directors in 1988 and to FirstEnergy's Board of Directors in 1997. Mr. Smart will not hold an executive position with FirstEnergy. STRATEGY AND RISKS We continue to pursue our goal of being the leading regional supplier of energy and related services in the northeast and mid-Atlantic region, where we see the best opportunities for growth. Our fundamental business strategy remains stable and unchanged. While we continue to build toward a strong regional presence, key elements for our strategy are in place and management's focus continues to be on execution. We intend to continue providing competitively priced, high-quality products and value-added services - energy sales and services, energy delivery, power supply and supplemental services related to our core business. As our industry changes to a more competitive environment, we have taken and expect to take actions designed to create a larger, stronger regional enterprise that will be positioned to compete in the changing energy marketplace. Our current focus includes: (1) minimizing unplanned extended generation outages; (2) improving our system reliability; (3) optimizing our generation portfolio; (4) effectively managing commodity supplies and risks; (5) reducing our cost structure; (6) enhancing our credit profile and financial flexibility; (7) managing the skills and diversity of our workforce; and (8) satisfactory resolution of the pending Ohio rate plan. Risks We face a number of industry and enterprise risks and challenges, among which include: o Weather and other weather-related phenomena (short-term and long-term) o General economic conditions and the resulting impact on our service area economies o Conditions in capital markets affecting availability of funds and interest rates o Environmental laws and regulations o Fluctuations in commodity prices o Actions taken by regulatory agencies o Changing competitive landscape o Potential acts of terrorism Supply Plan Our affiliates are obligated to provide generation service with an estimated power supply of 100,000 gigawatt-hours for 2004. These obligations arise from customers who have elected to continue to receive generation service from our EUOCs under regulated retail rate tariffs and from customers who have selected FES as their alternate generation provider. Geographically, approximately 64% of the total generation service obligation is for customers located in the Midwest Independent System Operator (ISO) market area and 36% for customers located in the PJM Interconnection, LLC ISO market area. Included in the PJM ISO market area are obligations of FES to provide power to electric distribution companies in the state of New Jersey, including JCP&L. FES incurred this obligation as a successful bidder in the State of New Jersey's auction of basic generation service (BGS). 7 Within the franchise territories of the EUOC, alternative energy suppliers currently provide generation service to approximate 1,400 megawatts (summer peak) of load with an estimated energy requirement of 6,700 gigawatt-hours. If these alternate suppliers fail to deliver power to their customers located in the EUOC's service areas, the EUOC must procure replacement power in the role of PLR (see Note 2(D) for discussion of the auction of JCP&L's PLR obligation). The EUOC costs for any replacement power would be recovered under the applicable state regulatory rules. To meet these generation service obligations, our affiliates own and operate 13,387 megawatts (MW) of installed generating capacity which for 2004 is expected to provide approximately 75% of the power supply required. The balance of the power supply expected to be required in 2004 has been secured through a mix of long-term purchases (term of contract greater than one year) and short-term purchases (term of contract less than one year). Changes in power supply requirements will be met through spot market transactions. Davis-Besse Restoration On April 30, 2002, the Nuclear Regulatory Commission (NRC) initiated a formal inspection process at the Davis-Besse nuclear plant. This action was taken in response to corrosion found by FirstEnergy Nuclear Operating Company (FENOC) in the reactor vessel head near the nozzle penetration hole during a refueling outage in the first quarter of 2002. The purpose of the formal inspection process is to establish criteria for NRC oversight of the licensee's performance and to provide a record of the major regulatory and licensee actions taken, and technical issues resolved, leading to the NRC's approval of restart of the plant. Restart activities include both hardware and management issues. In addition to refurbishment and installation work at the plant, we made significant management and human performance changes with the intent of re-establishing the proper safety culture throughout the workforce. Work was completed on the reactor head during 2002 and efforts continued in 2003 to focus on design enhancements to the unit's reliability and performance. We also accelerated maintenance work that had been planned for future refueling and maintenance outages. We installed a state-of-the-art leak-detection system around the reactor, as well as modified high-pressure injection pumps. Testing of the bottom of the reactor for leaks was completed in October 2003 and no indication of leakage was discovered. The focus of activities now involves management and human performance issues. As a result, incremental maintenance and capital expenditures declined in 2003 as emphasis shifted to performance issues; replacement power costs were higher in 2003. We anticipate that Davis-Besse will be ready for restart in the first quarter of 2004. The NRC must authorize restart of the plant following its formal inspection process before the unit can be returned to service. Delays in Davis-Besse's return to service contributed to Standard & Poor's (S&P's) reduction in our credit rating in the fourth quarter of 2003 (see Cash Flows from Financing Activities below). Incremental costs associated with the extended Davis-Besse outage for 2003 and 2002 were as follows: Costs of Davis-Besse Increase Extended Outage 2003 2002 (Decrease) ----------------------------------------------------------------------------- (In millions) Incremental Expense Replacement power.............. $196 $120 $ 76 Maintenance.................... 93 115 (22) - ------------------------------------------------------------------------------ Total...................... $289 $235 $ 54 ============================================================================= Incremental Net of Tax Expense... $170 $138 $ 32 ============================================================================ Capital Expenditures............. $ 21 $ 63 $(42) ============================================================================= We anticipate spending $10 million in 2004 for remaining non-capital restart activities, expected NRC inspection activities after Davis-Besse's return to service and other related activities. No additional capital expenditures related to the restoration are expected. Replacement power costs are expected to be $15-20 million per month during the remaining period of the outage. We have hedged the on-peak replacement energy supply for Davis-Besse for the expected length of the outage. If there are significant delays in the NRC approval process, replacement power costs will continue to be incurred, adversely affecting FirstEnergy's cash flows and results of operations. Power Outage On August 14, 2003, various states in the northeast United States and southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other 8 things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest ISO and PJM Interconnection) to provide effective diagnostic support. We remain convinced that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. We believe that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the Federal Energy Regulatory Commission (FERC) ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. RESTATEMENTS AND RECLASSIFICATIONS We filed an amended Form 10-K during 2003 to restate our consolidated financial statements for the year ended December 31, 2002 to reflect a change in the method of amortizing costs being recovered under the Ohio transition plan and to recognize above-market liabilities of certain leased generation facilities. In addition, the restated Consolidated Statement of Income for the year ended December 31, 2002 reflects reclassifying the results of divested businesses as discontinued operations (see Note 2(I)). Financial comparisons described below reflect the effect of these restatements and reclassifications of 2002 financial results. The 2001 results of the divested entities were not significant and the 2001 Consolidated Statement of Income was not reclassified to separately report discontinued operations. MERGER WITH GPU On November 7, 2001, the merger of FirstEnergy and GPU became effective with FirstEnergy as the surviving company. The merger was accounted for using purchase accounting under the guidelines of Statement of Financial Accounting Standards No. (SFAS) 141, "Business Combinations." Under purchase accounting, the results of operations for the combined entity are reported from the point of consummation forward. As a result, our financial statements for 2001 reflect twelve months of operations for our pre-merger organization and seven weeks of operations (November 7, 2001 to December 31, 2001) for the former GPU companies. In 2003 and 2002, our financial statements include twelve months of operations for both our pre-merger organization and the former GPU companies. Additional goodwill resulting from the merger ($3.8 billion) as of December 31, 2003, is not being amortized, reflecting the application of SFAS 142, "Goodwill and Other Intangible Assets." Goodwill is subject to review, at least annually, for potential impairment (see Critical Accounting Policies - Goodwill). As a result of the merger, we issued nearly 73.7 million shares of our common stock, which are reflected in the calculation of earnings per share of common stock in 2003 and 2002 and for the seven-week period outstanding in 2001. RESULTS OF OPERATIONS Net Income and Earnings Per Share Net income decreased to $423 million in 2003, compared to $553 million in 2002 and $646 million in 2001. Net income in 2003 and 2002 included after-tax charges for discontinued operations of $101 million and $80 million, respectively, or $0.33 and $0.27 per share (basic and diluted), primarily reflecting losses on the sale or abandonment of remaining international operations acquired through the merger with GPU (see Discontinued Operations below). Results for 2003 also include an after-tax credit of $102 million from the cumulative effect of an accounting change (basic and diluted earnings per share of $0.33). The 2003 credit resulted from the January 2003 adoption of SFAS 143, "Accounting for Asset Retirement Obligations." Net income in 2001 also included the cumulative effect of an accounting change resulting in a net after-tax charge of $9 million (see Cumulative Effect of Accounting Change below). Major factors reducing net income in 2003, compared to 2002, included the adverse impact from the JCP&L rate case decision to disallow costs of $109 million ($0.36 per share of common stock), a non-cash goodwill impairment charge of $81 million ($0.27 per share of common stock), asset impairments of $47 million ($0.15 per share of common stock) and increased costs associated with the Davis-Besse extended outage of $32 million ($0.09 per share of common stock). Of the $81 million goodwill impairment charge, $3 million is included in the net of tax loss from discontinued operations. Partially offsetting these charges was a gain of $99 million or $0.33 per share of common stock representing net proceeds from the settlement of our claim against NRG Energy, Inc. NRG relating to the terminated sale of four fossil power plants. 9 On September 17, 2003, we completed the issuance and sale of 32.2 million shares of common stock (see Cash Flows from Financing Activities below) which were included in the calculation of earnings per share on a weighted average basis in 2003. The additional shares reduced earnings per share of common stock by $0.04 (basic and diluted). If the shares had been outstanding for the entire year, basic and diluted earnings would have been reduced by $0.13 per share of common stock.
FirstEnergy 2003 2002 2001 -------------------------------------------------------------------------------------- (In millions) Total revenues.................................. $12,307 $12,047 $7,999 Income before interest and income taxes......... 1,640 2,115 1,685 Income before discontinued operations and cumulative effect of accounting changes.. 422 633 655 Discontinued operations......................... (101) (80) -- Cumulative effect of accounting changes......... 102 -- (9) -------------------------------------------------------------------------------------- Net Income...................................... 423 553 646 -------------------------------------------------------------------------------------- Basic Earnings Per Share: Income before discontinued operations and cumulative effect of accounting changes $1.39 $2.16 $2.85 Discontinued operations...................... (0.33) (0.27) -- Cumulative effect of accounting changes...... 0.33 -- (.03) -------------------------------------------------------------------------------------- Net Income...................................... $1.39 $1.89 $2.82 ====================================================================================== Diluted Earnings Per Share: Income before discontinued operations and cumulative effect of accounting changes $1.39 $2.15 $2.84 Discontinued operations...................... (0.33) (0.27) -- Cumulative effect of accounting changes...... 0.33 -- (0.03) -------------------------------------------------------------------------------------- Net Income...................................... $1.39 $1.88 $2.81 ======================================================================================
Unusual Items Unusual charges (credits) included in income before discontinued operations and the cumulative effect of accounting changes are summarized in the following table:
Unusual Items (pre-tax) 2003 2002 2001 ---------------------------------------------------------------------------------------------- (In millions) Investment impairments................................... $ 56 $ 101 $ -- Regulatory assets disallowance - JCP&L................... 185 -- -- Lake plants transaction - net settlement proceeds........ (168) -- -- - depreciation & sales costs..... -- 29 -- Goodwill impairment...................................... 117 -- -- Environmental liability.................................. 15 -- -- Long-term derivative contract adjustment................. -- 18 -- Generation project cancellation.......................... -- 17 -- Severance costs.......................................... -- 11 -- Uncollectible reserve and contract losses................ -- -- 9 Early retirement costs................................... -- -- 9 Estimated claim settlement............................... -- 17 -- ---------------------------------------------------------------------------------------------- Decrease in Pre-tax Earnings............................. $ 205 $ 193 $ 18 ============================================================================================== Reduction to earnings per share of common stock: Basic.................................................... $0.47 $0.40 $0.05 Diluted.................................................. $0.47 $0.40 $0.05
10 Results of Operations - 2003 Compared With 2002 Sources of changes in total revenues are summarized in the following table: Increase Sources of Revenue Changes 2003 2002 (Decrease) --------------------------------------------------------------------------- (In millions) Retail Electric Sales: Regulated services................ $ 7,926 $ 8,229 $(303) Competitive services.............. 566 348 218 Wholesale Electric Sales: Regulated services................ 593 550 43 Competitive services.............. 1,182 570 612 - --------------------------------------------------------------------------- Electric Sales...................... 10,267 9,697 570 Gas Sales........................... 624 613 11 Other Revenues: Regulated - principally transmission services........... 459 386 73 Competitive products and services. 886 964 (78) International....................... 25 294 (269) Other............................... 46 93 (47) --------------------------------------------------------------------------- Total Revenues...................... $12,307 $12,047 $ 260 ========================================================================== Changes in electric generation sales and distribution deliveries in 2003 are summarized in the following table: Increase Changes in KWH Sales (Decrease) ------------------------------------------------------ Electric Generation Sales: Retail - Regulated services.................... (7.2)% Competitive services.................. 53.0% Wholesale............................... 40.2% --------------------------------------------------- Total Electric Generation Sales........... 8.3% =================================================== EUOC Distribution Deliveries: Residential............................. (0.7)% Commercial and industrial............... 0.3% --------------------------------------------------- Total Distribution Deliveries............. --% =================================================== Retail electric sales from our regulated services segment declined principally due to increased sales by alternative suppliers in our franchise areas. Alternative suppliers provided 21.8% of the total energy delivered to retail customers in 2003, compared to 15.7% in 2002. As a result, generation kilowatt-hour sales to retail customers of our regulated services were 7.2% lower, which reduced retail electric sales revenues by $250 million. Additional credits provided to customers under the Ohio transition plan to promote customer shopping for alternative suppliers further reduced regulated retail electric sales revenues by $45 million. The latter decreases in revenues are deferred for future recovery under our Ohio transition plan and do not materially affect current period earnings. Revenues from distribution deliveries decreased $8 million with kilowatt-hour deliveries to franchise customers unchanged in 2003. The slight decrease in revenues resulted from additional distribution deliveries to the commercial sector due to the strengthening in the service area economy toward the end of 2003 which nearly offset a slight decline in distribution deliveries to residential and industrial customers. Regulated retail revenues were reduced by the New Jersey Board of Public Utilities (NJBPU) decision in July 2003 (see State Regulatory Matters - New Jersey) that lowered JCP&L's base electric rates effective August 1, 2003, on an annualized basis, by approximately $62 million. Retail sales by our competitive services segment increased by $218 million as a result of a 53% increase in kilowatt-hour sales. That increase primarily resulted from retail customers within our Ohio franchise areas switching to FES under Ohio's electricity choice program and from growth in competitive retail sales outside our franchise areas. Revenues from the wholesale market increased significantly by $655 million and kilowatt-hour sales rose by 40%. A majority of the increase was due to sales by our competitive services segment for a portion of New Jersey's BGS requirements and sales in the spot market. Higher electric sales revenues were more than offset by increased fuel and purchased power costs. Purchased power costs increased by $889 million due to higher unit costs and additional quantities purchased. Increased volumes were required to supply obligations assumed by FES for BGS sales in New Jersey, as well as other wholesale commitments, and additional supplies were required to replace reduced nuclear generation (down 14%). Reduced nuclear generation output resulted from additional refueling outage work performed at the Perry and Beaver Valley plants 11 in 2003. Reported purchased power costs in 2003 also included $153 million of power costs that were disallowed in the JCP&L rate case decision (see State Regulatory Matters - New Jersey). Electric sales revenues net of fuel and purchased power reduced income before interest and taxes by $328 million. Other factors contributing to reduced income before interest and taxes in 2003 include: o Asset impairment charges of $56 million incurred in 2003 including a $26 million non-cash charge related to the divestiture of our interest in Termobarranquilla S.A., Empresa de Servicios Publicos (TEBSA), a Colombian electric generation operation; a $13 million impairment on the monetization of the note received from the sale of our 79.9% interest in Avon Energy Partners Holding's (see Note 3); an additional $5 million impairment upon the divestiture of our remaining interest in Avon; and $12 million related to the disposition of Northeast Ohio Natural Gas (see Note 2(I)) and the write down of our investment in Pantellos, an internet business-to-business marketplace serving the utility sector. o A non-cash goodwill impairment charge of $117 million recorded in the third quarter of 2003 reducing the carrying value of FSG. This charge reflects the continued slow down in the development of competitive retail markets and depressed economic conditions that affect the value of FSG. o Increased energy delivery costs of $86 million principally due to storm restoration expenses and an accelerated reliability program within JCP&L's service territory. o Higher nuclear production costs of $54 million as a result of an additional nuclear refueling outage in 2003 and unplanned work performed during the refueling outages at the Perry Plant and Beaver Valley Unit 1. The higher production costs were partially offset by lower maintenance costs at the Davis-Besse Plant. o Planned maintenance outages at three of our fossil generating plants during the fourth quarter of 2003 increased non-nuclear operating expenses by approximately $25 million. o Increased postretirement plan expenses (see Postretirement Plans below) offset in part by lower incentive compensation costs contributed to a net cost increase of $94 million. o Revenues less operating expenses for energy-related services declined $17 million due to general declines associated with economic conditions. o An estimated environmental liability of $15 million was recognized in the fourth quarter of 2003. Partially offsetting these higher costs were three factors: o A settlement of our claim against NRG for the terminated sale of four fossil plants resulted in a $168 million gain. o Charges for depreciation and amortization decreased by $17 million due to: higher shopping incentive deferrals under the Ohio transition plan ($45 million), lower charges resulting from the implementation of SFAS 143 ($61 million), revised service life assumptions for nuclear generating plants ($28 million) and reduced depreciation rates resulting from the JCP&L rate case ($18 million). Partially offsetting these decreases were higher charges resulting from increased amortization of the Ohio transition regulatory assets ($70 million), termination of tax related deferrals in 2003 ($36 million), and costs disallowed in the JCP&L rate case decision ($33 million). o The absence of unusual charges recognized in 2002 resulted in a further net reduction of other operating expenses ($181 million) in 2003. Income before discontinued operations and the cumulative effect of accounting changes decreased $211 million from the prior period. The change also reflects reduced net interest charges ($146 million) and income taxes ($118 million), in addition to the changes discussed above. The decrease in interest expenses reflects debt and preferred stock redemptions and financing activities and the sale of our 79.9% interest in Avon in 2002. Redemption and refinancing activities for debt and preferred stock aggregated approximately $2.582 billion during 2003. Proceeds from the issuance of 32.2 million shares of common stock in September 2003 accelerated the repayment of debt. The redemption and refinancing activities and pollution control note repricings are expected to result in annualized savings of $125 million. We also exchanged existing fixed-rate payments on outstanding debt (notional amount of $1.15 billion at year end 2003) for short-term variable rate payments through interest rate swap transactions (see Market Risk Information - Interest Rate Swap Agreements below). Net interest charges were reduced by $27 million in 2003 as a result of these swaps. Counterparties called $594 million of our swaps during 2003 yielding total payments to FirstEnergy 12 of $20 million. Interest expense in 2003 was reduced $4 million due to cancellation of the swaps related primarily to our unregulated generation capacity. Discontinued Operations In 2003 and 2002, discontinued operations were reflected for GPU Empresa Distribuidora Electrica Regional S.A. and affiliates (Emdersa) and Empresa Guaracachi S.A. (EGSA), as we substantially completed our exit from foreign operations acquired through the merger with GPU in 2001. In addition, the results for the FSG subsidiaries, Colonial Mechanical, Webb Technologies and Ancoma, Inc. and the MARBEL subsidiary, Northeast Ohio Natural Gas Corp., which were divested in 2003, have been reported as discontinued operations for the years 2003 and 2002. The following table summarizes the sources of losses from discontinued operations: Discontinued Operations (Net of tax) 2003 2002 ------------------------------------------------------------------ (In millions) Emdersa - Abandonment........................ $ (67) $ -- EGSA - Loss on sale.......................... (33) -- Ancoma - Loss on sale........................ (3) -- ----------------------------------------------------------------- Total losses.............................. (103) -- Reclassification of operating income (loss).. to discontinued operations................ 2 (80) ------------------------------------------------------------------ Total........................................ $(101) $(80) ================================================================== Cumulative Effect of Accounting Change Results in 2003 include an after-tax credit to net income of $102 million recorded upon the adoption of SFAS 143 in January 2003 (see discussion below). FirstEnergy identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning, reclamation of a sludge disposal pond at the Bruce Mansfield Plant and two coal ash disposal sites. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $602 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $415 million. The ARO liability at the date of adoption was $1.107 billion, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, FirstEnergy had recorded decommissioning liabilities of $1.244 billion. FirstEnergy expects substantially all of its nuclear decommissioning costs for Met-Ed, Penelec, JCP&L and Penn to be recoverable in rates over time. Therefore, FirstEnergy recognized a regulatory liability of $185 million upon adoption of SFAS 143 for the transition amounts related to establishing the ARO for nuclear decommissioning for those companies. The remaining cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $175 million increase to income, or $102 million net of income taxes. Earnings Effect of SFAS 143 The application of SFAS 143 (excluding the cumulative adjustment described above) resulted in the following changes to expense categories and net income in 2003: Increase Effect of SFAS 143 (Decrease) ---------------------------------------------------------------------- (In millions) Other operating expense: Cost of removal expenditures (previously included in depreciation)...................................... $ 10 Depreciation: Elimination of decommissioning expense.................. (89) Depreciation of asset retirement cost................... 2 Accretion of asset retirement liability................. 42 Elimination of removal cost component................... (16) ------------------------------------------------------------------ Net decrease to depreciation............................ (61) ------------------------------------------------------------------ Income taxes............................................ 21 ----------------------------------------------------------------- Net income effect....................................... $ 30 ================================================================= 13 Results of Operations - 2002 Compared With 2001 Net income in 2002 included an after-tax loss of $80 million for discontinued operations. The loss primarily resulted from our divesting ownership of Emdersa through the abandonment of our shares in the parent company of the Argentina operation. We reclassified the results of Emdersa for the year ended December 31, 2002, recording its after-tax loss as discontinued operations. In the fourth quarter of 2002 we recognized a $50 million impairment charge on our remaining 20.1% interest in Avon. Originally acquired as part of the merger with GPU, we previously sold a 79.9% equity interest in Avon to Aquila in May 2002. As a result of our merger with GPU, results for 2002 include twelve months of operations for the former GPU companies compared to only seven weeks in 2001. The following table and related discussion excludes results for the former GPU companies in the 2002 and 2001 periods in order to provide a meaningful comparison.
Increase FirstEnergy 2002 2001 (Decrease) ------------------------------------------------------------------------------------------- (In millions) Total revenues.............................. $7,235 $7,366 $(131) Income before interest and income taxes..... 1,171 1,561 (390) Income before discontinued operations and cumulative effect of accounting change... 391 624 (233) Discontinued operations..................... 2 -- 2 Cumulative effect of accounting change...... -- (9) 9 ------------------------------------------------------------------------------------------ Net Income.................................. 393 615 (222) ------------------------------------------------------------------------------------------
Sources of changes in pre-merger revenues are summarized in the following table:
Increase Sources of Revenue Changes 2002 2001 (Decrease) --------------------------------------------------------------------------------------------- (In millions) Retail Electric Sales: Regulated services .............................. $4,282 $4,610 $(328) Competitive services.............................. 348 212 136 Wholesale Electric Sales: Regulated services .............................. 319 303 16 Competitive services: Nonaffiliated.................................. 570 430 140 Affiliated (former GPU companies).............. 378 33 345 ------------------------------------------------------------------------------------------ Electric Sales...................................... 5,897 5,588 309 Gas Sales........................................... 613 792 (179) Other Revenues: Regulated - principally transmission services..... 248 246 2 Competitive products and services................. 477 740 (263) ------------------------------------------------------------------------------------------ Total Revenues...................................... $7,235 $7,366 $(131) ==========================================================================================
Changes in electric generation sales and distribution deliveries in 2002 for our pre-merger companies are summarized in the following table: Increase Changes in KWH Sales (Decrease) --------------------------------------------- Electric Generation Sales: Retail - Regulated services............. (14.2)% Competitive services........... 59.0% Wholesale........................ 122.6% -------------------------------------------- Total Electric Generation Sales.... 22.0% ============================================ EUOC Distribution Deliveries: Residential...................... 6.3% Commercial and industrial........ (3.2)% -------------------------------------------- Total Distribution Deliveries...... (0.5)% ============================================ Retail electric sales from our regulated services segment declined due in large part to increased sales by alternative suppliers in our franchise areas (23.6% of total energy delivered in 2002 versus 11.3% in 2001). Generation kilowatt-hour sales to retail customers were 14.2% lower in 2002 than the prior year, which reduced retail electric sales revenues by $230 million. 14 Revenue from distribution deliveries decreased by $12 million or 0.4% in 2002 compared to 2001. Kilowatt-hour deliveries to franchise customers were lower due to a decline in kilowatt-hour deliveries to commercial and industrial customers as a result of sluggish economic conditions, offset in part by higher kilowatt-hour deliveries to residential customers primarily due to warmer summer weather in 2002. The remaining decrease in regulated retail electric sales revenues resulted from additional transition plan incentives provided to customers to promote customer shopping for alternative suppliers - $86 million of additional credits. These reductions to revenues are deferred for future recovery under our Ohio transition plan and do not materially affect current period earnings. Retail sales by our competitive services segment increased by $136 million as a result of a 59% increase in kilowatt-hour sales. That increase resulted from retail customers switching to FES, our unregulated subsidiary, under Ohio's electricity choice program. The higher kilowatt-hour sales in Ohio were partially offset by lower retail sales in markets outside of Ohio. Revenues from the wholesale market increased $501 million in 2002 from 2001 as kilowatt-hour sales more than doubled. More than half of the increase resulted from additional affiliated company sales by FES to Met-Ed and Penelec. FES assumed the supply obligation in the third quarter of 2002 for a portion of Met-Ed's and Penelec's PLR supply requirements (see State Regulatory Matters - Pennsylvania). The increase also included sales into the New Jersey market as an alternative supplier for a portion of New Jersey's BGS. Reduced gas revenues resulted principally from lower prices combined with a slight decline in sales volume. The elimination of coal trading activities in the second half of 2001 also contributed to the reduction in other competitive revenues along with reduced revenues from FSG primarily reflecting the divestiture of Colonial Mechanical and Webb Technologies in early 2003. Higher electric revenues were more than offset by increased fuel and purchased power costs. Purchased power costs increased by $332 million due to additional volumes to cover supply obligations assumed by FES. Fuel expense increased $100 million principally due to additional internal generation (5.4% higher) and an increased mix of higher cost coal and natural gas generation in 2002. The extended outage at the Davis-Besse nuclear plant produced a 15% decline in nuclear generation. An increase in natural gas margins resulted from purchased gas costs (i.e., lower unit costs) declining more than our gas sales prices. Higher other operating expenses also reduced income before interest and income taxes. Nuclear operating costs increased $125 million primarily due to $115 million of incremental Davis-Besse costs related to its extended outage (see Davis-Besse Restoration). An aggregate increase in administrative and general expenses and non-operating costs of $127 million resulted in large part from higher employee benefit expenses. FSG revenues, net of related expenses, reduced income before interest and taxes by $13 million. A number of unusual charges further contributed to the decrease as follows:
Increase Unusual Charges -- Pre-Merger Companies (pre-tax) 2002 2001 (Decrease) ------------------------------------------------------------------------------------------------- (In millions) Investment impairments........................................ $ 48 $-- $48 Lake Plants - sales costs..................................... 17 -- 17 Long-term derivative contract adjustment...................... 18 -- 18 Generation project cancellation............................... 17 -- 17 Severance costs - 2002........................................ 11 -- 11 Uncollectible reserve and contract losses..................... -- 9 (9) Early retirement costs - 2001................................. -- 9 (9) Estimated claim settlement.................................... 5 -- 5 ------------------------------------------------------------------------------------------------ $116 $18 $98 ================================================================================================
Charges for depreciation and amortization increased $74 million. This increase resulted from several factors: (1) higher amortization costs under the Ohio transition plan; (2) higher depreciation from the start-up of a new fluidized bed boiler in January 2002, owned by Bayshore Power Company, a wholly owned subsidiary; (3) new combustion turbine capacity added in late 2001; and (4) two months of 2001 depreciation ($12 million) recorded in 2002 (for the four fossil plants we chose not to sell) increased depreciation expense in 2002. However, two factors offset a portion of the above increase: shopping incentive deferrals and tax deferrals under the Ohio transition plan ($109 million) and the cessation of goodwill amortization ($56 million) beginning January 1, 2002. General taxes increased $28 million principally due to additional property taxes and the absence in 2002 of a benefit of $15 million resulting from the successful resolution of certain property tax issues in the prior year. 15 Partially offsetting these higher costs were the elimination in the second half of 2001 of coal trading activities ($95 million) and the reversal of lease obligations related to the Bruce Mansfield fossil facility and Beaver Valley nuclear facility which reduced other operating expenses by $85 million. Income before discontinued operations and cumulative effect of accounting changes decreased $233 million. The change reflects reduced net interest charges ($62 million) and income taxes ($95 million) in addition to the changes discussed above. Continued redemption and refinancing of our outstanding debt and preferred stock during 2002, maintained our downward trend in financing costs, before the effects of the merger with GPU. Excluding activities related to the former GPU companies, redemption and refinancing activities for debt and preferred stock aggregated approximately $1.2 billion during 2002 and is expected to result in annualized savings of $86 million. We also exchanged existing fixed-rate payments on outstanding debt (principal amount of $594 million at year end 2002) for short-term variable rate payments through interest rate swap transactions (see Market Risk Information - Interest Rate Swap Agreements below). Net interest charges for both pre-merger and post-merger companies were reduced by $17 million in 2002 as a result of these swaps. The related cash premiums will be recognized as a component of interest expense over the remaining maturity of each respective hedged security. The effective tax rate was 45.2% for 2002 compared to 42.0% in 2001. The increase in the effective tax rate was primarily attributable to new Ohio Franchise and Municipal income taxes implemented in 2002 as a result of Ohio Electric Restructuring. Discontinued Operations The divestiture of Colonial, Webb, Ancoma and Northeast Ohio Natural Gas resulted in their revenues and expenses, with net after-tax earnings of $2 million, being reported as discontinued operations in 2002. Cumulative Effect of Accounting Change In 2001, we adopted SFAS 133 (as amended), "Accounting for Derivative Instruments and Hedging Activities" resulting in a $9 million after-tax charge. POSTRETIREMENT PLANS Declines in equity markets in 2001 and 2002 and a reduction in our assumed discount rate in 2002 have combined to produce a negative trend in pension expenses. Also, increases in health care payments and a related increase in projected trend rates have led to higher other postemployment benefits (OPEB). The following table includes the portion of postretirement costs that were expensed in 2003 and 2002. Postretirement Expenses (Income) 2003 2002 Increase ----------------------------------------------------------------- (In millions) Pension........................ $123 $(14) $137 OPEB........................... 156 102 54 - ---------------------------------------------------------------- Total.......................... $279 $ 88 $191 ================================================================ The following table presents the pre-tax pension and OPEB expenses for 2002 and 2001 excluding the former GPU companies. Postretirement Expenses (Income) 2002 2001 Increase ----------------------------------------------------------------- (In millions) Pension........................ $ 16 $(11) $27 OPEB........................... 99 87 12 - ---------------------------------------------------------------- Total.......................... $115 $ 76 $39 ================================================================ The pension and OPEB expense increases are included in various cost categories and have contributed to other cost increases discussed above. See "Critical Accounting Policies - Pension and Other Postretirement Benefits Accounting" for a discussion of the impact of underlying assumptions on postretirement expenses. PJM INTERCONNECTION TRANSACTIONS Our subsidiaries record purchase and sales transactions with PJM Interconnection ISO, an independent system operator, on a gross basis in accordance with Emerging Issues Task Force (EITF) Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." This gross basis classification of revenues and costs may not be comparable to other energy companies that operate in regions that have not established ISOs and do not meet EITF 99-19 criteria. The aggregate purchase and sales transactions for the three years ended December 31, 2003, are summarized as follows: 16 2003 2002 2001 - --------------------------------------------------------------- (In millions) Sales............. $ 990 $453 $142 Purchases......... 1,019 687 204 -------------------------------------------------------------- Our revenues on the Consolidated Statements of Income include wholesale electricity sales revenues from the PJM ISO for power sales (as reflected in the table above) during periods when we had additional available power for sale. Revenues also include our sales of power sourced from the PJM ISO (reflected as purchases in the table above) during periods when we required additional power to meet our retail load requirements and, secondarily, to sell in the wholesale market. RESULTS OF OPERATIONS - BUSINESS SEGMENTS We manage our business as two separate major business segments - regulated services and competitive services. The regulated services segment operates and maintains our regulated domestic transmission and distribution systems and also provides generation services to franchise customers who have not chosen an alternative generation supplier. The Ohio Companies (OE, CEI and TE) and Penn obtain generation through a power supply agreement with the competitive services segment. The competitive services segment also supplies a substantial portion of the PLR requirements for Met-Ed and Penelec through a wholesale contract. The competitive services segment includes all competitive energy and energy-related services including commodity sales (both electricity and natural gas) in the retail and wholesale markets, marketing, generation, trading and sourcing of commodity requirements, as well as other competitive energy application services such as heating, ventilation and air-conditioning. International operations, corporate support costs and interest costs on holding company debt are included in the aggregate "other" segment (see Note 8 for further discussion). Our two major business segments include all or a portion of the following business entities: o Regulated operations include the regulated sale of electricity and distribution and transmission services by OE, CEI, TE, Penn, JCP&L, Met-Ed, Penelec and ATSI. o Competitive operations include the operation of generation facilities owned by OE, CEI, TE and Penn, and all operations of FES, FSG, MYR, MARBEL and First Communications. Financial results discussed below include revenues and expenses from transactions among our business segments. A reconciliation of segment financial results to consolidated financial results is provided in Note 8 to the consolidated financial statements. Net income (loss) by business segment was as follows: Net Income (Loss) By Business Segment 2003 2002 2001 ----------------------------------------------------------------- (In millions) Regulated services......... $ 986 $ 928 $729 Competitive services....... (210) (109) (32) Other...................... (353) (266) (51) ------------------------------------------------------------------ Total...................... $ 423 $ 553 $646 =================================================================== Excluding the results associated with the former GPU companies, comparable results for 2002 and 2001 are as follows: Net Income (Loss) By Business Segment 2002 2001 -------------------------------------------------- (In millions) Regulated Services...... $ 560 $674 Competitive Services.... (114) (35) Other................... (53) (24) ------------------------------------------------- Total................... $ 393 $615 ================================================ 17 Regulated Services 2003 versus 2002: Financial results for 2003 and 2002 include an entire year of operations for the former GPU companies.
Increase Regulated Services 2003 2002 (Decrease) ---------------------------------------------------------------------------------------- (In millions) Total revenues............................... $10,070 $10,218 $(148) Income before interest and income taxes....... 2,034 2,214 (180) Income before cumulative effect of accounting changes.................................... 885 928 (43) Net Income.................................... 986 928 58 ----------------------------------------------------------------------------------------
The change in operating revenues resulted from the following sources: Increase Sources of Revenue Changes 2003 2002 (Decrease) ---------------------------------------------------------------------- (In millions) Electric: External sales.......... $ 8,519 $ 8,779 $(260) Internal sales.......... 777 741 36 ------------------------------------------------------------------- 9,296 9,520 (224) ------------------------------------------------------------------- Other: External sales.......... 459 387 72 Internal sales.......... 315 311 4 ------------------------------------------------------------------- 774 698 76 ------------------------------------------------------------------- Total Revenues............. $10,070 $10,218 $(148) ------------------------------------------------------------------- External electric sales revenues declined $260 million, reflecting a $303 million decrease in retail revenues partially offset by a $43 million increase in sales to wholesale customers. The net decline in retail revenues resulted from the following factors: o Reduced generation sales revenue of $250 million on a 7.2% reduction in kilowatt-hour sales (6.1 percentage point increase in generation provided to customers by alternative suppliers); o Additional reductions to revenues from increased credits of $45 million provided to customers to promote shopping for alternative suppliers; and o Lower revenues from distribution deliveries of $8 million. The additional internal sales resulted from sales by the EUOC to FES. Lower electric sales revenue due to reduced kilowatt-hour sales, an increase in purchased power costs and higher energy delivery and other costs, particularly employee benefit costs, combined to reduce income before interest and taxes by $391 million. The increase of $86 million in energy delivery costs was principally due to storm restoration expenses and an accelerated reliability plan within JCP&L's service territory. Partially offsetting these factors were: o Settlement of our claim against NRG for the terminated sale of four fossil plants resulted in our recording a $168 million pre-tax credit to earnings. o Charges for depreciation and amortization decreased $25 million. This decrease resulted from several factors: higher shopping incentive deferrals under the Ohio transition plan, lower charges resulting from the implementation of SFAS 143, revised service life assumptions for nuclear generating plants and reduced depreciation rates resulting from the JCP&L rate case. Partially offsetting these decreases were increased charges resulting from increased amortization of the Ohio transition regulatory assets, termination of tax related deferrals in 2003, and costs disallowed in the JCP&L rate case decision. o The absence of unusual charges recognized in 2002 resulted in a further net reduction of other operating expenses ($35 million) from last year. 2002 versus 2001: Excluding the results associated with the former GPU companies, comparable results for 2002 and 2001 are as follows: 18 Regulated Services (Pre-Merger) 2002 2001 (Decrease) - ------------------------------------------------------------------------------- (In millions) Total revenues........................... $5,870 $6,400 $(530) Income before interest and income taxes.. 1,407 1,713 (306) Net Income............................... 560 674 (114) - ------------------------------------------------------------------------------ Lower generation sales, additional transition plan incentives and a slight decline in revenue from distribution deliveries combined for a $312 million reduction in external revenues in 2002 from the prior year. Shopping by Ohio customers from alternative energy suppliers together with the effect of a sluggish national economy on our regional business reduced retail electric sales revenues. In addition, a $188 million decline in revenues resulted from lower sales to FES, due to the extended outage of the Davis-Besse nuclear plant, which reduced generation available for sale. A reduction in purchased power costs of $180 million reflects the impact of the lower generation kilowatt-hour sales discussed above. Excluding the net effect of lower electric revenues and purchased power, income before interest and taxes increased $44 million. The increase was caused by reduced operating costs ($114 million) offset in part by higher depreciation ($59 million) and general taxes ($11 million). The increase in depreciation resulted from higher incremental transition costs partially offset by new deferred regulatory assets under the Ohio transition plan and the cessation of goodwill amortization beginning January 1, 2002. Net income decreased $114 million. The change reflects decreased net interest charges ($132 million) and reduced income taxes ($60 million) in addition to the changes discussed above. Competitive Services 2003 versus 2002: Financial results for 2003 and 2002 include a full twelve months of operations for the former GPU companies. Increase Competitive Services 2003 2002 (Decrease) - -------------------------------------------------------------------------------- (In millions) Total revenues................................ $5,402 $4,526 $ 876 Loss before interest and income tax benefit... (287) (154) (133) Loss before discontinued operations and cumulative effect of accounting changes.... (205) (111) (94) Net loss...................................... (210) (109) (101) - ------------------------------------------------------------------------------- The change in total revenues resulted from the following sources: Increase Sources of Revenue Changes 2003 2002 (Decrease) - ------------------------------------------------------------------------ (In millions) Electric: External sales.............. $1,748 $ 918 $ 830 Internal sales.............. 2,168 2,044 124 - --------------------------------------------------------------------- 3,916 2,962 954 - --------------------------------------------------------------------- Other External: Natural Gas sales........... 624 613 11 Energy-related sales........ 766 904 (138) Other....................... 96 47 49 - --------------------------------------------------------------------- 1,486 1,564 (78) - ---------------------------------------------------------------------- Total Revenues................. $5,402 $4,526 $ 876 - ---------------------------------------------------------------------- The increase in external electric revenues resulted from: o Retail sales increased by $218 million as a result of a 53% increase in kilowatt-hour sales. The increase primarily resulted from retail customers within our Ohio franchise areas switching to FES under Ohio's electricity choice program and from growth in competitive retail sales outside our franchise areas. o Revenues from the wholesale market increased $612 million and kilowatt-hour sales rose by 75%. The increase reflects sales as an alternative supplier for a portion of New Jersey's BGS requirements. Internal electric revenues increased from sales by FES to the EUOC to meet their energy requirements. Revenues from energy-related services declined 15% due to declines associated with weak economic conditions. Electric revenue, net of purchased power costs and the absence of $69 million of unusual charges (representing the net of unusual charges in 2003 and 2002), contributed $185 million to income before interest and taxes. Offsetting these increases were: 19 o Recognition of a non-cash goodwill impairment charge of $117 million (excluding amount in discontinued operations) in the third quarter of 2003 reducing the carrying value of FSG. This charge reflects the continued slow down in the development of competitive retail markets and depressed economic conditions that affect the value of FSG. o Nuclear production costs increased $54 million as a result of an additional nuclear refueling outage in 2003 and longer outages involving additional maintenance work, offset in part by reduced maintenance work at Davis-Besse. o Planned maintenance outages at three of our fossil generating plants during the fourth quarter of 2003 increased non-nuclear operating expenses by approximately $25 million. o Revenues less expenses for energy-related services declined $17 million due to declines associated with economic conditions. o General taxes increased $15 million in 2003 compared to last year. Higher payroll and kilowatt-hour taxes in 2003 were the principal factors contributing to the increase. o Higher depreciation and employee benefits costs also contributed to the decrease in income before interest and taxes. 2002 versus 2001: Excluding the results associated with the former GPU companies, comparable results for 2002 and 2001 are as follows:
Increase Competitive Services (Pre-Merger) 2002 2001 (Decrease) ---------------------------------------------------------------------------------------- (In millions) Total revenues................................. $4,005 $3,948 $ 57 Loss before interest and income tax benefit.... (162) (27) (135) Loss before discontinued operations and cumulative effect of accounting changes..... (116) (26) (90) Net loss....................................... (114) (35) (79) ---------------------------------------------------------------------------------------
The $57 million increase in revenues in 2002, compared to 2001, is the net effect of several factors. Kilowatt-hour sales in the wholesale market more than doubled in 2002, increasing revenues by $485 million. More than half of the increase resulted from additional kilowatt-hour sales to Met-Ed and Penelec to supply a portion of their PLR requirements in Pennsylvania, as well as BGS sales in New Jersey and sales under several other contracts. Retail revenues increased by $137 million as a result of additional kilowatt-hour sales within Ohio under Ohio's electricity choice program. Total electric sales revenue increased $622 million in 2002 from 2001, accounting for almost all of the net increase in revenues. Offsetting the higher electric sales revenue were reduced natural gas revenues ($179 million) primarily due to lower prices, and less revenue from FSG ($213 million) reflecting its reclassification to discontinued operations and the sluggish economy. Internal sales to the regulated services segment decreased $180 million in large part due to the impact of customer shopping reducing requirements by the regulated services segment. Higher electric revenues were nearly offset by increased fuel and purchased power costs. Higher purchased power costs resulted from additional volumes to cover supply obligations assumed by FES. Fuel costs increased in part due to an increased mix of higher cost fossil generation in 2002. The extended outage at the Davis-Besse nuclear plant produced a 15% decline in nuclear generation. Lower purchased gas costs due to lower unit costs more than offset reduced gas revenues resulting in an improvement in gas margins. Nuclear operating costs increased $125 million primarily due to $115 million of incremental Davis-Besse costs related to its extended outage (see Davis-Besse Restoration). A number of unusual charges discussed above increased other expenses by $76 million in 2002. Loss before discontinued operations and cumulative effect of accounting changes increased $90 million. The change reflects increased net interest charges ($20 million) and increased income tax benefit ($66 million), as well as the changes discussed above. The divestiture of Colonial, Webb, Ancoma and Northeast Ohio Natural Gas resulted in their revenues and expenses, with net after-tax earnings of $2 million, being reported as discontinued operations in 2002. 20 Net income in 2001 also includes the cumulative effect of an accounting change from the adoption of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" which resulted in an after-tax charge of $9 million. CAPITAL RESOURCES AND LIQUIDITY Changes in Cash Position The primary source of ongoing cash for FirstEnergy, as a holding company, is cash dividends from its subsidiaries. The holding company also has access to $1.25 billion through revolving credit facilities. In 2003, FirstEnergy received $864 million of cash dividends on common stock from its subsidiaries and paid $453 million in cash dividends on common stock to its shareholders. There are no material restrictions on the payments of cash dividends by FirstEnergy's subsidiaries. As of December 31, 2003, we had $114 million of cash and cash equivalents, compared with $196 million as of December 31, 2002. Cash and cash equivalents as of December 31, 2003 included $32 million received in December 2003 which was included in the NRG settlement claim sold in January 2004 (see Note 3). Cash and cash equivalents as of December 31, 2002 included $50 million used for the redemption of long-term debt in January 2003. The major sources for changes in these balances are summarized below. Cash Flows From Operating Activities Our consolidated net cash from operating activities is provided by our regulated and competitive energy services businesses (see Results of Operations - Business Segments above). Net cash provided from operating activities was $1.952 billion in 2003, $1.915 billion in 2002 and $1.282 billion in 2001, summarized as follows: Operating Cash Flows 2003 2002 2001 ------------------------------------------------------------ (In millions) Cash earnings (1).............. $1,829 $1,655 $1,294 Working capital and other...... 123 260 (12) -------------------------------------------------------------- Total.......................... $1,952 $1,915 $1,282 ============================================================= (1) Includes net income, depreciation and amortization, deferred income taxes, investment tax credits and major noncash charges. Net cash provided from operating activities increased $37 million in 2003 compared to 2002 due to a $174 million increase in cash earnings and a $137 million decrease from changes in working capital. Net cash from operating activities in 2001 included seven weeks of results of the former GPU companies. Excluding the former GPU companies, 2002 and 2001 cash flows from operating activities totaled $1.464 billion and $1.572 billion, respectively, with the decrease principally reflecting reduced cash earnings. Cash Flows From Financing Activities In 2003 and 2002, the net cash used for financing activities of $1.322 billion and $1.123 billion, respectively, primarily reflects the redemptions of debt and preferred stock shown below. The following table provides details regarding new issues and redemptions during 2003 and 2002: Securities Issued or Redeemed 2003 2002 ------------------------------------------------------------------------ (In millions) New Issues Pollution Control Notes................. $ -- $ 143 Transition Bonds (See Note 5(H))........ -- 320 Secured Notes........................... 400 -- Unsecured Notes......................... 627 210 Other, principally debt discounts....... -- (4) ------------------------------------------------------------------------ $1,027 $ 669 Redemptions First Mortgage Bonds.................... $1,483 $ 728 Pollution Control Notes................. 238 93 Secured Notes........................... 323 278 Unsecured Notes ........................ 85 189 Preferred Stock......................... 127 522 Other, principally redemption premiums.. -- 21 ------------------------------------------------------------------------ $2,256 $1,831 Short-term Borrowings, Net....................... $ (575) $ 479 ------------------------------------------------------------------------ 21 Net cash used for financing activities increased by $199 million in 2003 as compared to 2002. The increase in funds used for financing activities resulted from an increase in net redemptions of debt and preferred securities of $1.1 billion partially offset by $934 million of common equity financing in 2003. We had approximately $522 million of short-term indebtedness at the end of 2003 compared to approximately $1.1 billion at the end of 2002. Available borrowing capability as of December 31, 2003 included the following:
FirstEnergy Borrowing Capability Holding Company OE TE Total -------------------------------------------------------------------------------------- (In millions) Long-Term Revolver.............. $ 875 $375 $ -- $1,250 Utilized........................ (270) (40) -- (310) Letters of Credit............... (184) -- -- (184) -------------------------------------------------------------------------------------- Net............................. 421 335 -- 756 ------------------------------------------------------------------------------------- Short-Term Facilities: Revolver........................ 375 125 -- 500 Bank ........................... -- 34 70 104 ------------------------------------------------------------------------------------- 375 159 70 604 Utilized: Revolver........................ (280) -- -- (280) Bank............................ -- (17) (70) (87) -------------------------------------------------------------------------------------- Net............................. 95 142 -- 237 ------------------------------------------------------------------------------------- Amount Available................ $ 516 $477 $ -- $ 993 =====================================================================================
At the end of 2003, the Ohio companies and Penn had the aggregate capability to issue approximately $3.1 billion of additional first mortgage bonds (FMB) on the basis of property additions and retired bonds, although unsecured senior note indentures entered into by OE and CEI in 2003 limit each company's ability to issue secured debt, including FMBs, subject to certain exceptions. JCP&L, Met-Ed and Penelec no longer issue FMB other than as collateral for senior notes, since their senior note indentures prohibit them (subject to certain exceptions) from issuing any debt which is senior to the senior notes. As of December 31, 2003, JCP&L, Met-Ed and Penelec had the aggregate capability to issue $339 million of additional senior notes using FMB collateral. Based upon applicable earnings coverage tests in their respective charters, OE, Penn, TE and JCP&L could issue a total of $2.8 billion of preferred stock (assuming no additional debt was issued) as of the end of 2003. CEI, Met-Ed and Penelec have no restrictions on the issuance of preferred stock (see Note 5(E)) - Long-Term Debt for discussion of debt covenants). In March 2003, we filed a registration statement with the U.S. Securities and Exchange Commission covering securities in the aggregate of up to $2 billion. The shelf registration provides the flexibility to issue and sell various types of securities, including common stock, debt securities, and share purchase contracts and related share purchase units. In September 2003, we used approximately one-half of the amount available with a common stock issuance of 32.2 million shares at $30 per share for net proceeds of approximately $935 million. At the end of 2003, our common equity as a percentage of capitalization stood at 45% compared to 38% and 35% at the end of 2002 and 2001, respectively. The higher common equity percentage in 2003 compared to 2001 reflects net redemptions of preferred stock and long-term debt, the issuance of equity discussed above, and the increase in retained earnings. In October 2003, FirstEnergy restructured its $1 billion 364-day revolving credit facility through a syndicated bank offering that was completed on October 23, 2003. The new syndicated FirstEnergy facilities consist of a $375 million 364-day revolving credit facility and a $375 million three-year revolving credit facility. Also on October 23, 2003, OE entered into a syndicated $125 million 364-day revolving credit facility and a syndicated $125 million three-year revolving credit facility. Combined with an existing syndicated $500 million three-year facility for FirstEnergy, maturing in November 2004, and an existing syndicated $250 million two-year facility for OE, maturing in May 2005, FirstEnergy's primary syndicated credit facilities total $1.75 billion. These facilities are intended to provide liquidity to meet the short-term working capital requirements of FE and its subsidiaries. Available borrowing capacity under existing facilities totaled $993 million at December 31, 2003. Borrowings under these facilities are conditioned on FirstEnergy and/or OE maintaining compliance with certain financial covenants in the agreements. FirstEnergy, under its $375 million 364-day and $375 million three-year facilities, and OE, under its $125 million 364-day and $250 million two-year facilities, are each required to maintain a debt to total capitalization ratio of no more than .65 to 1 and a contractually-defined fixed charge coverage ratio of no less than 2 to 1. Under its $500 million three-year facility, FirstEnergy is required to maintain a debt to total capitalization ratio of no more than .69 to 1 and a contractually-defined fixed charge coverage ratio for the most recent fiscal quarter of no less than 1.5 to 1. FirstEnergy and OE are in compliance with all of these financial covenants. The ability to draw on each of these facilities is also conditioned upon FirstEnergy or OE making certain representations and warranties to the lending 22 banks prior to drawing on their respective facilities, including a representation that there has been no material adverse change in its business, its condition (financial or otherwise), its results of operations, or its prospects. None of FirstEnergy's or OE's primary credit facilities contain provisions, whereby their ability to borrow would be restricted or denied, or repayment of outstanding loans under the facilities accelerated, as a result of any change in the credit ratings of FirstEnergy or OE by any of the nationally-recognized rating agencies. Borrowings under each of the primary facilities do contain "pricing grids", whereby the cost of funds borrowed under the facilities is related to the credit ratings of the company borrowing the funds. Our regulated companies have the ability to borrow from each other and the holding company to meet their short-term working capital requirements. A similar but separate arrangement exists among our competitive companies. FirstEnergy Service Company administers these two money pools and tracks surplus funds of FirstEnergy and the respective regulated and competitive subsidiaries, as well as proceeds available from bank borrowings. For the regulated companies, available bank borrowings include $1.75 billion from FirstEnergy's and OE's revolving credit facilities. For the competitive companies, available bank borrowings include only the $1.25 billion of FirstEnergy's revolving credit facility. Companies receiving a loan under the money pool agreements must repay the principal amount of such a loan, together with accrued interest, within 364 days of borrowing the funds. For the regulated and competitive money pools, the rate of interest is the same for each company receiving a loan from their respective pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47% for the regulated companies' pool and 1.90% for the competitive companies' pool. Our access to capital markets and costs of financing are dependent on the ratings of our securities. The following table shows our securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. Ratings of Securities - ------------------------------------------------------------------------------- Securities S&P Moody's Fitch - ------------------------------------------------------------------------------- FirstEnergy Senior unsecured BB+ Baa3 BBB- OE Senior secured BBB Baa1 BBB+ Senior unsecured BB+ Baa2 BBB Preferred stock BB Ba1 BBB- CEI Senior secured BBB- Baa2 BBB- Senior unsecured BB+ Baa3 BB Preferred stock BB Ba2 BB- TE Senior secured BBB- Baa2 BBB- Senior unsecured BB+ Baa3 BB Preferred stock BB Ba2 BB- Penn Senior secured BBB- Baa1 BBB+ Senior unsecured (1) BB+ Baa2 BBB Preferred stock BB Ba1 BBB- JCP&L Senior secured BBB Baa1 BBB+ Preferred stock BB Ba1 BBB Met-Ed Senior secured BBB Baa1 BBB+ Penelec Senior secured BBB Baa1 BBB+ Senior unsecured BBB- Baa2 BBB - ------------------------------------------------------------------------------ (1) Penn's only senior unsecured debt obligations are pollution control revenue refunding bonds issued in the name of the Ohio Air Quality Development Authority to which this rating applies. On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." Fitch also lowered the senior secured, senior unsecured, and preferred stock ratings of Met-Ed, Penelec, CEI, and TE. In addition, Fitch affirmed the ratings of OE, Penn and JCP&L. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy, and all of the securities of its electric utility operating companies. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." On December 23, 2003, S&P lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". Except 23 for OE's senior secured issue rating, which was left unchanged, all other subsidiary ratings were lowered one notch as well (see table above). The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions in our ratings included uncertainty regarding the timing of the Ohio Rate Plan filing (see State Regulatory Matters), the pending final report on the August 14th power outage (see Power Outage), the outcome of the remedial phase of litigation relating to the Sammis plant (see Environmental Matters), and the extended Davis-Besse outage and the related pending subpoena (see Davis-Besse Restoration). S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of our credit ratings in December 2003 triggered cash and letter-of-credit collateral calls (see Guarantees and Other Assurances below) in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2 and downgraded the senior secured debt of JCP&L, Met-Ed and Penelec to Baa1 from A2. Moody's also downgraded the preferred stock rating of JCP&L to Ba1 from Baa2 and the senior unsecured rating of Penelec to Baa2 from A2. The ratings of OE, CEI, TE and Penn were confirmed. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows From Investing Activities Net cash flows used in investing activities totaled $712 million in 2003. The net cash used for investing was principally for property additions. Regulated services expenditures for property additions primarily include expenditures supporting the distribution of electricity. Expenditures for property additions by the competitive services segment are principally generation-related, including $21 million for capital additions at the Davis-Besse nuclear plant during its extended outage. The following table summarizes 2003 investments by our regulated services and competitive services segments: Summary of 2003 Cash Flows Property Used for Investing Activities Additions Investments Other Total ----------------------------------------------------------------------------- Sources (Uses) (In millions) Regulated Services............. $(434)(1) $(38)(3) $ 16 $(456) Competitive Services........... (345)(2) 2 (4) (13) (356) Other.......................... (77) 101 (5) 76 100 ----------------------------------------------------------------------------- Total..................... $(856) $ 65 $ 79 $(712) ============================================================================= (1) Property additions primarily for transmission and distribution facilities. (2) Property additions to generation facilities. (3) Net of several items from cash and other investments and Penelec's NUG trust offset in part by investments in nuclear decommissioning trusts. (4) Net proceeds from sale of assets. (5) Proceeds from Aquila Note. In 2002, net cash flows used in investing activities totaled $816 million, principally due to property additions ($998 million) which were partially offset by proceeds from the sale of Midlands ($155 million). Net cash used for investing activities decreased by $104 million in 2003 compared to 2002 primarily due to decreased capital expenditures partially offset by net changes in nuclear decommissioning and NUG trust investments and decreased proceeds from sale of assets. Our cash requirements in 2004 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without increasing our net debt and preferred stock outstanding. In addition, a refunding payment of $50 million was made to the NUG trust fund (see State Regulatory Matters - Pennsylvania) in January 2004. Available borrowing capacity under existing credit facilities will be used to manage working capital requirements. Over the next three years, we expect our cash requirements will be met with cash from operations and funds from the capital markets, if needed. Our capital spending for the period 2004-2006 is expected to be about $2.3 billion (excluding nuclear fuel), of which approximately $713 million applies to 2004. Investments for additional nuclear fuel during the 2004-2006 period 24 are estimated to be approximately $323 million, of which about $90 million applies to 2004. During the same period, our nuclear fuel investments are expected to be reduced by approximately $285 million and $93 million, respectively, as the nuclear fuel is consumed. CONTRACTUAL OBLIGATIONS Contractual Obligations Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows:
2005- 2007- Contractual Obligations Total 2004 2006 2008 Thereafter - --------------------------------------------------------------------------------------------------------------- (In millions) Long-term debt................... $11,471 $1,256 $1,964 $ 572 $ 7,679 Short-term borrowings............ 522 522 -- -- -- Preferred stock (1).............. 19 2 4 13 -- Capital leases (2)............... 24 6 10 2 6 Operating leases (2)............. 2,545 182 363 358 1,642 Pension funding (3).............. 835 -- 546 289 -- Purchases (4).................... 15,145 2,603 3,886 3,325 5,331 - -------------------------------------------------------------------------------------------------------------- Total........................ $30,561 $4,571 $6,773 $4,559 $14,658 ============================================================================================================== (1) Subject to mandatory redemption. (2) See Note 4. (3) Amounts represent our estimate of the contributions necessary to maintain our defined benefit pension plan's funding at a minimum required level as determined by government regulations. Amounts are subject to change based on the performance of the assets in the plan as well as the discount rate used to determine the obligation. We are unable to estimate the projected contributions beyond 2007. (4) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing.
Guarantees and Other Assurances As part of normal business activities, we enter into various agreements on behalf of our subsidiaries to provide financial or performance assurances to third parties. Such agreements include contract guarantees, surety bonds, and letters of credit. Some contracts contain ratings contingent collateralization provisions. As of December 31, 2003, the maximum potential future payments under outstanding guarantees and other assurances totaled approximately $1.9 billion, as summarized below: Maximum Guarantees and Other Assurances Exposure -------------------------------------------------------- (In millions) FirstEnergy Guarantees of Subsidiaries Energy and Energy-Related Contracts(1) ..... $ 857 Other (2)................................... 174 -------------------------------------------------------- 1,031 Surety Bonds.................................. 161 Letters of Credit (3)(4)...................... 678 -------------------------------------------------------- Total Guarantees and Other Assurances....... $1,870 ======================================================== (1) Issued for a one-year term, with a 10-day termination right by FirstEnergy. (2) Issued for various terms. (3) Includes letters of credit of $184 million issued for various terms under letter of credit capacity available in FirstEnergy's revolving credit agreement. (4) Includes unsecured letters of credit of approximately $216 million pledged in connection with the sale and leaseback of Beaver Valley Unit 2 by CEI and TE (see Note 5 (E)), as well as collateralized letters of credit of $278 million pledged in connection with the sale and leaseback of Beaver Valley Unit 2 by OE (see Note 4). We guarantee energy and energy-related payments of our subsidiaries involved in energy marketing activities - principally to facilitate normal physical transactions involving electricity, gas, emission allowances and coal. We also provide guarantees to various providers of subsidiary financing principally for the acquisition of property, plant and equipment. These agreements legally obligate us and our subsidiaries to fulfill the obligations of our subsidiaries directly involved in these energy and energy-related transactions or financings where the law might otherwise limit the counterparties' claims. If demands of a counterparty were to exceed the ability of a subsidiary to satisfy existing 25 obligations, our guarantee enables the counterparty's legal claim to be satisfied by our other assets. The likelihood that such parental guarantees will increase amounts otherwise paid by us to meet our obligations incurred in connection with ongoing energy and energy-related contracts is remote. While these types of guarantees are normally parental commitments for the future payment of subsidiary obligations, subsequent to the occurrence of a credit rating-downgrade or "material adverse event" the immediate payment of cash collateral or provision of a letter of credit may be required. The following table summarizes collateral provisions as of December 31, 2003: Collateral Paid Total ---------------------------- Remaining Collateral Provisions Exposure Cash Letters of Credit Exposure (1) - -------------------------------------------------------------------------------- (In millions) Rating downgrade...... $187 $68 $ 5 $114 Adverse event......... 235 -- 65 170 -------------------------------------------------------------------------- Total................. $422 $68 $70 $284 ========================================================================== (1) As of February 11, 2004, we had a remaining exposure of $282 million with $106 million of cash and $87 million of letters of credit provided as collateral. Most of our surety bonds are backed by various indemnities common within the insurance industry. Surety bonds and related guarantees provide additional assurance to outside parties that contractual and statutory obligations will be met in a number of areas including construction contracts, environmental commitments and various retail transactions. We have guaranteed the obligations of the operators of the TEBSA project, up to a maximum of $6.0 million (subject to escalation) under the project's operations and maintenance agreement. In connection with the sale of TEBSA in January 2004, the purchaser indemnified FirstEnergy against any loss under this guarantee. We have provided the TEBSA project lenders a $50 million letter of credit (LOC) (under our existing $250 million LOC capacity available as part of our $1.25 billion credit facilities) to obtain TEBSA lender consent as substitute collateral for the release of the assets for us to abandon our Argentina operations, Emdersa (see Note 3). In December 2003, a replacement LOC was issued in the amount of $60 million, which is renewable and declines yearly based upon the senior outstanding debt of TEBSA. This LOC granted us the ability to sell our remaining 20.1% interest in Avon, as well as abandon the Argentina assets in April 2003. OFF-BALANCE SHEET ARRANGEMENTS We have obligations that are not included on our Consolidated Balance Sheets related to the sale and leaseback arrangements involving Perry Unit 1, Beaver Valley Unit 2 and the Bruce Mansfield Plant, which are reflected as part of the operating lease payments disclosed above (see Notes 4 and 9). The present value of these sale and leaseback operating lease commitments, net of trust investments, total $1.4 billion as of December 31, 2003. CEI and TE sell substantially all of their retail customer receivables to Centerior Funding Corporation (CFC), a wholly owned subsidiary of CEI. CFC subsequently transfers the receivables to a trust (a "qualified special purpose entity)" under SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," under an asset-backed securitization agreement. This provided $200 million of off-balance sheet financing as of December 31, 2003. See Note 2(C) for additional discussion about this arrangement. As of December 31, 2003, off-balance sheet arrangements include certain statutory business trusts created by CEI, Met-Ed and Penelec to issue trust preferred securities aggregating $285 million. These trusts were included in the consolidated financial statements of FirstEnergy prior to adoption of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", but have subsequently been deconsolidated under "FIN 46R" (see Note 9 - New Accounting Standards and Interpretations). This has not resulted in any change in outstanding debt. FirstEnergy has equity ownership interests in certain various businesses that are accounted for using the equity method. There are no undisclosed material contingencies related to these investments. Certain guarantees that we do not expect to have a material current or future effect on our financial condition, liquidity or results of operations are disclosed under contractual obligations above. MARKET RISK INFORMATION We use various market risk sensitive instruments, including derivative contracts, primarily to manage the risk of price and interest rate fluctuations. Our Risk Policy Committee, comprised of executive officers, exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. 26 Commodity Price Risk We are exposed to market risk primarily due to fluctuations in electricity, natural gas and coal prices. To manage the volatility relating to these exposures, we use a variety of non-derivative and derivative instruments, including forward contracts, options, futures contracts and swaps. The derivatives are used principally for hedging purposes and, to a much lesser extent, for trading purposes. Most of our non-hedge derivative contracts represent non-trading positions that do not qualify for hedge treatment under SFAS 133. The change in the fair value of commodity derivative contracts related to energy production during 2003 is summarized in the following table:
Increase (Decrease) in the Fair Value of Derivative Contracts Non-Hedge Hedge Total - -------------------------------------------------------------------------------------------------------- (In millions) Change in the fair value of commodity derivative contracts Outstanding net asset as of January 1, 2003........................ $ 54 $ 24 $ 78 Additions/Increase in value of existing contracts.................. 8 35 43 Change in techniques/assumptions................................... 9 -- 9 Settled contracts.................................................. (4) (47) (51) - ------------------------------------------------------------------------------------------------------- Outstanding net asset as of December 31, 2003 (1).................. 67 12 79 - ------------------------------------------------------------------------------------------------------- Non-commodity net assets as of December 31, 2003: Interest Rate Swaps (2)......................................... -- (6) (6) - ------------------------------------------------------------------------------------------------------- Net Assets - Derivatives Contracts as of December 31, 2003 (3)..... $ 67 $ 6 $ 73 ======================================================================================================= Impact of Changes in Commodity Derivative Contracts (4) Income Statement Effects (Pre-Tax)................................. $(13) $ -- $(13) Balance Sheet Effects: OCI (Pre-Tax)................................................... $ -- $(12) $(12) Regulatory Liability............................................ $ 26 $ -- $ 26 (1) Includes $61 million in non-hedge commodity derivative contracts which are offset by a regulatory liability. (2) Interest rate swaps are primarily treated as fair value hedges. Changes in derivative values of the fair value hedges are offset by changes in the hedged debts' premium or discount (see Interest Rate Swap Agreements below). (3) Excludes $17 million of derivative contract fair value decrease, representing our 50% share of Great Lakes Energy Partners, LLC. (4) Represents the increase in value of existing contracts, settled contracts and changes in techniques/ assumptions.
Derivatives are included on the Consolidated Balance Sheet as of December 31, 2003 as follows: Non-Hedge Hedge Total - ----------------------------------------------------------------------- (In millions) Current- Other Assets.................... $13 $ 2 $ 15 Other Liabilities................ (8) -- (8) Non-Current- Other Deferred Charges........... 62 14 76 Other Noncurrent Liabilities..... -- (10) (10) ---------------------------------------------------------------------- Net assets..................... $67 $ 6 $ 73 ====================================================================== The valuation of derivative contracts is based on observable market information to the extent that such information is available. In cases where such information is not available, we rely on model-based information. The model provides estimates of future regional prices for electricity and an estimate of related price volatility. We use these results to develop estimates of fair value for financial reporting purposes and for internal management decision making. Sources of information for the valuation of commodity derivative contracts by year are summarized in the following table:
Source of Information - - Fair Value by Contract Year 2004 2005 2006 2007 Thereafter Total - ---------------------------------------------------------------------------------------------------------- (In millions) Prices actively quoted(1)............. $11 $ 1 $ -- $-- $-- $12 Other external sources(2)............. 15 10 -- -- -- 25 Prices based on models................ -- -- 10 9 23 42 - --------------------------------------------------------------------------------------------------------- Total(3).......................... $26 $11 $10 $ 9 $23 $79 ========================================================================================================= (1) Exchange traded. (2) Broker quote sheets. (3) Includes $61 million from an embedded option that is offset by a regulatory liability and does not affect earnings.
27 We perform sensitivity analyses to estimate our exposure to the market risk of our commodity positions. A hypothetical 10% adverse shift in quoted market prices in the near term on both our trading and nontrading derivative instruments would not have had a material effect on our consolidated financial position or cash flows as of December 31, 2003. We estimate that if energy commodity prices experienced an adverse 10% change, net income for the next twelve months would decrease by approximately $3 million. Interest Rate Risk Our exposure to fluctuations in market interest rates is reduced since a significant portion of our debt has fixed interest rates, as noted in the table below.
Comparison of Carrying Value to Fair Value - --------------------------------------------------------------------------------------------------------------------- There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - --------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets Investments other than Cash and Cash Equivalents-Fixed Income... $326 $ 64 $ 82 $ 77 $ 57 $1,882 $ 2,488 $ 2,597 Average interest rate...... 7.5% 7.8% 7.8% 7.9% 7.7% 6.2% 6.6% _____________________________________________________________________________________________________________________ Liabilities - -------------------------------------------------------------------------------------------------------------------- Long-term Debt and Other Long-Term Obligations: Fixed rate (1)................ $986 $547 $1,377 $237 $335 $6,644 $10,126 $10,625 Average interest rate ..... 7.3% 7.3% 5.7% 6.6% 5.3% 6.7% 6.6% Variable rate (1)............. $270 $ 40 $1,035 $ 1,345 $ 1,345 Average interest rate...... 2.4% 2.3% 2.3% 2.4% Preferred Stock Subject to Mandatory Redemption....... $ 2 $ 2 $ 2 $ 12 $ 1 $ 19 $ 19 Average dividend rate...... 7.5% 7.5% 7.5% 7.6% 7.4% 7.6% Short-term Borrowings......... $522 $ 522 $ 522 Average interest rate...... 2.1% 2.1% - --------------------------------------------------------------------------------------------------------------------- (1) Balances and rates do not reflect the fixed-to-floating interest rate swap agreements discussed below.
We are subject to the inherent interest rate risks related to refinancing maturing debt by issuing new debt securities. As discussed in Note 4 to the consolidated financial statements, our investments in capital trusts effectively reduce future lease obligations, also reducing interest rate risk. While fluctuations in the fair value of our Ohio EUOC decommissioning trust balances will eventually affect earnings (affecting OCI initially) based on the guidance provided by SFAS 115, our non-Ohio EUOC have the opportunity to recover from customers the difference between the investments held in trust and their decommissioning obligations. Thus, there is not expected to be an earnings effect from fluctuations in their decommissioning trust balances. As of December 31, 2003, decommissioning trust balances totaled $1.352 billion, with $797 million held by our Ohio EUOC and the balance held by our non-Ohio EUOC. As of year end 2003, trust balances of our Ohio EUOC included 62% of equity securities and 38% of debt instruments. Interest Rate Swap Agreements We have entered into various fixed-to-floating interest rate swap agreements, as part of our ongoing effort to manage the interest rate risk of our debt portfolio. These derivatives are treated as fair value hedges of fixed-rate, long-term debt issues - protecting against the risk of changes in the fair value of fixed-rate debt instruments due to lower interest rates. Swap maturities, call options, fixed interest rates and interest payment dates match those of the underlying obligations. Reductions to interest expense recorded in 2003 and 2002 due to the difference between fixed and variable debt rates totaled $27 million and $17 million, respectively. As of December 31, 2003, the debt underlying the interest rate swaps had a weighted average fixed interest rate of 5.39%, which the swaps have effectively converted to a current weighted average variable interest rate of 2.06%. GPU Power (through a subsidiary) used existing dollar-denominated interest rate swap agreements in 2003. The swaps convert variable-rate debt to fixed-rate debt to manage the risk of increases in variable interest rates. GPU Power's swaps had a weighted average fixed interest rate of 6.68% in 2003 and 2002. The following summarizes the principal characteristics of the swap agreements: 28
December 31, 2003 December 31, 2002 ----------------------------- ------------------------------ Notional Maturity Fair Notional Maturity Fair Interest Rate Swaps Amount Date Value Amount Date Value -------------------------------------------------------------------------------------------- (Dollars in millions) Fixed to Floating Rate (Fair value hedges) $200 2006 $ 1 50 2008 -- 100 2010 1 100 2011 1 350 2013 (1) 150 2015 (10) 150 2018 1 50 2019 1 -- -- -- $444 2023 $16 -- -- -- 150 2025 6 Floating to Fixed Rate* (Cash flow hedges) $ 7 2005 $ -- $ 16 2005 $(1) --------------------------------------------------------------------------------------------- * FirstEnergy no longer had the cash flow hedges as of January 30, 2004 as a result of GPU Power divestiture (see Note 3).
Equity Price Risk Included in nuclear decommissioning trusts are marketable equity securities carried at their market value of approximately $779 million and $532 million as of December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges, would result in a $78 million reduction in fair value as of December 31, 2003 (see Note 2(M) - Cash and Financial Instruments). Foreign Currency Risk Due to the disposition of foreign operations, we are no longer exposed to foreign currency risk from investments in international business operations. In 2002, we experienced net foreign currency translation losses in connection with our Argentina operations (see Note 3 - Divestitures). CREDIT RISK Credit risk is the risk of an obligor's failure to meet the terms of any investment contract, loan agreement or otherwise perform as agreed. Credit risk arises from all activities in which success depends on issuer, borrower or counterparty performance, whether reflected on or off the balance sheet. We engage in transactions for the purchase and sale of commodities including gas, electricity, coal and emission allowances. These transactions are often with major energy companies within the industry. We maintain stringent credit policies with respect to our counterparties that management believes minimizes overall credit risk. This includes performing independent risk evaluations, actively monitoring portfolio trends and using collateral and contract provisions to mitigate exposure. As part of our credit program, we aggressively manage the quality of our portfolio of energy contracts evidenced by a current weighted risk S&P rating for energy contract counterparties of "BBB." As of December 31, 2003, the largest credit concentration to any counterparty was 8 percent - which is a currently rated investment grade counterparty. STATE REGULATORY MATTERS In Ohio, New Jersey and Pennsylvania, laws applicable to electric industry deregulation included similar provisions which are reflected in our EUOC's respective state regulatory plans. However, despite these similarities, the specific approach taken by each state and for each of our EUOCs varies. Those provisions include: o allowing the EUOC's electric customers to select their generation suppliers; o establishing PLR obligations to customers in the EUOC's service areas; o allowing recovery of transition costs (sometimes referred to as stranded investment) not otherwise recoverable in a competitive generation market; o itemizing (unbundling) the price of electricity into its component elements - including generation, transmission, distribution and transition costs recovery charges; o deregulating the electric generation businesses; o continuing regulation of the EUOC's transmission and distribution systems; and 29 o requiring corporate separation of regulated and unregulated business activities. Regulatory assets are costs which the respective regulatory agencies have authorized for recovery from customers in future periods and, without such authorization, would have been charged to income when incurred. All of the regulatory assets are expected to continue to be recovered under the provisions of the respective transition and regulatory plans as discussed below. The regulatory assets of the individual companies are as follows:
Regulatory Assets As of December 31 2003 2002 (Decrease) --------------------------------------------------------------------------------------- (In millions) OE....................................... $1,451 $1,787 $ (336) CEI...................................... 1,056 1,145 (89) TE....................................... 459 545 (86) Penn..................................... 28 151 (123) JCP&L.................................... 2,558 3,058 (500) Met-Ed................................... 1,028 1,179 (151) Penelec.................................. 497 600 (103) -------------------------------------------------------------------------------------- Total.................................... $7,077 $8,465 $(1,388) ======================================================================================
Regulatory assets by source are as follows:
Regulatory Assets By Source Increase As of December 31 2003 2002 (Decrease) --------------------------------------------------------------------------------------- (In millions) Regulatory transition charge............. $6,427 $7,608 $(1,181) Customer shopping incentives............. 371 188 183 Customer receivables for future income taxes.................................. 340 394 (54) Societal benefits charge................. 81 144 (63) Loss on reacquired debt.................. 75 74 1 Postretirement benefits.................. 77 88 (11) Nuclear decommissioning, decontamination and spent fuel disposal costs......................... (96) 99 (195) Asset removal costs...................... (321) (288) (33) Property losses and unrecovered plant costs.................................. 70 88 (18) Other.................................... 53 70 (17) --------------------------------------------------------------------------------------- Total.................................... $7,077 $8,465 $(1,388) =======================================================================================
Ohio FirstEnergy's transition plan for the Ohio EUOC included approval for recovery of transition costs, including regulatory assets, through no later than 2006 for OE, mid-2007 for TE and 2008 for CEI, except where a longer period of recovery is provided for in the settlement agreement; granting preferred access over our subsidiaries to nonaffiliated marketers, brokers and aggregators, to 1,120 MW of generation capacity through 2005 at established prices for sales to the Ohio EUOC's retail customers; and freezing customer prices through a five-year market development period (2001-2005), except for certain limited statutory exceptions including a 5% reduction in the price of generation for residential customers. In February 2003, the Ohio EUOC were authorized increases in revenues aggregating approximately $50 million (OE - $41 million, CEI - $4 million and TE - $5 million) to recover their higher tax costs resulting from the Ohio deregulation legislation. Our Ohio customers choosing alternative suppliers receive an additional incentive applied to the shopping credit (generation component) of 45% for residential customers, 30% for commercial customers and 15% for industrial customers. The amount of the incentive is deferred for future recovery from customers. Subject to approval by the PUCO, recovery will be accomplished by extending the respective transition cost recovery period. On October 21, 2003, the Ohio EUOC filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate generation supply at stable prices, and continuing our support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for our Ohio EUOC's customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. 30 Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of our support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, we are requesting: o Extension of the transition cost amortization period for OE from 2006 to 2007; for CEI from 2008 to 2009 and for TE from mid-2007 to 2008; o Deferral of interest costs on the accumulated shopping incentives and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates under certain limited conditions. On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 24, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S.-Canada Power System Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. New Jersey Under New Jersey transition legislation, all electric distribution companies were required to file rate cases to determine the level of unbundled rate components to become effective August 1, 2003. JCP&L's two August 2002 rate filings requested increases in base electric rates of approximately $98 million annually and requested the recovery of deferred energy costs that exceeded amounts being recovered under the current market transition charge (MTC) and societal benefits charge (SBC) rates; one proposed method of recovery of these costs is the securitization of the deferred balance. This securitization methodology is similar to the Oyster Creek securitization (see Note 5(H)). On July 25, 2003, the NJBPU announced its JCP&L base electric rate proceeding decision which reduced JCP&L's annual revenues by approximately $62 million effective August 1, 2003. The NJBPU decision also provided for an interim return on equity of 9.5 percent on JCP&L's rate base for the next six to twelve months. During that period, JCP&L will initiate another proceeding to request recovery of additional costs incurred to enhance system reliability. In that proceeding, the NJBPU could increase the return on equity to 9.75% or decrease it to 9.25%, depending on its assessment of the reliability of JCP&L's service. Any reduction would be retroactive to August 1, 2003. The revenue decrease in the decision consists of a $223 million decrease in the electricity delivery charge, a $111 million increase due to the August 1, 2003 expiration of annual customer credits previously mandated by the New Jersey transition legislation, a $49 million increase in the MTC tariff component, and a net $1 million increase in the SBC charge. The MTC allows for the recovery of $465 million in deferred energy costs over the next ten years on an interim basis, thus disallowing $153 million of the $618 million provided for in a preliminary settlement agreement between certain parties. As a result, JCP&L recorded charges to net income for the year ended December 31, 2003, aggregating $185 million ($109 million net of tax) consisting of the $153 million deferred energy costs and other regulatory assets. JCP&L filed a motion for rehearing and reconsideration with the NJBPU on August 15, 2003 with respect to the following issues: (1) the disallowance of the $153 million deferred energy costs; (2) the reduced rate of return on equity; and (3) $42.7 million of disallowed costs to achieve merger savings. On October 10, 2003, the NJBPU held the motion in abeyance until the final NJBPU decision and order is issued. This is expected to occur in the first quarter of 2004. On July 5, 2003, JCP&L experienced a series of 34.5 kilo-volt sub-transmission line faults that resulted in outages on the New Jersey shore. The NJBPU instituted an investigation into these outages, and directed that a Special Reliability Master be hired to oversee the investigation. On December 8, 2003, the Special Reliability Master issued his Interim Report recommending that JCP&L implement a series of actions to improve reliability in the area affected by the outages. The NJBPU adopted the findings and recommendations of the Interim Report on December 17, 2003, and ordered JCP&L to implement the recommended actions on a staggered basis, with initial actions to be completed by March 31, 2004. JCP&L expects to spend $12.5 million implementing these actions during 2004. 31 Pennsylvania In June 2001, the Pennsylvania Public Utility Commission (PPUC) approved the Settlement Stipulation with all of the major parties in the combined merger and rate proceedings which approved the FirstEnergy/GPU merger and provided PLR deferred accounting treatment for energy costs, permitting Met-Ed and Penelec to defer, for future recovery, energy costs in excess of amounts reflected in their capped generation rates retroactive to January 1, 2001. This PLR deferral accounting procedure was later reversed in a February 2002 Commonwealth Court of Pennsylvania decision. The court decision affirmed the PPUC decision regarding approval of the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. FirstEnergy established reserves in 2002 for Met-Ed's and Penelec's PLR deferred energy costs which aggregated $287.1 million, reflecting the potential adverse impact of the then pending Pennsylvania Supreme Court decision whether to review the Commonwealth Court decision. We recorded in 2002 an aggregate non-cash charge of $55.8 million ($32.6 million net of tax) to income for the deferred costs incurred subsequent to the merger. The reserve for the remaining $231.3 million of deferred costs increased goodwill by an aggregate net of tax amount of $135.3 million. On April 2, 2003, the PPUC remanded the issue relating to merger savings to the Office of Administrative Law Judge (ALJ) for hearings, directed Met-Ed and Penelec to file a position paper on the effect of the Commonwealth Court order on the Settlement Stipulation and allowed other parties to file responses to the position paper. Met-Ed and Penelec filed a letter with the ALJ on June 11, 2003, voiding the Stipulation in its entirety and reinstating Met-Ed's and Penelec's restructuring settlement previously approved by the PPUC. On October 2, 2003, the PPUC issued an order concluding that the Commonwealth Court reversed the PPUC's June 20, 2001 order in its entirety. The PPUC directed Met-Ed and Penelec to file tariffs within thirty days of the order to reflect the competitive transition charge (CTC) rates and shopping credits that were in effect prior to the June 21, 2001 order to be effective upon one day's notice. In response to that order, Met-Ed and Penelec filed these supplements to their tariffs to become effective October 24, 2003. On October 8, 2003, Met-Ed and Penelec filed a petition for clarification relating to the October 2, 2003 order on two issues: to establish June 30, 2004 as the date to fully refund the NUG trust fund and to clarify that the ordered accounting treatment regarding the CTC rate/shopping credit swap should follow the ratemaking, and that the PPUC's findings would not impair their rights to recover all of their stranded costs. On October 9, 2003, ARIPPA (an intervenor in the proceedings) petitioned the PPUC to direct Met-Ed and Penelec to reinstate accounting for the CTC rate/shopping credit swap retroactive to January 1, 2002. Several other parties also filed petitions. On October 16, 2003, the PPUC issued a reconsideration order granting the date requested by Met-Ed and Penelec for the NUG trust fund refund and, denying Met-Ed's and Penelec's other clarification requests and granting ARIPPA's petition with respect to the retroactive accounting treatment of the changes to the CTC rate/shopping credit swap. On October 22, 2003, Met-Ed and Penelec filed an Objection with the Commonwealth Court asking that the Court reverse the PPUC's finding that requires Met-Ed and Penelec to treat the stipulated CTC rates that were in effect from January 1, 2002 on a retroactive basis. Met-Ed and Penelec are considering filing an appeal to the Commonwealth Court on the PPUC orders as well. On October 27, 2003, one Commonwealth Court judge issued an Order denying Met-Ed's and Penelec's objection without explanation. Due to the vagueness of the Order, Met-Ed and Penelec, on October 31, 2003, filed an Application for Clarification with the judge. Concurrent with this filing, Met-Ed and Penelec, in order to preserve their rights, also filed with the Commonwealth Court both a Petition for Review of the PPUC's October 16 and October 22 Orders, and an application for reargument, if the judge, in his clarification order, indicates that Met-Ed's and Penelec's objection was intended to be denied on the merits. In addition to these findings, Met-Ed and Penelec, in compliance with the PPUC's Orders, filed revised PPUC quarterly reports for the twelve months ended December 31, 2001 and 2002, and for the first two quarters of 2003, reflecting balances consistent with the PPUC's findings in their Orders. Effective September 1, 2002, Met-Ed and Penelec assigned their PLR responsibility to their FES affiliate through a wholesale power sale agreement. The PLR sale will be automatically extended for each successive calendar year unless any party elects to cancel the agreement by November 1 of the preceding year. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by Met-Ed and Penelec under their NUG contracts and other power contracts with nonaffiliated third party suppliers. This arrangement reduces Met-Ed's and Penelec's exposure to high wholesale power prices by providing power at a fixed price for their uncommitted PLR energy costs during the term of the agreement with FES. FES has hedged most of Met-Ed's and Penelec's unfilled PLR on-peak obligation through 2004 and a portion of 2005, the period during which deferred accounting was previously allowed under the PPUC's order. Met-Ed and Penelec are authorized to continue deferring differences between NUG contract costs and current market prices. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin 32 filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. We are currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of Met-Ed's, Penelec's and Penn's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. We are unable to predict the outcome of the investigation or the impact of the PPUC Order. FERC REGULATORY MATTERS On December 19, 2002, the FERC granted unconditional Regional Transmission Organization status to PJM Interconnection, LLC which includes JCP&L, Met-Ed and Penelec as transmission owners. The FERC also conditionally accepted GridAmerica's filing to become an independent transmission company within Midwest Independent System Operator, Inc. (MISO). GridAmerica will operate ATSI's transmission facilities. Effective October 1, 2003, MISO received operational control of ATSI's transmission facilities. Transmission service over the facilities of ATSI is now provided under the MISO Open Access Transmission Tariff. A settlement of all rate matters related to ATSI's integration into MISO was filed with the FERC on December 18, 2003 and has been certified to the Commission as an uncontested settlement. PJM and MISO were ordered by the FERC to develop a common market between the regions by October 31, 2004. The FERC also initiated a Section 206 investigation into the reasonableness of the "through-and-out" transmission rates charged by PJM and MISO. By order issued November 17, 2003, MISO, PJM and certain unaffiliated transmission owners in the Midwest were directed to eliminate rates for point-to-point service between the two RTOs effective April 1, 2004. A settlement judge has been appointed by the FERC to resolve compliance filings by the affected transmission providers. AEP, Commonwealth Edison and other utilities have appealed the FERC's November 17, 2003 order to the federal court of appeals for the District of Columbia. ENVIRONMENTAL MATTERS We believe we are in material compliance with current sulfur dioxide (SO2) and nitrogen oxide (NOx) reduction requirements under the Clean Air Act Amendments of 1990. In 1998, the Environmental Protection Agency (EPA) finalized regulations requiring additional NOx reductions from the Companies' Ohio and Pennsylvania facilities. Various regulatory and judicial actions have since sought to further define NOx reduction requirements (see Note 7(D) - Environmental Matters). We continue to evaluate our compliance plans and other compliance options. Clean Air Act Compliance Violations of federally approved SO2 regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. We cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. W. H. Sammis Plant In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a Compliance Order to nine utilities covering 44 power plants, including the W. H. Sammis Plant. In addition, the U.S. Department of Justice filed eight civil complaints against various investor-owned utilities, which included a complaint against OE and Penn in the U.S. District Court for the Southern District of Ohio. The NOV and complaint allege violations of the Clean Air Act based on operation and maintenance of the W. H. Sammis Plant dating back to 1984. The complaint requests permanent injunctive relief to require the installation of "best available control technology" and civil penalties of up to $27,500 per day of violation. On August 7, 2003, the United States District Court for the Southern District of Ohio ruled that 11 projects undertaken at the W. H. Sammis Plant between 1984 and 1998 required pre-construction permits under the Clean Air Act. The ruling concludes the liability phase of the case, which deals with applicability of Prevention of Significant Deterioration provisions of the Clean Air Act. The remedy phase, which is currently scheduled to be ready for trial beginning July 19, 2004, will address civil penalties and what, if any, actions should be taken to further reduce emissions at the plant. In the ruling, the Court indicated that the remedies it "may consider and impose involved a much broader, equitable analysis, requiring the Court to consider air quality, public health, economic impact, and employment consequences. The Court may also consider the less than consistent efforts of the EPA to apply and further enforce the Clean Air Act." The potential penalties that may be imposed, as well as the capital expenditures necessary to comply with substantive remedial measures that may be required, could have a material adverse impact on the Company's financial condition and results of operations. Management is unable to predict the ultimate outcome of this matter and no liability has been accrued as of December 31, 2003. 33 Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. The EUOC have been named as "potentially responsible parties" (PRPs) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Companies' proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. In addition, JCP&L has accrued liabilities for environmental remediation of former manufactured gas plants in New Jersey; those costs are being recovered by JCP&L through a non-bypassable societal benefits charge. The Companies have total accrued liabilities aggregating approximately $65 million as of December 31, 2003. Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. We cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by FirstEnergy is lower than many regional competitors due to FirstEnergy's diversified generation sources which includes the low or non-CO2 emitting gas-fired and nuclear generators. OTHER LEGAL MATTERS A number of legal and regulatory proceedings have been filed against FirstEnergy in connection with, among other things, the restatements of earnings, the August 14th regional outage described above, and the extended outage at Davis-Besse, alleging violations of federal securities laws, breaches of fiduciary duties by its directors and officers or damages as a result of one or more of those events. All shareholder derivative actions filed in federal court have been consolidated into one action, as have all federal securities actions.Three tort actions seeking damages allegedly caused by the August 14th power outage were filed in Ohio State court and were dismissed on jurisdictional grounds. Two of those decisions have been appealed and the third case was refiled at the PUCO. We were also named as a respondent in two regulatory proceedings initiated at the PUCO in response to complaints alleging failure to provide reasonable and adequate service. Two tort actions relating to the power outage were preliminarily commenced in New York State court, but have not been pursued to date. We intend to defend all of these actions vigorously, but cannot predict the outcome of any of these proceedings or whether any further regulatory proceedings or legal actions may be instituted against us. In particular, if we were ultimately determined to have legal liability in connection with any of these proceedings, it could have a material adverse effect on our financial condition and results of operations. FENOC recently received a subpoena from a grand jury sitting in the United States District Court for the Northern District of Ohio, Eastern Division requesting the production of certain documents and records relating to the inspection and maintenance of the reactor vessel head at the Davis-Besse plant. We are unable to predict the outcome of this investigation. In addition, FENOC remains subject to possible civil enforcement action by the NRC in connection with the events leading to the Davis-Besse outage. If it were ultimately determined that FirstEnergy has legal liability or is otherwise made subject to regulatory or civil enforcement action with respect to the Davis-Besse outage, it could have a material adverse effect on FirstEnergy's financial condition and results of operations. CRITICAL ACCOUNTING POLICIES We prepare our consolidated financial statements in accordance with accounting principles that are generally accepted in the United States. Application of these principles often requires a high degree of judgment, estimates and assumptions that affect financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting these specific factors. Our more significant accounting policies are described below. 34 Regulatory Accounting Our regulated services segment is subject to regulation that sets the prices (rates) it is permitted to charge its customers based on costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. As a result of the changing regulatory framework in each state in which we operate, a significant amount of regulatory assets have been recorded - $7.1 billion as of December 31, 2003. We regularly review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Derivative Accounting Determination of appropriate accounting for derivative transactions requires the involvement of management representing operations, finance and risk assessment. In order to determine the appropriate accounting for derivative transactions, the provisions of the contract need to be carefully assessed in accordance with the authoritative accounting literature and management's intended use of the derivative. New authoritative guidance continues to shape the application of derivative accounting. Management's expectations and intentions are key factors in determining the appropriate accounting for a derivative transaction and, as a result, such expectations and intentions are documented. Derivative contracts that are determined to fall within the scope of SFAS 133, as amended, must be recorded at their fair value. Active market prices are not always available to determine the fair value of the later years of a contract, requiring that various assumptions and estimates be used in their valuation. We continually monitor our derivative contracts to determine if our activities, expectations, intentions, assumptions and estimates remain valid. As part of our normal operations, we enter into a significant number of commodity contracts, as well as interest rate swaps, which increase the impact of derivative accounting judgments. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for electricity that has been delivered to customers but not yet billed through the end of the accounting period. The determination of unbilled revenues requires management to make various estimates including: o Net energy generated or purchased for retail load o Losses of energy over transmission and distribution lines o Mix of Kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers Pension and Other Postretirement Benefits Accounting Our reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions are dependent upon numerous factors resulting from actual plan experience and certain assumptions. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions we make to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as our merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, reduced FirstEnergy's obligation by $123 million and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. 35 In selecting an assumed discount rate, we consider currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, we reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. Our assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by our pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. Our pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and our pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $253 million, recording a decrease of $6 million in an intangible asset and crediting OCI by $145 million (offsetting previously recorded deferred tax benefits by $102 million). The remaining balance in OCI of $299 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $438 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, we will not be required to fund our pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. Pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 2(K)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining our trend rate assumptions, we included the specific provisions of our health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in our health care plans, and projections of future medical trend rates. The effect on our pension and OPEB costs and liabilities from changes in key assumptions are as follows:
Increase in Costs from Adverse Changes in Key Assumptions --------------------------------------------------------- Assumption Adverse Change Pension OPEB Total ------------------------------------------------------------------------------------------------ (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 5 $ 15 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% na $ 26 $ 26 Increase in Minimum Liability ----------------------------- Discount rate................ Decrease by 0.25% $104 na $104 ----------------------------------------------------------------------------------------------
Ohio Transition Cost Amortization In connection with FirstEnergy's restructuring plan, the PUCO determined allowable transition costs based on amounts recorded on the regulatory books of the Ohio electric utilities. These costs exceeded those deferred or capitalized on FirstEnergy's balance sheet prepared under GAAP since they included certain costs which have not yet been incurred or that were recognized on the regulatory financial statements (fair value purchase accounting adjustments). FirstEnergy uses an effective interest method for amortizing its transition costs, often referred to as a "mortgage-style" amortization. The interest rate under this method is equal to the rate of return authorized by the PUCO in the transition plan for each respective company. In computing the transition cost amortization, FirstEnergy includes only the portion of the transition revenues associated with transition costs included on the balance sheet prepared under GAAP. Revenues collected for the off-balance sheet costs and the return associated with these costs are recognized as income when received. Long-Lived Assets In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). 36 The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. Nuclear Decommissioning In accordance with SFAS 143, we recognize an ARO for the future decommissioning of our nuclear power plants. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. The scenarios consider settlement of the ARO at the expiration of the nuclear power plants' current license and settlement based on an extended license term. Goodwill In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Based on the guidance provided by SFAS 142, we evaluate goodwill for impairment at least annually and would make such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. When impairment is indicated we recognize a loss - calculated as the difference between the implied fair value of a reporting unit's goodwill and the carrying value of the goodwill. Our annual review was completed in the third quarter of 2003. As a result of that review, a non-cash goodwill impairment charge of $122 million was recognized in the third quarter of 2003, reducing the carrying value of FSG. Of this amount, $117 million is reported as an operating expense and $5 million is included, net of tax, in the loss from discontinued operations. The impairment charge reflects the continued slow down in the development of competitive retail markets and depressed economic conditions that affect the value of FSG. The forecasts used in our evaluations of goodwill reflect operations consistent with our general business assumptions. Unanticipated changes in those assumptions could have a significant effect on our future evaluations of goodwill. The impairment analysis includes a significant source of cash representing the EUOC recovery of transition costs as described in Note 2(D). A summary of the changes in our goodwill for the twelve months ended December 31, 2003 is shown below: Segments ----------------------- Regulated Competitive Total --------- ----------- ----- (In millions) Balance as of December 31, 2002...... $5,993 $ 285 $6,278 Impairment charges................... -- (122) (122) FSG divestitures..................... -- (41) (41) Other................................ -- 13 13 ------ ------ ------ Balance as of December 31, 2003...... $5,993 $ 135 $6,128 ====== ====== ====== NEW ACCOUNTING STANDARDS AND INTERPRETATIONS ADOPTED FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements", referred to as FIN 46R, which requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, FirstEnergy adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. We will adopt FIN 46R for all other types of entities effective March 31, 2004. FirstEnergy currently has transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. Upon adoption of FIN 46R effective December 31, 2003, FirstEnergy consolidated the PNBV Capital Trust (PNBV) and the Shippingport Capital Trust (Shippingport) which were created in 1996 and 1997, respectively, to refinance debt in connection with sale and leaseback transactions. Consolidation of PNBV changed the trust investment of $361 million to an investment in collateralized lease bonds of $372 million. The $11 million increase represents the minority interest in the total assets of the trust. Prior to the adoption of FIN 46R, the assets and liabilities of Shippingport were included on a proportionate basis in the financial statements of CEI and TE. Adoption of FIN 46R did not impact FirstEnergy with respect to this trust, but did result in recording all of the trust assets and liabilities on CEI's financial statements. 37 As described in Note 5(G), CEI, Met-Ed and Penelec created statutory business trusts to issue trust preferred securities in the aggregate of $285 million. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. Therefore, FirstEnergy has deconsolidated the trusts and recognized an equity investment in the trusts of $9 million ($3 million each for CEI, Met-Ed and Penelec) and subordinated debentures to the trusts of $294 million ($103 million for CEI, $96 million for Met-Ed and $95 million for Penelec) as of December 31, 2003. In August 1995, Los Amigos Leasing Company, Ltd. (Los Amigos) was formed as a consolidated subsidiary of GPU Power to own and lease to TEBSA equipment comprised of an 895 megawatt plant constructed and operated by TEBSA. Upon application of FIN 46R, Los Amigos met the criteria of a VIE and FirstEnergy was determined not to be its primary beneficiary. Therefore, effective December 31, 2003 Los Amigos was deconsolidated, resulting in the removal of approximately $243 million of total assets (primarily unbilled lease receivable) and liabilities (primarily senior and subordinated debt) from FirstEnergy's Consolidated Balance Sheets. Los Amigos was sold as part of the TEBSA divestiture on January 30, 2004. We have evaluated numerous entities with which the Companies have contractual, ownership, or other financial interests and we continue to evaluate other entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. See Note 9 for further discussion of FIN 46R. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, certain financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, FirstEnergy reclassified as debt the preferred stock of consolidated subsidiaries subject to mandatory redemption with a carrying value of approximately $18.5 million ($5.0 million for CEI and $13.5 million for Penn) as of December 31, 2003. Adoption of SFAS 150 had no impact on FirstEnergy's Consolidated Statements of Income because the preferred dividends were previously included in net interest charges and required no reclassification. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, FirstEnergy implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See "Cumulative Effect of Accounting Change" and "Earnings Effect of SFAS 143" discussed above and Notes 2(F) and 2(J) for further discussions of SFAS 143. 38 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2003 2002 2001 - --------------------------------------------------------------------------------------------------------------------- (See Note 2(I)) (In thousands, except per share amounts) REVENUES: Electric utilities.................................................... $ 8,978,021 $ 9,165,805 $ 5,729,036 Unregulated businesses................................................ 3,329,026 2,881,543 2,270,326 ----------- ------------ ----------- Total revenues.................................................... 12,307,047 12,047,348 7,999,362 ----------- ------------ ----------- EXPENSES: Fuel and purchased power.............................................. 4,567,859 3,670,844 1,421,525 Purchased gas......................................................... 586,799 587,860 820,031 Other operating expenses.............................................. 3,643,575 3,725,587 2,727,794 Provision for depreciation and amortization........................... 1,281,690 1,298,290 889,550 Goodwill impairment (Note 2(L))....................................... 116,988 -- -- General taxes......................................................... 638,465 649,898 455,340 ----------- ------------ ----------- Total expenses.................................................... 10,835,376 9,932,479 6,314,240 ----------- ------------ ----------- CLAIM SETTLEMENT (Note 3)................................................ 167,937 -- -- ----------- ------------ ----------- INCOME BEFORE INTEREST AND INCOME TAXES.................................. 1,639,608 2,114,869 1,685,122 ----------- ------------ ----------- NET INTEREST CHARGES: Interest expense...................................................... 801,184 906,970 519,131 Capitalized interest.................................................. (31,900) (24,474) (35,473) Subsidiaries' preferred stock dividends............................... 42,369 75,647 72,061 ----------- ------------ ----------- Net interest charges.............................................. 811,653 958,143 555,719 ----------- ------------ ----------- INCOME TAXES............................................................. 405,959 524,059 474,457 ----------- ------------ ----------- INCOME BEFORE DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES.......................................... 421,996 632,667 654,946 Discontinued operations (net of income taxes (benefit) of ($1,499,000) and $4,635,000, respectively) (Note 2(I))........................... (101,379) (79,863) -- Cumulative effect of accounting changes (net of income taxes (benefit) of $72,516,000 and ($5,839,000), respectively) (Note 2(J))............. 102,147 -- (8,499) ----------- ------------ ----------- NET INCOME............................................................... $ 422,764 $ 552,804 $ 646,447 =========== ============ =========== BASIC EARNINGS PER SHARE OF COMMON STOCK: Income before discontinued operations and cumulative effect of accounting changes............................................................. $1.39 $2.16 $ 2.85 Discontinued operations (Note 2(I))................................... (0.33) (0.27) -- Cumulative effect of accounting changes (Note 2(J))................... 0.33 -- (0.03) ----- ----- ------ Net income............................................................ $1.39 $1.89 $ 2.82 ===== ===== ====== WEIGHTED AVERAGE NUMBER OF BASIC SHARES OUTSTANDING...................... 303,582 293,194 229,512 ======= ======= ======= DILUTED EARNINGS PER SHARE OF COMMON STOCK: Income before discontinued operations and cumulative effect of accounting changes............................................................. $1.39 $2.15 $ 2.84 Discontinued operations (Note 2(I))................................... (0.33) (0.27) -- Cumulative effect of accounting changes (Note 2(J))................... 0.33 -- (0.03) ----- ----- ------ Net income............................................................ $1.39 $1.88 $ 2.81 ===== ===== ====== WEIGHTED AVERAGE NUMBER OF DILUTED SHARES OUTSTANDING.................... 304,972 294,421 230,430 ======= ======= ======= DIVIDENDS DECLARED PER SHARE OF COMMON STOCK............................. $1.50 $1.50 $1.50 ===== ===== ===== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
39 FIRSTENERGY CORP. CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 2002 - --------------------------------------------------------------------------------------------------------------------- (In thousands) ASSETS CURRENT ASSETS: Cash and cash equivalents......................................................... $ 113,975 $ 196,301 Receivables- Customers (less accumulated provisions of $50,247,000 and $52,514,000 respectively, for uncollectible accounts)...................................... 1,000,259 1,153,486 Other (less accumulated provisions of $18,283,000 and $12,851,000 respectively, for uncollectible accounts)...................................... 505,241 469,606 Materials and supplies, at average cost- Owned............................................................................ 325,303 253,047 Under consignment................................................................ 95,719 174,028 Prepayments and other.............................................................. 202,814 203,630 ----------- ----------- 2,243,311 2,450,098 PROPERTY, PLANT AND EQUIPMENT: In service......................................................................... 21,594,746 20,372,224 Less--Accumulated provision for depreciation....................................... 9,105,303 8,264,075 ---------- ----------- 12,489,443 12,108,149 Construction work in progress...................................................... 779,479 859,016 ----------- ----------- 13,268,922 12,967,165 INVESTMENTS: Nuclear plant decommissioning trusts............................................... 1,351,650 1,049,560 Investments in lease obligation bonds (Note 4)..................................... 989,425 1,079,435 Letter of credit collateralization (Note 4)........................................ 277,763 277,763 Other.............................................................................. 878,853 918,874 ----------- ----------- 3,497,691 3,325,632 DEFERRED CHARGES: Regulatory assets.................................................................. 7,076,923 8,464,549 Goodwill........................................................................... 6,127,883 6,278,072 Other.............................................................................. 695,218 900,837 ----------- ----------- 13,900,024 15,643,458 $32,909,948 $34,386,353 LIABILITIES AND CAPITALIZATION CURRENT LIABILITIES: Currently payable long-term debt and preferred stock............................... $ 1,754,197 $ 1,702,822 Short-term borrowings (Note 6)..................................................... 521,540 1,092,817 Accounts payable................................................................... 725,239 906,468 Accrued taxes...................................................................... 669,529 455,121 Lease market valuation liability................................................... 84,800 84,800 Other.............................................................................. 716,862 1,009,215 ----------- ----------- 4,472,167 5,251,243 CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholders' equity........................................................ 8,289,341 7,050,661 Preferred stock of consolidated subsidiaries-- Not subject to mandatory redemption.............................................. 335,123 335,123 Subject to mandatory redemption.................................................. -- 18,521 Subsidiary-obligated mandatorily redeemable preferred securities................... -- 409,867 Long-term debt and other long-term obligations-- Preferred stock of consolidated subsidiaries subject to mandatory redemption..... 16,764 -- Subordinated debentures to affiliated trusts..................................... 294,324 -- Other............................................................................ 9,477,978 10,872,216 ----------- ----------- 18,413,530 18,686,388 NONCURRENT LIABILITIES: Accumulated deferred income taxes.................................................. 2,178,075 2,069,682 Asset retirement obligations (Note 2(F))........................................... 1,179,493 -- Nuclear plant decommissioning costs................................................ -- 1,243,558 Power purchase contract loss liability............................................. 2,727,892 3,136,538 Retirement benefits................................................................ 1,591,006 1,564,930 Lease market valuation liability................................................... 1,021,000 1,105,800 Other.............................................................................. 1,326,785 1,328,214 ----------- ----------- 10,024,251 10,448,722 COMMITMENTS, GUARANTEES AND CONTINGENCIES (Notes 4 and 7)............................. ----------- ----------- $32,909,948 $34,386,353 The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
40 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CAPITALIZATION
As of December 31, 2003 2002 - --------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDERS' EQUITY: Common stock, $0.10 par value - authorized 375,000,000 shares- 329,836,276 and 297,636,276 shares outstanding, respectively......................... $ 32,984 $ 29,764 Other paid-in capital.................................................................. 7,062,825 6,120,341 Accumulated other comprehensive loss (Note 5(I))....................................... (352,649) (656,148) Retained earnings (Note 5(A)).......................................................... 1,604,385 1,634,981 Unallocated employee stock ownership plan common stock- 2,896,951 and 3,966,269 shares, respectively (Note 5(B))............................. (58,204) (78,277) ---------- ------------ Total common stockholders' equity.................................................... 8,289,341 7,050,661 ---------- ----------- Number of Shares Optional Outstanding Redemption Price ---------------- ----------------------- 2003 2002 Per Share Aggregate ---- ---- --------- --------- PREFERRED STOCK OF CONSOLIDATED SUBSIDIARIES (Note 5(D)): Ohio Edison Company Cumulative, $100 par value- Authorized 6,000,000 shares Not Subject to Mandatory Redemption: 3.90%.............................. 152,510 152,510 $103.63 $ 15,804 15,251 15,251 4.40%.............................. 176,280 176,280 108.00 19,038 17,628 17,628 4.44%.............................. 136,560 136,560 103.50 14,134 13,656 13,656 4.56%.............................. 144,300 144,300 103.38 14,917 14,430 14,430 ------- ------- -------- ------ ------ Total Not Subject to Mandatory Redemption............... 609,650 609,650 $ 63,893 60,965 60,965 ======= ======== ======== ------ ------ Pennsylvania Power Company Cumulative, $100 par value- Authorized 1,200,000 shares Not Subject to Mandatory Redemption: 4.24%.............................. 40,000 40,000 103.13 $ 4,125 4,000 4,000 4.25%.............................. 41,049 41,049 105.00 4,310 4,105 4,105 4.64%.............................. 60,000 60,000 102.98 6,179 6,000 6,000 7.75%.............................. 250,000 250,000 100.00 25,000 25,000 25,000 ------- ------- --------- ---------- -------- Total Not Subject to Mandatory Redemption......................... 391,049 391,049 $ 39,614 39,105 39,105 ======= ======= ========= ---------- ------ Subject to Mandatory Redemption (Note 5(F)): 7.625%*............................ -- 142,500 -- 14,250 Redemption Within One Year*.......... -- (750) ------- ------- ---------- ------ Total Subject to Mandatory Redemption* -- 142,500 -- 13,500 Cleveland Electric Illuminating Company Cumulative, without par value- Authorized 4,000,000 shares Not Subject to Mandatory Redemption: $ 7.40 Series A................... 500,000 500,000 101.00 $ 50,500 50,000 50,000 Adjustable Series L................ 474,000 474,000 100.00 47,400 46,404 46,404 ------- ------- --------- ---------- ----------- Total Not Subject to Mandatory Redemption......................... 974,000 974,000 $ 97,900 96,404 96,404 ======= ======= ========= ========== =========== Subject to Mandatory Redemption (Note 5(F)): $ 7.35 Series C*.................. -- 60,000 -- 6,021 Redemption Within One Year*.......... -- (1,000) ------- ------- ---------- ----------- Total Subject to Mandatory Redemption* -- 60,000 -- 5,021 ======= ======= ---------- -----------
41 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont'd)
As of December 31, 2003 2002 - --------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) Number of Shares Optional Outstanding Redemption Price ---------------- ------------------------ 2003 2002 Per Share Aggregate ---- ---- --------- --------- PREFERRED STOCK OF CONSOLIDATED SUBSIDIARIES (Cont'd) Toledo Edison Company Cumulative, $100 par value- Authorized 3,000,000 shares Not Subject to Mandatory Redemption: $ 4.25............................ 160,000 160,000 $104.63 $ 16,740 $ 16,000 $ 16,000 $ 4.56............................ 50,000 50,000 101.00 5,050 5,000 5,000 $ 4.25............................ 100,000 100,000 102.00 10,200 10,000 10,000 --------- --------- --------- --------- --------- 310,000 310,000 31,990 31,000 31,000 --------- --------- --------- --------- --------- Cumulative, $25 par value- Authorized 12,000,000 shares Not Subject to Mandatory Redemption: $2.365............................. 1,400,000 1,400,000 27.75 38,850 35,000 35,000 Adjustable Series A................ 1,200,000 1,200,000 25.00 30,000 30,000 30,000 Adjustable Series B................ 1,200,000 1,200,000 25.00 30,000 30,000 30,000 --------- --------- --------- --------- --------- 3,800,000 3,800,000 98,850 95,000 95,000 --------- --------- --------- --------- --------- Total Not Subject to Mandatory Redemption....................... 4,110,000 4,110,000 $ 130,840 126,000 126,000 ========= ========= ========= --------- --------- Jersey Central Power & Light Company Cumulative, $100 stated value- Authorized 15,600,000 shares Not Subject to Mandatory Redemption: 4.00% Series....................... 125,000 125,000 106.50 $ 13,313 12,649 12,649 ========= =========== ========= --------- --------- SUBSIDIARY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST OR LIMITED PARTNERSHIP HOLDING SOLELY SUBORDINATED DEBENTURES OF SUBSIDIARIES (NOTE 5(G)): Cleveland Electric Illuminating Co. Cumulative, $25 stated value- Authorized 4,000,000 shares 9.00%................................ -- 4,000,000 -- 100,000 ========= =========== --------- --------- Jersey Central Power & Light Co. Cumulative, $25 stated value- Authorized 5,000,000 shares 8.56%................................ -- 5,000,000 -- 125,244 ========= =========== --------- --------- Metropolitan Edison Co. Cumulative, $25 stated value- Authorized 4,000,000 shares 7.35%................................ -- 4,000,000 -- 92,409 ========= =========== --------- --------- Pennsylvania Electric Co. Cumulative, $25 stated value- Authorized 4,000,000 shares 7.34%................................ -- 4,000,000 -- 92,214 ========= =========== --------- ---------
42 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont'd)
LONG-TERM DEBT (Note 5(E)) (Interest rates reflect weighted average rates) (In thousands) - ----------------------------------------------------------------------------------------------------------------------- FIRST MORTGAGE BONDS SECURED NOTES UNSECURED NOTES TOTAL - ----------------------------------------------------------------------------------------------------------------------- As of December 31, 2003 2002 2003 2002 2003 2002 2003 2002 ---- ---- ---- ---- ---- ---- ---- ---- Ohio Edison Co. - Due 2003-2008 6.88% $ 80,000 $230,000 5.62% $ 227,761 $ 189,264 3.95% $526,725 $441,725 Due 2009-2013 -- -- -- 6.98% 2,752 2,753 -- -- -- Due 2014-2018 -- -- -- 5.01% 59,000 59,000 5.45% 150,000 -- Due 2019-2023 7.99% -- 219,460 7.01% 60,443 60,443 -- -- -- Due 2024-2028 -- -- -- 5.38% 13,522 13,522 -- -- -- Due 2029-2033 -- -- -- 3.10% 308,012 308,012 -- -- -- -------- -------- --------- --------- -------- -------- ---------- ---------- Total-Ohio Edison 80,000 449,460 671,490 632,994 676,725 441,725 $1,428,215 $1,524,179 -------- --------- --------- --------- -------- -------- ---------- ---------- Cleveland Electric Illuminating Co. - Due 2003-2008 6.86% 125,000 525,000 6.78% 470,905 680,205 5.58% 27,700 27,700 Due 2009-2013 -- -- -- 7.43% 151,580 151,580 5.72% 378,700 78,700 Due 2014-2018 -- -- -- 6.03% 412,630 300,000 -- -- -- Due 2019-2023 9.00% -- 150,000 6.67% 186,660 216,660 -- -- -- Due 2024-2028 -- -- -- 7.59% 148,843 148,843 -- -- -- Due 2029-2033 -- -- -- 1.45% 30,000 30,000 9.00% 103,093 -- -------- -------- --------- --------- -------- ------- --------- ---------- Total-Cleveland Electric 125,000 675,000 1,400,618 1,527,288 509,493 106,400 2,035,111 2,308,688 -------- -------- --------- --------- -------- ------- --------- ---------- Toledo Edison Co. - Due 2003-2008 7.88% 145,000 178,725 7.51% 100,000 229,700 4.88% 85,250 91,130 Due 2009-2013 -- -- -- -- -- -- 10.00% -- 730 Due 2019-2023 -- -- -- 7.92% 144,500 164,700 -- -- -- Due 2024-2028 -- -- -- 5.90% 13,851 13,851 -- -- -- Due 2029-2033 -- -- -- 1.43% 51,100 51,100 -- -- -- -------- -------- --------- --------- -------- ------- --------- ---------- Total-Toledo Edison 145,000 178,725 309,451 459,351 85,250 91,860 539,701 729,936 -------- -------- --------- ---------- -------- ------- --------- ---------- Pennsylvania Power Co. - Due 2003-2008 6.88% 39,370 80,344 2.59% 10,300 10,300 3.40% 19,700 19,700 Due 2009-2013 9.74% 4,870 4,870 5.40% 1,000 1,000 -- -- -- Due 2014-2018 9.74% 4,870 4,870 4.00% 45,325 45,325 -- -- -- Due 2019-2023 8.37% 34,757 34,757 3.62% 27,182 27,182 -- -- -- Due 2024-2028 -- -- -- 5.79% 22,934 22,934 -- -- -- Due 2029-2033 -- -- -- 5.95% 238 238 -- -- -- -------- -------- --------- --------- -------- ------- --------- ---------- Total-Penn Power 83,867 124,841 106,979 106,979 19,700 19,700 210,546 251,520 -------- -------- --------- --------- -------- ------- --------- ---------- Jersey Central Power & Light Co. - Due 2003-2008 7.01% 251,575 442,989 5.75% 217,336 241,135 7.69% 99 115 Due 2009-2013 7.13% 4,725 4,725 5.64% 130,024 130,024 7.69% 144 144 Due 2014-2018 7.10% 12,200 12,200 5.34% 248,841 98,841 7.69% 208 208 Due 2019-2023 7.75% 205,000 241,586 -- -- -- 7.69% 302 302 Due 2024-2028 7.18% 200,000 200,000 -- -- -- 7.69% 437 437 Due 2029-2033 -- -- -- -- -- -- 7.69% 633 633 Due 2034-2038 -- -- -- -- -- -- 7.69% 917 917 Due 2039-2043 -- -- -- -- -- -- 7.69% 228 228 -------- -------- --------- --------- -------- ------- --------- ---------- Total-Jersey Central 673,500 901,500 596,201 470,000 2,968 2,984 1,272,669 1,374,484 -------- -------- --------- --------- -------- ------- --------- ---------- Metropolitan Edison Co. - Due 2003-2008 6.44% 128,265 208,700 5.79% 150,000 150,000 7.69% 199 230 Due 2009-2013 -- -- -- 4.75% 250,000 -- 7.69% 288 288 Due 2014-2018 -- -- -- -- -- -- 7.69% 417 417 Due 2019-2023 6.10% 28,500 208,500 -- -- -- 7.69% 603 604 Due 2024-2028 5.95% 13,690 13,690 -- -- -- 7.69% 874 874 Due 2029-2033 -- -- -- -- -- -- 7.69% 1,266 1,266 Due 2034-2038 -- -- -- -- -- -- 7.69% 1,834 1,834 Due 2039-2043 -- -- -- -- -- -- 7.98% 96,166 455 -------- -------- --------- --------- -------- ------- --------- ----------\ Total-Metropolitan Edison 170,455 430,890 400,000 150,000 101,647 5,968 672,102 586,858 -------- -------- --------- --------- -------- ------- --------- ----------
43 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont'd)
LONG-TERM DEBT (Interest rates reflect weighted average rates) (Cont'd) (In thousands) - ----------------------------------------------------------------------------------------------------------------------------- FIRST MORTGAGE BONDS SECURED NOTES UNSECURED NOTES TOTAL - ----------------------------------------------------------------------------------------------------------------------------- As of December 31, 2003 2002 2003 2002 2003 2002 2003 2002 ---- ---- ---- ---- ---- ---- ---- ---- Pennsylvania Electric Co. - Due 2003-2008 6.13% $ 3,700 $ 3,905 -- $ -- $ -- 5.86% $ 133,099 $ 133,115 Due 2009-2013 5.35% 24,310 24,310 -- -- -- 6.55% 135,144 135,144 Due 2014-2018 -- -- -- -- -- -- 7.69% 208 208 Due 2019-2023 5.80% 20,000 20,000 -- -- -- 6.63% 125,302 125,302 Due 2024-2028 6.05% 25,000 25,000 -- -- -- 7.69% 437 437 Due 2029-2033 -- -- -- -- -- -- 7.69% 633 633 Due 2034-2038 -- -- -- -- -- -- 7.69% 917 917 Due 2039-2043 -- -- -- -- -- -- 7.98% 95,748 228 ----------- ---------- ---------- ---------- ---------- ---------- ----------- ----------- Total-Pennsylvania Electric 73,010 73,215 -- -- 491,488 395,984 $ 564,498 $ 469,199 ----------- ---------- ---------- ---------- ---------- ---------- ----------- ----------- FirstEnergy Corp. - Due 2003-2008 -- -- -- -- -- -- 5.58% 1,570,000 1,695,000 Due 2009-2013 -- -- -- -- -- -- 6.45% 1,500,000 1,500,000 Due 2029-2033 -- -- -- -- -- -- 7.38% 1,500,000 1,500,000 ---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------- Total-FirstEnergy -- -- -- -- 4,570,000 4,695,000 4,570,000 4,695,000 ---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------- Bay Shore Power -- -- 6.24% 140,600 143,200 -- -- -- 140,600 143,200 Facilities Services Group -- -- 6.72% 7,754 13,205 -- -- -- 7,754 13,205 FirstEnergy Generation -- -- -- -- -- 5.00% 15,000 15,000 15,000 15,000 FirstEnergy Properties -- -- 7.89% 9,438 9,679 -- -- -- 9,438 9,679 Warrenton River Terminal -- -- 5.00% 410 634 -- -- -- 410 634 First Communications -- -- -- -- -- 6.21% 5,407 -- 5,407 -- GPU Capital -- -- -- -- -- 5.78% -- 101,467 -- 101,467 GPU Power -- -- 7.14% -- 174,760 11.87% -- 67,372 -- 242,132 ---------- ---------- ---------- --------- ---------- ---------- ----------- ----------- Total $1,350,832 $2,833,631 $3,642,941 $3,688,090 $6,477,678 $5,943,460 11,471,451 12,465,181 ========== ========== ========== ========== ========== ========== ----------- ----------- Preferred stock subject to mandatory redemption*................................................................... 18,514 -- Capital lease obligations..................................................................... 13,313 15,761 Net unamortized premium on debt............................................................... 39,985 92,346 Long-term debt due within one year*........................................................... (1,754,197) (1,701,072) ----------- ----------- Total long-term debt*......................................................................... 9,789,066 10,872,216 ----------- ----------- TOTAL CAPITALIZATION* $18,413,530 $18,686,388 - ----------------------------------------------------------------------------------------------------------------------------- * The December 31, 2003 balance for Preferred Stock subject to Mandatory Redemption is classified as debt under SFAS 150 (see Note 9). The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
44 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
Accumulated Unallocated Other Other ESOP Comprehensive Number Par Paid-In Comprehensive Retained Common Income of Shares Value Capital Income (Loss) Earnings Stock ------------- --------- ------- ------- ------------- -------- ----------- (Dollars in thousands) Balance, January 1, 2001........................ 224,531,580 $22,453 $3,531,821 $ 593 $1,209,991 $(111,732) GPU acquisition.............................. 73,654,696 7,366 2,586,097 Net income................................... $646,447 646,447 Minimum liability for unfunded retirement benefits, net of $(182,000) of income taxes...................................... (268) (268) Unrealized loss on derivative hedges, net of $(116,521,000) of income taxes (169,408) (169,408) Unrealized gain on investments, net of $56,000 of income taxes.................... 81 81 Currency translation adjustments, net of $(1,000) of income taxes................ (1) (1) -------- Comprehensive income......................... $476,851 ======== Reacquired common stock...................... (550,000) (55) (15,253) Allocation of ESOP shares.................... 10,595 14,505 Cash dividends on common stock............... (334,633) - ---------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001...................... 297,636,276 29,764 6,113,260 (169,003) 1,521,805 (97,227) Net income................................... $552,804 552,804 Minimum liability for unfunded retirement benefits, net of $(316,681,000) of income taxes............................... (449,615) (449,615) Unrealized gain on derivative hedges, net of $37,458,000 of income taxes. 59,187 59,187 Unrealized loss on investments, net of $(3,796,000) of income taxes............... (5,269) (5,269) Currency translation adjustments............. (91,448) (91,448) --------- Comprehensive income......................... $ 65,659 ======== Stock options exercised...................... (8,169) Allocation of ESOP shares.................... 15,250 18,950 Cash dividends on common stock............... (439,628) - ---------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002...................... 297,636,276 29,764 6,120,341 (656,148) 1,634,981 (78,277) Net income................................... $422,764 422,764 Minimum liability for unfunded retirement benefits, net of $101,950,000 of income taxes............................... 144,236 144,236 Unrealized loss on derivative hedges, net of $(241,000) of income taxes.............. (347) (347) Unrealized gain on investments, net of $53,431,000 of income taxes................ 68,162 68,162 Currency translation adjustments. 91,448 91,448 -------- Comprehensive income......................... $726,263 ======== Stock options exercised...................... (3,502) Common stock issued.......................... 32,200,000 3,220 930,918 Allocation of ESOP shares.................... 15,068 20,073 Cash dividends on common stock............... (453,360) - ---------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003...................... 329,836,276 $32,984 $7,062,825 $(352,649) $1,604,385 $(58,204) ================================================================================================================================== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
45 CONSOLIDATED STATEMENTS OF PREFERRED STOCK Not Subject to Subject to Mandatory Redemption Mandatory Redemption -------------------- -------------------- Par or Par or Number Stated Number Stated of Shares Value of Shares Value --------- ------ --------- ------- (Dollars in thousands) Balance, January 1, 2001 12,324,699 $ 648,395 5,177,216 $ 246,571 GPU acquisition 125,000 12,649 13,515,001 365,151 Issues- 9.00% Series 4,000,000 100,000 Redemptions- 8.45% Series (50,000) (5,000) $ 7.35 Series C (10,000) (1,000) $88.00 Series R (50,000) (50,000) $91.50 Series Q (10,716) (10,716) $90.00 Series S (18,750) (18,750) Amortization of fair market value adjustments- $ 7.35 Series C (11) $88.00 Series R (1,128) $90.00 Series S (668) - -------------------------------------------------------------------------------- Balance, December 31, 2001 12,449,699 661,044 22,552,751 624,449 Redemptions- 7.75% Series (4,000,000) (100,000) $7.56 Series B (450,000) (45,071) $42.40 Series T (200,000) (96,850) $8.32 Series (100,000) (10,000) $7.76 Series (150,000) (15,000) $7.80 Series (150,000) (15,000) $10.00 Series (190,000) (19,000) $2.21 Series (1,000,000) (25,000) 7.625% Series (7,500) (750) $7.35 Series C (10,000) (1,000) $90.00 Series S (17,750) (17,010) 8.65% Series J (250,001) (26,750) 7.52% Series K (265,000) (28,951) 9.00% Series (4,800,000) (120,000) Amortization of fair market value adjustments- $ 7.35 Series C (9) $90.00 Series S (258) 8.56% Series (6) 7.35% Series 209 7.34% Series 214 - -------------------------------------------------------------------------------- Balance, December 31, 2002 6,209,699 335,123 17,202,500 430,138 Redemptions- 7.625% Series (7,500) (750) $7.35 Series C (10,000) (1,000) 8.56% Series (5,000,000) (125,242) FIN 46 Deconsolidation- 9.00% Series (4,000,000) (100,000) 7.35% Series (4,000,000) (92,618) 7.34% Series (4,000,000) (92,428) Amortization of fair market value adjustments- $ 7.35 Series C (7) 8.56% Series (2) 7.35% Series 209 7.34% Series 214 - -------------------------------------------------------------------------------- Balance, December 31, 2003 6,209,699 $335,123 185,000 $ 18,514* ================================================================================ * The December 31, 2003 balance for Preferred Stock subject to mandatory redemption is classified as debt under SFAS 150 (see Note 9). The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 46 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2003 2002 2001 - --------------------------------------------------------------------------------------------------------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income...................................................... $ 422,764 $ 552,804 $ 646,447 Adjustments to reconcile net income to net cash from operating activities: Provision for depreciation and amortization................ 1,281,690 1,298,290 889,550 Nuclear fuel and capital lease amortization................ 66,072 80,507 98,178 Other amortization and accruals, net (Note 2(M))........... (16,278) (16,593) (11,927) Deferred costs recoverable as regulatory assets............ (216,829) (362,956) (31,893) Goodwill impairment (Note 2(L))............................ 116,988 -- -- Disallowed purchased power costs........................... 152,500 -- -- Investment impairments (Note 3)............................ 43,803 50,000 -- Deferred income taxes, net................................. 80,043 103,293 31,625 Investment tax credits, net................................ (26,404) (26,507) (22,545) Cumulative effect of accounting change..................... (174,663) -- 14,338 Loss from discontinued operations (see Note 2(I)).......... 101,379 79,863 -- Receivables................................................ 66,311 (73,392) 53,099 Materials and supplies..................................... 5,399 (29,134) (50,052) Accounts payable........................................... (169,652) 218,226 (84,572) Deferred lease costs....................................... (119,398) (84,800) -- Other (Note 10)............................................ 338,737 125,686 (250,564) ----------- ----------- ----------- Net cash provided from operating activities.............. 1,952,462 1,915,287 1,281,684 ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Common stock................................................. 934,138 -- -- Preferred stock.............................................. -- -- 96,739 Long-term debt............................................... 1,027,312 668,676 4,338,080 Short-term borrowings, net................................... -- 478,520 -- Redemptions and Repayments- Common stock................................................. -- -- (15,308) Preferred stock.............................................. (127,087) (522,223) (85,466) Long-term debt............................................... (2,128,567) (1,308,814) (394,017) Short-term borrowings, net................................... (575,391) -- (1,641,484) Common Stock Dividend Payments.................................. (453,360) (439,628) (334,633) ----------- ----------- ----------- Net cash provided from (used for) financing activities... (1,322,955) (1,123,469) 1,963,911 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: GPU acquisition, net of cash.................................... -- -- (2,013,218) Property additions.............................................. (856,316) (997,723) (852,449) Proceeds from sale of assets.................................... 78,743 155,034 -- Avon cash and cash equivalents (Note 3)......................... -- 31,326 -- Net assets held for sale........................................ -- (31,326) -- Cash investments (Note 2(M)).................................... 52,884 81,349 24,518 Other (Note 10)................................................. 12,856 (54,355) (233,526) ----------- ----------- ----------- Net cash used for investing activities................... (711,833) (815,695) (3,074,675) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents............ (82,326) (23,877) 170,920 Cash and cash equivalents at beginning of year.................. 196,301 220,178 49,258 ----------- ----------- ----------- Cash and cash equivalents at end of year*....................... $ 113,975 $ 196,301 $ 220,178 =========== =========== =========== SUPPLEMENTAL CASH FLOWS INFORMATION: Cash Paid During the Year- Interest (net of amounts capitalized)........................ $ 730,277 $ 881,515 $ 425,737 Income taxes................................................. $ 161,915 $ 389,180 $ 433,640 * 2001 excludes amounts in "Assets Pending Sale" on the Consolidated Balance Sheet as of December 31, 2001. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
47 FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF TAXES
For the Years Ended December 31, 2003 2002 2001 - --------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: Real and personal property........................................... $ 183,694 $ 218,683 $ 176,916 State gross receipts*................................................ 130,244 132,622 102,335 Kilowatt-hour excise*................................................ 228,216 219,970 117,979 Social security and unemployment..................................... 68,019 46,345 44,480 Other................................................................ 28,292 32,709 13,630 ----------- ----------- ----------- Total general taxes........................................... $ 638,465 $ 650,329 $ 455,340 =========== =========== =========== PROVISION FOR INCOME TAXES: Currently payable- Federal........................................................... $ 306,347 $ 326,417 $ 375,108 State............................................................. 118,155 104,867 84,322 Foreign........................................................... (1,165) 20,624 108 ----------- ----------- ----------- 423,337 451,908 459,538 ----------- ----------- ----------- Deferred, net- Federal........................................................... 71,910 81,934 37,888 State............................................................. 8,133 7,759 (6,177) Foreign........................................................... -- 13,600 (86) ----------- ----------- ----------- 80,043 103,293 31,625 ----------- ----------- ----------- Investment tax credit amortization................................... (26,404) (26,507) (22,545) ----------- ----------- ----------- Total provision for income taxes.............................. $ 476,976 $ 528,694 $ 468,618 =========== =========== =========== RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes........................ $ 899,740 $ 1,081,498 $ 1,115,065 =========== =========== =========== Federal income tax expense at statutory rate......................... $ 314,909 $ 378,524 $ 390,273 Increases (reductions) in taxes resulting from- Amortization of investment tax credits............................ (26,404) (26,507) (22,545) State income taxes, net of federal income tax benefit............. 82,088 73,207 50,794 Amortization of tax regulatory assets............................. 31,909 29,296 30,419 Amortization of goodwill.......................................... -- -- 18,416 Preferred stock dividends......................................... 7,202 13,634 19,733 Reserve for foreign operations.................................... 44,305 48,587 -- Other, net........................................................ 22,967 11,953 (18,472) ----------- ----------- ------------ Total provision for income taxes.............................. $ 476,976 $ 528,694 $ 468,618 =========== =========== =========== ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: Property basis differences........................................... $ 2,293,209 $ 2,052,594 $ 1,996,937 Customer receivables for future income taxes......................... 139,335 144,073 178,683 Regulatory transition charge......................................... 1,084,871 1,408,232 1,289,438 Deferred sale and leaseback costs.................................... (95,474) (99,647) (77,099) Nonutility generation costs.......................................... (221,063) (228,476) (178,393) Unamortized investment tax credits................................... (70,054) (78,227) (86,256) Other comprehensive income........................................... (243,743) (398,883) (115,395) Lease market valuation liability..................................... (455,074) (490,698) -- Other (Note 10)...................................................... (253,932) (239,286) (323,696) ------------ ----------- ----------- Net deferred income tax liability**........................... $ 2,178,075 $ 2,069,682 $ 2,684,219 =========== =========== =========== * Collected from customers through regulated rates and included in revenue on the Consolidated Statements of Income. ** 2001 excludes amounts in "Liabilities Related to Assets Pending Sale" on the Consolidated Balance Sheet as of December 31, 2001. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. GENERAL: The consolidated financial statements include FirstEnergy Corp., a registered public utility holding company, and its principal electric utility operating subsidiaries, Ohio Edison Company (OE), The Cleveland Electric Illuminating Company (CEI), Pennsylvania Power Company (Penn), The Toledo Edison Company (TE), American Transmission Systems, Inc. (ATSI), Jersey Central Power & Light Company (JCP&L), Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec). ATSI owns and operates FirstEnergy's transmission facilities within the service areas of OE, CEI and TE (Ohio Companies) and Penn. The operating utility subsidiaries are referred to throughout as "Companies." FirstEnergy's 2001 results include the results of JCP&L, Met-Ed and Penelec from the period they were acquired on November 7, 2001 through December 31, 2001. The consolidated financial statements also include FirstEnergy's other principal subsidiaries: FirstEnergy Solutions Corp. (FES); FirstEnergy Facilities Services Group, LLC (FSG); MYR Group, Inc.; MARBEL Energy Corporation; First Communications, LLC; FirstEnergy Nuclear Operating Company (FENOC); GPU Capital, Inc.; GPU Power, Inc.; and FirstEnergy Service Company (FESC). FES provides energy-related products and services and, through its FirstEnergy Generation Corp. (FGCO) subsidiary, operates FirstEnergy's nonnuclear generation business. FENOC operates the Companies' nuclear generating facilities. FSG is the parent company of several heating, ventilating, air conditioning and energy management companies, and MYR is a utility infrastructure construction service company. MARBEL holds FirstEnergy's interest in Great Lakes Energy Partners, LLC. First Communications provides local and long-distance phone service. GPU Capital owned and operated electric distribution systems in foreign countries and GPU Power owned and operated generation facilities in foreign countries. FESC provides legal, financial and other corporate support services to affiliated FirstEnergy companies. The Companies follow the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the Public Utilities Commission of Ohio (PUCO), the Pennsylvania Public Utility Commission (PPUC), the New Jersey Board of Public Utilities (NJBPU) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. FirstEnergy's consolidated financial statements for the year ended December 31, 2002 were restated to reflect a change in the method of amortizing costs being recovered under the Ohio transition plan, recognition of above-market liabilities of certain leased generation facilities, Ohio transition plan regulatory assets and goodwill. Certain prior year amounts have been reclassified to conform with the current year presentation, as described further in Notes 2(F), 2(I) and 8. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (A) CONSOLIDATION- FirstEnergy consolidates all majority-owned subsidiaries over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) over which the Company has the ability to exercise significant influence, but not control, are accounted for on the equity basis. (B) EARNINGS PER SHARE- Basic earnings per share are computed using the weighted average of actual common shares outstanding as the denominator. Diluted earnings per share reflect the weighted average of actual common shares outstanding plus the potential additional common shares that could result if dilutive securities and agreements were exercised in the denominator. In 2003, 2002 and 2001, stock-based awards to purchase shares of common stock totaling 3.3 million, 3.4 million and 0.1 million, respectively, were excluded from the calculation of diluted earnings per share of common stock because their exercise prices were greater than the average market price of common shares during the period. The numerators for the calculations of basic and diluted earnings per share are Income Before Discontinued Operations and Cumulative Effect of Accounting Changes and Net Income. The following table reconciles the denominators for basic and diluted earnings per share: 49
Years Ended December 31, ------------------------------------- Denominator for Earnings per Share Calculations 2003 2002 2001 -------------------------------------------------------------------------------------------- (In thousands) Denominator for basic earnings per share (weighted average shares actually outstanding)... 303,582 293,194 229,512 Assumed exercise of dilutive securities or agreements to issue common stock................. 1,390 1,227 918 ------------------------------------------------------------------------------------------- Denominator for diluted earnings per share......... 304,972 294,421 230,430 ===========================================================================================
(C) REVENUES- The Companies' principal business is providing electric service to customers in Ohio, Pennsylvania and New Jersey. The Companies' retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. See Note 10 - Other Information for discussion of reporting of independent system operator (ISO) transactions. Receivables from customers include sales to residential, commercial and industrial customers and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of FirstEnergy's customers. Total customer receivables were $1.0 billion (billed - $664 million and unbilled - $336 million) and $1.2 billion (billed - $808 million and unbilled - $345 million) as of December 31, 2003 and 2002, respectively. CEI and TE sell substantially all of their retail customers' receivables to Centerior Funding Corporation (CFC), a wholly owned subsidiary of CEI. CFC subsequently transfers the receivables to a trust (a "qualified special purpose entity") under Statement of Financial Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," under an asset-backed securitization agreement. Transfers are made in return for an interest in the trust (19% as of December 31, 2003), which is stated at fair value, reflecting adjustments for anticipated credit losses. The average collection period for billed receivables is 28 days. Given the short collection period after billing, the fair value of CFC's interest in the trust approximates the stated value of its retained interest in underlying receivables after adjusting for anticipated credit losses. Accordingly, subsequent measurements of the retained interest under SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities", (as an available-for-sale financial instrument) result in no material change in value. Sensitivity analyses reflecting 10% and 20% increases in the rate of anticipated credit losses would not have significantly affected FirstEnergy's retained interest in the pool of receivables through the trust. Of the $250 million sold to the trust and outstanding as of December 31, 2003, FirstEnergy's retained interests in $48 million of the receivables are included as other receivables on the Consolidated Balance Sheets. Accordingly, receivables recorded on the Consolidated Balance Sheets were reduced by approximately $202 million due to these sales. Collections of receivables previously transferred to the trust and used for the purchase of new receivables from CFC during 2003 totaled approximately $2.4 billion. CEI and TE processed receivables for the trust and received servicing fees of approximately $3.6 million in 2003. Expenses associated with the factoring discount related to the sale of receivables were $3.5 million, $4.7 million and $12.0 million in 2003, 2002 and 2001. (D) REGULATORY MATTERS- In Ohio, New Jersey and Pennsylvania, laws applicable to electric industry deregulation contain similar provisions which are reflected in the Companies' respective state regulatory plans: o allowing the Companies' electric customers to select their generation suppliers; o establishing provider of last resort (PLR) obligations to customers in the Companies' service areas; o allowing recovery of transition costs (sometimes referred to as stranded investment); o itemizing (unbundling) the price of electricity into its component elements - including generation, transmission, distribution and transition costs recovery charges; o deregulating the Companies' electric generation businesses; o continuing regulation of the Companies' transmission and distribution system; and o requiring corporate separation of regulated and unregulated business activities. 50 Ohio In July 1999, Ohio's electric utility restructuring legislation, which allowed Ohio electric customers to select their generation suppliers beginning January 1, 2001, was signed into law. Among other things, the legislation provided for a 5% reduction on the generation portion of residential customers' bills and the opportunity to recover transition costs, including regulatory assets, from January 1, 2001 through December 31, 2005 (market development period). The period for the recovery of regulatory assets only can be extended up to December 31, 2010. The recovery period extension is related to the customer shopping incentives recovery discussed below. The PUCO was authorized to determine the level of transition cost recovery, as well as the recovery period for the regulatory assets portion of those costs, in considering each Ohio electric utility's transition plan application. In July 2000, the PUCO approved FirstEnergy's transition plan for OE, CEI and TE (Ohio Companies) as modified by a settlement agreement with major parties to the transition plan. The application of SFAS 71, "Accounting for the Effects of Certain Types of Regulation" to OE's generation business and the nonnuclear generation businesses of CEI and TE was discontinued with the issuance of the PUCO transition plan order, as described further below. Major provisions of the settlement agreement consisted of approval of recovery of generation-related transition costs as filed of $4.0 billion net of deferred income taxes (OE-$1.6 billion, CEI-$1.6 billion and TE-$0.8 billion) and transition costs related to regulatory assets as filed of $2.9 billion net of deferred income taxes (OE-$1.0 billion, CEI-$1.4 billion and TE-$0.5 billion), with recovery through no later than 2006 for OE, mid-2007 for TE and 2008 for CEI, except where a longer period of recovery is provided for in the settlement agreement. The generation-related transition costs include $1.4 billion, net of deferred income taxes, (OE-$1.0 billion, CEI-$0.2 billion and TE-$0.2 billion) of impaired generating assets recognized as regulatory assets as described further below, $2.4 billion, net of deferred income taxes, (OE-$1.2 billion, CEI-$0.4 billion and TE-$0.8 billion) of above market operating lease costs and $0.8 billion, net of deferred income taxes, (CEI-$0.5 billion and TE-$0.3 billion) of additional plant costs that were reflected on CEI's and TE's regulatory financial statements. Also as part of the settlement agreement, FirstEnergy gives preferred access over its subsidiaries to nonaffiliated marketers, brokers and aggregators to 1,120 megawatts (MW) of generation capacity through 2005 at established prices for sales to the Ohio Companies' retail customers. Customer prices are frozen through the five-year market development period, which runs through the end of 2005, except for certain limited statutory exceptions, including the 5% reduction referred to above. In February 2003, the Ohio Companies were authorized increases in annual revenues aggregating approximately $50 million (OE-$41 million, CEI-$4 million and TE-$5 million) to recover their higher tax costs resulting from the Ohio deregulation legislation. FirstEnergy's Ohio customers choosing alternative suppliers receive an additional incentive applied to the shopping credit (generation component) of 45% for residential customers, 30% for commercial customers and 15% for industrial customers. The amount of the incentive is deferred for future recovery from customers. Subject to approval by the PUCO, recovery will be accomplished by extending the respective transition cost recovery period. On October 21, 2003, the Ohio Companies filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate supply and continuing our support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service, including PLR responsibility, for the Ohio Companies' customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of the Ohio Companies' support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, we are requesting: o Extension of the transition cost amortization period for OE from 2006 to 2007; for CEI from 2008 to 2009 and for TE from mid-2007 to 2008; 51 o Deferral of interest costs on the accumulated shopping incentives and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates under certain limited conditions. On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 24, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S./Canada Power Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. New Jersey JCP&L's 2001 Final Decision and Order (Final Order) with respect to its rate unbundling, stranded cost and restructuring filings confirmed rate reductions set forth in its 1999 Summary Order, which had been in effect at increasing levels through July 2003. The Final Order also confirmed the establishment of a non-bypassable societal benefits charge (SBC) to recover costs which include nuclear plant decommissioning and manufactured gas plant remediation, as well as a non-bypassable market transition charge (MTC) primarily to recover stranded costs. The NJBPU has deferred making a final determination of the net proceeds and stranded costs related to prior generating asset divestitures until JCP&L's request for an Internal Revenue Service (IRS) ruling regarding the treatment of associated federal income tax benefits is acted upon. Should the IRS ruling support the return of the tax benefits to customers, there would be no effect to FirstEnergy's or JCP&L's net income since the contingency existed prior to the merger and there would be an adjustment to goodwill. In addition, the Final Order provided for the ability to securitize stranded costs associated with the divested Oyster Creek Nuclear Generating Station. Under NJBPU authorization in 2002, JCP&L issued through its wholly owned subsidiary, JCP&L Transition Funding LLC, $320 million of transition bonds (recognized on the Consolidated Balance Sheet) which securitized the recovery of these costs and which provided for a usage-based non-bypassable transition bond charge (TBC) and for the transfer of the bondable transition property to another entity. Prior to August 1, 2003, JCP&L's PLR obligation to provide basic generation service (BGS) to non-shopping customers was supplied almost entirely from contracted and open market purchases. JCP&L is permitted to defer for future collection from customers the amounts by which its costs of supplying BGS to non-shopping customers and costs incurred under nonutility generation (NUG) agreements exceed amounts collected through BGS and MTC rates. As of December 31, 2003, the accumulated deferred cost balance totaled approximately $440 million, after the charge discussed below. The NJBPU also allowed securitization of JCP&L's deferred balance to the extent permitted by law upon application by JCP&L and a determination by the NJBPU that the conditions of the New Jersey restructuring legislation are met. There can be no assurance as to the extent, if any, that the NJBPU will permit such securitization. Under New Jersey transition legislation, all electric distribution companies were required to file rate cases to determine the level of unbundled rate components to become effective August 1, 2003. JCP&L's two August 2002 rate filings requested increases in base electric rates of approximately $98 million annually and requested the recovery of deferred costs that exceeded amounts being recovered under the current MTC and SBC rates; one proposed method of recovery of these costs is the securitization of the deferred balance. This securitization methodology is similar to the Oyster Creek securitization discussed above. On July 25, 2003, the NJBPU announced its JCP&L base electric rate proceeding decision, which reduced JCP&L's annual revenues by approximately $62 million effective August 1, 2003. The NJBPU decision also provided for an interim return on equity of 9.5% on JCP&L's rate base for six to twelve months. During that period, JCP&L will initiate another proceeding to request recovery of additional costs incurred to enhance system reliability. In that proceeding, the NJBPU could increase the return on equity to 9.75% or decrease it to 9.25%, depending on its assessment of the reliability of JCP&L's service. Any reduction would be retroactive to August 1, 2003. The net revenue decrease from the NJBPU's decision consists of a $223 million decrease in the electricity delivery charge, a $111 million increase due to the August 1, 2003 expiration of annual customer credits previously mandated by the New Jersey transition legislation, a $49 million increase in the MTC tariff component, and a net $1 million increase in the SBC charge. The MTC allows for the recovery of $465 million in deferred energy costs over the next ten years on an interim basis, thus disallowing $153 million of the $618 million provided for in a preliminary settlement agreement between certain parties. As a result, JCP&L recorded charges to net income for the year ended December 31, 2003, aggregating $185 million ($109 million net of tax) consisting of the $153 million of disallowed deferred energy costs and 52 other regulatory assets. JCP&L filed a motion for rehearing and reconsideration with the NJBPU on August 15, 2003 with respect to the following issues: (1) the disallowance of the $153 million deferred energy costs; (2) the reduced rate of return on equity; and (3) $42.7 million of disallowed costs to achieve merger savings. On October 10, 2003, the NJBPU held the motion in abeyance until the final NJBPU decision and order which is expected to be issued in the first quarter of 2004. JCP&L's BGS obligation for the twelve month period beginning August 1, 2003 was auctioned in February 2003. The auction covered a fixed price bid (applicable to all residential and smaller commercial and industrial customers) and an hourly price bid (applicable to all large industrial customers) process. JCP&L sells all self-supplied energy (NUGs and owned generation) to the wholesale market with offsetting credits to its deferred energy balances. The BGS auction for the subsequent period was completed in February 2004. The NJBPU adjusted the generation component of JCP&L's retail rates on August 1, 2003 to reflect the results of the BGS auction. Pennsylvania The PPUC authorized 1998 rate restructuring plans for Penn, Met-Ed and Penelec. In 2000, the PPUC disallowed a portion of the requested additional stranded costs above those amounts granted in Met-Ed's and Penelec's 1998 rate restructuring plan orders. The PPUC required Met-Ed and Penelec to seek an IRS ruling regarding the return of certain unamortized investment tax credits and excess deferred income tax benefits to customers. Similar to JCP&L's situation, if the IRS ruling ultimately supports returning these tax benefits to customers, there would be no effect to FirstEnergy's, Met-Ed's or Penelec's net income since the contingency existed prior to the merger and would be an adjustment to goodwill. In June 2001, the PPUC approved the Settlement Stipulation with all of the major parties in the combined merger and rate relief proceedings which approved the FirstEnergy/GPU merger and provided PLR deferred accounting treatment for energy costs, permitting Met-Ed and Penelec to defer, for future recovery, energy costs in excess of amounts reflected in their capped generation rates retroactive to January 1, 2001. This PLR deferral accounting procedure was later denied in a February 2002 Commonwealth Court of Pennsylvania decision. The court decision also affirmed the PPUC decision regarding approval of the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. FirstEnergy established reserves in 2002 for Met-Ed's and Penelec's PLR deferred energy costs which aggregated $287.1 million, reflecting the potential adverse impact of the then pending Pennsylvania Supreme Court decision whether to review the Commonwealth Court decision. As a result, FirstEnergy recorded in 2002 an aggregate non-cash charge of $55.8 million ($32.6 million net of tax) to income for the deferred costs incurred subsequent to the merger. The reserve for the remaining $231.3 million of deferred costs increased goodwill by an aggregate net of tax amount of $135.3 million. On April 2, 2003, the PPUC remanded the issue relating to merger savings to the Office of Administrative Law for hearings, directed Met-Ed and Penelec to file a position paper on the effect of the Commonwealth Court order on the Settlement Stipulation and allowed other parties to file responses to the position paper. Met-Ed and Penelec filed a letter with the Administrative Law Judge (ALJ) on June 11, 2003, voiding the Stipulation in its entirety and reinstating Met-Ed's and Penelec's restructuring settlement previously approved by the PPUC. On October 2, 2003, the PPUC issued an order concluding that the Commonwealth Court reversed the PPUC's June 20, 2001 order in its entirety. The PPUC directed Met-Ed and Penelec to file tariffs within thirty days of the order to reflect the competitive transition charge (CTC) rates and shopping credits that were in effect prior to the June 21, 2001 order to be effective upon one day's notice. In response to that order, Met-Ed and Penelec filed these supplements to their tariffs to become effective October 24, 2003. On October 8, 2003, Met-Ed and Penelec filed a petition for clarification relating to the October 2, 2003 order on two issues: to establish June 30, 2004 as the date to fully refund the NUG trust fund and to clarify that the ordered accounting treatment regarding the CTC rate/shopping credit swap should follow the ratemaking, and that the PPUC's findings would not impair their rights to recover all of their stranded costs. On October 9, 2003, ARIPPA (an intervenor in the proceedings) petitioned the PPUC to direct Met-Ed and Penelec to reinstate accounting for the CTC rate/shopping credit swap retroactive to January 1, 2002. Several other parties also filed petitions. On October 16, 2003, the PPUC issued a reconsideration order granting the date requested by Met-Ed and Penelec for the NUG trust fund refund, denying Met-Ed's and Penelec's other clarification requests and granting ARIPPA's petition with respect to the accounting treatment of the changes to the CTC rate/shopping credit swap. On October 22, 2003, Met-Ed and Penelec filed an Objection with the Commonwealth Court asking that the Court reverse the PPUC's finding that requires Met-Ed and Penelec to treat the stipulated CTC rates that were in effect from January 1, 2002 on a retroactive basis. Met-Ed and Penelec are considering filing an appeal to the Commonwealth Court on the PPUC orders as well. On October 27, 2003, a Commonwealth Court judge issued an Order denying Met-Ed's and Penelec's objection without explanation. Due to the vagueness of the Order, Met-Ed and Penelec, on October 31, 2003, filed an Application for Clarification with the judge. Concurrent with this filing, Met-Ed and Penelec, in order to preserve their 53 rights, also filed with the Commonwealth Court both a Petition for Review of the PPUC's October 16 and October 22 Orders, and an application for reargument, if the judge, in his clarification order, indicates that Met-Ed's and Penelec's objection was intended to be denied on the merits. In addition to these findings, Met-Ed and Penelec, in compliance with the PPUC's Orders, filed revised PPUC quarterly reports for the twelve months ended December 31, 2001 and 2002, and for the first two quarters of 2003, reflecting balances consistent with the PPUC's findings in their Orders. Effective September 1, 2002, Met-Ed and Penelec assigned their PLR responsibility to their FES affiliate through a wholesale power sale agreement. The PLR sale will be automatically extended for each successive calendar year unless any party elects to cancel the agreement by November 1 of the preceding year. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by Met-Ed and Penelec under their NUG contracts and other power contracts with nonaffiliated third party suppliers. This arrangement reduces Met-Ed's and Penelec's exposure to high wholesale power prices by providing power at a fixed price for their uncommitted PLR energy costs during the term of the agreement with FES. FES has hedged most of Met-Ed's and Penelec's unfilled PLR on-peak obligation through 2004 and a portion of 2005, the period during which deferred accounting was previously allowed under the PPUC's order. Met-Ed and Penelec are authorized to continue deferring differences between NUG contract costs and current market prices. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. Met-Ed, Penelec and Penn are currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March of 2004. On January 16, 2004, the PPUC initiated a formal investigation of Met-Ed's, Penelec's and Penn's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. FirstEnergy is unable to predict the outcome of the investigation or the impact of the PPUC order. Transition Cost Amortization - OE, CEI and TE amortize transition costs (see Regulatory Matters - Ohio) using the effective interest method. Under the current Ohio transition plan, total transition cost amortization is expected to approximate the following for 2004 through 2009. (In millions) --------------------------------- 2004.................. $794 2005.................. 922 2006.................. 371 2007.................. 208 2008.................. 164 2009.................. 46 ------------------------------ The decrease in amortization beginning in 2006 results from the termination of generation-related transition cost recovery under the Ohio transition plan. Regulatory Assets- The Companies recognize, as regulatory assets, costs which the FERC, PUCO, PPUC and NJBPU have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are expected to continue to be recovered from customers under the Companies' respective transition and regulatory plans. Based on those plans, the Companies continue to bill and collect cost-based rates for their transmission and distribution services, which remain regulated; accordingly, it is appropriate that the Companies continue the application of SFAS 71 to those operations. Regulatory assets which do not earn a current return totaled approximately $625 million as of December 31, 2003. 54 Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2003 2002 - ------------------------------------------------------------------------------ (In millions) Regulatory transition charge................... $6,427 $7,608 Customer shopping incentives................... 371 188 Customer receivables for future income taxes... 340 394 Societal benefits charge....................... 81 144 Loss on reacquired debt........................ 75 74 Employee postretirement benefit costs.......... 77 88 Nuclear decommissioning, decontamination and spent fuel disposal costs.................... (96) 99 Component removal costs........................ (321) (288) Property losses and unrecovered plant costs.... 70 88 Other.......................................... 53 70 - --------------------------------------------------------------------------- Total.................................... $7,077 $8,465 - --------------------------------------------------------------------------- Regulatory Accounting for Generation Operations- The application of SFAS 71 was discontinued with respect to the Companies' generation operations. The SEC's interpretive guidance regarding asset impairment measurement providing that any supplemental regulated cash flows such as a CTC should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. Consistent with the SEC guidance, $1.8 billion of impaired plant investments ($1.2 billion, $227 million, $304 million and $53 million for OE, Penn, CEI and TE, respectively) were recognized as regulatory assets recoverable as transition costs through future regulatory cash flows. The following summarizes net assets included in property, plant and equipment relating to operations for which the application of SFAS 71 was discontinued, compared with the respective company's total assets as of December 31, 2003. SFAS 71 Discontinued Net Assets Total Assets -------------------------------------------- (In millions) OE............. $ 976 $6,591 CEI............ 1,429 6,773 TE............. 561 2,855 Penn........... 92 879 JCP&L.......... 42 7,579 Met-Ed......... 15 3,474 --------------------------------------- (E) PROPERTY, PLANT AND EQUIPMENT- Property, plant and equipment reflects original cost (except for nuclear generating assets which were adjusted to fair value), including payroll and related costs such as taxes, employee benefits, administrative and general costs, and interest costs incurred to place the assets in service. JCP&L holds a 50% ownership interest in Yards Creek Pumped Storage Facility - its net book value was approximately $20.7 million as of December 31, 2003. FirstEnergy also had shared ownership interests in various foreign properties - all such assets were divested by January 30, 2004. FirstEnergy's accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. The Companies provide for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The respective annual composite rates for the Companies' electric plant in 2003, 2002 and 2001 (post-merger periods only for JCP&L, Met-Ed and Penelec) are shown in the following table: Annual Composite Depreciation Rate ------------------------- 2003 2002 2001 ------------------------------------------------ OE............... 2.8% 2.7% 2.7% CEI.............. 3.0 3.4 3.2 TE............... 3.0 3.9 3.5 Penn............. 2.6 2.9 2.9 JCP&L............ 2.8 3.5 3.4 Met-Ed........... 2.7 3.0 3.0 Penelec.......... 2.7 3.0 2.9 ------------------------------------------------ 55 Nuclear Fuel - Nuclear fuel is recorded at original cost, which includes material, enrichment, fabrication and interest costs incurred prior to reactor load. The Companies amortize the cost of nuclear fuel based on the rate of consumption. (F) ASSET RETIREMENT OBLIGATION- In January 2003, FirstEnergy implemented SFAS 143, "Accounting for Asset Retirement Obligations", which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. FirstEnergy identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning, reclamation of a sludge disposal pond related to the Bruce Mansfield Plant, and closure of two coal ash disposal sites. The ARO liability as of the date of adoption of SFAS 143 was $1.107 billion, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. The ARO liability was $1.179 billion as of December 31, 2003 and included $1.166 billion for nuclear decommissioning of the Beaver Valley, Davis-Besse, Perry, and Three Mile Island Unit 2 (TMI-2) nuclear generating facilities (discussed below). The Companies' share of the obligation to decommission these units was developed based on site specific studies performed by an independent engineer. FirstEnergy utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Companies maintain nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $1.352 billion. Payments for decommissioning of the nuclear generating units are expected to begin in 2014, when actual decommissioning work is expected to begin. The following table provides the beginning and ending aggregate carrying amount of the total ARO and the changes to the balance during 2003. ARO Reconciliation 2003 - ---------------------------------------------------------------------------- (In millions) Beginning balance as of January 1, 2003 ...................... $1,107 Liabilities incurred.......................................... -- Liabilities settled........................................... -- Accretion in 2003............................................. 72 Revisions in estimated cash flows............................. -- - ------------------------------------------------------------------------ Ending balance as of December 31, 2003........................ $1,179 - ------------------------------------------------------------------------ The following table provides the year-end balance of the ARO for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 - ----------------------------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002....................... $1,042 Accretion in 2002............................................. 65 - ------------------------------------------------------------------------ Ending balance as of December 31, 2002........................ $1,107 - ------------------------------------------------------------------------ In addition to the nuclear decommissioning ARO, FirstEnergy has also recognized estimated liabilities for post defueling monitored storage at TMI-2 of $26 million and decontamination and decommissioning of nuclear enrichment facilities of $28 million. Under terms of the NRC license, FirstEnergy is required to monitor and maintain TMI-2 to ensure that there is no deterioration of the facility. As required by the Energy Policy Act of 1992, FirstEnergy participates in the decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy. In accordance with SFAS 143, FirstEnergy ceased the accounting practice of depreciating non-regulated generation assets using a cost of removal component in the depreciation rates. That practice recognized accumulated depreciation in excess of the historical cost of an asset because the removal cost would exceed the estimated salvage value. Beginning in 2003, the cost of removal related to non-regulated generation assets is charged to expense rather than to the accumulated provision for depreciation. In accordance with SFAS 71, the cost of removal on regulated plant assets continues to be accounted for as a component of depreciation rates and is recognized as a regulatory liability. 56
The following table provides the effect on income as if SFAS 143 had been applied during 2002 and 2001. Effect of the Change in Accounting Principle Applied Retroactively 2002 2001 -------------------------------------------------------------------------------------------------- (In millions, except per share amounts) Reported net income............................................... $553 $646 Increase (Decrease): Elimination of decommissioning expense............................ 88 88 Depreciation of asset retirement cost............................. (3) (3) Accretion of ARO liability........................................ (38) (35) Non-regulated generation cost of removal component, net........... 15 11 Income tax effect................................................. (25) (25) ------------------------------------------------------------------------------------------- Net earnings increase............................................. 37 36 ------------------------------------------------------------------------------------------ Net income adjusted............................................... $590 $682 ========================================================================================== Basic earnings per share of common stock: Net income as previously reported................................. $1.89 $2.82 Adjustment for effect of change in accounting principle applied retroactively...................... 0.12 0.16 - ------------------------------------------------------------------------------------------- Net income adjusted............................................... $2.01 $2.98 ========================================================================================== Diluted earnings per share of common stock: Net income as previously reported................................. $1.88 $2.81 Adjustment for effect of change in accounting principle applied retroactively...................... 0.12 0.16 - ------------------------------------------------------------------------------------------- Net income adjusted .............................................. $2.00 $2.97 ==========================================================================================
(G) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 5(C)). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date, resulting in substantially no intrinsic value. If FirstEnergy had elected to account for employee stock options under the fair value method (as provided under SFAS 123, "Accounting for Stock-Based Compensation") a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 ---------------------------------------------------------------------------- Valuation assumptions: Expected option term (years)... 7.9 8.1 8.3 Expected volatility............ 26.91% 23.31% 23.45% Expected dividend yield........ 5.09% 4.36% 5.00% Risk-free interest rate........ 3.67% 4.60% 4.67% Fair value per option............ $5.09 $6.45 $4.97 ---------------------------------------------------------------------------- If fair value accounting were applied to FirstEnergy's stock options, net income and earnings per share would be reduced as summarized below.
2003 2002 2001 ---------------------------------------------------------------------------------- (In thousands, except per share amounts) Net Income, as reported.............. $422,764 $552,804 $646,447 Add back compensation expense reported in net income, net of tax (based on APB 25).................. 163 166 25 Deduct compensation expense based upon estimated fair value, net of tax............................. (12,354) (8,825) (3,748) ----------------------------------------------------------------------------------- Adjusted net income.................. $410,573 $544,145 $642,724 ----------------------------------------------------------------------------------- Earnings Per Share of Common Stock - Basic As Reported...................... $1.39 $1.89 $2.82 Adjusted......................... $1.35 $1.86 $2.80 Diluted As Reported...................... $1.39 $1.88 $2.81 Adjusted......................... $1.35 $1.85 $2.79
57 (H) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. FirstEnergy has capital loss carryforwards of approximately $1.1 billion, most of which expire in 2007. The deferred tax assets associated with these capital loss carryforwards ($374 million) are fully offset by a valuation allowance as of December 31, 2003, since management is unable to predict whether sufficient capital gains will be generated to utilize all of these capital loss carryforwards. Any ultimate utilization of capital loss carryforwards for which valuation allowances were established through purchase accounting would adjust goodwill. The Company has also recorded valuation allowances of $92 million for deferred tax assets associated with impairment losses related to certain domestic assets and the divestiture of international assets acquired through the merger with GPU (see Note 12). FirstEnergy has net operating loss carryforwards for state and local income tax purposes of approximately $693 million. A valuation allowance of $5 million has been recorded against the associated deferred tax assets of $30 million. These losses expire as follows: Expiration Period Amount ----------------------------------- (in millions) 2004-2008 $102 2009-2013 147 2014-2018 130 2019-2022 314 ------------------------------ $693 ============================== (I) DISCONTINUED OPERATIONS - FirstEnergy has included in "Discontinued Operations" on the Consolidated Statements of Income for the years ended December 31, 2003 and 2002 operating income and losses on sales of its international operations in Argentina and Bolivia and certain domestic subsidiaries of FSG and MARBEL, all of which were sold in 2003. Discontinued operations in 2003 of $(101) million, net of tax benefits of $2 million, included operating results of $2 million (revenues of $52 million and pretax income of $2 million) and losses on sales or abandonments of $103 million. A net operating loss of $80 million (revenues of $284 million and pretax loss of $75 million) attributable to these entities was included in discontinued operations in 2002. The 2001 results of the divested entities were not significant and the 2001 Consolidated Statement of Income was not reclassified to separately report discontinued operations. On April 18, 2003, FirstEnergy divested its ownership in Emdersa through the abandonment of its shares in Emdersa's parent company, GPU Argentina Holdings, Inc. The abandonment was accomplished by relinquishing FirstEnergy's shares to the independent Board of Directors of GPU Argentina Holdings, relieving FirstEnergy of all rights and obligations relative to this business. FirstEnergy included in discontinued operations Emdersa's net income of $7 and a $67 million charge for the abandonment in the second quarter of 2003 (no income tax benefit was recognized). An after-tax loss of $87 million (including $109 million in currency transaction losses arising principally from U.S. dollar denominated debt) was included in discontinued operations in 2002. In December 2003, Empresa Guaracachi S.A. (EGSA), GPU Power's Bolivia subsidiary, was sold to Bolivia Integrated Energy Limited. FirstEnergy included in discontinued operations a $33 million loss on the sale of EGSA in the fourth quarter of 2003 (no income tax benefit was realized) and an operating loss for the year of $2 million. Discontinued operations in 2002 include EGSA's operating income of $6 million. The FSG subsidiaries, Colonial Mechanical and Webb Technologies, were sold in January 2003 and Ancoma, Inc. was sold in December 2003; the MARBEL subsidiary, Northeast Ohio Natural Gas Corp. was sold in June 2003. The 2003 and 2002 results for these divested business operations included in discontinued operations for the years ended December 2003 and 2002 totaled $(3) million and $2 million, respectively. The following table summarizes major assets and liabilities for all of these divestitures included in FirstEnergy's Consolidated Balance Sheets as of December 31, 2002. 58 As of December 31 2002 ---------------------------------------------------------- (In millions) Current assets................................ $106 Property and investments...................... 175 Deferred Charges.............................. 44 ----- Total assets.................................. $325 ==== Current liabilities........................... $ 64 Capitalization................................ 205 Noncurrent liabilities........................ 56 ---- Total liabilities and capitalization.......... $325 ==== (J) CUMULATIVE EFFECT OF ACCOUNTING CHANGE As a result of adopting SFAS 143 in January 2003, asset retirement costs were recorded in the amount of $602 million as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $415 million. The ARO liability on the date of adoption was $1.107 billion, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. The remaining cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $175 million increase to income, $102 million net of tax, or $0.33 per share of common stock (basic and diluted) in the year ended December 31, 2003 (see Note 9). On January 1, 2001, FirstEnergy adopted SFAS 133 as amended, "Accounting for Derivative Instruments and Hedging Activities". The cumulative effect to January 1, 2001 was a charge of $9 million (net of $6 million of income taxes) or $0.03 per share of common stock. (K) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of its employees. The trusteed plans provide defined benefits based on years of service and compensation levels. The Company's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company recognizes the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as the merger with GPU, Inc. in November 2001), which impact employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes in key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced the Company's obligation by $123 million and $121 million, respectively. In early 2004, the Company announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. 59
Obligations and Funded Status Pension Benefits Other Benefits ---------------- -------------- As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $ 1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition (Note 12)................ -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------- Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $ 2,077 ====== ====== ======= ======= Change in fair value of plan assets Fair value of plan assets at beginning of year................................ $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------- Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ======= Funded status............................ $ (847) $ (977) $(1,831) (1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit)............................... 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ ------- ------- Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Amounts Recognized in the Consolidated Balance Sheets As of December 31 ----------------------------------------- Accrued benefit cost..................... $ (438) $ (548) $ (975) $ (867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ------ ------ ------- ------- Net amount recognized.................. $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Increase (decrease) in minimum liability included in other comprehensive income (net of tax)........................... $ (145) $ 444 -- -- Assumptions Used to Determine Benefit Obligations As of December 31 ---------------------------------------- Discount rate........................... 6.25% 6.75% 6.25% 6.75% Rate of compensation increase........... 3.50% 3.50% Allocation of Plan Assets As of December 31 ---------------------------------------- Asset Category Equity securities..................... 70% 61% 71% 58% Debt securities....................... 27 35 22 29 Real estate........................... 2 2 -- -- Cash.................................. 1 2 7 13 --- --- --- --- Total................................. 100% 100% 100% 100% === === === === Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 ----------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889 Pension Benefits Other Benefits ---------------------- -------------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 ---------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset)................................ -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ----- ----- ----- ----- ---- ---- Net periodic cost (income).............. $ 142 $ (29) $ (24) $ 177 $114 $ 92 ===== ===== ===== ===== ==== ====
60
Weighted-Average Assumptions Used Pension Benefits Other Benefits to Determine Net Periodic Benefit Cost ------------------------ -------------------- for Years Ended December 31 2003 2002 2001 2003 2002 2001 ---------------------------------------------------------------------------------------------- Discount rate.......................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets............................... 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase.......... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy. Assumed Health Care Cost Trend Rates As of December 31 2003 2002 - ------------------------------------------------------------------------------ Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2008-2010 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Increase Point Decrease - -------------------------------------------------------------------------------- (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of the increased market value of its pension plan assets, FirstEnergy reduced its minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $253 million, recording a decrease of $6 million in an intangible asset and crediting OCI by $145 million (offsetting previously recorded deferred tax benefits by $102 million). The remaining balance in OCI of $299 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $438 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. (L) GOODWILL- In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Under SFAS 142, "Goodwill and Other Intangible Assets," amortization of existing goodwill ceased January 1, 2002. Instead, FirstEnergy evaluates goodwill for impairment at least annually and makes such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. When impairment is indicated, FirstEnergy recognizes a loss - calculated as the difference between the implied fair value of a reporting unit's goodwill and the carrying value of the goodwill. FirstEnergy's annual review was completed in the third quarter of 2003. As a result of that review, a non-cash goodwill impairment charge of $122 million was recognized in the third quarter of 2003, reducing the carrying value of FSG. Of this amount, $117 million is reported as an operating expense and $5 million is included, net of tax, in the loss from discontinued operations. The 61 impairment charge reflects the continued slow down in the development of competitive retail markets and depressed economic conditions that affect the value of FSG. The fair value of FSG was estimated using primarily the expected discounted future cash flows. The forecasts used in FirstEnergy's evaluations of goodwill reflect operations consistent with its general business assumptions. Unanticipated changes in those assumptions could have a significant effect on FirstEnergy's future evaluations of goodwill. As of December 31, 2003, FirstEnergy had $6.1 billion of goodwill that primarily relates to its regulated services segment. The impairment analysis includes a significant source of cash representing the Companies' recovery of transition costs as described above under Note 2(D). FirstEnergy does not believe that completion of transition cost recovery will result in an impairment of goodwill relating to its regulated business segment. The following table displays what net income and earnings per share would have been if goodwill amortization had been excluded in 2001: 2003 2002 2001 ---- ---- ---- (In thousands, except per share amounts) Reported net income................... $422,764 $552,804 $646,447 Goodwill amortization (net of tax).... -- -- 54,584 -------- -------- -------- Adjusted net income................... $422,764 $552,804 $701,031 ======== ======== ======== Basic earnings per common share: Reported earnings per share........ $1.39 $1.89 $2.82 Goodwill amortization.............. -- -- 0.23 ----- ----- ----- Adjusted earnings per share........ $1.39 $1.89 $3.05 ===== ===== ===== Diluted earnings per common share: Reported earnings per share........ $1.39 $1.88 $2.81 Goodwill amortization.............. -- -- 0.23 ----- ----- ----- Adjusted earnings per share........ $1.39 $1.88 $3.04 ===== ===== ===== A summary of the changes in FirstEnergy's goodwill for the years ended December 31, 2002 and 2003 is shown below: 2003 2002 ---- ---- (In millions) Balance as of January 1................. $6,278 $5,983 Impairment charges...................... (122) -- FSG divestitures........................ (41) -- GPU acquisition (see Note 12)........... -- 286 Other................................... 13 9 ------ ------ Balance as of December 31............... $6,128 $6,278 ====== ====== (M) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Consolidated Balance Sheets at cost, which approximates their fair market value. Cash and cash equivalents as of December 31, 2003 included $32 million received in December 2003 which was included in the NRG settlement claim sold in January 2004 (see Note 3). Cash and cash equivalents as of December 31, 2002 included $50 million used for the redemption of long-term debt in January 2003. Noncash financing and investing activities in 2001 included $2.6 billion of common stock issued for the GPU acquisition and capital lease transactions amounting to $3 million. There were no capital lease transactions in 2003 or 2002. Net losses on foreign currency exchange transactions reflected on FirstEnergy's 2002 Consolidated Statement of Income consisted of approximately $104 million from FirstEnergy's Argentina operations (see Note 3 - Divestitures). On the Consolidated Statements of Cash Flows, the amounts included in "Cash investments" under Cash Flows From Investing Activities primarily consist of changes in investments in collateralized lease bonds (see Note 4) of $85 million and other cash investments of $(32) million in 2003 and changes in investments in collateralized lease bonds of $87 million and other cash investments of $(6) million in 2002. The amounts included in "Other amortization and accruals, net" under Cash Flows From Operating Activities include amounts from the reduction of an electric service obligation under a CEI electric service prepayment program. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Consolidated Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31: 62
2003 2002 - ------------------------------------------------------------------------------------------------ Carrying Fair Carrying Fair Value Value Value Value (In millions) Long-term debt.......................... $11,471 $11,970 $12,465 $12,761 ------------------------------------------------------------------------------------------------ Preferred stock*........................ $ 19 $ 19 $ 445 $ 454 ------------------------------------------------------------------------------------------------ Investments other than cash and cash equivalents: Debt securities: -Maturity (5-10 years)............ $ 452 $ 427 $ 502 $ 471 -Maturity (more than 10 years).... 871 1,005 927 1,030 Equity securities................... -- -- 15 15 All other........................... 1,944 1,944 1,668 1,669 - ------------------------------------------------------------------------------------------------- $ 3,267 $ 3,376 $ 3,112 $ 3,185 ================================================================================================= * The December 31, 2003 amount is classified as debt under SFAS 150.
The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by corporations with credit ratings similar to the Companies' ratings. The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. The Companies have no securities held for trading purposes. See Note 10 for discussion of SFAS 115 activity related to available-for-sale securities. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "All other" in the table above) consist of equity securities ($779 million) and fixed income securities ($573 million) as of December 31, 2003. In 2001, unrealized gains and losses applicable to all of FirstEnergy's decommissioning trusts were recognized in the trust investment with a corresponding change to the decommissioning liability. In 2003 and 2002, unrealized gains and losses applicable to the decommissioning trusts of FirstEnergy's Ohio Companies were reclassified to OCI in accordance with SFAS 115, as fluctuations in the fair value of these trust balances will eventually affect earnings. Realized gains (losses) are recognized as additions (reductions) to trust asset balances. For 2003 and 2002, net realized gains (losses) were approximately $6.0 million and $(15.6) million and interest and dividend income totaled approximately $37.0 million and $33.2 million, respectively. The Board of Directors authorized the repurchase of up to 15 million shares of FirstEnergy's common stock over a three-year period beginning in 1999. Repurchases were made on the open market, at prevailing prices, and were funded primarily through the use of operating cash flows. During 2001, FirstEnergy repurchased and retired 550,000 shares (average price of $27.82 per share). FirstEnergy is exposed to financial risks resulting from the fluctuation of interest rates and commodity prices, including electricity, natural gas and coal. To manage the volatility relating to these exposures, FirstEnergy uses a variety of non-derivative and derivative instruments, including forward contracts, options, futures contracts and swaps. The derivatives are used principally for hedging purposes, and to a lesser extent, for trading purposes. FirstEnergy's Risk Policy Committee, comprised of executive officers, exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. FirstEnergy uses derivatives to hedge the risk of price and interest rate fluctuations. FirstEnergy's primary ongoing hedging activity involves cash flow hedges of electricity and natural gas purchases. The maximum periods over which the variability of electricity and natural gas cash flows are hedged are two and three years, respectively. Gains and losses from hedges of commodity price risks are included in net income when the underlying hedged commodities are delivered. Also, gains and losses are included in net income when ineffectiveness occurs on certain natural gas hedges. The impact of ineffectiveness on earnings during 2003 was not material. FirstEnergy entered into interest rate derivative transactions during 2001 to hedge a portion of the anticipated interest payments on debt related to the GPU acquisition. Gains and losses from hedges of anticipated interest payments on acquisition debt are included in net income over the periods that hedged interest payments are made - 5, 10 and 30 years. Gains and losses from derivative contracts are included in other operating expenses. Accumulated Other Comprehensive Loss (AOCL) as of December 31, 2003 includes a net deferred loss of $111 million for derivative hedging activity. The $1 million increase from the December 31, 2002 balance of $110 million includes a $3 million reduction related to current hedging activity and a $4 million increase 63 due to net hedge gains included in earnings during the year. Approximately $22 million (after tax) of the current net deferred loss on derivative instruments in AOCL is expected to be reclassified to earnings during the next twelve months as hedged transactions occur. However, the fair value of these derivative instruments will fluctuate from period to period based on various market factors. During 2003, FirstEnergy and OE executed fixed-for-floating interest rate swap agreements with notional values of $950 million and $200 million, respectively, whereby FE and OE receive fixed cash flows based on the fixed coupons of the hedged securities and pay variable cash flows based on short-term variable market interest rates (6 month LIBOR index). These derivatives are treated as fair value hedges of fixed-rate, long-term debt issues - protecting against the risk of changes in the fair value of fixed-rate debt instruments due to lower interest rates. Swap maturities, fixed interest rates received, and interest payment dates match those of the underlying obligations. FirstEnergy entered into interest rate swap agreements on a $950 million notional amount of its and its subsidiaries' senior notes and first mortgage bonds with a weighted average fixed interest rate of 5.46%. OE entered into interest rate swap agreements on a $200 million notional amount of its senior notes with a weighted average fixed interest rate of 5.09%. In addition, the cancellation options (options with strike prices equivalent to that of the options embedded in the call feature of the securities), on $593.5 million notional amount of cancelable interest rate swaps on callable first mortgage bonds were exercised by swap counterparties. As a result of the counterparties exercising these options, FirstEnergy received $20.2 million in cash swap cancellation premiums during 2003. The amount of the cash premiums will be recognized over the remaining maturity of each respective hedged security. As of December 31, 2003 interest rate swap agreements with notional values totaling $1.15 billion were outstanding. FirstEnergy engages in the trading of commodity derivatives and periodically experiences net open positions. FirstEnergy's risk management policies limit the exposure to market risk from open positions and require daily reporting to management of potential financial exposures. 3. DIVESTITURES: INTERNATIONAL OPERATIONS- FirstEnergy completed the sale of its international assets subsequent to December 31, 2003 with the sales of its remaining 20.1 percent interest in Avon (parent of Midlands Electricity in the United Kingdom) on January 16, 2004, and its 28.67 percent interest in Termobarranquilla S.A., Empresa de Servicios Publicos (TEBSA) for $12 million on January 30, 2004. An impairment loss of $26 million related to TEBSA was recorded in December 2003 in Other Operating Expenses on the 2003 Consolidated Statement of Income and no gain or loss was recognized upon the sale in 2004. Avon, TEBSA and other international assets sold in 2003 were acquired as part of FirstEnergy's November 2001 merger with the former GPU, Inc. FirstEnergy no longer has ownership interests in international operating assets. The divestiture in 2003 of international operations in Bolivia and Argentina included the sale of FirstEnergy's wholly owned subsidiary, Guaracachi America, Inc., a holding company with a 50.001 percent interest in EGSA, on December 11, 2003, and its ownership in Emdersa through the abandonment of its shares in Emdersa's parent company, GPU Argentina Holdings, Inc. on April 18, 2003 (see Note 2(I)). This resulted in a loss on sale of $33 million recognized in Discontinued Operations in the Consolidated Statement of Income for the year ended December 31, 2003. FirstEnergy had sold a 79.9 percent equity interest in Avon on May 8, 2002 to Aquila, Inc. (formerly UtiliCorp United) for approximately $1.9 billion (including the assumption of $1.7 billion of debt). Proceeds to FirstEnergy included $155 million in cash and a note receivable for approximately $87 million (representing the present value of $19 million per year to be received over six years beginning in 2003) from Aquila for its 79.9 percent interest. After reaching agreement to sell its remaining 20.1 percent interest in the fourth quarter of 2003, FirstEnergy recorded a $5 million after-tax charge to reduce the carrying value. In the fourth quarter of 2002, FirstEnergy recorded a $50 million after-tax charge to reduce the carrying value of its remaining 20.1 percent interest. In the second quarter of 2003, FirstEnergy recognized an impairment of $13 million ($8 million net of tax) related to the carrying value of the note FirstEnergy had with Aquila from the 2002 sale of the 79.9 percent interest in Avon. The charges in the fourth quarter of 2002 and second quarter of 2003 are included in Other Operating Expenses on the Consolidated Statements of Income for the years ended December 31, 2002 and 2003, respectively. After receiving the first annual installment payment of $19 million in May 2003, FirstEnergy sold the remaining balance of its note receivable in the secondary market and received $63 million in proceeds on July 28, 2003. Through 2002, FirstEnergy was unsuccessful in divesting of GPU's former Argentina operations and made the decision to abandon its interest in Emdersa in early 2003. A number of economic events occurred in Argentina that hindered FirstEnergy's ability to realize Emdersa's estimated fair value. These events included currency devaluation, restrictions on repatriation of cash, and the anticipation of future asset sales in that region by competitors. The abandonment was accomplished by relinquishing FirstEnergy's shares to the independent Board of Directors of GPU Argentina Holdings, relieving FirstEnergy of all rights and obligations relative to this business. As a result of the abandonment, FirstEnergy recognized a one-time, non-cash charge of $67 million, or $0.23 per share of common stock in the second quarter of 2003. This charge is the result of realizing the currency translation adjustment (CTA) losses through current period 64 earnings ($90 million, or $0.30 per share), partially offset by the gain recognized from abandoning FirstEnergy's investment in Emdersa ($23 million, or $0.07 per share). Since FirstEnergy had previously recorded $90 million of CTA adjustments in OCI, the net effect of the $67 million charge was an increase in common stockholders' equity of $23 million. In addition, FirstEnergy reflected Emdersa's 2002 results of an after-tax loss of $87 million (including $109 million in currency transaction losses arising principally from U.S. dollar denominated debt) as discontinued operations in the Consolidated Statement of Income for the year ended December 31, 2002. FirstEnergy also recognized a CTA of $91 million in 2002 which reduced FirstEnergy's common stockholders' equity. This adjustment represented the impact of translating Emdersa's financial statements from its functional currency to the U.S. dollar for GAAP financial reporting. The $67 million after-tax charge in 2003 does not include the expected income tax benefits related to the abandonment, which were fully reserved during the second quarter of 2003. FirstEnergy expects tax benefits of approximately $129 million, of which $50 million would increase net income in the period that it becomes probable those benefits will be realized. The remaining $79 million of tax benefits would reduce goodwill recognized in connection with the acquisition of GPU. GENERATION ASSETS- In November 2001, FirstEnergy reached an agreement to sell four coal-fired power plants totaling 2,535 MW to NRG Energy Inc. On August 8, 2002, FirstEnergy notified NRG that it was canceling the agreement because NRG stated that it could not complete the transaction under the original terms of the agreement. NRG filed voluntary bankruptcy petitions in May 2003; subsequently FirstEnergy reached an agreement for settlement of its claim against NRG. Under NRG's proposed Plan of Reorganization, FirstEnergy, as an unsecured creditor, could receive an estimated settlement of approximately $198 million, with payment in the form of cash (12%), notes (15.2%) and new NRG common stock (72.8%). FirstEnergy sold its entire claim (including $32 million of cash proceeds received in December 2003) for $170 million in January 2004. In December 2002, FirstEnergy decided to retain ownership of these plants after reviewing other bids it subsequently received from other parties who had expressed interest in purchasing the plants. Since FirstEnergy did not execute a sales agreement by year-end, it reflected approximately $74 million ($43 million net of tax) of previously unrecognized depreciation and other transaction costs in the fourth quarter of 2002 related to these plants from November 2001 through December 2002 on its Consolidated Statements of Income. OTHER DOMESTIC OPERATIONS- Sales of domestic assets in 2003 included three FSG subsidiaries - Ancoma, Inc., a mechanical contracting company based in Rochester, New York, and Virginia-based Colonial Mechanical and Webb Technologies - and a MARBEL subsidiary - Northeast Ohio Natural Gas (see Note 2(I)). 4. LEASES: The Companies lease certain generating facilities, office space and other property and equipment under cancelable and noncancelable leases. OE sold portions of its ownership interests in Perry Unit 1 and Beaver Valley Unit 2 and entered into operating leases on the portions sold for basic lease terms of approximately 29 years. CEI and TE also sold portions of their ownership interests in Beaver Valley Unit 2 and Bruce Mansfield Units 1, 2 and 3 and entered into similar operating leases for lease terms of approximately 30 years. During the terms of their respective leases, OE, CEI and TE continue to be responsible, to the extent of their individual combined ownership and leasehold interests, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. They have the right, at the expiration of the respective basic lease terms, to renew their respective leases. They also have the right to purchase the facilities at the expiration of the basic lease term or any renewal term at a price equal to the fair market value of the facilities. The basic rental payments are adjusted when applicable federal tax law changes. OES Finance, Incorporated, a wholly owned subsidiary of OE, maintains deposits pledged as collateral to secure reimbursement obligations relating to certain letters of credit supporting OE's obligations to lessors under the Beaver Valley Unit 2 sale and leaseback arrangements. The deposits of approximately $278 million pledged to the financial institution providing those letters of credit are the sole property of OES Finance and are investments which are classified as "Held to Maturity". In the event of liquidation, OES Finance, as a separate corporate entity, would have to satisfy its obligations to creditors before any of its assets could be made available to OE as sole owner of OES Finance common stock. 65 Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 2003 are summarized as follows: 2003 2002 2001 - ------------------------------------------------------------------------------- (In millions) Operating leases Interest element...................... $181 $188 $194 Other................................. 150 136 120 Capital leases Interest element...................... 2 2 8 Other................................. 2 3 36 - ----------------------------------------------------------------------------- Total rentals...................... $335 $329 $358 ============================================================================= OE invested in the PNBV Capital Trust, which was established to purchase a portion of the lease obligation bonds issued on behalf of lessors in OE's Perry Unit 1 and Beaver Valley Unit 2 sale and leaseback transactions. CEI and TE established the Shippingport Capital Trust to purchase the lease obligation bonds issued on behalf of lessors in their Bruce Mansfield Units 1, 2 and 3 sale and leaseback transactions. The PNBV and Shippingport Capital Trust arrangements effectively reduce lease costs related to those transactions (see Note 9). The future minimum lease payments as of December 31, 2003, are:
Operating Leases ----------------------------------- Capital Lease Capital Leases Payments Trusts Net -------------------------------------------------------------------------------------------- (In millions) 2004.................................. $ 6 $ 294 $ 112 $ 182 2005.................................. 5 313 130 183 2006.................................. 5 322 142 180 2007.................................. 1 300 131 169 2008.................................. 1 294 105 189 Years thereafter...................... 6 2,514 872 1,642 -------------------------------------------------------------------------------------------- Total minimum lease payments.......... 24 $4,037 $1,492 $2,545 ====== ====== ====== Executory costs....................... 5 --------------------------------------------- Net minimum lease payments............ 19 Interest portion...................... 6 --------------------------------------------- Present value of net minimum lease payments...................... 13 Less current portion.................. 2 --------------------------------------------- Noncurrent portion.................... $11 ---------------------------------------------
FirstEnergy has recorded above-market lease liabilities for Beaver Valley Unit 2 and the Bruce Mansfield Plant associated with the 1997 merger between OE and Centerior. The total above-market lease obligation of $722 million associated with Beaver Valley Unit 2 is being amortized on a straight-line basis through the end of the lease term in 2017 (approximately $37 million per year). The total above-market lease obligation of $755 million associated with the Bruce Mansfield Plant is being amortized on a straight-line basis through the end of 2016 (approximately $48 million per year). As of December 31, 2003 the above-market lease liabilities for Beaver Valley Unit 2 and the Bruce Mansfield Plant totaled $1.1 billion, of which $85 million is current. 5. CAPITALIZATION: (A) RETAINED EARNINGS- There are no restrictions on retained earnings for payment of cash dividends on FirstEnergy's common stock. (B) EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) - An ESOP Trust funds most of the matching contribution for FirstEnergy's 401(k) savings plan. All full-time employees eligible for participation in the 401(k) savings plan are covered by the ESOP. The ESOP borrowed $200 million from OE and acquired 10,654,114 shares of OE's common stock (subsequently converted to FirstEnergy common stock) through market purchases. Dividends on ESOP shares are used to service the debt. Shares are released from the ESOP on a pro rata basis as debt service payments are made. In 2003, 2002 and 2001, 1,069,318 shares, 1,151,106 shares and 834,657 shares, respectively, were allocated to employees with the corresponding expense recognized based on the shares allocated method. The fair value of 2,896,951 shares unallocated as of December 31, 2003, was approximately $102.0 million. Total ESOP-related compensation expense was calculated as follows: 66 2003 2002 2001 - ------------------------------------------------------------------------------- (In millions) Base compensation............................ $35.1 $34.2 $25.1 Dividends on common stock held by the ESOP and used to service debt................... (9.1) (7.8) (6.1) - -------------------------------------------------------------------------------- Net expense.............................. $26.0 $26.4 $19.0 ================================================================================ (C) STOCK COMPENSATION PLANS- In 2001, FirstEnergy assumed responsibility for two stock-based plans as a result of its acquisition of GPU. No further stock-based compensation can be awarded under the GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan) or the 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan). All options and restricted stock under both plans have been converted into FirstEnergy options and restricted stock. Options under the GPU Plan became fully vested on November 7, 2001, and will expire on or before June 1, 2010. Under the MYR Plan, all options and restricted stock maintained their original vesting periods, which range from one to four years, and will expire on or before December 17, 2006. Additional stock-based plans administered by FirstEnergy include the Centerior Equity Plan (CE Plan) and the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). All options are fully vested under the CE Plan, and no further awards are permitted. Outstanding options will expire on or before February 25, 2007. Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 2003 2002 2001 - ---------------------------------------------------------------------------- Restricted common shares granted......... -- 36,922 133,162 Weighted average market price ........... n/a (1) $36.04 $35.68 Weighted average vesting period (years).. n/a (1) 3.2 3.7 Dividends restricted..................... n/a (1) Yes -- (2) - ---------------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares; MYR Plan dividends are paid as unrestricted cash on 128,662 shares Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. See Note 10(D) for discussion of stock-based employee compensation expense recognized for restricted stock and EDCP stock units. 67 Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price - ------------------------------------------------------------------------------ Balance, January 1, 2001.............. 5,021,862 24.09 (473,314 options exercisable)......... 24.11 Options granted..................... 4,240,273 28.11 Options exercised................... 694,403 24.24 Options forfeited................... 120,044 28.07 Balance, December 31, 2001............ 8,447,688 26.04 (1,828,341 options exercisable)....... 24.83 Options granted..................... 3,399,579 34.48 Options exercised................... 1,018,852 23.56 Options forfeited................... 392,929 28.19 Balance, December 31, 2002............ 10,435,486 28.95 (1,400,206 options exercisable)....... 26.07 Options granted..................... 3,981,100 29.71 Options exercised................... 455,986 25.94 Options forfeited................... 311,731 29.09 Balance, December 31, 2003............ 13,648,869 29.27 (1,919,662 options exercisable)....... 29.67 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. Options outstanding by plan and range of exercise price as of December 31, 2003 were as follows: Range of Options FirstEnergy Program Exercise Prices Outstanding ------------------------------------------------------------------------ FE plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU plan $23.75 - $35.92 501,734 Other plans 27,673 ---------------------------------------------------------------------- Total 13,648,869 ====================================================================== No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 2(G) - Stock-Based Compensation. (D) PREFERRED AND PREFERENCE STOCK- All preferred stock may be redeemed by the Companies in whole, or in part, with 30-90 days' notice. Met-Ed's and Penelec's preferred stock authorization consists of 10 million and 11.435 million shares, respectively, without par value. No preferred shares are currently outstanding for the two companies. The Companies' preference stock authorization consists of 8 million shares without par value for OE; 3 million shares without par value for CEI; and 5 million shares, $25 par value for TE. No preference shares are currently outstanding. (E) LONG-TERM DEBT- Each of the Companies has a first mortgage indenture under which it issues first mortgage bonds secured by a direct first mortgage lien on substantially all of its property and franchises, other than specifically excepted property. FirstEnergy and its subsidiaries have various debt covenants under their respective financing arrangements. The most restrictive of the debt covenants relate to the nonpayment of interest and/or principal on debt and the maintenance of certain financial ratios. The nonpayments debt covenant which could trigger a default is applicable to financing arrangements of FirstEnergy and all of the Companies. The maintenance of minimum fixed charge ratios and debt to capitalization ratios covenants is applicable to financing arrangements of FirstEnergy, the Ohio Companies and Penn. There also exist cross-default provisions among financing arrangements of FirstEnergy and the Companies. 68 Based on the amount of bonds authenticated by the respective mortgage bond trustees through December 31, 2003, the Companies' annual sinking fund requirements for all bonds issued under the various mortgage indentures of the Companies amounts to $61.9 million. OE and Penn expect to deposit funds with their respective mortgage bond trustees in 2004 that will then be withdrawn upon the surrender for cancellation of a like principal amount of bonds, specifically authenticated for such purposes against unfunded property additions or against previously retired bonds. This method can result in minor increases in the amount of the annual sinking fund requirement. JCP&L, Met-Ed and Penelec expect to fulfill their sinking fund obligations by providing bondable property additions and/or retired bonds to the respective mortgage bond trustees. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) -------------------------------- 2004.............. $1,750 2005.............. 683 2006.............. 1,377 2007.............. 237 2008.............. 385 -------------------------------- Included in the table above are amounts for various variable interest rate long-term debt which have provisions by which individual debt holders have the option to "put back" or require the respective debt issuer to redeem their debt at those times when the interest rate may change prior to its maturity date. These amounts are $494 million, $97 million and $50 million in 2004, 2005 and 2008, respectively, which represents the next date at which the debt holders may exercise this provision. The Companies' obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds. Certain pollution control revenue bonds are entitled to the benefit of irrevocable bank letters of credit of $220 million and noncancelable municipal bond insurance policies of $482 million to pay principal of, or interest on, the pollution control revenue bonds. To the extent that drawings are made under the letters of credit or policies, the Companies are entitled to a credit against their obligation to repay those bonds. The Companies pay annual fees of 1.125% to 1.50% of the amounts of the letters of credit to the issuing banks and are obligated to reimburse the banks for any drawings thereunder. FirstEnergy had unsecured borrowings of $270 million as of December 31, 2003, under its $500 million revolving credit facility agreement which expires November 29, 2004. FirstEnergy currently pays an annual facility fee of 0.425% on the total credit facility amount. FirstEnergy had no borrowings as of December 31, 2003 under a new $375 million long-term revolving credit facility agreement which expires October 23, 2006. FirstEnergy currently pays an annual facility fee of 0.50% on the total credit facility amount. The fees are subject to change based on changes to FirstEnergy's credit ratings. OE had unsecured borrowings of $40 million as of December 31, 2003 under a $250 million long-term revolving credit facility agreement which expires May 12, 2005. OE currently pays an annual facility fee of 0.20% on the total credit facility amount. OE had no unsecured borrowings as of December 31, 2003 under a $125 million long-term revolving credit facility which expires October 23, 2006. OE currently pays an annual facility fee of 0.25% on the total credit facility amount. The fees are subject to change based on changes to OE's credit ratings. CEI and TE have unsecured letters of credit of approximately $216 million in connection with the sale and leaseback of Beaver Valley Unit 2 that expire in April 2005. CEI and TE are jointly and severally liable for the letters of credit. In connection with its Beaver Valley Unit 2 sale and leaseback arrangements, OE has similar letters of credit secured by deposits held by its subsidiary, OES Finance (see Note 4). (F) LONG-TERM DEBT: PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- Effective July 1, 2003, upon adoption of SFAS 150 (see Note 9), FirstEnergy reclassified as debt the preferred stock of consolidated subsidiaries subject to mandatory redemption. Prior year amounts were not reclassified. Annual sinking fund provisions for the Companies' preferred stock are as follows: Redemption Price Per Series Shares Share ------------------------------------------------------------------ CEI.......... $7.35C 10,000 $ 100 Penn......... 7.625% 7,500 100 ------------------------------------------------------------------ 69 Annual sinking fund requirements for the next five years are $1.8 million in each year 2004 through 2006, $12.3 million in 2007 and $1.0 million in 2008. (G) LONG-TERM DEBT: SUBORDINATED DEBENTURES TO AFFILIATED TRUSTS- CEI formed a wholly owned statutory business trust to sell preferred securities and invest the gross proceeds in the 9.00% subordinated debentures of CEI. The sole assets of the trust are the applicable subordinated debentures. Interest payment provisions of the subordinated debentures match the distribution payment provisions of the trust's preferred securities. In addition, upon redemption or payment at maturity of subordinated debentures, the trust's preferred securities will be redeemed on a pro rata basis at their liquidation value. Under certain circumstances, the applicable subordinated debentures could be distributed to the holders of the outstanding preferred securities of the trust in the event that the trust is liquidated. CEI has effectively provided a full and unconditional guarantee of payments due on the trust's preferred securities. The trust's preferred securities are redeemable at 100% of their principal amount at CEI's option beginning in December 2006. Met-Ed and Penelec each formed statutory business trusts for substantially similar transactions to those of CEI. However, ownership of the respective Met-Ed and Penelec trusts is through separate wholly owned limited partnerships. In these transactions, each trust invested the gross proceeds from the sale of its preferred securities in the preferred securities of the applicable limited partnership, which in turn invested those proceeds in the 7.35% and 7.34% subordinated debentures of Met-Ed and Penelec, respectively. In each case, Met-Ed and Penelec has effectively provided a full and unconditional guarantee of obligations under the trust's preferred securities. The trust's preferred securities are redeemable at the option of Met-Ed and Penelec beginning in May 2004 and September 2004, respectively, at 100% of their principal amount. In each of these transactions, interest on the subordinated debentures (and therefore distributions on the trust's preferred securities) may be deferred for up to 60 months, but CEI, Met-Ed and Penelec may not pay dividends on, or redeem or acquire, any of its cumulative preferred or common stock until deferred payments on its subordinated debentures are paid in full. Upon adoption of FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51" (FIN 46R), the limited partnerships and statutory business trusts discussed above are not consolidated on the financial statements of FirstEnergy, CEI, Met-Ed and Penelec as of December 31, 2003 (see Note 9). The following table displays information regarding preferred securities of statutory business trusts outstanding as of December 31, 2003:
Stated Subordinated Maturity Rate Value Debentures - ------------------------------------------------------------------------------------------ (In millions) Cleveland Electric Financing Trust (a) 2031 9.00% $100.0 $103.1 Met-Ed Capital Trust (b).............. 2039 7.35% $100.0 $103.1 Penelec Capital Trust (b)............. 2039 7.34% $100.0 $103.1 - ------------------------------------------------------------------------------------------ (a) The sole assets of the trust are CEI's subordinated debentures with the same rate and maturity date as the preferred securities. (b) The sole assets of the trust are the preferred securities of Met-Ed Capital II, L.P. and Penelec Capital II, L.P., respectively, whose sole assets are the subordinated debentures of Met-Ed and Penelec, respectively, with the same rate and maturity date as the preferred securities.
(H) SECURITIZED TRANSITION BONDS- On June 11, 2002, JCP&L Transition Funding LLC (Issuer), a wholly owned limited liability company of JCP&L, sold $320 million of transition bonds to securitize the recovery of JCP&L's bondable stranded costs associated with the previously divested Oyster Creek Nuclear Generating Station. JCP&L does not own nor did it purchase any of the transition bonds, which are included in long-term debt on FirstEnergy's Consolidated Balance Sheet. The transition bonds represent obligations only of the Issuer and are collateralized solely by the equity and assets of the Issuer, which consist primarily of bondable transition property. The bondable transition property is solely the property of the Issuer. Bondable transition property represents the irrevocable right of a utility company to charge, collect and receive from its customers, through a non-bypassable TBC, the principal amount and interest on the transition bonds and other fees and expenses associated with their issuance. JCP&L, as servicer, manages and administers the bondable transition property, including the billing, collection and remittance of the TBC, pursuant to a servicing agreement with the Issuer. JCP&L is entitled to a quarterly servicing fee of $100,000 that is payable from TBC collections. 70 (I) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholders' equity except those resulting from transactions with common stockholders. As of December 31, 2003, accumulated other comprehensive income (loss) consisted of a minimum liability for unfunded retirement benefits of $306 million, unrealized gains on investments in securities available for sale of $64 million, and unrealized losses on derivative instrument hedges of $111 million. Other comprehensive income (loss) reclassified to net income in 2003, 2002 and 2001 totaled $29 million, $(10) million and $31 million, respectively. These amounts were net of income taxes in 2003, 2002 and 2001 of $20 million, $(7) million and $22 million, respectively. 6. SHORT-TERM BORROWINGS AND BANK LINES OF CREDIT: Short-term borrowings outstanding as of December 31, 2003, consisted of $372 million of bank borrowings and $150 million of OES Capital, Incorporated commercial paper. OES Capital is a wholly owned subsidiary of OE whose borrowings are secured by customer accounts receivable. OES Capital can borrow up to $170 million under a receivables financing agreement at rates based on certain bank commercial paper and is required to pay an annual fee of 0.50% on the amount of the entire finance limit. The receivables financing agreement expires in October 2004. FirstEnergy and its subsidiaries have various credit facilities (including a FirstEnergy $375 million short-term revolving credit facility) with domestic and foreign banks that provide for borrowings of up to $604 million under various interest rate options. To assure the availability of these lines, FirstEnergy and its subsidiaries are required to pay annual commitment fees that vary from 0.20% to 0.375%. These lines expire at various times during 2004. The weighted average interest rates on short-term borrowings outstanding as of December 31, 2003 and 2002 were 2.14% and 2.41%, respectively. 7. COMMITMENTS, GUARANTEES AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- FirstEnergy's current forecast reflects expenditures of approximately $2.3 billion for property additions and improvements from 2004-2006, of which approximately $713 million is applicable to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $323 million, of which approximately $90 million applies to 2004. During the same periods, the Companies' nuclear fuel investments are expected to be reduced by approximately $285 million and $93 million, respectively, as the nuclear fuel is consumed. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. The Companies' maximum potential assessment under the industry retrospective rating plan would be $402 million per incident but not more than $40 million in any one year for each incident. The Companies are also insured under policies for each nuclear plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination costs. The Companies have also obtained approximately $1.2 billion of insurance coverage for replacement power costs. Under these policies, the Companies can be assessed a maximum of approximately $64 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Companies intend to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, repair and replacement costs and other such costs arising from a nuclear incident at any of the Companies' plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Companies' insurance policies, or to the extent such insurance becomes unavailable in the future, the Companies would remain at risk for such costs. (C) GUARANTEES AND OTHER ASSURANCES- As part of normal business activities, FirstEnergy enters into various agreements on behalf of its subsidiaries to provide financial or performance assurances to third parties. Such agreements include contract guarantees, surety bonds and ratings contingent collateralization provisions. As of December 31, 2003, outstanding guarantees and other assurances aggregated approximately $1.9 billion. 71 FirstEnergy guarantees energy and energy-related payments of its subsidiaries involved in energy marketing activities - principally to facilitate normal physical transactions involving electricity, gas, emission allowances and coal. FirstEnergy also provides guarantees to various providers of subsidiary financing principally for the acquisition of property, plant and equipment. These agreements legally obligate FirstEnergy and its subsidiaries to fulfill the obligations of those subsidiaries directly involved in energy and energy-related transactions or financing where the law might otherwise limit the counterparties' claims. If demands of a counterparty were to exceed the ability of a subsidiary to satisfy existing obligations, FirstEnergy's guarantee enables the counterparty's legal claim to be satisfied by other FirstEnergy assets. The likelihood that such parental guarantees of $1.0 billion (included in the $1.9 billion discussed above) as of December 31, 2003 will increase amounts otherwise to be paid by FirstEnergy to meet its obligations incurred in connection with financings and ongoing energy and energy-related activities is remote. While guarantees are normally parental commitments for the future payment of subsidiary obligations, subsequent to the occurrence of a credit rating-downgrade or "material adverse event" the immediate payment of cash collateral or provision of a letter of credit may be required. The following table summarizes collateral provisions as of December 31, 2003:
Collateral Paid ---------------------------- Remaining Collateral Provisions Exposure Cash Letters of Credit Exposure(1) - ------------------------------------------------------------------------------------------ (In millions) Rating downgrade.......... $187 $68 $ 5 $114 Adverse Event............. 235 -- 65 170 ------------------------------------------------------------------------------------- Total..................... $422 $68 $70 $284 ===================================================================================== (1) As of February 11, 2004, we had a remaining exposure of $282 million with $106 million of cash and $87 million of letters of credit provided as collateral.
Most of FirstEnergy's surety bonds are backed by various indemnities common within the insurance industry. Surety bonds and related FirstEnergy guarantees of $161 million provide additional assurance to outside parties that contractual and statutory obligations will be met in a number of areas including construction jobs, environmental commitments and various retail transactions. FirstEnergy has also guaranteed the obligations of the operators of the TEBSA project, up to a maximum of $6 million (subject to escalation) under the project's operations and maintenance agreement. In connection with the sale of TEBSA in January 2004, the purchaser indemnified FirstEnergy against any loss under this guarantee. FirstEnergy had provided the TEBSA project lenders a $50 million letter of credit (LOC) (under FirstEnergy's existing $250 million LOC capacity available as part of a $1.25 billion FirstEnergy credit facility) to obtain TEBSA lender consent as substitute collateral for the release of the assets for FirstEnergy to abandon its Argentina operations, Emdersa (see Note 3). In December 2003, a replacement LOC was issued in the amount of $60 million, which is renewable and declines yearly based upon the senior outstanding debt of TEBSA. This LOC granted FirstEnergy the ability to sell its remaining 20.1% interest in Avon, as well as abandon the Argentina assets in April 2003. (D) ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Companies with regard to air and water quality and other environmental matters. The effects of compliance on the Companies with regard to environmental matters could have a material adverse effect on FirstEnergy's earnings and competitive position. These environmental regulations affect FirstEnergy's earnings and competitive position to the extent that it competes with companies that are not subject to such regulations and therefore do not bear the risk of costs associated with compliance, or failure to comply, with such regulations. Overall, FirstEnergy believes it is in material compliance with existing regulations but is unable to predict future change in regulatory policies and what, if any, the effects of such change would be. FirstEnergy estimates additional capital expenditures for environmental compliance of approximately $91 million for 2004 through 2006, which is included in the $2.3 billion of forecasted capital expenditures for 2004 through 2006 (see Note 7(A)). Additional estimated capital expenditures of $481 million relating to proposed environmental laws could be required after 2006. Clean Air Act Compliance The Companies are required to meet federally approved sulfur dioxide (SO2) regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The Environmental Protection Agency (EPA) has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Companies cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. The Companies are complying with SO2 reduction requirements under the Clean Air Act Amendments of 1990 by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or using emission 72 allowances. NOx reductions required by the 1990 Amendments are being achieved through combustion controls and the generation of more electricity at lower-emitting plants. In September 1998, the EPA finalized regulations requiring additional NOx reductions from the Companies' Ohio and Pennsylvania facilities. The EPA's NOx Transport Rule imposes uniform reductions of NOx emissions (an approximate 85% reduction in utility plant NOx emissions from projected 2007 emissions) across a region of nineteen states (including Michigan, New Jersey, Ohio and Pennsylvania) and the District of Columbia based on a conclusion that such NOx emissions are contributing significantly to ozone pollution in the eastern United States. State Implementation Plans (SIP) must comply by May 31, 2004 with individual state NOx budgets established by the EPA. New Jersey and Pennsylvania submitted a SIP that required compliance with the NOx budgets at the Companies' New Jersey and Pennsylvania facilities by May 1, 2003. Michigan and Ohio submitted a SIP that requires compliance with the NOx budgets at the Companies' Michigan and Ohio facilities by May 31, 2004. National Ambient Air Quality Standards In July 1997, the EPA promulgated changes in the National Ambient Air Quality Standard (NAAQS) for ozone and proposed a new NAAQS for fine particulate matter. On December 17, 2003, the EPA proposed the "Interstate Air Quality Rule" covering a total of 29 states (including New Jersey, Ohio and Pennsylvania) and the District of Columbia based on proposed findings that air pollution emissions from 29 eastern states and the District of Columbia significantly contribute to nonattainment of the NAAQS for fine particles and/or the "8-hour" ozone NAAQS in other states. The EPA has proposed the Interstate Air Quality Rule to "cap-and-trade" NOx and SO2 emissions in two phases (Phase I in 2010 and Phase II in 2015). According to the EPA, SO2 emissions would be reduced by approximately 3.6 million tons in 2010, across states covered by the rule, with reductions ultimately reaching more than 5.5 million tons annually. NOx emission reductions would measure about 1.5 million tons in 2010 and 1.8 million tons in 2015. The future cost of compliance with these proposed regulations may be substantial and will depend on whether and how they are ultimately implemented by the states in which the Companies operate affected facilities. Mercury Emissions In December 2000, the EPA announced it would proceed with the development of regulations regarding hazardous air pollutants from electric power plants, identifying mercury as the hazardous air pollutant of greatest concern. On December 15, 2003, the EPA proposed two different approaches to reduce mercury emissions from coal-fired power plants. The first approach would require plants to install controls known as "maximum achievable control technologies" (MACT) based on the type of coal burned. According to the EPA, if implemented, the MACT proposal would reduce nationwide mercury emissions from coal-fired power plants by fourteen tons to approximately thirty-four tons per year. The second approach proposes a cap-and-trade program that would reduce mercury emissions in two distinct phases. Initially, mercury emissions would be reduced by 2010 as a "co-benefits" from implementation of SO2 and NOx emission caps under the EPA's proposed Interstate Air Quality Rule. Phase II of the mercury cap-and-trade program would be implemented in 2018 to cap nationwide mercury emissions from coal-fired power plants at fifteen tons per year. The EPA has agreed to choose between these two options and issue a final rule by December 15, 2004. The future cost of compliance with these regulations may be substantial. W. H. Sammis Plant In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a Compliance Order to nine utilities covering 44 power plants, including the W. H. Sammis Plant. In addition, the U.S. Department of Justice filed eight civil complaints against various investor-owned utilities, which included a complaint against OE and Penn in the U.S. District Court for the Southern District of Ohio. The NOV and complaint allege violations of the Clean Air Act based on operation and maintenance of the W. H. Sammis Plant dating back to 1984. The complaint requests permanent injunctive relief to require the installation of "best available control technology" and civil penalties of up to $27,500 per day of violation. On August 7, 2003, the United States District Court for the Southern District of Ohio ruled that 11 projects undertaken at the W. H. Sammis Plant between 1984 and 1998 required pre-construction permits under the Clean Air Act. The ruling concludes the liability phase of the case, which deals with applicability of Prevention of Significant Deterioration provisions of the Clean Air Act. The remedy phase, which is currently scheduled to be ready for trial beginning July 19, 2004, will address civil penalties and what, if any, actions should be taken to further reduce emissions at the plant. In the ruling, the Court indicated that the remedies it "may consider and impose involved a much broader, equitable analysis, requiring the Court to consider air quality, public health, economic impact, and employment consequences. The Court may also consider the less than consistent efforts of the EPA to apply and further enforce the Clean Air Act." The potential penalties that may be imposed, as well as the capital expenditures necessary to comply with substantive remedial measures that may be required, could have a material adverse impact on FirstEnergy's financial condition and results of operations. Management is unable to predict the ultimate outcome of this matter and no liability has been accrued as of December 31, 2003. 73 Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. The Companies have been named as "potentially responsible parties" (PRPs) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Companies' proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. In addition, JCP&L has accrued liabilities for environmental remediation of former manufactured gas plants in New Jersey; those costs are being recovered by JCP&L through a non-bypassable societal benefits charge. Included in Current Liabilities and Other Noncurrent Liabilities are accrued liabilities aggregating approximately $65 million as of December 31, 2003. The Companies accrue environmental liabilities only when they can conclude that it is probable that they have an obligation for such costs and can reasonably determine the amount of such costs. Unasserted claims are reflected in the Companies' determination of environmental liabilities and are accrued in the period that they are both probable and reasonably estimable. Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but it failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. The Companies cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Companies is lower than many regional competitors due to the Companies' diversified generation sources which includes low or non-CO2 emitting gas-fired and nuclear generators. Clean Water Act Various water quality regulations, the majority of which are the result of the federal Clean Water Act and its amendments, apply to the Companies' plants. In addition, Ohio, New Jersey and Pennsylvania have water quality standards applicable to the Companies' operations. As provided in the Clean Water Act, authority to grant federal National Pollutant Discharge Elimination System water discharge permits can be assumed by a state. Ohio, New Jersey and Pennsylvania have assumed such authority. (E) OTHER LEGAL PROCEEDINGS- Various lawsuits, claims for personal injury, asbestos and property damage and proceedings related to FirstEnergy's normal business operations are pending against FirstEnergy and its subsidiaries. The most significant not otherwise discussed above are described below. Power Outages In July 1999, the Mid-Atlantic states experienced a severe heat storm which resulted in power outages throughout the service territories of many electric utilities, including JCP&L's territory. In an investigation into the causes of the outages and the reliability of the transmission and distribution systems of all four New Jersey electric utilities, the NJBPU concluded that there was not a prima facie case demonstrating that, overall, JCP&L provided unsafe, inadequate or improper service to its customers. Two class action lawsuits (subsequently consolidated into a single proceeding) were filed in New Jersey Superior Court in July 1999 against JCP&L, GPU and other GPU companies, seeking compensatory and punitive damages arising from the July 1999 service interruptions in the JCP&L territory. 74 Since July 1999, this litigation has involved a substantial amount of legal discovery including interrogatories, request for production of documents, preservation and inspection of evidence, and depositions of the named plaintiffs and many JCP&L employees. In addition, there have been many motions filed and argued by the parties involving issues such as the primary jurisdiction and findings of the NJBPU, consumer fraud by JCP&L, strict product liability, class decertification, and the damages claimed by the plaintiffs. In January 2000, the NJ Appellate Division determined that the trial court has proper jurisdiction over this litigation. In August 2002, the trial court granted partial summary judgment to JCP&L and dismissed the plaintiffs' claims for consumer fraud, common law fraud, negligent misrepresentation, and strict products liability. In November 2003, the trial court granted JCP&L's motion to decertify the class and denied plaintiffs' motion to permit into evidence their class-wide damage model indicating damages in excess of $50 million. These class decertification and damage rulings have been appealed to the Appellation Division and oral argument is scheduled for May 2004. FirstEnergy is unable to predict the outcome of these matters and no liability has been accrued as of December 31, 2003. On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. Davis-Besse FENOC recently received a subpoena from a grand jury sitting in the United States District Court for the Northern District of Ohio, Eastern Division requesting the production of certain documents and records relating to the inspection and maintenance of the reactor vessel head at the Davis-Besse plant. We are unable to predict the outcome of this investigation. In addition, FENOC remains subject to possible civil enforcement action by the NRC in connection with the events leading to the Davis Besse outage. If it were ultimately determined that FirstEnergy has legal liability or is otherwise made subject to regulatory or civil enforcement action with respect to the Davis-Besse outage, it could have a material adverse effect on FirstEnergy's financial condition and results of operations. Other Legal Matters Various legal proceedings have been filed against FirstEnergy in connection with, among other things, the restatements in August 2003, by FirstEnergy and its Ohio utility subsidiaries of previously reported results, the August 14th power outage described above, and the extended outage at the Davis-Besse Nuclear Power Station. Depending upon the particular proceeding, the issues raised include alleged violations of federal securities laws, breaches of fiduciary duties under state law by FirstEnergy directors and officers, and damages as a result of one or more of the noted events. The securities cases have been consolidated into one action pending in federal court in Akron. The derivative actions filed in federal court likewise have been consolidated as a separate matter, also in federal court in Akron. There also are pending derivative actions in state court. FirstEnergy's Ohio utility subsidiaries also were named as respondents in two regulatory proceedings initiated at the PUCO in response to complaints alleging failure to provide reasonable and adequate service stemming primarily from the August 14th power outage. FirstEnergy is vigorously defending these actions, but cannot predict the outcome of any of these proceedings or whether any further regulatory proceedings or legal actions may be instituted against them. In particular, if FirstEnergy were ultimately determined to have legal liability in connection with these proceedings, it could have a material adverse effect on its financial condition and results of operations. 75 8. SEGMENT INFORMATION: FirstEnergy operates under two reportable segments: regulated services and competitive services. The aggregate "Other" segments do not individually meet the criteria to be considered a reportable segment. "Other" consists of interest expense related to the 2001 merger acquisition debt; the corporate support services operating segment and the international businesses acquired in the 2001 merger. The international business assets reflected in the 2001 "Other" assets amount included assets in the United Kingdom identified for divestiture (see Note 3 - Divestitures) which were sold in 2002. As those assets were in the process of being sold, their performance was not being reviewed by a chief operating decision maker and in accordance with SFAS 131, "Disclosures about Segments of an Enterprise and Related Information," did not qualify as an operating segment. The remaining assets and revenues for the corporate support services and the remaining international businesses were below the quantifiable threshold for operating segments for separate disclosure as "reportable segments." FirstEnergy's primary segment is its regulated services segment, whose operations include the regulated sale of electricity and distribution and transmission services by its eight electric utility operating companies in Ohio, Pennsylvania and New Jersey (OE, CEI, TE, Penn, JCP&L, Met-Ed, Penelec and ATSI). The competitive services business segment consists of the subsidiaries (FES, FSG, MYR, MARBEL and First Communications) that operate unregulated energy and energy-related businesses, including the operation of generation facilities of OE, CEI, TE and Penn resulting from the deregulation of the Companies' electric generation business (see Note 2(D) - Regulatory Matters). The regulated services segment designs, constructs, operates and maintains FirstEnergy's regulated transmission and distribution systems. It also provides generation services to regulated franchise customers who have not chosen a competing generation supplier. The regulated services segment obtains a portion of its required generation through power supply agreements with the competitive services segment. The competitive services segment includes all domestic unregulated energy and energy-related services including commodity sales (both electricity and natural gas) in the retail and wholesale markets, marketing, generation and sourcing of commodity requirements, as well as other competitive energy-application services. Competitive products are increasingly marketed to customers as bundled services. Segment financial data in 2002 has been adjusted to reflect the reclassification of revenue, expense, interest expense and tax amounts of divested businesses reflected as discontinued operations (see Note 2(I)). 76 Segment Financial Information - -----------------------------
Regulated Competitive Reconciling Services Services Other Adjustments Consolidated --------- ----------- ----- ------------ ------------ (In millions) 2003 ---- External revenues....................... $ 8,978 $3,234 $ 71 $ 24 (a) $12,307 Internal revenues....................... 1,092 2,168 547 (3,807)(b) -- Total revenues....................... 10,070 5,402 618 (3,783) 12,307 Depreciation and amortization........... 1,209 33 40 -- 1,282 Goodwill impairment..................... -- 117 -- -- 117 Net interest charges.................... 499 44 344 (75)(b) 812 Income taxes............................ 650 (126) (118) -- 406 Income before discontinued operations and cumulative effect of accounting change 885 (205) (258) -- 422 Discontinued operations................. -- (6) (95) -- (101) Cumulative effect of accounting change.. 101 1 -- -- 102 Net income.............................. 986 (210) (353) -- 423 Total assets............................ 29,789 2,335 786 -- 32,910 Total goodwill.......................... 5,993 135 -- -- 6,128 Property additions...................... 434 345 77 -- 856 2002 ---- External revenues....................... $ 9,166 $2,482 $ 386 $ 13 (a) $12,047 Internal revenues....................... 1,052 2,044 478 (3,574)(b) -- Total revenues....................... 10,218 4,526 864 (3,561) 12,047 Depreciation and amortization........... 1,235 28 35 -- 1,298 Net interest charges.................... 588 44 384 (58)(b) 958 Income taxes............................ 698 (87) (87) -- 524 Income before discontinued operations... 928 (111) (184) -- 633 Discontinued operations................. -- 2 (82) -- (80) Net income.............................. 928 (109) (266) -- 553 Total assets............................ 30,494 2,281 1,611 -- 34,386 Total goodwill.......................... 5,993 285 -- -- 6,278 Property additions...................... 490 403 105 -- 998 2001 ---- External revenues....................... $ 5,729 $2,165 $ 11 $ 94 (a) $ 7,999 Internal revenues....................... 1,645 1,846 350 (3,841)(b) -- Total revenues....................... 7,374 4,011 361 (3,747) 7,999 Depreciation and amortization........... 841 21 28 -- 890 Net interest charges.................... 571 25 74 (114)(b) 556 Income taxes............................ 537 (23) (40) -- 474 Income before cumulative effect of accounting change.................... 729 (23) (51) -- 655 Net income.............................. 729 (32) (51) -- 646 Total assets............................ 28,054 2,981 6,317 -- 37,352 Total goodwill.......................... 5,325 276 -- -- 5,601 Property additions...................... 447 375 30 -- 852 Reconciling adjustments to segment operating results from internal management reporting to consolidated external financial reporting: (a) Principally fuel marketing revenues which are reflected as reductions to expenses for internal management reporting purposes. (b) Elimination of intersegment transactions.
Products and Services* ---------------------- Energy Related Electricity Oil & Gas Sales and Year Sales Sales Services ---- ----------- --------- -------------- (In millions) 2003......... $10,267 $624 $766 2002......... 9,697 613 904 2001......... 6,078 792 693
2003 2002 -------------------------- -------------------------- Geographic Information* Revenues Assets Revenues Assets ---------------------- -------- ------ -------- ------ (In millions) United States............. $12,282 $32,826 $11,753 $33,628 Foreign countries*........ 25 84 294 758 ------- ------- ------- ------- Total................... $12,307 $32,910 $12,047 $34,386 ======= ======= ======= ======= * See Note 3 for discussion of divestitures of business operations and Note 2(I) for discussion of discontinued operations.
77 9. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS FASB Staff Position (FSP) 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" Issued January 12, 2004, FSP 106-1 permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). The Company has elected to defer the effects of the Act due to the lack of specific guidance. Any measure of the accumulated postretirement benefit obligation or net periodic postretirement benefit cost in the financial statements or the accompanying notes do not reflect the impact of the Act on the plans. At this time, specific authoritative guidance on the accounting for the federal subsidy provided by the Act is pending and that guidance could require the Company to change previously reported information. FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued this revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". This Interpretation, referred to below as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise either absorbs a majority of the VIE's expected losses or receives a majority of the VIE's expected residual returns as a result of ownership, contractual or other financial interests in the VIE. Prior to FIN 46R, entities were generally consolidated by an enterprise that had a controlling financial interest through ownership of a majority voting interest in the entity. FIN 46R defines a VIE as an entity in which equity investors do not have the characteristics of a controlling financial interest nor have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. Adoption of FIN 46R is required of public entities that have interests in VIEs or potential VIEs commonly referred to as special-purpose entities for periods ending after December 15, 2003. Adoption by public entities for all other types of entities is required for periods ending after March 15, 2004 (FirstEnergy's first quarter of 2004). FirstEnergy currently has transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. Upon adoption of FIN 46R effective December 31, 2003, FirstEnergy consolidated two VIEs; the PNBV Capital Trust (PNBV) and the Shippingport Capital Trust were created in 1996 and 1997, respectively, to refinance debt in connection with these sale and leaseback transactions. PNBV issued equity and notes to fund the acquisition of a portion of the collateralized lease bonds that had been issued by certain owner trusts in connection with the sale and leaseback in 1987 of a portion of OE's interest in the Perry Plant and Beaver Valley Unit 2. OE used debt and available funds to purchase the notes issued by the PNBV Capital Trust. Ownership of the trust includes a three-percent equity interest by a nonaffiliated third party and a three-percent equity interest held by OES Ventures, a wholly owned subsidiary of OE. Consolidation of the trust as of December 31, 2003 changed the PNBV trust investment of $361 million to an investment in collateralized lease bonds of $372 million. The increase in $11 million represents the minority interest in the total assets of the trust. Shippingport was established to purchase all of the lease obligation bonds issued by the owner trusts in the Bruce Mansfield Plant sale and leaseback transactions in 1987. CEI and TE acquired all of the notes issued by Shippingport Capital Trust. Upon adoption of FIN 46R, this entity was consolidated on the books of CEI; the investment in the trusts was previously recorded on the books of both CEI and TE. Consolidation of this entity therefore had no impact on the financial statements of FirstEnergy. In addition to the two entities created to refinance debt discussed above, the Company evaluated its interest in the owner trusts that acquired the interests in the Perry Plant, Beaver Valley Unit 2 and the Bruce Mansfield Plant. FirstEnergy concluded that the operating companies (OE, CEI and TE) were not the primary beneficiaries of these owner trusts and were therefore not required to consolidate these entities. The leases are accounted for as operating leases in accordance with GAAP and their related obligations are disclosed in Note 4. The combined purchase price of $3.1 billion for all of the interests acquired by the owner trusts in 1987 was funded with debt of $2.5 billion and equity of $600 million. FirstEnergy is exposed to losses under the sale-leaseback agreements upon the occurrence of certain contingent events that the Company considers unlikely to occur. The Company's maximum exposure to loss is currently estimated to be $2.0 billion, which represents the net amount of casualty value payments upon the occurrence of specified casualty events that render the plants worthless. Under the sale and leaseback agreements, FirstEnergy has minimum undiscounted net lease payments of $2.6 billion that would not be payable if the casualty value payments are made. In addition, the Company has recorded above market lease obligations of $1.1 billion, of which $85 million is current, related to the Bruce Mansfield Plant and Beaver Valley Unit 2 as of December 31, 2003 related to the acquisition by FirstEnergy of CEI and TE. 78 As described in Note 5(G), CEI, Met-Ed and Penelec created statutory business trusts to issue trust preferred securities in the aggregate of $285 million. Prior to the adoption of FIN 46R, these trusts had been consolidated by FirstEnergy and the respective operating company. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. Therefore, FirstEnergy, CEI, Met-Ed and Penelec have deconsolidated the trusts. As of December 31, 2003, FirstEnergy reported subordinated debentures to the respective trusts of $294 million ($103 million for CEI, $96 million for Met-Ed and $95 million for Penelec) within the balance sheet liability caption "Subordinated debentures to affiliated trusts" and the equity investment in the trusts of $9 million ($3 million each for CEI, Met-Ed and Penelec) within the balance sheet asset caption "Investments - Other." In August 1995, Los Amigos Leasing Company, Ltd. (Los Amigos) was formed as a consolidated subsidiary of GPU Power to own and lease to TEBSA equipment comprised of an 895 megawatt plant constructed and operated by TEBSA. Upon application of FIN 46R, Los Amigos met the criteria of a VIE and FirstEnergy was determined not to be its primary beneficiary. Therefore, effective December 31, 2003, Los Amigos was deconsolidated, resulting in the removal of approximately $243 million of total assets (primarily unbilled lease receivable) and liabilities (primarily senior and subordinated debt) from FirstEnergy's Consolidated Balance Sheets. Los Amigos was sold as part of the TEBSA divestiture on January 30, 2004. FirstEnergy is evaluating other entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. Included in this analysis are non-utility generators in which we have neither debt nor equity investments but are generally the sole purchaser of their power. SFAS 132 (revised December 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits - An amendment of FASB Statements No. 87, 88, and 106" Issued by the FASB in December 2003 and effective for financial statements with fiscal years ending after December 15, 2003, this revision to SFAS 132 revises employers' disclosures about pension plans and other postretirement benefits plans. SFAS 132 (as revised) does not change the measurement or recognition of those plans as required by FASB Statements No. 87, 88, and 106, but requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. FirstEnergy has included the additional disclosure requirements in Note 2(K) - Pension and Other Postretirement Benefit Plans. EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" In November 2003, the EITF reached consensus that certain quantitative and qualitative disclosures are required for debt and equity securities classified as available-for-sale or held-to-maturity. The guidance requires the disclosure of the aggregate amount of unrealized losses and the aggregate related fair value for investments with unrealized losses that have not been recognized as other-than-temporary impairments. FirstEnergy has adopted the disclosure requirements of EITF Issue No. 03-1 as of December 31, 2003 (See Note 10(E)). EITF Issue No. 03-11, "Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and Not "Held for Trading Purposes" as Defined in EITF Issue 02-03, "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities." In July 2003, the EITF reached a consensus that determining whether realized gains and losses on physically settled derivative contracts not "held for trading purposes" should be reported in the income statement on a gross or net basis is a matter of judgment that depends on the relevant facts and circumstances. The consideration of the facts and circumstances, including economic substance, should be made in the context of the various activities of the entity rather than based solely on the terms of the individual contracts. The Company adopted this consensus effective January 1, 2004. The impact on operating revenues and operating expenses has not been determined but is not expected to be material. The adoption of EITF C3-11 will have no impact on net income. DIG Implementation Issue No. C20 for SFAS 133, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) Regarding Contracts with a Price Adjustment Feature" In June 2003, the FASB cleared DIG Issue C20 for implementation in fiscal quarters beginning after July 10, 2003. The issue supersedes earlier DIG Issue C11, "Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception." DIG Issue C20 provides guidance regarding when the presence of a general index, such as the Consumer Price Index, in a contract would prevent that contract from qualifying for the normal purchases and normal sales exception under SFAS 133, as amended, and therefore exempt from the mark-to-market treatment of certain contracts. Adoption of DIG Issue C20 did not have a material impact on the Companies' financial statements. 79 EITF Issue No. 01-8, "Determining Whether an Arrangement Contains a Lease" In May 2003, the EITF reached a consensus regarding when arrangements contain a lease. Based on the EITF consensus, an arrangement contains a lease if: (1) it identifies specific property, plant or equipment (explicitly or implicitly); and (2) the arrangement transfers the right to the purchaser to control the use of the property, plant or equipment. The consensus is to be applied prospectively to arrangements committed to, modified or acquired through a business combination after the effective date of the consensus. The adoption of this consensus as of July 1, 2003 did not affect FirstEnergy's financial statements. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, certain financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, FirstEnergy reclassified as debt the preferred stock of consolidated subsidiaries subject to mandatory redemption with a carrying value of approximately $19 million ($5 million for CEI and $14 million for Penn) as of December 31, 2003. Adoption of SFAS 150 had no impact on FirstEnergy's Consolidated Statements of Income because the preferred dividends were previously included in net interest charges and required no reclassification. SFAS 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" Issued by the FASB in April 2003, SFAS 149 further clarifies and amends accounting and reporting for derivative instruments. The statement amends SFAS 133 for decisions made by the Derivative Implementation Group (DIG), as well as issues raised in connection with other FASB projects and implementation issues. The statement was effective for contracts entered into or modified after June 30, 2003 except for implementation issues that were effective for reporting periods beginning before June 15, 2003, that continue to be applied based on their original effective dates. Adoption of SFAS 149 did not have a material impact on the Companies' financial statements. SFAS 143, "Accounting for Asset Retirement Obligations" The Company adopted SFAS 143 effective January 1, 2003. The impact of this new accounting standard is discussed above under Notes 2(F) and 2(J). FASB Interpretation (FIN) No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others - an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34" The FASB issued FIN 45 in January 2003. This interpretation identifies minimum guarantee disclosures required for annual periods ending after December 15, 2002. It also clarifies that providers of guarantees must record the fair value of those guarantees at their inception. This accounting guidance was applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Adoption of FIN 45 for guarantees issued during 2003 did not have a material impact on FirstEnergy's financial statements. 80 10. OTHER INFORMATION: The following provides supplemental unaudited information to the consolidated financial statements and notes previously reported in 2001: (A) Consolidated Statements of Cash Flows (Unaudited) 2003 2002 2001 ---- ---- ---- (In thousands) Other Cash Flows From Operating Activities: Accrued taxes........................... $ 219,936 $ 35,108 $ 8,915 Accrued interest........................ (57,509) (27,420) 117,520 Retail rate refund obligation payments.. (71,984) (43,016) -- Interest rate hedge..................... -- -- (132,376) Prepayments and other................... (31,155) 133,677 (146,741) Accrued retirement benefit obligations.. 282,804 124,678 19,797 Accrued compensation, net............... (74,401) (92,197) (118,325) Tax refund related to pre-merger period. 51,073 -- -- Energy derivative transactions.......... (70,498) (8,682) -- Asset retirement obligation............. 97,820 -- -- All other............................... (7,349) 3,538 646 ---------------------------------------------------------------------------- Total-Other........................... $ 338,737 $ 125,686 $(250,564) ============================================================================= Other Cash Flows from Investing Activities: Retirements and transfers............... $ 37,580 $ 29,619 $ 40,106 Nonutility generation trusts withdrawals........................... 66,327 49,044 -- Contributions to nuclear decommissioning trusts................................ (101,218) (103,143) (90,995) Nuclear decommissioning trust investments........................... (143,493) 16,922 17,614 Long-term notes receivable.............. 82,250 (91,335) -- Other investments....................... 29,137 (7,944) (165,938) All other............................... 42,273 52,482 (34,313) ---------------------------------------------------------------------------- Total-Other........................... $ 12,856 $ (54,355) $(233,526) ============================================================================= (B) Consolidated Statements of Taxes (Unaudited) 2003 2002 2001 ---- ---- ---- (In thousands) Other Accumulated Deferred Income Taxes as of December 31: Retirement Benefits..................... $(359,038) $(223,065) $(133,282) Oyster Creek securitization (Note 5(H)). 193,558 202,447 -- Loss carryforwards...................... (495,254) (507,690) (486,495) Loss carryforward valuation reserve..... 470,813 482,061 459,170 Purchase accounting basis differences... (2,657) (2,657) (147,450) Sale of generating assets............... (11,785) (11,786) 207,787 Provision for rate refund............... -- (29,370) (46,942) All other............................... (49,569) (149,226) (176,484) --------- --------- --------- Total-Other........................... $(253,932) $(239,286) $(323,696) ========= ========= ========= (C) Revenues - Independent System Operator (ISO) Transactions FirstEnergy's regulated and competitive subsidiaries record purchase and sales transactions with PJM Interconnection ISO, an independent system operator, on a gross basis in accordance with EITF Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." The aggregate purchase and sales transactions for the three years ended December 31, 2003, are summarized as follows: (Unaudited) 2003 2002 2001 - ----------------------------------------------------------------------- (In millions) Sales................. $ 990 $453 $142 Purchases............. 1,019 687 204 ---------------------------------------------------------------------- FirstEnergy's revenues on the Consolidated Statements of Income include wholesale electricity sales revenues from the PJM ISO from power sales (as reflected in the table above) during periods when FirstEnergy had 81 additional available power capacity. Revenues also include sales by FirstEnergy of power sourced from the PJM ISO (reflected as purchases in the table above) during periods when FirstEnergy required additional power to meet its retail load requirements and, secondarily, to make sales to the wholesale market. (D) Stock Based Compensation (2001 Unaudited) Stock-based employee compensation expense recognized for the FirstEnergy Programs' restricted stock during 2003, 2002 and 2001 totaled $1,747,000, $2,259,000 and $1,342,000, respectively. In addition, stock-based employee compensation expense of $2,312,000, $206,000 and $1,637,000 during 2003, 2002 and 2001, respectively, was recognized for EDCP stock units (see Note 5(C) for further discussion). (E) SFAS 115 Activity Investments other than cash and cash equivalents in the table in Note 2(M) - Cash and Financial Instruments include available-for-sale securities, at fair value, with the following net results: (Unaudited) 2003* 2002* 2001 - ------------------------------------------------------------------------------- (In millions) Unrealized gains (losses)........... $116 $ (48) $2 Proceeds from sales................. 516 421 -- Realized gains (losses)............. 3 (15) -- ------------------------------------------------------------------------------ * Includes the available-for-sale securities of FirstEnergy's Ohio Companies' decommissioning trusts. As of December 31, 2003 accumulated other comprehensive income (loss) for available-for-sale securities consisted of investments with net unrealized gains of $153 million and net unrealized losses of $45 million. The following table provides details for the available-for-sale securities with net unrealized losses as of December 31, 2003.
Less Than 12 Months 12 Months or More Total -------------------- -------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Security Type Value Losses Value Losses Value Losses - ------------------------------------------------------------------------------------------------------- (In millions) Equity Securities....... 17 5 43 40 60 45 Debt Securities......... 33 -- -- -- 33 -- - ------------------------------------------------------------------------------------------------------- Total............... 50 5 43 40 93 45 - -------------------------------------------------------------------------------------------------------
All of the aggregate unrealized losses related to available-for-sale securities in the table above are considered to be temporary in nature. These securities are primarily held by the nuclear decommissioning trusts of FirstEnergy's Ohio Companies. FirstEnergy has the ability and intent to hold these securities for the period necessary to fund their cost. 82 11. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 2003 and 2002.
March 31, June 30, September 30, December 31, Three Months Ended (a) 2003 2003 2003 2003 - ------------------------------------------------------------------------------------------------------------------ (In millions, except per share amounts) Revenues......................................... $3,221 $2,853 $3,434 $2,799 Expenses......................................... 2,806 2,619 2,947 2,463 Claim Settlement (Note 3)........................ -- -- -- 168 - ------------------------------------------------------------------------------------------------------------------ Income Before Interest and Income Taxes.......... 415 234 487 504 Net Interest Charges............................. 206 205 201 200 Income Taxes..................................... 94 19 135 158 - ------------------------------------------------------------------------------------------------------------------ Income Before Discontinued Operations and Cumulative Effect of Accounting Change........ 115 10 151 146 - ------------------------------------------------------------------------------------------------------------------ Discontinued Operations (Net of Income Taxes).... 2 (68) 1 (36) Cumulative Effect of Accounting Change (Net of Income Taxes)......................... 102 -- -- -- - ------------------------------------------------------------------------------------------------------------------ Net Income (Loss)................................ $ 219 $ (58) $ 152 $ 110 ================================================================================================================== Basic Earnings (Loss) Per Share of Common Stock: Before Discontinued Operations and Cumulative Effect of Accounting Change................. $ 0.39 $ 0.03 $ 0.51 $ 0.44 Discontinued Operations....................... -- (0.23) -- (0.11) Cumulative Effect of Accounting Change........ 0.35 -- -- -- - ------------------------------------------------------------------------------------------------------------------ Basic Earnings (Loss) Per Share of Common Stock.. $ 0.74 $(0.20) $ 0.51 $ 0.33 - ------------------------------------------------------------------------------------------------------------------ Diluted Earnings (Loss) Per Share of Common Stock: Before Discontinued Operations and Cumulative Effect of Accounting Change................. $ 0.39 $ 0.03 $ 0.50 $ 0.44 Discontinued Operations....................... -- (0.23) -- (0.11) Cumulative Effect of Accounting Change........ 0.35 -- -- -- - ------------------------------------------------------------------------------------------------------------------ Diluted Earnings (Loss) Per Share of Common Stock $ 0.74 $(0.20) $ 0.50 $ 0.33 ================================================================================================================== March 31, June 30, September 30, December 31, Three Months Ended (a) 2002 2002 2002 2002 - ------------------------------------------------------------------------------------------------------------------ (In millions, except per share amounts) Revenues......................................... $2,810 $2,854 $3,407 $2,976 Expenses......................................... 2,322 2,232 2,684 2,694 - ------------------------------------------------------------------------------------------------------------------ Income Before Interest and Income Taxes.......... 488 622 723 282 Net Interest Charges............................. 278 249 220 211 Income Taxes..................................... 93 167 220 44 - ------------------------------------------------------------------------------------------------------------------ Income Before Discontinued Operations............ 117 206 283 27 - ------------------------------------------------------------------------------------------------------------------ Discontinued Operations (Net of Income Taxes).... 1 2 2 (85) - ------------------------------------------------------------------------------------------------------------------ Net Income (Loss)................................ $ 118 $ 208 $ 285 $ (58) ================================================================================================================== Basic Earnings (Loss) Per Share of Common Stock: Before Discontinued Operations................ $ 0.40 $ 0.71 $ 0.96 $ 0.09 Discontinued Operations....................... -- -- 0.01 (0.29) - ------------------------------------------------------------------------------------------------------------------ Basic Earnings (Loss) Per Share of Common Stock.. $ 0.40 $ 0.71 $ 0.97 $(0.20) - ------------------------------------------------------------------------------------------------------------------ Diluted Earnings (Loss) Per Share of Common Stock: Before Discontinued Operations................ $ 0.40 $ 0.70 $ 0.96 $ 0.09 Discontinued Operations....................... -- -- 0.01 (0.29) - ------------------------------------------------------------------------------------------------------------------ Diluted Earnings (Loss) Per Share of Common Stock $ 0.40 $ 0.70 $ 0.97 $(0.20) ================================================================================================================== (a) Revenues, expenses, net interest charges and income taxes have been revised to reflect reclassifications of the results of discontinued operations.
Net income for the three months ended December 31, 2003, was increased by $7.4 million due to adjustments relating to the first nine months of 2003. After-tax income of $16.3 million resulted from adjustments for costs charged to expense in prior quarters of 2003 that were subsequently capitalized to regulated segment construction projects in the fourth quarter, partially offset by after-tax charges of $8.9 million for adjustments relating to prior quarters for the competitive segment. Management concluded that these adjustments were not material to the reported consolidated results of operations for any quarter of 2003 (after-tax amounts of $3.1 million, $0.6 million and $3.7 million for the first three quarters of 2003, respectively). However, the adjustments relating to the regulated segment were material to the separate reported results of JCP&L, Penelec and TE; accordingly, the reported results of operations for the first three quarters of 2003 for those subsidiaries will be restated in their separate financial statements. The impact of these adjustments was not material to FirstEnergy's consolidated balance sheets or consolidated statements of cash flows for any quarter of 2003. The net loss for the second quarter of 2003 included a charge resulting from the NJBPU's decision to disallow recovery by JCP&L of $153 million in deferred energy costs and a $67 million non-cash charge (no tax benefit recognized) from the abandonment of operations in Argentina. Results for the fourth quarter of 2003 included a $33 million after-tax loss from the divestiture of assets in Bolivia included in discontinued operations and a $26 million impairment of the equity TEBSA investment in Columbia included in continuing operations. The fourth quarter results also include a $170 million gain ($168 million net of expenses) from the NRG Energy Inc. settlement claim. 83 The operating results in 2002 related to assets sold in 2003 have been reclassified as discontinued operations. The fourth quarter discontinued operations include an $88 million loss from operations of the Argentina assets. 12. GPU MERGER (UNAUDITED); On November 7, 2001, the merger of FirstEnergy and GPU became effective pursuant to the Agreement and Plan of Merger, dated August 8, 2000 (Merger Agreement). As a result of the merger, GPU's former wholly owned subsidiaries, including JCP&L, Met-Ed and Penelec, (collectively, the Former GPU Companies), became wholly owned subsidiaries of FirstEnergy. Under the terms of the Merger Agreement, GPU shareholders received the equivalent of $36.50 for each share of GPU common stock they owned, payable in cash and/or FirstEnergy common stock. GPU shareholders receiving FirstEnergy shares received 1.2318 shares of FirstEnergy common stock for each share of GPU common stock they exchanged. The cash portion of the merger consideration was approximately $2.2 billion and nearly 73.7 million shares of FirstEnergy common stock were issued to GPU shareholders for the share portion of the transaction consideration. The merger was accounted for by the purchase method of accounting and, accordingly, the Consolidated Statements of Income include the results of the Former GPU Companies beginning November 7, 2001. The assets acquired and liabilities assumed were recorded at estimated fair values as determined by FirstEnergy's management based on information currently available and on current assumptions as to future operations. The merger purchase accounting adjustments, which were recorded in the records of GPU's direct subsidiaries, primarily consist of: (1) revaluation of GPU's international operations to fair value; (2) revaluation of property, plant and equipment; (3) adjusting preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (4) recognizing additional obligations related to retirement benefits; and (5) recognizing estimated severance and other compensation liabilities. Other assets and liabilities were not adjusted since they remain subject to rate regulation on a historical cost basis. The severance and compensation liabilities are based on anticipated workforce reductions reflecting duplicate positions primarily related to corporate support groups including finance, legal, communications, human resources and information technology. The workforce reductions represented the expected reduction of approximately 700 employees at a cost of approximately $140 million. Merger related staffing reductions began in late 2001 and the remaining reductions occurred in 2003 as merger-related transition assignments were completed. The merger greatly expanded the size and scope of FirstEnergy's electric business and the goodwill recognized primarily relates to the regulated services segment. The combination of FirstEnergy and GPU was a key strategic step in FirstEnergy achieving its vision of being the leading energy and related services provider in the region. The merger combined companies with the management, employee experience and technical expertise, retail customer base, energy and related services platform and financial resources to grow and succeed in a rapidly changing energy marketplace. The merger also allowed for a natural alliance of companies with adjoining service areas and interconnected transmission systems to eliminate duplicative costs, maximize efficiencies and increase management and operational flexibility in order to enhance operations and become a more effective competitor. Under the purchase method of accounting, tangible and identifiable intangible assets acquired and liabilities assumed are recorded at their estimated fair values. The excess of the purchase price, including estimated fees and expenses related to the merger, over the net assets acquired, is classified as goodwill and amounts to $3.8 billion as of December 31, 2003. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed on the date of acquisition. ------------------------------------------------------------- (In millions) Current assets................... $ 1,027 Goodwill......................... 3,698 Regulatory assets................ 4,352 Other............................ 5,595 ------------------------------------------------------------- Total assets acquired........ 14,672 ------------------------------------------------------------- Current liabilities.............. (2,615) Long-term debt................... (2,992) Other............................ (4,785) ------------------------------------------------------------- Total liabilities assumed.... (10,392) Net assets acquired pending sale. 566 ------------------------------------------------------------- Net assets acquired.............. $ 4,846 ------------------------------------------------------------- During 2002, certain pre-acquisition contingencies and other final adjustments to the fair values of the assets acquired and liabilities assumed were reflected in the final allocation of the purchase price. These adjustments primarily related to: (1) final actuarial calculations related to pension and postretirement benefit obligations; (2) updated valuations 84 of GPU's international operations as of the date of the merger; (3) establishment of a reserve for deferred energy costs recognized prior to the merger; and (4) return to accrual adjustments for income taxes. As a result of these and other minor adjustments, goodwill increased by approximately $286 million as of December 31, 2002. The increase was attributable to the regulated services segment. The following pro forma combined condensed statement of income of FirstEnergy give effect to the FirstEnergy/GPU merger as if it had been consummated on January 1, 2001, with the purchase accounting adjustments actually recognized in the business combination. The pro forma adjustments reflect a reduction in debt from application of the proceeds from certain pending divestitures as well as the related reduction in interest costs. Year Ended December 31, 2001 ---------------------------- (In millions, except per share amounts) Revenues.................................... $12,108 Expenses.................................... 9,768 ------------------------------------------------------- Income Before Interest and Income Taxes..... 2,340 Net Interest Charges........................ 941 Income Taxes................................ 561 ------------------------------------------------------- Net Income.................................. $ 838 ------------------------------------------------------- Earnings per Share of Common Stock.......... $ 2.87 ------------------------------------------------------- 85 EX-21 6 fe_ex21.txt FE - LIST OF SUBS EXHIBIT 21 FIRSTENERGY CORP. LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 2003 Ohio Edison Company - Incorporated in Ohio The Cleveland Electric Illuminating Company - Incorporated in Ohio The Toledo Edison Company - Incorporated in Ohio Centerior Service Company - Incorporated in Ohio FirstEnergy Properties Company - Incorporated in Ohio FirstEnergy Ventures Corporation - Incorporated in Ohio FirstEnergy Facilities Services Group, LLC - Incorporated in Ohio FirstEnergy Securities Transfer Company - Incorporated in Ohio FirstEnergy Service Company - Incorporated in Ohio FirstEnergy Solutions Corp. - Incorporated in Ohio MARBEL Energy Corporation - Incorporated in Ohio FirstEnergy Nuclear Operating Company - Incorporated in Ohio FirstEnergy Holdings, LLC - Incorporated in Ohio FE Acquisition Corp. - Incorporated in Ohio American Transmission Systems, Inc. - Incorporated in Ohio FELHC, Inc. - Incorporated in Ohio Jersey Central Power & Light Company - Incorporated in New Jersey Metropolitan Edison Company - Incorporated in Pennsylvania Pennsylvania Electric Company - Incorporated in Pennsylvania GPU Advanced Resources, Inc. - Incorporated in Delaware GPU Capital, Inc. - Incorporated in Delaware GPU Diversified Holdings, LLC - Incorporated in Delaware GPU Nuclear, Inc. - Incorporated in New Jersey GPU Power, Inc. - Incorporated in Delaware GPU Service, Inc. - Incorporated in Pennsylvania GPU Telecom Services, Inc. - Incorporated in Delaware MYR Group, Inc. - Incorporated in Delaware Statement of Differences ------------------------ Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 2003, is not included in the printed document. EX-23 7 fe_ex23.txt FE - PWC CONSENT EXHIBIT 23 FIRSTENERGY CORP. CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-48587, 333-102074 and 333-103865) and Form S-8 (Nos. 333-48651, 333-56094, 333-58279, 333-67798, 333-72764, 333-72766, 333-72768, 333-75985, 333-81183, 333-89356, 333-101472 and 333-110662) of FirstEnergy Corp. of our report dated February 25, 2004 relating to the consolidated financial statements, which appears in the Annual Report to Stockholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 25, 2004 relating to the financial statement schedules, which appear in this Form 10-K. PricewaterhouseCoopers LLP Cleveland, Ohio March 11, 2004 105 EX-31 8 fe_ex31-1.txt CEO CERT LETTER (AJA) Exhibit 31.1 Certification I, Anthony J. Alexander, certify that: 1. I have reviewed this annual report on Form 10-K of FirstEnergy Corp., Ohio Edison Company, The Cleveland Electric Illuminating Company, The Toledo Edison Company, Pennsylvania Power Company, Metropolitan Edison Company and Pennsylvania Electric Company; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of each registrant as of, and for, the periods presented in this annual report; 4. Each registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for such registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to such registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of such registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in such registrant's internal control over financial reporting that occurred during such registrant's most recent fiscal year that has materially affected, or is reasonably likely to materially affect, such registrant's internal control over financial reporting; and 5. Each registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to such registrant's auditors and the audit committee of such registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect such registrant's ability to record, process, summarize and report financial data; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in such registrant's internal control over financial reporting. Date: March 15, 2004 /s/Anthony J. Alexander ----------------------------------- Anthony J. Alexander Chief Executive Officer 109 EX-31 9 fe_ex31-2.txt EX-31-2 CFO CERT (AJA) Exhibit 31.2 Certification I, Richard H. Marsh, certify that: 1. I have reviewed this annual report on Form 10-K of FirstEnergy Corp., Ohio Edison Company, The Cleveland Electric Illuminating Company, The Toledo Edison Company, Pennsylvania Power Company, Jersey Central Power & Light Company, Metropolitan Edison Company and Pennsylvania Electric Company; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of each registrant as of, and for, the periods presented in this annual report; 4. Each registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for such registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to such registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of such registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in such registrant's internal control over financial reporting that occurred during such registrant's most recent fiscal year that has materially affected, or is reasonably likely to materially affect, such registrant's internal control over financial reporting; and 5. Each registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to such registrant's auditors and the audit committee of such registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect such registrant's ability to record, process, summarize and report financial data; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in such registrant's internal control over financial reporting. Date: March 15, 2004 /s/Richard H. Marsh ------------------------------------ Richard H. Marsh Chief Financial Officer 110 EX-32 10 fe_ex32-1.txt EX 32-1 CEO/CFO CERT Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the Annual Reports of FirstEnergy Corp., Ohio Edison Company, The Cleveland Electric Illuminating Company, The Toledo Edison Company, Pennsylvania Power Company, Metropolitan Edison Company, and Pennsylvania Electric Company ("Companies") on Form 10-K for the year ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Reports"), each undersigned officer of each of the Companies does hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that to the best of his knowledge: (1) Each of the Reports fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in each of the Reports fairly presents, in all material respects, the financial condition and results of operations of the Company to which it relates. /s/Anthony J. Alexander ----------------------------------- Anthony J. Alexander Chief Executive Officer March 15, 2004 /s/Richard H. Marsh ----------------------------------- Richard H. Marsh Chief Financial Officer March 15, 2004 112 EX-4 11 oe_ex4-1.txt EX4-1 74TH SI - -------------------------------------------------------------------------------- OHIO EDISON COMPANY with THE BANK OF NEW YORK, As Trustee ----------------------- SEVENTY-FOURTH SUPPLEMENTAL INDENTURE Providing among other things for FIRST MORTGAGE BONDS Class A Series A of 2003 due 2015 --------- Dated as of February 1, 2003 - -------------------------------------------------------------------------------- SUPPLEMENTAL INDENTURE, dated as of February 1, 2003 between OHIO EDISON COMPANY, a corporation organized and existing under the laws of the State of Ohio (hereinafter called the "Company"), party of the first part, and THE BANK OF NEW YORK, a banking corporation organized and existing under the laws of the State of New York, as Trustee under the Indenture hereinafter referred to, party of the second part. WHEREAS, the Company has heretofore executed and delivered to BANKERS TRUST COMPANY (hereinafter called the "Old Trustee"), as trustee, a certain Indenture, dated as of August 1, 1930, to secure an issue of bonds of the Company, issued and to be issued in series, from time to time, in the manner and subject to the conditions set forth in the said Indenture; and the said Indenture has been supplemented by seventy-three supplemental indentures, which Indenture as so supplemented and to be hereby supplemented is hereinafter referred to as the "Indenture"; and WHEREAS, The Bank of New York has succeeded the Old Trustee as trustee under the Indenture (hereinafter called the "Trustee") pursuant to Article XVI thereof; and WHEREAS, the Indenture provides for the issuance of bonds thereunder in one or more series, the form of each series of bonds and of the coupons to be attached to the coupon bonds, if any, to be substantially in the forms set forth therein with such insertions, omissions and variations as the Board of Directors of the Company may determine; WHEREAS, the Company has entered into an Insurance Agreement, dated as of February 3, 2003 (the "Insurance Agreement"), with Ambac Assurance Corporation, a Wisconsin-domiciled stock insurance corporation (the "Insurer"), in connection with the remarketing of a series of municipal bonds pursuant to a loan agreement, dated as of April 15, 1981, between the Company and the Ohio Air Quality Development Authority; WHEREAS, the Company has agreed to issue to The Bank of New York, as Trustee under the Company's General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, as heretofore supplemented and as to be supplemented by a Supplemental Indenture to be dated as of February 1, 2003 (as so supplemented, the "General Mortgage"), a series of bonds under the Indenture, to secure the issue of bonds (the "Mortgage Bonds") issued under the General Mortgage to the Insurer pursuant to the Insurance Agreement. WHEREAS, the Company, by appropriate corporate action in conformity with the terms of the Indenture, has duly determined to create a new series of bonds under the Indenture, as the basis for the issuance of the Mortgage Bonds, such new series of bonds consisting of $50,000,000 in aggregate principal amount to be designated as "First Mortgage Bonds, Class A Series A of 2003 due 2015" (hereinafter sometimes referred to as "the bonds of the 2003 Class A Series A"), the bonds of which series shall bear interest at the rate per annum set forth in, shall be subject to certain redemption rights and obligations set forth in, and will otherwise be in the form and have the terms and provisions provided for in this Supplemental Indenture and set forth in the form of such bonds below; and WHEREAS, the definitive registered bonds without coupons of the bonds of the 2003 Class A Series A and the Trustee's certificate of authentication to be borne by such bonds are to be substantially in the following form: [FORM OF BOND OF 2003 CLASS A SERIES A FACE] [FACE] This bond is not transferable except to a successor to The Bank of New York, as trustee under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, between the Company and The Bank of New York, as trustee, or in connection with the exercise of the rights and remedies of the holder hereof consequent upon a "default" as defined in the Indenture referred to herein. OHIO EDISON COMPANY FIRST MORTGAGE BOND, CLASS A SERIES A OF 2003 DUE 2015 Due February 1, 2015 No. R- $ OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to The Bank of New York, as trustee under the General Mortgage (hereinbelow defined), or registered assigns, ________________________________________________ Dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio, on February 1, 2015 in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said offices or agencies to the registered owner hereof, in like coin or currency, interest thereon from the Initial Interest Accrual Date (hereinbelow defined) at the rate from time to time borne by the Mortgage Bonds, Pledge Series A of 2003 due 2015 (the "Mortgage Bonds") issued by the Company under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, as heretofore supplemented (the "General Mortgage"), by the Company to The Bank of New York, as trustee; provided, however, that in no event shall the rate of interest borne by the Bonds of this series exceed fourteen per centum per annum. Payments of principal of and interest on this bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Payment of principal of, or premium or interest on, the Company's Mortgage Bonds shall, to the extent thereof, be deemed to satisfy and discharge the obligation of the Company, if any, to make a payment of principal, premium or interest, as the case may be, in respect of this bond which is then due. 2 The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Indenture referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his signature or a facsimile thereof, and its corporate seal to be printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his signature or a facsimile thereof. OHIO EDISON COMPANY, By: ----------------------------- Name: Title: Vice President Attest: - ------------------------------------- Name: Title: Assistant Corporate Secretary [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series designated therein, described in the within-mentioned Mortgage. Dated: THE BANK OF NEW YORK, as Trustee, By: ----------------------------- Authorized Officer 3 [FORM OF BOND OF 2003 CLASS A SERIES A] [REVERSE] OHIO EDISON COMPANY FIRST MORTGAGE BOND, CLASS A SERIES A OF 2003 DUE 2015 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its First Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any sinking fund established in accordance with the provisions of the Indenture hereinafter mentioned for the bonds of any particular series) by an Indenture, dated as of August 1, 1930, executed by the Company to The Bank of New York, as Trustee (the "Trustee"), as amended and supplemented by indentures supplemental thereto, to which Indenture as so amended and supplemented (herein referred to as the "Indenture") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The Initial Interest Accrual Date for the bonds of this series shall be the date that interest begins to accrue on the Mortgage Bonds. The Bonds of this series are subject to mandatory redemption, in whole or in part, as the case may be, on each date that Mortgage Bonds are to be redeemed. The principal amount of the Bonds of this series to be redeemed on any such date shall be equal to the principal amount of Mortgage Bonds called for redemption on that date. All redemption of Bonds of this series shall be at 100 percent of the principal amount thereof, plus accrued interest to the redemption date. The Bonds of this series are not otherwise redeemable prior to their maturity. Notwithstanding the foregoing, Bonds of this series shall be deemed to be paid and no longer outstanding under the Indenture to the extent that Mortgage Bonds are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company. The Trustee may conclusively presume that the obligation of the Company to pay the principal of, and interest, if any, on the bonds of this series as the same shall become due and payable shall have been fully satisfied and discharged unless and until it shall have received a written notice from the trustee under the General Mortgage, signed by an authorized officer thereof, stating that any such principal of or interest on the Mortgage Bonds has become due and payable and has not been fully paid and specifying the amount of funds required to make such payment. 4 As more fully described in the supplemental indenture establishing the terms and provisions of the bonds of this series, the Company reserves the right, without any consent or other action by holders of the bonds of this series, to amend the Indenture to provide (a) that the Indenture, the rights and obligations of the Company and the rights of the bondholders may be modified with the consent of the holders of not less than 60% in principal amount of the bonds adversely affected; provided, however, that no modification shall (1) extend the time, or reduce the amount, of any payment on any bond, without the consent of the holder of each bond so affected, (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Indenture, without the consent of the holders of all bonds then outstanding, or (3) reduce the above percentage of the principal amount of bonds the holders of which are required to approve any such modification without the consent of the holders of all bonds then outstanding and (b) that (i) additional bonds may be issued against 70% of the value of the property which forms the basis for such issuance and (ii) the charge against property subject to a prior lien which is used to effectuate the release of property under the Indenture be similarly based. The principal hereof may be declared or may become due on the conditions, in the manner and at the time set forth in the Indenture, upon the occurrence of a completed default as in the Indenture provided. No recourse shall be had for the payment of the principal of or interest on this bond against any incorporator or any past, present or future subscriber to the capital stock, stockholder, officer or director of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, under any rule of law, statute or constitution or by the enforcement of any assessment or otherwise, all such liability of incorporators, subscribers, stockholders, officers and directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000 and any multiple thereof. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. Registered bonds of this series shall be exchangeable at said offices or agencies of the Company for registered bonds of other authorized denominations having the same aggregate principal amount, in the manner and upon the conditions prescribed in the Indenture. Notwithstanding any provision of the Indenture, (a) neither the Company nor the Trustee shall be required to make transfers or exchanges of bonds of this series during the period between any interest payment date for such series and the record date next preceding such interest payment date, and (b) no charge shall be made upon any transfer or exchange of bonds of this series other than for any tax or taxes or other governmental charge required to be paid by the Company. [END OF FORM OF BOND OF 2003 CLASS A SERIES A] and 5 WHEREAS, Section 115 of the Indenture provides that the Company and the Trustee may, from time to time and at any time, enter into such indentures supplemental thereto as shall be deemed necessary or desirable for one or more purposes, including, among others, to describe and set forth the particular terms and the form of additional series of bonds to be issued under the Indenture, to add other limitations on the issue of bonds, withdrawal of cash or release of property, to add to the covenants and agreements of the Company for the protection of the holders of the bonds and of the mortgaged and pledged property, to supplement defective or inconsistent provisions contained in the Indenture, and for any other purpose not inconsistent with the terms of the Indenture; and WHEREAS, all things necessary to make the bonds of the 2003 Class A Series A when authenticated by the Trustee and issued as in the Indenture provided, the valid, binding and legal obligations of the Company, entitled in all respects to the security of the Indenture, have been done and performed, and the creation, execution and delivery of this Supplemental Indenture have in all respects been duly authorized; and WHEREAS, the Company and Trustee deem it advisable to enter into this Supplemental Indenture for the purposes of describing the bonds of the 2003 Class A Series A and of establishing the terms and provisions thereof, confirming the mortgaging under the Indenture of additional property for the equal and proportionate benefit and security of the holders of all bonds at any time issued thereunder, amplifying the description of the property mortgaged, adding other limitations to the Indenture on the issue of bonds, withdrawal of cash or release of property, and adding to the covenants and agreements of the Company for the protection of the holders of bonds and of mortgaged and pledged property; NOW, THEREFORE, THIS SUPPLEMENTAL INDENTURE WITNESSETH: That OHIO EDISON COMPANY, in consideration of the premises 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, and of the purchase and acceptance of the bonds issued or to be issued hereunder by the holders thereof, and in order to secure the payment both of the principal and interest of all bonds at any time issued and outstanding under the Indenture, according to their tenor and effect, and the performance of all the provisions of the Indenture and of said bonds, hath granted, bargained, sold, released, conveyed, assigned, transferred, pledged, set over and confirmed and by these presents doth grant, bargain, sell, release, convey, assign, transfer, pledge, set over and confirm unto THE BANK OF NEW YORK, as Trustee, and to its successor or successors in said trust, and to its and their assigns forever, all the properties of the Company, now owned or hereafter acquired, wherever located, described in the Indenture and not therein expressly excepted. TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any wise appertaining to the aforesaid property or any part thereof, with the reversion and reversions, remainder and remainders and (subject to the provisions of Article XI of the Indenture) the tolls, rents, revenues, issues, earnings, income, product and profits thereof, and all the estate, right, title and interest and claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to the aforesaid property and franchises and every part and parcel thereof. 6 The Company does hereby agree and does hereby confirm and reaffirm the agreement made by it in the Indenture, dated as of August 1, 1930, that all property, rights and franchises acquired by the Company after the date of the Indenture, dated as of August 1, 1930 (except any hereinafter expressly excepted), shall be as fully embraced within the lien of the Indenture as if such property had been owned by the Company on the date of the Indenture, dated as of August 1, 1930 and was specifically described therein and conveyed thereby and does hereby confirm that the Company will not cause or consent to a partition, whether voluntary or through legal proceedings, of property, whether herein described or heretofore or hereafter acquired, in which its ownership shall be as a tenant in common except as permitted by and in conformity with the provisions of the Indenture and particularly of Article XI thereof. PROVIDED that the following are not and are not intended to be now or hereafter granted, bargained, sold, released, conveyed, assigned, transferred, mortgaged, pledged, set over or confirmed hereunder and are hereby expressly excepted from the lien and operation of the Indenture, viz.: cash, shares of stock and obligations (including bonds, notes and other securities) not heretofore or hereafter specifically pledged, paid or deposited or delivered under the Indenture or covenanted so to be. TO HAVE AND TO HOLD all such properties, real, personal and mixed, mortgaged, pledged or conveyed by the Company as aforesaid, or intended so to be, unto the Trustee and its successors and assigns forever. IN TRUST, NEVERTHELESS, upon the terms and trusts of the Indenture for those who shall hold the bonds and coupons issued and to be issued thereunder, or any of them, without preference, priority or distinction as to lien of any of said bonds and coupons over any others thereof by reason of priority in the time of the issue or negotiations thereof, or otherwise howsoever, subject, however, to the provisions in reference to extended, transferred or pledged coupons and claims for interest set forth in the Indenture (and subject to any sinking funds that may be hereafter created for the benefit of any particular series). PROVIDED, HOWEVER, and these presents are upon the condition that if the Company, its successors or assigns, shall pay or caused to be paid, the principal of and interest on said bonds, at the times and in the manner stipulated therein and herein, and shall keep, perform and observe all and singular the covenants and promises in said bonds and in the Indenture expressed to be kept, performed and observed by or on the part of the Company, then this Supplemental Indenture and the estate and rights hereby granted shall cease, determine and be void, otherwise to be and remain in full force and effect. IT IS HEREBY COVENANTED, DECLARED AND AGREED, by the Company, that all such bonds and coupons are to be issued, authenticated and delivered, and that all property subject or to become subject hereto is to be held, subject to the further covenants, conditions, uses and trusts in the Indenture set forth, and the parties hereto mutually agree as follows: SECTION 1. Bonds of 2003 Class A Series A shall mature on February 1, 2015, and shall be designated as the Company's "First Mortgage Bonds, Class A Series A of 2003 due 2015." Each bond of the 2003 Class A Series A shall bear interest from the Initial Interest Accrual Date (as defined in the form of such 7 bond hereinabove set forth) at the rate from time to time borne by the series of the Mortgage Bonds referred to in said form; provided, however that in no event shall the rate of interest borne by the bonds of the 2003 Class A Series A exceed fourteen per centum per annum. Principal and interest on the bonds of the 2003 Class A Series A shall be payable in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Definitive bonds of the 2003 Class A Series A may be issued, originally or otherwise, only as registered bonds, substantially in the form of bond hereinbefore recited, and in the denominations of $1,000 and any multiple thereof. Delivery of a bond of the 2003 Class A Series A to the Trustee for authentication shall be conclusive evidence that its serial number has been duly approved by the Company. Bonds of the 2003 Class A Series A are subject to mandatory redemption, in whole or in part, as the case may be, on each date that the Mortgage Bonds to which they relate are to be redeemed. The principal amount of the bonds of the Class A Series A to be redeemed on any such date shall be equal to the principal amount of Mortgage Bonds called for redemption on that date. All redemption of bonds of the Class A Series A shall be at 100 percent of the principal amount thereof, plus accrued interest to the redemption date. Notwithstanding the provisions of Section 58 of the Indenture, any holder of bonds of the 2003 Class A Series A is deemed to have (i) agreed that notice of any such mandatory redemption may be made to such holder not less than three (3) nor more than sixty (60) days prior to such redemption date, and (ii) waived any requirements for publication of any such notice. The bonds of the Class A Series A are not otherwise redeemable prior to their maturity. SECTION 2. Bonds of the 2003 Class A Series A shall be deemed to be paid and no longer outstanding under the Indenture to the extent that Mortgage Bonds to which they relate are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company. The Trustee may conclusively presume that the obligation of the Company to pay the principal of, and interest, if any, on the bonds of the 2003 Class A Series A as the same shall become due and payable shall have been fully satisfied and discharged unless and until it shall have received a written notice from the trustee under the General Mortgage, signed by an authorized officer thereof, stating that any such principal of or interest on the Mortgage Bonds to which they relate has become due and payable and has not been fully paid and specifying the amount of funds required to make such payment. SECTION 3. Bonds of the 2003 Class A Series A may be transferred by the registered owners thereof, in person or by attorney duly authorized, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio but only in the manner and upon the conditions prescribed in the Indenture and in the form of bond hereinbefore recited. Bonds of the 2003 Class A Series A shall be exchangeable for other registered bonds of the same series, in the manner and upon the conditions prescribed in the Indenture, and in the form of bond hereinbefore recited, upon the surrender of such bonds at said offices or agencies of the Company. However, notwithstanding the provisions of Section 14 or 15 of the Indenture, no charge shall be made upon any transfer or exchange of bonds of said series other than 8 for any tax or taxes or other governmental charge required to be paid by the Company. SECTION 4. The Company reserves the right, without any consent or other action by holders of the bonds of the 2003 Class A Series A, or any subsequent series of bonds, to amend the Indenture by inserting the following language as Section 115A immediately following current Section 115 of the Indenture: With the consent of the holders of not less than sixty per centum (60%) in principal amount of the bonds at the time outstanding or their attorneys-in-fact duly authorized, or, if the rights of the holders of one or more, but not all, series then outstanding are affected, the consent of the holders of not less than sixty per centum (60%) in aggregate principal amount of the bonds at the time outstanding of all affected series, taken together, and not any other series, the Company, when authorized by a resolution, and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or of any supplemental indenture or modifying the rights and obligations of the Company and the rights of the holders of any of the bonds and coupons; provided, however, that no such supplemental indenture shall (1) extend the maturity of any of the bonds or reduce the rate or extend the time of payment of interest thereon, or reduce the amount of the principal thereof, or reduce any premium, payable on the redemption thereof or change the coin or currency in which any bond or interest thereon is payable, without the consent of the holder of each bond so affected, or (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of this Indenture, without the consent of the holders of all of the bonds then outstanding, or (3) reduce the aforesaid percentage of the principal amount of bonds the holders of which are required to approve any such supplemental indenture, without the consent of the holders of all the bonds then outstanding. For the purposes of this Section, bonds shall be deemed to be affected by a supplemental indenture if such supplemental indenture adversely affects or diminishes the right of holders thereof against the Company or against its property. Upon the written request of the Company, accompanied by a resolution authorizing the execution of any such supplemental indenture, and upon the filing with the Trustee of evidence of the consent of bondholders as aforesaid (the instrument or instruments evidencing such consent to be dated within one year of such request), the Trustee shall join with the Company in the execution of such supplemental indenture unless such supplemental indenture affects the Trustee's owns rights, duties or immunities under this Indenture or otherwise, in which case the Trustee may in its discretion but shall not be obligated to enter into such supplemental indenture. The Trustee shall be entitled to receive and, subject to Section 102 of the Indenture and Article Five of the Seventh Supplemental Indenture, may rely upon an opinion of counsel as conclusive evidence that any such supplemental indenture is authorized or permitted by the provisions of this Section. 9 It shall not be necessary for the consent of the bondholders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such consent shall approve the substance thereof. The Company and the Trustee, if they so elect, and either before or after such 60% or greater consent has been obtained, may require the holder of any bond consenting to the execution of any such supplemental indenture to submit his bond to the Trustee or to such bank, banker or trust company as may be designated by the Trustee for the purpose, for the notation thereon of the fact that the holder of such bond has consented to the execution of such supplemental indenture, and in such case such notation, in form satisfactory to the Trustee, shall be made upon all bonds so submitted, and such bonds bearing such notation shall forthwith be returned to the persons entitled thereto. All subsequent holders of bonds bearing such notation shall be deemed to have consented to the execution of such supplemental indenture, and consent, once given or deemed to be given, may not be withdrawn. Prior to the execution by the Company and the Trustee of any supplemental indenture pursuant to the provisions of this Section, the Company shall publish a notice, setting forth in general terms the substance of such supplemental indenture, at least once in one daily newspaper of general circulation in each city in which the principal of any of the bonds shall be payable, or, if all bonds outstanding shall be registered bonds without coupons or coupon bonds registered as to principal, such notice shall be sufficiently given if mailed, first class, postage prepaid, and registered if the Company so elects, to each registered holder of bonds at the last address of such holder appearing on the registry books, such publication or mailing, as the case may be, to be made not less than thirty days prior to such execution. Any failure of the Company to give such notice, or any defect therein, shall not, however, in any way impair or affect the validity of any such supplemental indenture. SECTION 5. The Company reserves the right, without any consent or other action by the holders of the bonds of the 2003 Class A Series A, or any subsequent series of bonds, to amend the Indenture by deleting the phrase "sixty per centum (60%)" in Section 28 of the Indenture and substituting therefor the phrase "seventy per centum (70%)" and by deleting the phrase "One hundred sixty-six and two-thirds per cent. (166 2/3%)" in Sections 65 and 67 of the Indenture and substituting therefor the phrase "One hundred and forty-two and eighty-six hundredths per cent. (142.86%)". SECTION 6. Except as herein otherwise expressly provided, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this Supplemental Indenture; the Trustee shall not be responsible for the recitals herein or in the bonds (except the Trustee's authentication certificate), all of which are made by the Company solely; and this Supplemental Indenture is executed and accepted by the Trustee, subject to all the terms and conditions set forth in the Indenture, as fully to all intents and purposes as if the terms and conditions of the Indenture were herein set forth at length. 10 SECTION 7. As supplemented by this Supplemental Indenture, the Indenture is in all respects ratified and confirmed, and the Indenture as herein defined, and this Supplemental Indenture, shall be read, taken and construed as one and the same instrument. SECTION 8. Nothing in this Supplemental Indenture contained shall or shall be construed to confer upon any person other than a holder of bonds issued under the Indenture, the Company and the Trustee any right or interest to avail himself of any benefit under any provision of the Indenture or of this Supplemental Indenture. SECTION 9. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. [Remainder of this page intentionally left blank] 11 IN WITNESS WHEREOF, OHIO EDISON COMPANY and THE BANK OF NEW YORK have caused these presents to be executed in their respective names by their respective Presidents or one of their Vice Presidents or Assistant Vice Presidents and their respective seals to be hereunto affixed and attested by their respective Secretaries or one of their Assistant Secretaries or Assistant Treasurers, all as of the day and year first above written. OHIO EDISON COMPANY By: ------------------------------------------ Richard H. Marsh, Senior Vice President and Chief Financial Officer [Seal] Attest: ------------------------------------------------ Edward J. Udovich, Assistant Corporate Secretary Signed, Sealed and Acknowledged on behalf of OHIO EDISON COMPANY in the presence of: - ------------------------------------------------------ Name: Amit D. Patel - ------------------------------------------------------ Name: Julie A. Phillips 12 THE BANK OF NEW YORK By: ------------------------------ Name: Patricia Gallagher Title: Vice President [Seal] Attest: ----------------------------------- Name: Julie Salovitch-Miller Title: Vice President Signed, Sealed and Acknowledged on behalf of THE BANK OF NEW YORK in the presence of: - ------------------------------------------ Print Name: Timothy Shea - ------------------------------------------ Print Name: Sirojni Dindial 13 STATE OF OHIO ) ) ss.: COUNTY OF SUMMIT ) On the 3rd day of February in the year 2003 before me, the undersigned, personally appeared Richard H. Marsh and Edward J. Udovich, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instrument. -------------------------------------- Susie M. Hoisten Notary Public Residence Summit County Statewide Jurisdiction Ohio My commission expires December 9, 2006 [SEAL] STATE OF NEW YORK ) ) ss.: COUNTY OF NEW YORK ) On the 3rd day of February in the year 2003 before me, the undersigned, personally appeared Patricia Gallagher and Julie Salovitch-Miller, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instrument. -------------------------------------- William J. Cassels Notary Public, State of New York No. 01CA5027729 Qualified in Bronx County Commission Expires May 18, 2006 [SEAL] The Bank of New York hereby certifies that its precise name and address as Trustee hereunder are: The Bank of New York 101 Barclay Street City, County and State of New York 10286 THE BANK OF NEW YORK By: ------------------------------------ Name: Patricia Gallagher Title: Vice President This Instrument was prepared by FirstEnergy Corp. EX-4 12 oe_ex4-2.txt EX 4-2 75TH SI - -------------------------------------------------------------------------------- OHIO EDISON COMPANY with THE BANK OF NEW YORK, As Trustee ----------------------- SEVENTY-FIFTH SUPPLEMENTAL INDENTURE Providing among other things for FIRST MORTGAGE BONDS Pledge Series A of 2003 due 2033 Pledge Series B of 2003 due 2033 --------- Dated as of March 1, 2003 - -------------------------------------------------------------------------------- SUPPLEMENTAL INDENTURE, dated as of March 1, 2003 between OHIO EDISON COMPANY, a corporation organized and existing under the laws of the State of Ohio (hereinafter called the "Company"), party of the first part, and THE BANK OF NEW YORK, a banking corporation organized and existing under the laws of the State of New York, as Trustee under the Indenture hereinafter referred to, party of the second part. WHEREAS, the Company has heretofore executed and delivered to BANKERS TRUST COMPANY (hereinafter called the "Old Trustee"), as trustee, a certain Indenture, dated as of August 1, 1930, to secure an issue of bonds of the Company, issued and to be issued in series, from time to time, in the manner and subject to the conditions set forth in the said Indenture; and the said Indenture has been supplemented by seventy-four supplemental indentures, which Indenture as so supplemented and to be hereby supplemented is hereinafter referred to as the "Indenture"; and WHEREAS, The Bank of New York has succeeded the Old Trustee as trustee under the Indenture (hereinafter called the "Trustee") pursuant to Article XVI thereof; and WHEREAS, the Indenture provides for the issuance of bonds thereunder in one or more series, the form of each series of bonds and of the coupons to be attached to the coupon bonds, if any, to be substantially in the forms set forth therein with such insertions, omissions and variations as the Board of Directors of the Company may determine; and WHEREAS, the Company, by appropriate corporate action in conformity with the terms of the Indenture, has duly determined to create a new series of bonds under the Indenture, consisting of $41,000,000 in principal amount to be designated as "First Mortgage Bonds, Pledge Series A of 2003 due 2033" (hereinafter sometimes referred to as the "bonds of Pledge Series A") and $9,000,000 in principal amount to be designated as "First Mortgage Bonds, Pledge Series B of 2003 due 2033" (hereinafter sometimes referred to as the "bonds of Pledge Series B", together with the bonds of Pledge Series A, the "bonds of the 2003 Pledge Series"), which shall bear interest at the rate per annum set forth in, shall be subject to certain redemption rights and obligations set forth in, and will otherwise be in the form and have the terms and provisions provided for in this Supplemental Indenture and set forth in the form of such bonds below: 2 [FORM OF BOND OF PLEDGE SERIES A] This Bond is not transferable except to a successor trustee under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, between the Company and The Bank of New York, as Trustee, or in connection with the exercise of the rights and remedies of the holder hereof consequent upon a "default" as defined in the Mortgage referred to herein. OHIO EDISON COMPANY FIRST MORTGAGE BONDS, PLEDGE SERIES A OF 2003 DUE 2033 Due June 1, 2033 $ No. OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to ____________, or registered assigns, ____________ dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio, on June 1, 2033 in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said offices or agencies to the registered owner hereof, in like coin or currency, interest thereon from the Initial Interest Accrual Date (hereinbelow defined) at the rate per annum from time to time borne by the Mortgage Bonds, Guarantee Series A of 2003 due 2033 (the "Mortgage Bonds") issued by the Company under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, as heretofore supplemented (the "General Mortgage") by the Company to The Bank of New York, as trustee, on each June 1 and December 1 commencing on the June 1 or December 1 immediately succeeding the Initial Interest Accrual Date (as defined below) each such date herein referred to as an "interest payment date") on and until maturity, or, in the case of any bonds of this series duly called for redemption, on and until the redemption date, or in the case of any default by the Company in the payment of the principal due on any bonds of this series, until the Company's obligation with respect to the payment of the principal shall be discharged as provided in the Indenture referred to on the reverse hereof. Payments of principal of and interest on this bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Payment of principal of, or premium or interest on, the Mortgage Bonds shall, to the extent thereof, be deemed to satisfy and discharge the obligation of the Company, if any, to make a payment of principal, premium or interest, as the case may be, in respect of this bond which is then due. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Mortgage referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. 3 IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his signature or a facsimile thereof, and its corporate seal to be printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his signature or a facsimile thereof. Dated: OHIO EDISON COMPANY, By: ------------------------------------- Title: Attest: - ------------------------------ Title: [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series designated therein, described in the within-mentioned Mortgage. THE BANK OF NEW YORK, as Trustee, By:______________________________________ Authorized Officer 4 [FORM OF BOND OF PLEDGE SERIES A] [REVERSE] OHIO EDISON COMPANY FIRST MORTGAGE BONDS, PLEDGE SERIES A OF 2003 DUE 2033 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its First Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any sinking fund established in accordance with the provisions of the Mortgage hereinafter mentioned for the bonds of any particular series) by an Indenture, dated as of August 1, 1930, executed by the Company to The Bank of New York, as Trustee, as amended and supplemented by indentures supplemental thereto, to which Indenture as so amended and supplemented (herein referred to as the "Mortgage") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The Bonds of this series are subject to mandatory redemption, in whole or in part, as the case may be, on each date that the Mortgage Bonds are to be redeemed. The principal amount of the Bonds of this series to be redeemed on any such date shall be equal to the principal amount of Mortgage Bonds called for redemption on that date. All redemption of Bonds of this series shall be at 100 percent of the principal amount thereof, plus accrued interest to the redemption date. The Bonds of this series are not otherwise redeemable prior to their maturity. Notwithstanding the foregoing, Bonds of this series shall be deemed to be paid and no longer outstanding under the Mortgage to the extent that Mortgage Bonds are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company. The Trustee may conclusively presume that the obligation of the Company to pay the principal of, and interest, if any, on the bonds of this series as the same shall become due and payable shall have been fully satisfied and discharged unless and until it shall have received a written notice from the trustee under the General Mortgage, signed by an authorized officer thereof, stating that any such principal of or interest on the Mortgage Bonds has become due and payable and has not been fully paid and specifying the amount of funds required to make such payment. The Initial Interest Accrual Date for the bonds of this series shall be the date that interest begins to accrue on the Mortgage Bonds. As more fully described in the supplemental indenture establishing the terms and provisions of the bonds of this series, the Company reserves the 5 right, without any consent or other action by holders of the bonds of this series, to amend the Mortgage to provide (a) that the Mortgage, the rights and obligations of the Company and the rights of the bondholders may be modified with the consent of the holders of not less than 60% in principal amount of the bonds adversely affected; provided, however, that no modification shall (1) extend the time, or reduce the amount, of any payment on any bond, without the consent of the holder of each bond so affected, (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Mortgage, without the consent of the holders of all bonds then outstanding, or (3) reduce the above percentage of the principal amount of bonds the holders of which are required to approve any such modification without the consent of the holders of all bonds then outstanding and (b) that (i) additional bonds may be issued against 70% of the value of the property which forms the basis for such issuance and (ii) the charge against property subject to a prior lien which is used to effectuate the release of property under the Mortgage be similarly based. The principal hereof may be declared or may become due on the conditions, in the manner and at the time set forth in the Mortgage, upon the occurrence of a completed default as in the Mortgage provided. No recourse shall be had for the payment of the principal of or interest on this bond against any incorporator or any past, present or future subscriber to the capital stock, stockholder, officer or director of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, under any rule of law, statute or constitution or by the enforcement of any assessment or otherwise, all such liability of incorporators, subscribers, stockholders, officers and directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Mortgage. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000 and, if higher, in multiples of $1.00. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. Registered bonds of this series shall be exchangeable at said offices or agencies of the Company for registered bonds of other authorized denominations having the same aggregate principal amount, in the manner and upon the conditions prescribed in the Mortgage. Notwithstanding any provision of the Mortgage, (a) neither the Company nor the Trustee shall be required to make transfers or exchanges of bonds of this series during the period between any interest payment date for such series and the record date next preceding such interest payment date, and (b) no charge shall be made upon any transfer or exchange of bonds of this series other than for any tax or taxes or other governmental charge required to be paid by the Company. [END OF FORM OF BOND OF PLEDGE SERIES A] [FORM OF BOND OF PLEDGE SERIES B] 6 This Bond is not transferable except to a successor trustee under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, between the Company and The Bank of New York, as Trustee, or in connection with the exercise of the rights and remedies of the holder hereof consequent upon a "default" as defined in the Mortgage referred to herein. OHIO EDISON COMPANY FIRST MORTGAGE BONDS, PLEDGE SERIES B OF 2003 DUE 2033 Due June 1, 2033 $ No. OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to , or registered assigns, dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio, on June 1, 2033 in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said offices or agencies to the registered owner hereof, in like coin or currency, interest thereon from the Initial Interest Accrual Date (hereinbelow defined) at the rate per annum from time to time borne by the Mortgage Bonds, Guarantee Series B of 2003 due 2033 (the "Mortgage Bonds") issued by the Company under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, as heretofore supplemented (the "General Mortgage") by the Company to The Bank of New York, as trustee, on each June 1 and December 1 commencing on the June 1 or December 1 immediately succeeding the Initial Interest Accrual Date (as defined below) each such date herein referred to as an "interest payment date") on and until maturity, or, in the case of any bonds of this series duly called for redemption, on and until the redemption date, or in the case of any default by the Company in the payment of the principal due on any bonds of this series, until the Company's obligation with respect to the payment of the principal shall be discharged as provided in the Indenture referred to on the reverse hereof. Payments of principal of and interest on this bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Payment of principal of, or premium or interest on, the Mortgage Bonds shall, to the extent thereof, be deemed to satisfy and discharge the obligation of the Company, if any, to make a payment of principal, premium or interest, as the case may be, in respect of this bond which is then due. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Mortgage referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his signature or a 7 facsimile thereof, and its corporate seal to be printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his signature or a facsimile thereof. Dated: OHIO EDISON COMPANY, By: ---------------------------------------- Title: Attest: - -------------------------------- Title: [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series designated therein, described in the within-mentioned Mortgage. THE BANK OF NEW YORK, as Trustee, By:__________________________________________ Authorized Officer 8 [FORM OF BOND OF PLEDGE SERIES B] [REVERSE] OHIO EDISON COMPANY FIRST MORTGAGE BONDS, PLEDGE SERIES B OF 2003 DUE 2033 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its First Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any sinking fund established in accordance with the provisions of the Mortgage hereinafter mentioned for the bonds of any particular series) by an Indenture, dated as of August 1, 1930, executed by the Company to The Bank of New York, as Trustee, as amended and supplemented by indentures supplemental thereto, to which Indenture as so amended and supplemented (herein referred to as the "Mortgage") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The Bonds of this series are subject to mandatory redemption, in whole or in part, as the case may be, on each date that the Mortgage Bonds are to be redeemed. The principal amount of the Bonds of this series to be redeemed on any such date shall be equal to the principal amount of Mortgage Bonds called for redemption on that date. All redemption of Bonds of this series shall be at 100 percent of the principal amount thereof, plus accrued interest to the redemption date. The Bonds of this series are not otherwise redeemable prior to their maturity. Notwithstanding the foregoing, Bonds of this series shall be deemed to be paid and no longer outstanding under the Mortgage to the extent that Mortgage Bonds are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company. The Trustee may conclusively presume that the obligation of the Company to pay the principal of, and interest, if any, on the bonds of this series as the same shall become due and payable shall have been fully satisfied and discharged unless and until it shall have received a written notice from the trustee under the General Mortgage, signed by an authorized officer thereof, stating that any such principal of or interest on the Mortgage Bonds has become due and payable and has not been fully paid and specifying the amount of funds required to make such payment. The Initial Interest Accrual Date for the bonds of this series shall be the date that interest begins to accrue on the Mortgage Bonds. As more fully described in the supplemental indenture establishing the terms and provisions of the bonds of this series, the Company reserves the 9 right, without any consent or other action by holders of the bonds of this series, to amend the Mortgage to provide (a) that the Mortgage, the rights and obligations of the Company and the rights of the bondholders may be modified with the consent of the holders of not less than 60% in principal amount of the bonds adversely affected; provided, however, that no modification shall (1) extend the time, or reduce the amount, of any payment on any bond, without the consent of the holder of each bond so affected, (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Mortgage, without the consent of the holders of all bonds then outstanding, or (3) reduce the above percentage of the principal amount of bonds the holders of which are required to approve any such modification without the consent of the holders of all bonds then outstanding and (b) that (i) additional bonds may be issued against 70% of the value of the property which forms the basis for such issuance and (ii) the charge against property subject to a prior lien which is used to effectuate the release of property under the Mortgage be similarly based. The principal hereof may be declared or may become due on the conditions, in the manner and at the time set forth in the Mortgage, upon the occurrence of a completed default as in the Mortgage provided. No recourse shall be had for the payment of the principal of or interest on this bond against any incorporator or any past, present or future subscriber to the capital stock, stockholder, officer or director of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, under any rule of law, statute or constitution or by the enforcement of any assessment or otherwise, all such liability of incorporators, subscribers, stockholders, officers and directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Mortgage. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000 and, if higher, in multiples of $1.00. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. Registered bonds of this series shall be exchangeable at said offices or agencies of the Company for registered bonds of other authorized denominations having the same aggregate principal amount, in the manner and upon the conditions prescribed in the Mortgage. Notwithstanding any provision of the Mortgage, (a) neither the Company nor the Trustee shall be required to make transfers or exchanges of bonds of this series during the period between any interest payment date for such series and the record date next preceding such interest payment date, and (b) no charge shall be made upon any transfer or exchange of bonds of this series other than for any tax or taxes or other governmental charge required to be paid by the Company. [END OF FORM OF BOND OF PLEDGE SERIES B] 10 WHEREAS, Section 115 of the Indenture provides that the Company and the Trustee may, from time to time and at any time, enter into such indentures supplemental thereto as shall be deemed necessary or desirable for one or more purposes, including, among others, to describe and set forth the particular terms and the form of additional series of bonds to be issued under the Indenture, to add other limitations on the issue of bonds, withdrawal of cash or release of property, to add to the covenants and agreements of the Company for the protection of the holders of the bonds and of the mortgaged and pledged property, to supplement defective or inconsistent provisions contained in the Indenture, and for any other purpose not inconsistent with the terms of the Indenture; and WHEREAS, all things necessary to make the bonds of the 2003 Pledge Series when authenticated by the Trustee and issued as in the Indenture provided, the valid, binding and legal obligations of the Company, entitled in all respects to the security of the Indenture, have been done and performed, and the creation, execution and delivery of this Supplemental Indenture have in all respects been duly authorized; and WHEREAS, the Company and Trustee deem it advisable to enter into this Supplemental Indenture for the purposes of describing the bonds of the 2003 Pledge Series and of establishing the terms and provisions thereof, confirming the mortgaging under the Indenture of additional property for the equal and proportionate benefit and security of the holders of all bonds at any time issued thereunder, amplifying the description of the property mortgaged, adding other limitations to the Indenture on the issue of bonds, withdrawal of cash or release of property, and adding to the covenants and agreements of the Company for the protection of the holders of bonds and of mortgaged and pledged property; NOW, THEREFORE, THIS SUPPLEMENTAL INDENTURE WITNESSETH: That OHIO EDISON COMPANY, in consideration of the premises 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, and of the purchase and acceptance of the bonds issued or to be issued hereunder by the holders thereof, and in order to secure the payment both of the principal and interest of all bonds at any time issued and outstanding under the Indenture, according to their tenor and effect, and the performance of all the provisions of the Indenture and of said bonds, hath granted, bargained, sold, released, conveyed, assigned, transferred, pledged, set over and confirmed and by these presents doth grant, bargain, sell, release, convey, assign, transfer, pledge, set over and confirm unto THE BANK OF NEW YORK, as Trustee, and to its successor or successors in said trust, and to its and their assigns forever, all the properties of the Company described in Schedule A (which is identified by the signature of an officer of each party hereto at the end thereof) hereto annexed and hereby made a part hereof; TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any wise appertaining to the aforesaid property or any part thereof, with the reversion and reversions, remainder and remainders and (subject to the provisions of Article XI of the Indenture) the tolls, rents, revenues, issues, earnings, income, product and profits thereof, and all the 11 estate, right, title and interest and claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to the aforesaid property and franchises and every part and parcel thereof. The Company does hereby agree and does hereby confirm and reaffirm the agreement made by it in the Indenture, dated as of August 1, 1930, that all property, rights and franchises acquired by the Company after the date of the Indenture, dated as of August 1, 1930 (except any hereinafter expressly excepted), shall be as fully embraced within the lien of the Indenture as if such property had been owned by the Company on the date of the Indenture, dated as of August 1, 1930 and was specifically described therein and conveyed thereby and does hereby confirm that the Company will not cause or consent to a partition, whether voluntary or through legal proceedings, of property, whether herein described or heretofore or hereafter acquired, in which its ownership shall be as a tenant in common except as permitted by and in conformity with the provisions of the Indenture and particularly of Article XI thereof. PROVIDED that the following are not and are not intended to be now or hereafter granted, bargained, sold, released, conveyed, assigned, transferred, mortgaged, pledged, set over or confirmed hereunder and are hereby expressly excepted from the lien and operation of the Indenture, viz.: cash, shares of stock and obligations (including bonds, notes and other securities) not heretofore or hereafter specifically pledged, paid or deposited or delivered under the Indenture or covenanted so to be. TO HAVE AND TO HOLD all such properties, real, personal and mixed, mortgaged, pledged or conveyed by the Company as aforesaid, or intended so to be, unto the Trustee and its successors and assigns forever. IN TRUST, NEVERTHELESS, upon the terms and trusts of the Indenture for those who shall hold the bonds and coupons issued and to be issued thereunder, or any of them, without preference, priority or distinction as to lien of any of said bonds and coupons over any others thereof by reason of priority in the time of the issue or negotiations thereof, or otherwise howsoever, subject, however, to the provisions in reference to extended, transferred or pledged coupons and claims for interest set forth in the Indenture (and subject to any sinking funds that may be hereafter created for the benefit of any particular series). PROVIDED, HOWEVER, and these presents are upon the condition that if the Company, its successors or assigns, shall pay or caused to be paid, the principal of and interest on said bonds, at the times and in the manner stipulated therein and herein, and shall keep, perform and observe all and singular the covenants and promises in said bonds and in the Indenture expressed to be kept, performed and observed by or on the part of the Company, then this Supplemental Indenture and the estate and rights hereby granted shall cease, determine and be void, otherwise to be and remain in full force and effect. IT IS HEREBY COVENANTED, DECLARED AND AGREED, by the Company, that all such bonds and coupons are to be issued, authenticated and delivered, and that all property subject or to become subject hereto is to be held, subject to the further covenants, conditions, uses and trusts in the Indenture set forth, and the parties hereto mutually agree as follows: 12 SECTION 1. Bonds of the 2003 Pledge Series shall mature on the date set forth in the respective form of bond relating thereto hereinbefore set forth and, subject to the provisions of said form, shall bear interest at the rate per annum from time to time borne by the series of the Mortgage Bonds referred to in said form. Pledge Series A Bonds shall be designated as the Company's "First Mortgage Bonds, Pledge Series A of 2003 due 2033." Pledge Series B Bonds shall be designated as the Company's "First Mortgage Bonds, Pledge Series B of 2003 due 2033." The bonds of the 2003 Pledge Series shall bear interest from the Initial Interest Accrual Date (as defined in the form of the bond hereinabove set forth). Principal or redemption price of and interest on the bonds of the 2003 Pledge Series shall be payable in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Definitive bonds of the 2003 Pledge Series may be issued, originally or otherwise, only as registered bonds, substantially in the form of bond hereinbefore recited, and in the denominations of $1,000 and, if higher, in multiples of $1.00. Delivery of a bond of the 2003 Pledge Series to the Trustee for authentication shall be conclusive evidence that its serial number has been duly approved by the Company. SECTION 2. Bonds of the 2003 Pledge Series shall be deemed to be paid and no longer outstanding under the Indenture to the extent that Mortgage Bonds (as defined in the form of bonds hereinabove set forth) to which they relate are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company. SECTION 3. Bonds of the 2003 Pledge Series may be transferred by the registered owners thereof, in person or by attorney duly authorized, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio but only in the manner and upon the conditions prescribed in the Indenture and in the form of bond hereinbefore recited. Bonds of the 2003 Pledge Series shall be exchangeable for other registered bonds of the same series, in the manner and upon the conditions prescribed in the Indenture, and in the form of bond hereinbefore recited, upon the surrender of such bonds at said offices or agencies of the Company. However, notwithstanding the provisions of Section 14 or 15 of the Indenture, no charge shall be made upon any transfer or exchange of bonds of said series other than for any tax or taxes or other governmental charge required to be paid by the Company. SECTION 4. The Company reserves the right, without any consent or other action by holders of the bonds of the 2003 Pledge Series, or any subsequent series of bonds, to amend the Indenture by inserting the following language as Section 115A immediately following current Section 115 of the Indenture. With the consent of the holders of not less than sixty per centum (60%) in principal amount of the bonds at the time outstanding or their attorneys-in-fact duly authorized, or, if the rights of the holders of one or more, but not all, series then outstanding are affected, the consent of the holders of not less than sixty per centum (60%) in aggregate principal amount of the bonds at the time outstanding of all affected series, taken together, and not any other 13 series, the Company, when authorized by a resolution, and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or of any supplemental indenture or modifying the rights and obligations of the Company and the rights of the holders of any of the bonds and coupons; provided, however, that no such supplemental indenture shall (1) extend the maturity of any of the bonds or reduce the rate or extend the time of payment of interest thereon, or reduce the amount of the principal thereof, or reduce any premium, payable on the redemption thereof or change the coin or currency in which any bond or interest thereon is payable, without the consent of the holder of each bond so affected, or (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of this Indenture, without the consent of the holders of all of the bonds then outstanding, or (3) reduce the aforesaid percentage of the principal amount of bonds the holders of which are required to approve any such supplemental indenture, without the consent of the holders of all the bonds then outstanding. For the purposes of this Section, bonds shall be deemed to be affected by a supplemental indenture if such supplemental indenture adversely affects or diminishes the right of holders thereof against the Company or against its property. Upon the written request of the Company, accompanied by a resolution authorizing the execution of any such supplemental indenture, and upon the filling with the Trustee of evidence of the consent of bondholders as aforesaid (the instrument or instruments evidencing such consent to be dated within one year of such request), the Trustee shall join with the Company in the execution of such supplemental indenture unless such supplemental indenture affects the Trustee's owns rights, duties or immunities under this Indenture or otherwise, in which case the Trustee may in its discretion but shall not be obligated to enter into such supplemental indenture. The Trustee shall be entitled to receive and, subject to Section 102 of the Indenture and Article Five of the Seventh Supplemental Indenture, may rely upon an opinion of counsel as conclusive evidence that any such supplemental indenture is authorized or permitted by the provisions of this Section. It shall not be necessary for the consent of the bondholders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such consent shall approve the substance thereof. The Company and the Trustee, if they so elect, and either before or after such 60% or greater consent has been obtained, may require the holder of any bond consenting to the execution of any such supplemental indenture to submit his bond to the Trustee or to such bank, banker or trust company as may be designated by the Trustee for the purpose, for the notation thereon of the fact that the holder of such bond has consented to the execution of such supplemental indenture, and in such case such notation, in form satisfactory to the Trustee, shall be made upon all bonds so submitted, and such bonds bearing such notation shall forthwith be returned to the persons entitled thereto. All subsequent holders of bonds bearing such notation shall be deemed to have consented to the execution of such supplemental indenture, and consent, once given or deemed to be given, may not be withdrawn. 14 Prior to the execution by the Company and the Trustee of any supplemental indenture pursuant to the provisions of this Section, the Company shall publish a notice, setting forth in general terms the substance of such supplemental indenture, at least once in one daily newspaper of general circulation in each city in which the principal of any of the bonds shall be payable, or, if all bonds outstanding shall be registered bonds without coupons or coupon bonds registered as to principal, such notice shall be sufficiently given if mailed, first class, postage prepaid, and registered if the Company so elects, to each registered holder of bonds at the last address of such holder appearing on the registry books, such publication or mailing, as the case may be, to be made not less than thirty days prior to such execution. Any failure of the Company to give such notice, or any defect therein, shall not, however, in any way impair or affect the validity of any such supplemental indenture. SECTION 5. The Company reserves the right, without any consent or other action by the holders of the bonds of the 2003 Pledge Series, or any subsequent series of bonds, to amend the Indenture by deleting the phrase "sixty per centum (60%)" in Section 28 of the Indenture and substituting therefor the phrase "seventy per centum (70%)" and by deleting the phrase "One hundred sixty-six and two-thirds per cent. (166 2/3%)" in Sections 65 and 67 of the Indenture and substituting therefor the phrase "One hundred and forty-two and eighty-six hundredths per cent. (142.86%)". SECTION 6. Except as herein otherwise expressly provided, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this Supplemental Indenture; the Trustee shall not be responsible for the recitals herein or in the bonds (except the Trustee's authentication certificate), all of which are made by the Company solely; and this Supplemental Indenture is executed and accepted by the Trustee, subject to all the terms and conditions set forth in the Indenture, as fully to all intents and purposes as if the terms and conditions of the Indenture were herein set forth at length. SECTION 7. As supplemented by this Supplemental Indenture, the Indenture is in all respects ratified and confirmed, and the Indenture as herein defined, and this Supplemental Indenture, shall be read, taken and construed as one and the same instrument. SECTION 8. Nothing in this Supplemental Indenture contained shall or shall be construed to confer upon any person other than a holder of bonds issued under the Indenture, the Company and the Trustee any right or interest to avail himself of any benefit under any provision of the Indenture or of this Supplemental Indenture. SECTION 9. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. 15 IN WITNESS WHEREOF, OHIO EDISON COMPANY and THE BANK OF NEW YORK have caused these presents to be executed in their respective names by their respective Presidents or one of their Vice Presidents or Assistant Vice Presidents and their respective seals to be hereunto affixed and attested by their respective Corporate Secretaries or one of their Assistant Corporate Secretaries or Assistant Treasurers, all as of the day and year first above written. OHIO EDISON COMPANY By:__________________________________________ Harvey L. Wagner, Vice President and Controller [Seal] Attest: ---------------------------------------- David W. Whitehead, Corporate Secretary Signed, Sealed and Acknowledged on behalf of OHIO EDISON COMPANY in the presence of: - ----------------------------- Julie A. Phillips - ----------------------------- Amit D. Patel THE BANK OF NEW YORK By:______________________________________ Patricia Gallagher, Vice President [Seal] Attest: ______________________________________ Margaret Ciesmelewski, Vice President Signed, Sealed and Acknowledged on behalf of THE BANK OF NEW YORK in the presence of: - ----------------------------- Barbara Bevelaqua - ----------------------------- Mary LaGumina 16 STATE OF OHIO ) : ss.: COUNTY OF SUMMIT ) On the 3rd day of March in the year 2003 before me, the undersigned, personally appeared Harvey L. Wagner and David W. Whitehead, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. ------------------------------------- Karen L. Pope Notary Public, State of Ohio My Commission Expires Jan. 16, 2005 Recorded in Stark County [SEAL] 17 STATE OF NEW YORK ) : ss.: COUNTY OF NEW YORK ) On the 3rd day of March in the year 2003 before me, the undersigned, personally appeared Patricia Gallagher and Margaret Ciesmelewski, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. -------------------------------- William J. Cassels Notary Public, State of New York No. 01CA5027729 Qualified in Bronx County Commission Expires May 18, 2006 [SEAL] 18 The Bank of New York hereby certifies that its precise name and address as Trustee hereunder are: The Bank of New York 101 Barclay Street City, County and State of New York 10286 THE BANK OF NEW YORK By: ---------------------------------- Patricia Gallagher, Vice President This instrument was prepared by FirstEnergy Corp. 19 EX-4 13 oe_ex4-3.txt EX 4-3 76TH SI - -------------------------------------------------------------------------------- OHIO EDISON COMPANY with THE BANK OF NEW YORK, As Trustee ----------------------- SEVENTY-SIXTH SUPPLEMENTAL INDENTURE Providing among other things for FIRST MORTGAGE BONDS Pledge Series C of 2003 due 2003 --------- Dated as of August 1, 2003 - -------------------------------------------------------------------------------- SUPPLEMENTAL INDENTURE, dated as of August 1, 2003 between OHIO EDISON COMPANY, a corporation organized and existing under the laws of the State of Ohio (hereinafter called the "Company"), party of the first part, and THE BANK OF NEW YORK, a banking corporation organized and existing under the laws of the State of New York, as Trustee under the Indenture hereinafter referred to, party of the second part. WHEREAS, the Company has heretofore executed and delivered to BANKERS TRUST COMPANY (hereinafter called the "Old Trustee"), as trustee, a certain Indenture, dated as of August 1, 1930, to secure an issue of bonds of the Company, issued and to be issued in series, from time to time, in the manner and subject to the conditions set forth in the said Indenture; and the said Indenture has been supplemented by seventy-five supplemental indentures, which Indenture as so supplemented and to be hereby supplemented is hereinafter referred to as the "Indenture"; and WHEREAS, The Bank of New York has succeeded the Old Trustee as trustee under the Indenture (hereinafter called the "Trustee") pursuant to Article XVI thereof; and WHEREAS, the Indenture provides for the issuance of bonds thereunder in one or more series, the form of each series of bonds and of the coupons to be attached to the coupon bonds, if any, to be substantially in the forms set forth therein with such insertions, omissions and variations as the Board of Directors of the Company may determine; and WHEREAS, the Company, by appropriate corporate action in conformity with the terms of the Indenture, has duly determined to create a new series of bonds under the Indenture, consisting of up to $450,000,000 in principal amount to be designated as "First Mortgage Bonds Pledge Series C of 2003 due 2003" (hereinafter sometimes referred to as the "bonds of the 2003C Pledge Series"), which shall bear interest at the rate per annum set forth in, shall be subject to certain redemption rights and obligations set forth in, and will otherwise be in the form and have the terms and provisions provided for in this Supplemental Indenture and set forth in the form of such bonds below: [FORM OF BOND OF PLEDGE SERIES C] This Bond is not transferable except to a successor trustee under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, between the Company and The Bank of New York, as Trustee, or in connection with the exercise of the rights and remedies of the holder hereof consequent upon a "default" as defined in the Mortgage referred to herein. OHIO EDISON COMPANY FIRST MORTGAGE BONDS PLEDGE SERIES C OF 2003 DUE 2003 Due December 31, 2003 $ No. OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to ____________, or registered assigns, ________________ dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio, on December 31, 2003 in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said offices or agencies to the registered owner hereof, in like coin or currency, interest thereon from the Initial Interest Accrual Date (as defined below) in the amounts, for the periods and payable at such times as interest shall accrue and be payable on the Mortgage Bonds Floating Rate Series A of 2003 due 2003 (the "Mortgage Bonds") issued by the Company under the General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, as heretofore supplemented (the "General Mortgage") by the Company to The Bank of New York, as trustee. Payments of principal of and interest on this bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Payment of principal of, or premium or interest on, the Mortgage Bonds shall, to the extent thereof, be deemed to satisfy and discharge the obligation of the Company, if any, to make a payment of principal, premium or interest, as the case may be, in respect of this bond which is then due. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Mortgage referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his signature or a facsimile thereof, and its corporate seal to be printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his signature or a facsimile thereof. 2 Dated: OHIO EDISON COMPANY, By: ----------------------------------------- Title: Attest: - ----------------------------------- Title: [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series designated therein, described in the within-mentioned Mortgage. THE BANK OF NEW YORK, as Trustee, By: ----------------------------------------- Authorized Officer 3 [FORM OF BOND OF 2003C PLEDGE SERIES] [REVERSE] OHIO EDISON COMPANY FIRST MORTGAGE BONDS PLEDGE SERIES C OF 2003 DUE 2003 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its First Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any sinking fund established in accordance with the provisions of the Mortgage hereinafter mentioned for the bonds of any particular series) by an Indenture, dated as of August 1, 1930, executed by the Company to The Bank of New York, as Trustee, as amended and supplemented by indentures supplemental thereto, to which Indenture as so amended and supplemented (herein referred to as the "Mortgage") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The bonds of this series are subject to mandatory redemption, in whole or in part, as the case may be, on each date that the Mortgage Bonds are to be redeemed. The principal amount of the bonds of this series to be redeemed on any such date shall be equal to the principal amount of Mortgage Bonds called for redemption on that date. All redemption of bonds of this series shall be at 100 percent of the principal amount thereof, plus accrued interest, if any, to the redemption date. The bonds of this series are not otherwise redeemable prior to their maturity. Notwithstanding the foregoing, bonds of this series shall be deemed to be paid and no longer outstanding under the Mortgage to the extent that Mortgage Bonds are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company. The Trustee may conclusively presume that the obligation of the Company to pay the principal of, and interest, if any, on the bonds of this series as the same shall become due and payable shall have been fully satisfied and discharged unless and until it shall have received a written notice from the trustee under the General Mortgage, signed by an authorized officer thereof, stating that any such principal of or interest on the Mortgage Bonds has become due and payable and has not been fully paid and specifying the amount of funds required to make such payment. Interest on the bonds of this series will accrue in the amounts, for the periods and be payable at such times as interest shall accrue and be payable on the Mortgage Bonds. The Initial Interest Accrual Date for the bonds of this series shall be the earliest date on which interest begins to accrue on any Mortgage Bonds. As more fully described in the supplemental indenture establishing the terms and provisions of the bonds of this series, the Company reserves the right, without any consent or other action by holders of the bonds of this 4 series, to amend the Mortgage to provide (a) that the Mortgage, the rights and obligations of the Company and the rights of the bondholders may be modified with the consent of the holders of not less than 60% in principal amount of the bonds adversely affected; provided, however, that no modification shall (1) extend the time, or reduce the amount, of any payment on any bond, without the consent of the holder of each bond so affected, (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Mortgage, without the consent of the holders of all bonds then outstanding, or (3) reduce the above percentage of the principal amount of bonds the holders of which are required to approve any such modification without the consent of the holders of all bonds then outstanding and (b) that (i) additional bonds may be issued against 70% of the value of the property which forms the basis for such issuance and (ii) the charge against property subject to a prior lien which is used to effectuate the release of property under the Mortgage be similarly based. The principal hereof may be declared or may become due on the conditions, in the manner and at the time set forth in the Mortgage, upon the occurrence of a completed default as in the Mortgage provided. No recourse shall be had for the payment of the principal of or interest on this bond against any incorporator or any past, present or future subscriber to the capital stock, stockholder, officer or director of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, under any rule of law, statute or constitution or by the enforcement of any assessment or otherwise, all such liability of incorporators, subscribers, stockholders, officers and directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Mortgage. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000,000 and, if higher, in multiples of $1,000,000. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. Registered bonds of this series shall be exchangeable at said offices or agencies of the Company for registered bonds of other authorized denominations having the same aggregate principal amount, in the manner and upon the conditions prescribed in the Mortgage. Notwithstanding any provision of the Mortgage, (a) neither the Company nor the Trustee shall be required to make transfers or exchanges of bonds of this series during the period between any interest payment date for such series and the record date next preceding such interest payment date, and (b) no charge shall be made upon any transfer or exchange of bonds of this series other than for any tax or taxes or other governmental charge required to be paid by the Company. [END OF FORM OF BOND OF 2003C PLEDGE SERIES] 5 WHEREAS, Section 115 of the Indenture provides that the Company and the Trustee may, from time to time and at any time, enter into such indentures supplemental thereto as shall be deemed necessary or desirable for one or more purposes, including, among others, to correct or amplify the description of any property mortgaged or intended so to be, to mortgage or pledge additional property, to describe and set forth the particular terms and provisions of additional series of bonds to be issued under the Indenture, to add other limitations on the issue of bonds, withdrawal of cash or release of property, to add to the covenants and agreements of the Company for the protection of the holders of the bonds and of the mortgaged and pledged property, to cure any ambiguity or to cure, correct or supplement defective or inconsistent provisions contained in the Indenture, and for any other purpose not inconsistent with the terms of the Indenture; WHEREAS, all things necessary to make the bonds of the 2003C Pledge Series when authenticated by the Trustee and issued as in the Indenture provided, the valid, binding and legal obligations of the Company, entitled in all respects to the security of the Indenture, have been done and performed, and the creation, execution and delivery of this Supplemental Indenture have in all respects been duly authorized; and WHEREAS, the Company deems it advisable to enter into this Supplemental Indenture for the purposes of describing the bonds of the 2003C Pledge Series and of establishing the terms and provisions thereof, confirming the mortgaging under the Indenture of additional property for the equal and proportionate benefit and security of the holders of all bonds at any time issued thereunder, amplifying the description of the property mortgaged, adding other limitations to the Indenture on the issue of bonds, withdrawal of cash or release of property, and adding to the covenants and agreements of the Company for the protection of the holders of bonds and of mortgaged and pledged property; NOW, THEREFORE, THIS SUPPLEMENTAL INDENTURE WITNESSETH: That OHIO EDISON COMPANY, in consideration of the premises 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, and of the purchase and acceptance of the bonds issued or to be issued hereunder by the holders thereof, and in order to secure the payment both of the principal and interest of all bonds at any time issued and outstanding under the Indenture, according to their tenor and effect, and the performance of all the provisions of the Indenture and of said bonds, hath granted, bargained, sold, released, conveyed, assigned, transferred, pledged, set over and confirmed and by these presents doth grant, bargain, sell, release, convey, assign, transfer, pledge, set over and confirm unto THE BANK OF NEW YORK, as Trustee, and to its successor or successors in said trust, and to its and their assigns forever, all the properties of the Company, now owned or hereafter acquired, wherever located, described in the Indenture and not therein expressly excepted; TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any wise appertaining to the aforesaid property or any part thereof, with the reversion and reversions, remainder and remainders and (subject to the provisions of Article XI of the Indenture) the tolls, rents, revenues, issues, earnings, income, product and profits thereof, and all the 6 estate, right, title and interest and claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to the aforesaid property and franchises and every part and parcel thereof. The Company does hereby agree and does hereby confirm and reaffirm the agreement made by it in the Indenture, dated as of August 1, 1930, that all property, rights and franchises acquired by the Company after the date of the Indenture, dated as of August 1, 1930 (except any hereinafter expressly excepted), shall be as fully embraced within the lien of the Indenture as if such property had been owned by the Company on the date of the Indenture, dated as of August 1, 1930 and was specifically described therein and conveyed thereby and does hereby confirm that the Company will not cause or consent to a partition, whether voluntary or through legal proceedings, of property, whether herein described or heretofore or hereafter acquired, in which its ownership shall be as a tenant in common except as permitted by and in conformity with the provisions of the Indenture and particularly of Article XI thereof. PROVIDED that the following are not and are not intended to be now or hereafter granted, bargained, sold, released, conveyed, assigned, transferred, mortgaged, pledged, set over or confirmed hereunder and are hereby expressly excepted from the lien and operation of the Indenture, viz.: cash, shares of stock and obligations (including bonds, notes and other securities) not heretofore or hereafter specifically pledged, paid or deposited or delivered under the Indenture or covenanted so to be. TO HAVE AND TO HOLD all such properties, real, personal and mixed, mortgaged, pledged or conveyed by the Company as aforesaid, or intended so to be, unto the Trustee and its successors and assigns forever. IN TRUST, NEVERTHELESS, upon the terms and trusts of the Indenture for those who shall hold the bonds and coupons issued and to be issued thereunder, or any of them, without preference, priority or distinction as to lien of any of said bonds and coupons over any others thereof by reason of priority in the time of the issue or negotiations thereof, or otherwise howsoever, subject, however, to the provisions in reference to extended, transferred or pledged coupons and claims for interest set forth in the Indenture (and subject to any sinking funds that may be hereafter created for the benefit of any particular series). PROVIDED, HOWEVER, and these presents are upon the condition that if the Company, its successors or assigns, shall pay or caused to be paid, the principal of and interest on said bonds, at the times and in the manner stipulated therein and herein, and shall keep, perform and observe all and singular the covenants and promises in said bonds and in the Indenture expressed to be kept, performed and observed by or on the part of the Company, then this Supplemental Indenture and the estate and rights hereby granted shall cease, determine and be void, otherwise to be and remain in full force and effect. IT IS HEREBY COVENANTED, DECLARED AND AGREED, by the Company, that all such bonds and coupons are to be issued, authenticated and delivered, and that all property subject or to become subject hereto is to be held, subject to the further covenants, conditions, uses and trusts in the Indenture set forth, and the parties hereto mutually agree as follows: 7 SECTION 1. Bonds of the 2003C Pledge Series shall mature on the date set forth in the form of bond relating thereto hereinbefore set forth and, subject to the provisions of said form, shall bear interest at the rate per annum from time to time borne by the tranche of Mortgage Bonds issued upon the basis of the delivery of such bonds of the 2003C Pledge Series to the trustee under the Indenture and having the same Initial Interest Accrual Date. Bonds of the 2003C Pledge Series shall be designated as the Company's "First Mortgage Bonds Pledge Series C of 2003 due 2003." The bonds of the 2003C Pledge Series shall bear interest from the Initial Interest Accrual Date (as defined in the form of the bond hereinabove set forth). Principal or redemption price of and interest on the bonds of the 2003C Pledge Series shall be payable in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Definitive bonds of the 2003C Pledge Series may be issued, originally or otherwise, only as registered bonds, substantially in the form of bond hereinbefore recited, and in the denominations of $1,000,000 and, if higher, in multiples of $1,000,000. Delivery of a bond of the 2003C Pledge Series to the Trustee for authentication shall be conclusive evidence that its serial number has been duly approved by the Company. SECTION 2. Bonds of the 2003C Pledge Series shall be deemed to be paid and no longer outstanding under the Indenture to the extent that the tranche of Mortgage Bonds (as defined in the form of bonds hereinabove set forth) to which they relate are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company. SECTION 3. Bonds of the 2003C Pledge Series may be transferred by the registered owners thereof, in person or by attorney duly authorized, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio but only in the manner and upon the conditions prescribed in the Indenture and in the form of bond hereinbefore recited. Bonds of the 2003C Pledge Series shall be exchangeable for other registered bonds of the same series, in the manner and upon the conditions prescribed in the Indenture, and in the form of bond hereinbefore recited, upon the surrender of such bonds at said offices or agencies of the Company. However, notwithstanding the provisions of Section 14 or 15 of the Indenture, no charge shall be made upon any transfer or exchange of bonds of said series other than for any tax or taxes or other governmental charge required to be paid by the Company. SECTION 4. The Company reserves the right, without any consent or other action by holders of the bonds of the 2003C Pledge Series, or any subsequent series of bonds, to amend the Indenture by inserting the following language as Section 115A immediately following current Section 115 of the Indenture. With the consent of the holders of not less than sixty per centum (60%) in principal amount of the bonds at the time outstanding or their attorneys-in-fact duly authorized, or, if the rights of the holders of one or more, but not all, series then outstanding are affected, the consent of the holders of not less than sixty per centum (60%) in 8 aggregate principal amount of the bonds at the time outstanding of all affected series, taken together, and not any other series, the Company, when authorized by a resolution, and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or of any supplemental indenture or modifying the rights and obligations of the Company and the rights of the holders of any of the bonds and coupons; provided, however, that no such supplemental indenture shall (1) extend the maturity of any of the bonds or reduce the rate or extend the time of payment of interest thereon, or reduce the amount of the principal thereof, or reduce any premium, payable on the redemption thereof or change the coin or currency in which any bond or interest thereon is payable, without the consent of the holder of each bond so affected, or (2) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of this Indenture, without the consent of the holders of all of the bonds then outstanding, or (3) reduce the aforesaid percentage of the principal amount of bonds the holders of which are required to approve any such supplemental indenture, without the consent of the holders of all the bonds then outstanding. For the purposes of this Section, bonds shall be deemed to be affected by a supplemental indenture if such supplemental indenture adversely affects or diminishes the right of holders thereof against the Company or against its property. Upon the written request of the Company, accompanied by a resolution authorizing the execution of any such supplemental indenture, and upon the filling with the Trustee of evidence of the consent of bondholders as aforesaid (the instrument or instruments evidencing such consent to be dated within one year of such request), the Trustee shall join with the Company in the execution of such supplemental indenture unless such supplemental indenture affects the Trustee's owns rights, duties or immunities under this Indenture or otherwise, in which case the Trustee may in its discretion but shall not be obligated to enter into such supplemental indenture. The Trustee shall be entitled to receive and, subject to Section 102 of the Indenture and Article Five of the Seventh Supplemental Indenture, may rely upon an opinion of counsel as conclusive evidence that any such supplemental indenture is authorized or permitted by the provisions of this Section. It shall not be necessary for the consent of the bondholders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such consent shall approve the substance thereof. The Company and the Trustee, if they so elect, and either before or after such 60% or greater consent has been obtained, may require the holder of any bond consenting to the execution of any such supplemental indenture to submit his bond to the Trustee or to such bank, banker or trust company as may be designated by the Trustee for the purpose, for the notation thereon of the fact that the holder of such bond has consented to the execution of such supplemental indenture, and in such case such notation, in form satisfactory to the Trustee, shall be made upon all bonds so submitted, and such bonds bearing such notation shall forthwith be returned to the persons entitled thereto. All subsequent holders of bonds bearing such notation shall be deemed to have consented to the execution of such supplemental indenture, and consent, once given or deemed to be given, may not be withdrawn. 9 Prior to the execution by the Company and the Trustee of any supplemental indenture pursuant to the provisions of this Section, the Company shall publish a notice, setting forth in general terms the substance of such supplemental indenture, at least once in one daily newspaper of general circulation in each city in which the principal of any of the bonds shall be payable, or, if all bonds outstanding shall be registered bonds without coupons or coupon bonds registered as to principal, such notice shall be sufficiently given if mailed, first class, postage prepaid, and registered if the Company so elects, to each registered holder of bonds at the last address of such holder appearing on the registry books, such publication or mailing, as the case may be, to be made not less than thirty days prior to such execution. Any failure of the Company to give such notice, or any defect therein, shall not, however, in any way impair or affect the validity of any such supplemental indenture. SECTION 5. The Company reserves the right, without any consent or other action by the holders of the bonds of the 2003C Pledge Series, or any subsequent series of bonds, to amend the Indenture by deleting the phrase "sixty per centum (60%)" in Section 28 of the Indenture and substituting therefor the phrase "seventy per centum (70%)" and by deleting the phrase "One hundred sixty-six and two-thirds per cent. (166 2/3%)" in Sections 65 and 67 of the Indenture and substituting therefor the phrase "One hundred and forty-two and eighty-six hundredths per cent. (142.86%)". SECTION 6. Except as herein otherwise expressly provided, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this Supplemental Indenture; the Trustee shall not be responsible for the recitals herein or in the bonds (except the Trustee's authentication certificate), all of which are made by the Company solely; and this Supplemental Indenture is executed and accepted by the Trustee, subject to all the terms and conditions set forth in the Indenture, as fully to all intents and purposes as if the terms and conditions of the Indenture were herein set forth at length. SECTION 7. As supplemented by this Supplemental Indenture, the Indenture is in all respects ratified and confirmed, and the Indenture as herein defined, and this Supplemental Indenture, shall be read, taken and construed as one and the same instrument. SECTION 8. Nothing in this Supplemental Indenture contained shall or shall be construed to confer upon any person other than a holder of bonds issued under the Indenture, the Company and the Trustee any right or interest to avail himself of any benefit under any provision of the Indenture or of this Supplemental Indenture. SECTION 9. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. 10 IN WITNESS WHEREOF, OHIO EDISON COMPANY and THE BANK OF NEW YORK have caused these presents to be executed in their respective names by their respective Presidents or one of their Vice Presidents or Assistant Vice Presidents and their respective seals to be hereunto affixed and attested by their respective Corporate Secretaries or one of their Assistant Corporate Secretaries or Assistant Treasurers, all as of the day and year first above written. OHIO EDISON COMPANY By: -------------------------------- Harvey L. Wagner, Vice President and Controller [Seal] Attest: ---------------------------- Edward J. Udovich, Assistant Corporate Secretary Signed, Sealed and Acknowledged on behalf of OHIO EDISON COMPANY in the presence of: - ----------------------------- Julie A. Phillips - ----------------------------- Diane L. Rapp THE BANK OF NEW YORK By: ---------------------------------- Barbara Bevelaqua, Vice President [Seal] Attest: _____________________________ Julie Salovitch-Miller, Vice President Signed, Sealed and Acknowledged on behalf of THE BANK OF NEW YORK in the presence of: - ----------------------------- Remo Reale - ----------------------------- James Logan 11 STATE OF OHIO ) : ss.: COUNTY OF SUMMIT ) On the 7th day of August in the year 2003 before me, the undersigned, personally appeared Harvey L. Wagner and Edward J. Udovich, Vice President and Controller and Assistant Corporate Secretary, respectively, of Ohio Edison Company, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. -------------------------------------- Susie M. Hoisten, Notary Public Residence-Summit County Statewide Jurisdiction, Ohio My Commission Expires December 9, 2006 [SEAL] 12 STATE OF NEW YORK ) :ss.: COUNTY OF NEW YORK ) On the 7th day of August in the year 2003 before me, the undersigned, personally appeared Barbara Bevelaqua and Julie-Salovitch-Miller, Vice Presidents of The Bank of New York, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. ------------------------------------- William J. Cassels Notary Public, State of New York No. 01CA5027729 Qualified in Bronx County Commission Expires May 18, 2006 [SEAL] 13 The Bank of New York hereby certifies that its precise name and address as Trustee hereunder are: The Bank of New York 101 Barclay Street City, County and State of New York 10286 THE BANK OF NEW YORK By: ------------------------------------- Barbara Bevelaqua, Vice President This instrument was prepared by FirstEnergy Corp. 14 EX-4 14 oe_ex4-4.txt EX 4-4 6TH SI --------------------------------------------- OHIO EDISON COMPANY WITH THE BANK OF NEW YORK, As Trustee --------------- SIXTH SUPPLEMENTAL INDENTURE Providing among other things for GENERAL MORTGAGE BONDS Pledge Series A of 2003 due 2015 --------------- Dated as of February 1, 2003 --------------------------------------------- SUPPLEMENTAL INDENTURE, dated as of February 1, 2003 between OHIO EDISON COMPANY, a corporation organized and existing under the laws of the State of Ohio (hereinafter called the "Company"), party of the first part, and THE BANK OF NEW YORK, a corporation organized and existing under the laws of the State of New York, as Trustee under the Indenture hereinafter referred to, party of the second part. WHEREAS, the Company has heretofore executed and delivered to THE BANK OF NEW YORK, as Trustee (hereinafter called the "Trustee"), a certain General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998 (the "Original Indenture"), to secure bonds of the Company, issued and to be issued in series, from time to time, in the manner and subject to the conditions set forth in the Original Indenture, which Original Indenture, as heretofore supplemented is hereinafter referred to as the "Indenture"; WHEREAS, the Company has heretofore entered into an Air Quality Facilities Loan Agreement dated as of April 15, 1981 (the "Loan Agreement"), with the Ohio Air Quality Development Authority (the "Authority") pursuant to which the Authority issued $50,000,000 aggregate principal amount of Air Quality Facilities Revenue Refunding Bonds 1988 Series A (Ohio Edison Company Project) (the "Authority Bonds") under the Indenture of Trust, dated as of January 1, 1988 (the "Authority Indenture"), between the Authority and J.P. Morgan Trust Company, National Association, as successor trustee (the "Authority Trustee"), in order to provide funds to loan to the Company for the purpose of refunding certain bonds of the Authority issued to assist the Company in the financing of the cost of certain air quality facilities; WHEREAS, in conjunction with the remarketing of the Authority Bonds, the Company has entered into an Insurance Agreement (the "Insurance Agreement"), dated as of February 3, 2003, between the Company and Ambac Assurance Corporation, a Wisconsin-domiciled stock insurance corporation (the "Insurer"), under which the Insurer has agreed to issue a financial guarantee insurance policy (the "Bond Policy") and a surety bond (together with the Bond Policy, the "Policies") in favor of the holders of the Authority Bonds and the Company has agreed to deliver to the Insurer a series of bonds issued by the Company under its General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, as supplemented, to The Bank of New York, as Trustee, as security for the Insurer's payment of the amounts due under the Policies; WHEREAS, the Company, by appropriate corporate action in conformity with the terms of the Indenture, has duly determined to create a new series of bonds under the Indenture consisting of $50,000,000 in principal amount, to be designated as "Mortgage Bonds, Pledge Series A of 2003 due 2015" (hereinafter sometimes referred to as the "bonds of the 2003 Pledge Series"), which shall bear interest at the rate per annum set forth in, shall be subject to certain redemption rights and obligations set forth in, and will otherwise be in the form and have the terms and provisions provided for in this Supplemental Indenture and set forth in the form of such bonds below; and WHEREAS, the definitive registered bonds without coupons of the 2003 Pledge Series and the Trustee's certificate of authentication to be borne by such bonds are to be substantially in the following form: [FORM OF BOND OF 2003 PLEDGE SERIES] [FACE] This Bond is not transferable except to a successor to Ambac Assurance Corporation under the Insurance Agreement, dated as of February 3, 2003, between the Company and Ambac Assurance Corporation, or in compliance with a final order of a court of competent jurisdiction in connection with any bankruptcy or reorganization proceeding of the Company. OHIO EDISON COMPANY MORTGAGE BOND, PLEDGE SERIES A OF 2003 DUE 2015 DUE FEBRUARY 1, 2015 No. R- $ OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to, _______________________________________________ or registered assigns, _______________________________ Dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, New York or in the City of Akron, Ohio, on February 1, 2015, in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said offices or agencies to the registered owner hereof, in like coin or currency, interest thereon from the Interest Payment Date (as defined herein) next preceding the date of this bond unless the date hereof is prior to the first Interest Payment Date for the bonds of this series, in which case from February 3, 2003 (the date of original issuance of the bonds of this series) (or, if this bond is dated between the Record Date (as defined herein) for any Interest Payment Date and such Interest Payment Date, then from such Interest Payment Date), at the rate from time to time borne by the Air Quality Facilities Revenue Refunding Bonds 1988 Series A (Ohio Edison Company Project) (the "Authority Bonds") issued by the Ohio Air Quality Development Authority (the "Authority") under the Trust Indenture, dated as of January 1, 1988, as amended and supplemented by the First Supplemental Trust Indenture, dated as of February 1, 2003 (as so amended and supplemented, the "Authority Indenture"), between the Authority and J.P. Morgan Trust Company, National Association, as successor trustee (the "Authority Trustee"); provided, however, that in no event shall the rate of interest borne by the Bonds of this series exceed 14% per annum. Payments of principal of and interest on this bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, New York or in the City of Akron, Ohio. 2 The interest so payable on any Interest Payment Date will, subject to certain exceptions in the Indenture hereinafter mentioned, be paid to the person in whose name this bond is registered at the close of business on the Record Date. As used herein, "Interest Payment Date" and "Record Date" shall mean an Interest Payment Date and Record Date, respectively, as defined in the Authority Bonds. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Indenture referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. [Remainder of page intentionally left blank] 3 IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his signature or a facsimile thereof, and its corporate seal to be affixed or printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his signature or a facsimile thereof. OHIO EDISON COMPANY, By _________________________ NAME: RICHARD H. MARSH TITLE: Senior Vice President and Chief Financial Officer Attest: - -------------------------------------- NAME: EDWARD J. UDOVICH TITLE: Assistant Corporate Secretary [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This is one of the bonds of the series designated therein referred to in the within-mentioned Indenture. Dated: THE BANK OF NEW YORK, as Trustee, By_________________________ Authorized Signatory 4 [FORM OF BOND OF 2003 PLEDGE SERIES] [REVERSE] OHIO EDISON COMPANY MORTGAGE BOND, PLEDGE SERIES A OF 2003 DUE 2015 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any money, obligations or other instruments, or earnings thereon, deposited with the Trustee or sinking fund established in accordance with the provisions of the Indenture hereinafter mentioned for the bonds of any particular series) by a General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, executed by the Company to The Bank of New York, as Trustee, as supplemented by indentures supplemental thereto, to which Indenture as so supplemented (herein referred to as the "Indenture") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The bonds of this series are issued and to be issued in order to provide security to Ambac Assurance Corporation, a Wisconsin-domiciled stock insurance corporation (the "Insurer"), in connection with its issuance of a financial guaranty insurance policy (the "Bond Policy") and a surety bond (together with the Bond Policy, the "Policies") in favor of the holders of the Authority Bonds pursuant to the Insurance Agreement (the "Insurance Agreement") dated as of February 3, 2003 between the Insurer and the Company in connection with the remarketing of the Authority Bonds on or about February 3, 2003. In order to provide monies to fund a loan made by the Authority to the Company pursuant to an Air Quality Facilities Loan Agreement dated as of April 15, 1981 between the Authority and the Company (the "Loan Agreement"), the Authority issued the Authority Bonds under and pursuant to the Authority Indenture. Payments made by the Company of principal and interest on the bonds of this series are intended to be sufficient to reimburse the Insurer for any payments of principal and interest made by the Insurer on the Authority Bonds pursuant to the Policies. The bonds of this series are not transferable except (i) as required to effect an assignment to a successor of the Insurer under the Insurance Agreement or (ii) in compliance with a final order of a court of competent jurisdiction in connection with any bankruptcy or reorganization proceeding of the Company. The Company's obligation to make payments with respect to the principal of and/or interest on the bonds of this series shall be fully or partially satisfied and discharged to the extent that, at the time any such payment shall be due, the corresponding amount then due of principal of and/or interest on the Authority Bonds shall have been fully or partially paid (other than by the application of the proceeds of any payment by the Insurer under the Policies), as the case may be, or there shall have been deposited with the Authority 5 Trustee pursuant to the Authority Indenture trust funds sufficient under such indenture to fully or partially pay, as the case may be, the corresponding amount then due of principal of and/or interest on the Authority Bonds (other than by the application of the proceeds of any payment by the Insurer under the Policies). Notwithstanding anything contained herein or in the Indenture to the contrary, the Company shall be obligated to make payments with respect to the principal of and/or interest on the bonds of this series only to the extent that the Insurer has made a payment with respect to the Authority Bonds under the Policies. Upon payment of the principal of and interest due on the Authority Bonds, whether at maturity or prior to maturity by acceleration, redemption or otherwise, or upon provision for the payment thereof having been made in accordance with the Authority Indenture (other than by the application of the proceeds of any payment by the Insurer under the Policies), the bonds of this series in a principal amount equal to the principal amount of Authority Bonds so paid or for which such provision for payment has been made shall be deemed fully paid, satisfied and discharged and the obligations of the Company thereunder shall be terminated and such bonds of this series shall be surrendered to and canceled by the Trustee. From and after the Release Date (as defined in the Insurance Agreement), the bonds of this series shall be deemed fully paid, satisfied and discharged and the obligation of the Company thereunder shall be terminated. On the Release Date, the bonds of this series shall be surrendered to and canceled by the Trustee. The bonds of this series are subject to mandatory redemption, in whole or in part, as the case may be, on each date that Authority Bonds are to be redeemed. The principal amount of the Bonds of this series to be redeemed on any such date shall be equal to the principal amount of Authority Bonds called for redemption on that date. All redemptions of bonds of this series shall be at 100% of the principal amount thereof, plus accrued interest to the redemption date. The principal hereof may be declared or may become due on the conditions, in the manner and at the time set forth in the Indenture, upon the occurrence of an Event of Default as in the Indenture provided. No recourse shall be had for the payment of the principal of or premium, or interest if any, on this bond, or any part thereof, or for any claim based thereon or otherwise in respect thereof, or of the indebtedness represented thereby, or upon any obligation, covenant or agreement under the Indenture, against any incorporator, stockholder, officer or director, as such, past, present or future of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, whether by virtue of any Constitutional provision, statute or rule of law, or by the enforcement of any assessment or penalty or otherwise, all such liability of incorporators, stockholders, officers and directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000 and authorized multiples thereof. This bond, subject to the limitations with regard thereto in the Authority Indenture and herein, is transferable as prescribed in the Indenture by the registered owner hereof, in person or by attorney duly authorized, at an office or agency of the Company, in the Borough of Manhattan, The City of New York, New York or in the City of Akron, Ohio, upon surrender and cancellation of this bond and thereupon 6 a new registered bond or bonds of the same series for a like principal amount, in authorized denominations, will be issued to the transferee in exchange therefor, as provided in the Indenture, and upon payment, if the Company shall require it, of the transfer charges therein prescribed. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. Bonds of this series shall be exchangeable at said offices or agencies of the Company for registered bonds of other authorized denominations having the same aggregate principal amount, in the manner and upon the conditions prescribed in the Indenture. [END OF FORM OF BOND OF 2003 PLEDGE SERIES] and WHEREAS, all things necessary to make the bonds of the 2003 Pledge Series, when authenticated by the Trustee and issued as in the Indenture provided, the valid, binding and legal obligations of the Company, entitled in all respects to the security of the Indenture, have been done and performed, and the creation, execution and delivery of this Supplemental Indenture has in all respects been duly authorized; and WHEREAS, the Company deems it advisable to enter into this Supplemental Indenture for the purposes of describing the bonds of the 2003 Pledge Series and establishing the form, terms and provisions thereof, as provided and contemplated by sections 2.01(a) and 3.01(b) of the Indenture, and the Company has requested and hereby requests the Trustee to join in the execution of this Supplemental Indenture; NOW, THEREFORE, IT IS HEREBY COVENANTED, DECLARED AND AGREED, by and between the Company and the Trustee, that all such bonds of the 2003 Pledge Series are to be issued, authenticated and delivered, subject to this Supplemental Indenture, and to the further covenants, conditions, uses and trusts in the Indenture set forth, and the parties hereto mutually agree as follows: SECTION 1. Bonds of the 2003 Pledge Series shall mature on the date set forth in the form of bond hereinbefore set forth and, subject to the provisions of said form, shall bear interest at the rate from time to time borne by the Authority Bonds; provided, however, that in no event shall the rate of interest borne by any bonds of the 2003 Pledge Series exceed 14% per annum. Such interest shall be payable as set forth in said form of bond of the 2003 Pledge Series, and such bonds of said series shall be designated as hereinbefore in the fourth Whereas clause set forth. Both principal of and interest on said bonds shall be payable, to the extent specified in the form of bond hereinabove set forth, in any coin or currency of the United States of America which at the time of payment is a coin or currency in which the Authority Bonds are payable and is legal tender for the payment of public and private debts, at the office or agency of the Company in the Borough of Manhattan, The City of New York, New York or in the City of Akron, Ohio. Definitive bonds of said series may be issued, originally or otherwise, only as registered bonds without coupons; and they and the Trustee's certificate of authentication shall be substantially in the form hereinbefore recited. 7 Definitive bonds of the 2003 Pledge Series may be issued, originally or otherwise, only as registered bonds, substantially in the form of bond hereinabove recited, and in denominations of $1,000 and authorized multiples thereof. Delivery of a bond of the 2003 Pledge Series to the Trustee for authentication shall be conclusive evidence that the multiple thereof and its serial number has been duly approved by the Company. The bonds of the 2003 Pledge Series shall be redeemable as provided in the form of bond hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. Except as provided in this Section 1, bonds of the 2003 Pledge Series shall be dated and bear interest as provided in Section 3.03 of the Indenture; provided, however, that, notwithstanding any provision of said Section 3.03, so long as there is no existing default in the payment of interest on said bonds, any bond of the 2003 Pledge Series authenticated by the Trustee between an Interest Payment Date (as defined in the form of bond hereinabove set forth) for bonds of such series and the Record Date (as defined in the form of the Bond hereinabove set forth) for such Interest Payment Date shall bear interest from such Interest Payment Date and the holder of any such bond shall not be entitled to payment of interest on such Interest Payment Date and shall have no claim against the Company with respect thereto. Bonds of the 2003 Pledge Series may be transferred by the registered owners thereof, in person or by attorney duly authorized, at an office or agency of the Company in the Borough of Manhattan, The City of New York, New York or in the City of Akron, Ohio, but only in the manner and upon the conditions prescribed in the Indenture and in the form of bond of such series hereinabove recited. The person in whose name any bond of the 2003 Pledge Series is registered at the close of business on any Record Date for such series with respect to any Interest Payment Date for such series shall be entitled to receive the interest payable on such Interest Payment Date notwithstanding the cancellation of such registered bond upon any transfer or exchange thereof subsequent to the Record Date and prior to such Interest Payment Date, except if and to the extent the Company shall default in the payment of the interest due on such Interest Payment Date, in which case such defaulted interest shall be paid to the person in whose name such bond (or any bond or bonds issued, directly or after intermediate transactions, upon transfer or exchange or in substitution thereof) is registered on a subsequent record date for such payment established as provided in Section 3.07 of the Indenture. Notices and demands to or upon the Company in respect of the bonds of the 2003 Pledge Series, this Supplemental Indenture and the Indenture may be served at the office or agency of the Company maintained for that purpose in the Borough of Manhattan, The City of New York, New York and in the City of Akron, Ohio. SECTION 2. As more fully set forth in the respective form thereof hereinabove recited, the Company's obligation to make payments with respect to the principal of and/or interest on any bond of the 2003 Pledge Series shall be fully or partially satisfied and discharged to the extent that, at the time any such payment shall be due, the corresponding amount then due of principal of 8 and/or interest then due on the Authority Bond shall have been fully or partially paid (other than by the application of the proceeds of any payment by the Insurer under the Policies), as the case may be, or there shall have been deposited with the Authority Trustee pursuant to the Authority Indenture trust funds sufficient under such indenture to fully or partially pay, as the case may be, the corresponding amount then due of principal of and/or interest on the Authority Bonds (other than by the application of the proceeds of any payment by the Insurer under the Policies). Notwithstanding anything contained herein or in the Indenture to the contrary, the Company shall be obligated to make payments with respect to the principal of and/or interest on the bonds of the 2003 Pledge Series only to the extent that the Insurer has made a payment with respect to the Authority Bonds under the Policies. Upon payment of the principal of and interest due on the Authority Bonds, whether at maturity or prior to maturity by acceleration, redemption or otherwise, or upon provision for the payment thereof having been made in accordance with the Authority Indenture (other than by the application of the proceeds of any payment by the Insurer under the Policies), bonds of the 2003 Pledge Series in a principal amount equal to the principal amount of the Authority Bonds so paid or for which such provision for payment has been made shall be deemed fully paid, satisfied and discharged and the obligations of the Company thereunder shall be terminated and such bonds of the 2003 Pledge Series shall be surrendered to and cancelled by the Trustee. From and after the date on which the Release Test (as defined in the Insurance Agreement) is satisfied (the "Release Date"), the bonds of the 2003 Pledge Series shall be deemed fully paid, satisfied and discharged and the obligation of the Company thereunder shall be terminated. On the Release Date, the bonds of the 2003 Pledge Series shall be surrendered to and canceled by the Trustee. The Trustee may conclusively presume that the obligation of the Company to pay the principal of, and interest, if any on the bonds of the 2003 Pledge Series as the same shall become due and payable shall have been fully satisfied and discharged unless and until it shall have received written notice from the Insurer, signed by an authorized officer thereof, stating that the Insurer is exercising its rights under the Insurance Agreement with respect to the bonds of the 2003 Pledge Series. SECTION 3. Except as herein otherwise expressly provided, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this Supplemental Indenture; the Trustee shall not be responsible in any manner whatsoever for or in respect of the validity or sufficiency of this Supplemental Indenture or for or in respect of the recitals herein or in the respective bonds (except the Trustee's authentication certificate), all of which are made by the Company solely; and this Supplemental Indenture is executed and accepted by the Trustee subject to all the terms and conditions set forth in the Indenture, as fully to all intents and purposes as if the terms and conditions of the Indenture were herein set forth at length. SECTION 4. The principal amount of bonds of 2003 Pledge Series which may be authenticated and delivered hereunder is limited to the aggregate principal amount of Fifty Million Dollars ($50,000,000). Bonds of the 2003 Pledge Series in the aggregate principal amount of Fifty Million Dollars ($50,000,000) may at any time subsequent to the execution hereof be executed by the Company and delivered to the Trustee and shall be 9 authenticated by the Trustee and delivered (either before or after the recording hereof) pursuant to a Company Order referred to in Section 4.01 of the Indenture and upon receipt by the Trustee of the opinions and other documents required by Sections 4.01 and 4.02 of the Indenture. SECTION 5. The consideration for the bonds of the 2003 Pledge Series shall be the issuance by the Insurer of the Policies pursuant to the Insurance Agreement. SECTION 6. As supplemented by this Supplemental Indenture, the Indenture is in all respects ratified and confirmed, and the Indenture as herein defined, and this Supplemental Indenture, shall be read, taken and construed as one and the same instrument. Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Original Indenture. SECTION 7. Nothing in this Supplemental Indenture contained shall or shall be construed to confer upon any person other than a Holder of bonds issued under the Indenture and this Supplemental Indenture, the Company and the Trustee any right or interest to avail himself of any benefit under any provision of the Indenture or of this Supplemental Indenture. SECTION 8. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. 10 IN WITNESS WHEREOF, OHIO EDISON COMPANY, party of the first part hereto, and THE BANK OF NEW YORK, party of the second part hereto, have caused these presents to be executed in their respective names by their respective Presidents or one of their Vice Presidents or Assistant Vice Presidents and their respective seals to be hereunto affixed and attested by their respective Corporate Secretaries or one of their Assistant Corporate Secretaries or Assistant Treasurers, all as of the day and year first above written. Ohio Edison Company By: ---------------------------------- Richard H. Marsh, Senior Vice President and Chief Financial Officer [Seal] Attest: -------------------------------------- Edward J. Udovich Assistant Corporate Secretary Signed, Sealed and Acknowledged on behalf of OHIO EDISON COMPANY in the presence of: - ----------------------------- Name: Julie A. Phillips - ----------------------------- Name: Amit D. Patel 11 THE BANK OF NEW YORK, as Trustee By: ---------------------------------- Name: Patricia Gallagher Title: Vice President [Seal] Attest: -------------------------------------------- Name: Margaret Ciesmelewski Title: Vice President Signed, Sealed and Acknowledged on behalf of THE BANK OF NEW YORK in the presence of: - ----------------------------- Name: Barbara Bevelaqua - ----------------------------- Name: James Logan 12 STATE OF OHIO ) ) ss.: COUNTY OF SUMMIT ) On the 3rd day of February in the year 2003 before me, the undersigned, personally appeared Richard H. Marsh and Edward J. Udovich, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instrument. -------------------------------------- Susie M. Hoisten Notary Public Residence Summit County Statewide Jurisdiction Ohio My commission expires December 9, 2006 [SEAL] 13 STATE OF NEW YORK ) ) ss.: COUNTY OF NEW YORK ) On the 3rd day of February in the year 2003 before me, the undersigned, personally appeared Patricia Gallagher and Margaret Ciesmelewski, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instrument. -------------------------------- William J. Cassels Notary Public, State of New York No. 01CA5027729 Qualified in Bronx County Commission Expires May 18, 2006 [SEAL] 14 The Bank of New York hereby certifies that its precise name and address as Trustee hereunder are: The Bank of New York 101 Barclay Street City, County and State of New York 10286 THE BANK OF NEW YORK By: ---------------------------------- Name: Patricia Gallagher Title: Vice President This instrument was prepared by FirstEnergy Corp. 15 EX-4 15 oe_ex4-5.txt EX 4-5 7TH SI - -------------------------------------------------------------------------------- OHIO EDISON COMPANY with THE BANK OF NEW YORK, As Trustee ---------- SEVENTH SUPPLEMENTAL INDENTURE Providing among other things for MORTGAGE BONDS Guarantee Series A of 2003 due 2033 Guarantee Series B of 2003 due 2033 --------- Dated as of March 1, 2003 - -------------------------------------------------------------------------------- SUPPLEMENTAL INDENTURE, dated as of March 1, 2003 between OHIO EDISON COMPANY, a corporation organized and existing under the laws of the State of Ohio (hereinafter called the "Company") and THE BANK OF NEW YORK, a banking corporation organized and existing under the laws of the State of New York, as Trustee under the Indenture hereinafter referred to. WHEREAS, the Company has heretofore executed and delivered to THE BANK OF NEW YORK, as Trustee (hereinafter called the "Trustee"), a certain General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, to secure bonds of the Company, issued and to be issued in series, from time to time, in the manner and subject to the conditions set forth in the said Indenture, which Indenture as heretofore and hereby supplemented is hereinafter referred to as the "Indenture"; and WHEREAS, the Company, by appropriate corporate action in conformity with the terms of the Indenture, has duly determined to create two new series of bonds under the Indenture, consisting of $41,000,000 in aggregate principal amount to be designated as "Mortgage Bonds Guarantee Series A of 2003 due 2033" (hereinafter sometimes referred to as the "bonds of Guarantee Series A") and $9,000,000 in aggregate principal amount to be designated as "Mortgage Bonds Guarantee Series B of 2003 due 2033" (hereinafter sometimes referred to as the "bonds of Guarantee Series B" and, with the bonds of Guarantee Series A, the "bonds of the 2003 Guarantee Series"), which shall bear interest at the rate per annum set forth in, shall be subject to certain redemption rights and obligations set forth in, and will otherwise be in the form and have the terms and provisions provided for in this Supplemental Indenture and set forth in the form of such bonds below: [FORM OF BOND OF GUARANTEE SERIES A] This bond is not transferable except to a successor trustee under the Trust Indenture dated as of June 1, 1999 between the Ohio Water Development Authority and J.P. Morgan Chase Trust Company, National Association, as successor trustee, or in connection with the exercise of the rights and remedies of the holder hereof consequent upon an "Event of Default" as defined in the Indenture referred to herein. OHIO EDISON COMPANY MORTGAGE BOND GUARANTEE SERIES A OF 2003 DUE 2033 Due June 1, 2033 $ No. OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to _________________________, or registered assigns, ___________________ dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or the City of Akron, Ohio, on June 1, 2033 in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said office or agency to the registered 2 owner hereof, in like coin or currency, interest thereon from the Initial Interest Accrual Date (hereinbelow defined) at the Revenue Bond Interest Rate (hereinbelow defined) per annum payable semi-annually on June 1 and December 1 in each year commencing on the June 1 or December 1 immediately succeeding the Initial Interest Accrual Date (as defined below) (each such date herein referred to as an "interest payment date") on and until maturity, or, in the case of any bonds of this series duly called for redemption, on and until the redemption date, or in the case of any default by the Company in the payment of the principal due on any bonds of this series, until the Company's obligation with respect to the payment of the principal shall be discharged as provided in the Indenture referred to on the reverse hereof. Payments of principal of and interest on this bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Indenture referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his or her signature or a facsimile thereof, and its corporate seal to be printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his or her signature or a facsimile thereof. Dated: OHIO EDISON COMPANY, By: ------------------------------ Title: Attest: - ----------------------------- Title: [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series designated therein, described in the within-mentioned Indenture. THE BANK OF NEW YORK, as Trustee By: ------------------------------ Authorized Signatory 3 [FORM OF BOND OF GUARANTEE SERIES A] [REVERSE] OHIO EDISON COMPANY MORTGAGE BOND GUARANTEE SERIES A OF 2003 DUE 2033 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any money, obligations or other instruments, or earnings thereon, deposited with the Trustee in accordance with the provisions of the Indenture hereinafter mentioned for the bonds of any particular series) by a General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, executed by the Company to The Bank of New York, as Trustee, as amended and supplemented by indentures supplemental thereto to which Indenture as so amended and supplemented (herein referred to as the "Indenture") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The bonds of this series shall be redeemed in whole, by payment of the principal amount thereof plus accrued interest thereon, if any, to the date fixed for redemption, upon receipt by the Trustee of a written advice from the trustee under the Trust Indenture (the "Revenue Bond Indenture") dated as of June 1, 1999, between the Ohio Water Development Authority and J.P. Morgan Chase Trust Company, National Association, as successor trustee (such trustee and any successor trustee being hereinafter referred to as the "Revenue Bond Trustee"), securing $41,000,000 of State of Ohio Pollution Control Revenue Refunding Bonds, Series 1999-A (Ohio Edison Company Project) which have been issued on behalf of the Company (the "Revenue Bonds"), stating that the principal amount of all the Revenue Bonds then outstanding under the Revenue Bond Indenture has been declared due and payable pursuant to the provisions of Section 11.02 of the Revenue Bond Indenture, specifying the date of the accelerated maturity of such Revenue Bonds and the date from which interest on the Revenue Bonds issued under the Revenue Bond Indenture has then accrued and is unpaid (specifying the rate or rates of such accrual and the principal amount of the particular Revenue Bonds to which such rates apply), stating such declaration of maturity has not been annulled and demanding payment of the principal amount hereof plus accrued interest hereon to the date fixed for such redemption. The date fixed for such redemption shall not be earlier than the date specified in the aforesaid written advice as the date of the accelerated maturity of the Revenue Bonds then outstanding under the Revenue Bond Indenture and not later than the 45th day after receipt by the Trustee of such advice, unless such 45th day is earlier than such date of accelerated maturity. The date fixed for such redemption shall be specified in a notice of redemption to be given not less than 30 days prior to the date so fixed for such redemption. Upon mailing of such notice of redemption, the date from which unpaid interest on the Revenue Bonds has then accrued (as specified by the Revenue Bond Trustee) shall become the initial interest accrual date (the "Initial Interest Accrual Date") with respect to the bonds of this series; provided, however, on any demand for payment of the principal amount hereof at maturity as a result of the principal of the Revenue Bonds becoming due and payable on the maturity date of the bonds of this series, the earliest date from which unpaid interest on the Revenue Bonds has then 4 accrued shall become the Initial Interest Accrual Date with respect to the bonds of this series, such date, together with each other different date from which unpaid interest on the Revenue Bonds has then accrued, as to be stated in a written notice from the Revenue Bond Trustee to the Trustee, which notice shall also specify the rate or rates of such accrual and the principal amount of the particular Revenue Bonds to which such rate or rates apply. The aforementioned notice of redemption shall become null and void for all purposes under the Indenture, (including the fixing of the Initial Interest Accrual Date with respect to the bonds of this series) upon receipt by the Trustee of written notice from the Revenue Bond Trustee of the annulment of the acceleration of the maturity of the Revenue Bonds then outstanding under the Revenue Bond Indenture and the rescission of the aforesaid written advice prior to the redemption date specified in such notice of redemption, and thereupon no redemption of the bonds of this series and no payment in respect thereof as specified in such notice of redemption shall be effected or required. But no such rescission shall extend to any subsequent written advice from the Revenue Bond Trustee or impair any right consequent on such subsequent written advice. Bonds of this series are not otherwise redeemable prior to their maturity. The "Revenue Bond Interest Rate" shall be the same rate of interest per annum as is borne by the Revenue Bonds; provided, however, that if there are different rates of interest borne by the Revenue Bonds, or if interest is required to be paid on the Revenue Bonds more frequently than on each June 1 or December 1, the Revenue Bond Interest Rate shall be the rate that results in the total amount of interest payable on an interest payment date, a redemption date or at maturity, as the case may be, or at any other time interest on this bond is due and payable, to be equal to the total amount of unpaid interest that has accrued on all then outstanding Revenue Bonds. The principal hereof may be declared or may become due on the conditions, in the manner and at the time set forth in the Indenture upon the occurrence of a completed default as in the Indenture provided. Bonds of this series shall be deemed to be paid and no longer outstanding under the Indenture to the extent the aggregate principal amount of bonds of this series exceeds the aggregate principal amount of the Revenue Bonds outstanding from time to time. The Trustee may rely on a certificate of the Company to this effect. No recourse shall be had for the payment of the principal of or premium, or interest if any, on this bond, or any part thereof, or for any claim based thereon or otherwise in respect thereof, or of the indebtedness represented thereby, or upon any obligation, covenant or agreement under the Indenture, against any incorporator, stockholder, officer or director, as such, past, present or future of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, whether by virtue of any Constitutional provision, statute or rule of law, or by the enforcement of any assessment or penalty or otherwise, all such liability of incorporators, stockholders, officers and 5 directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. The bonds of this series are issuable only as a single registered bond without coupons in a denomination equal to the aggregate principal amount of bonds of this series outstanding. If and to the extent this bond becomes transferable, the registered owner hereof, in person or by attorney duly authorized, may effectuate such transfer at an office or agency of the Company, in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio, upon surrender and cancellation of this bond and thereupon a new registered bond or bonds of the same series for a like principal amount, will be issued to the transferee in exchange therefor, as provided in the Indenture, and upon payment, if the Company shall require it, of the transfer charges therein prescribed. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. [END OF FORM OF BOND OF GUARANTEE SERIES A] [FORM OF BOND OF GUARANTEE SERIES B] This bond is not transferable except to a successor trustee under the Trust Indenture dated as of June 1, 1999 between the Ohio Air Quality Development Authority and J.P. Morgan Chase Trust Company, National Association, as successor trustee, or in connection with the exercise of the rights and remedies of the holder hereof consequent upon an "Event of Default" as defined in the Indenture referred to herein. OHIO EDISON COMPANY MORTGAGE BOND GUARANTEE SERIES B OF 2003 DUE 2033 Due June 1, 2033 $ No. OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to ____________, or registered assigns, __________ dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or the City of Akron, Ohio, on ___________ in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said office or agency to the registered owner hereof, in like coin or currency, interest thereon from the Initial Interest Accrual Date (hereinbelow defined) at the Revenue Bond Interest Rate (hereinbelow defined) per annum payable semi-annually on June 1 and December 1 in each year commencing on the June 1 or December 1 immediately succeeding the Initial Interest Accrual Date (as defined below) (each such date herein referred to as an "interest payment date") on and until maturity, or, in the case of any bonds of this series duly called for redemption, on and until the redemption date, or in the case of any default by the Company in the payment of the principal due on any bonds of this series, until the Company's obligation with respect to the payment of the principal shall be discharged as provided in the Indenture referred to on the reverse hereof. Payments of principal of and interest on this bond shall be made 6 at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Indenture referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his or her signature or a facsimile thereof, and its corporate seal to be printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his or her signature or a facsimile thereof. Dated: OHIO EDISON COMPANY, By: ------------------------------- Title: Attest: - ----------------------------- Title: [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series designated therein, described in the within-mentioned Indenture. THE BANK OF NEW YORK, as Trustee By: -------------------------------- Authorized Signatory 7 [FORM OF BOND OF GUARANTEE SERIES B] [REVERSE] OHIO EDISON COMPANY MORTGAGE BOND GUARANTEE SERIES B OF 2003 DUE 2033 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any money, obligations or other instruments, or earnings thereon, deposited with the Trustee in accordance with the provisions of the Indenture hereinafter mentioned for the bonds of any particular series) by a General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, executed by the Company to The Bank of New York, as Trustee, as amended and supplemented by indentures supplemental thereto, to which Indenture as so amended and supplemented (herein referred to as the "Indenture") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The bonds of this series shall be redeemed in whole, by payment of the principal amount thereof plus accrued interest thereon, if any, to the date fixed for redemption, upon receipt by the Trustee of a written advice from the trustee under the Trust Indenture (the "Revenue Bond Indenture") dated as of June 1, 1999, between the Ohio Air Quality Development Authority and J.P. Morgan Chase Trust Company, National Association, as successor trustee (such trustee and any successor trustee being hereinafter referred to as the "Revenue Bond Trustee"), securing $9,000,000 of State of Ohio Pollution Control Revenue Refunding Bonds, Series 1999-B (Ohio Edison Company Project) which have been issued on behalf of the Company (the "Revenue Bonds"), stating that the principal amount of all the Revenue Bonds then outstanding under the Revenue Bond Indenture has been declared due and payable pursuant to the provisions of Section 11.02 of the Revenue Bond Indenture, specifying the date of the accelerated maturity of such Revenue Bonds and the date from which interest on the Revenue Bonds issued under the Revenue Bond Indenture has then accrued and is unpaid (specifying the rate or rates of such accrual and the principal amount of the particular Revenue Bonds to which such rates apply), stating such declaration of maturity has not been annulled and demanding payment of the principal amount hereof plus accrued interest hereon to the date fixed for such redemption. The date fixed for such redemption shall not be earlier than the date specified in the aforesaid written advice as the date of the accelerated maturity of the Revenue Bonds then outstanding under the Revenue Bond Indenture and not later than the 45th day after receipt by the Trustee of such advice, unless such 45th day is earlier than such date of accelerated maturity. The date fixed for such redemption shall be specified in a notice of redemption to be given not less than 30 days prior to the date so fixed for such redemption. Upon mailing of such notice of redemption, the date from which unpaid interest on the Revenue Bonds has then accrued (as specified by the Revenue Bond Trustee) shall become the initial interest accrual date (the "Initial Interest Accrual Date") with respect to the bonds of this series; provided, however, on any demand for payment of the principal amount hereof at maturity as a result of the principal of the Revenue Bonds becoming due and payable on the maturity date of the bonds of this series, the earliest date from which unpaid interest on the Revenue Bonds has then accrued shall become the Initial Interest Accrual Date with 8 respect to the bonds of this series, such date, together with each other different date from which unpaid interest on the Revenue Bonds has then accrued, as to be stated in a written notice from the Revenue Bond Trustee to the Trustee, which notice shall also specify the rate or rates of such accrual and the principal amount of the particular Revenue Bonds to which such rate or rates apply. The aforementioned notice of redemption shall become null and void for all purposes under said supplemental indenture and the Indenture, (including the fixing of the Initial Interest Accrual Date with respect to the bonds of this series) upon receipt by the Trustee of written notice from the Revenue Bond Trustee of the annulment of the acceleration of the maturity of the Revenue Bonds then outstanding under the Revenue Bond Indenture and the rescission of the aforesaid written advice prior to the redemption date specified in such notice of redemption, and thereupon no redemption of the bonds of this series and no payment in respect thereof as specified in such notice of redemption shall be effected or required. But no such rescission shall extend to any subsequent written advice from the Revenue Bond Trustee or impair any right consequent on such subsequent written advice. Bonds of this series are not otherwise redeemable prior to their maturity. The "Revenue Bond Interest Rate" shall be the same rate of interest per annum as is borne by the Revenue Bonds; provided, however, that if there are different rates of interest borne by the Revenue Bonds, or if interest is required to be paid on the Revenue Bonds more frequently than on each June 1 or December 1, the Revenue Bond Interest Rate shall be the rate that results in the total amount of interest payable on an interest payment date, a redemption date or at maturity, as the case may be, or at any other time interest on this bond is due and payable, to be equal to the total amount of unpaid interest that has accrued on all then outstanding Revenue Bonds. The principal hereof may be declared or may become due on the conditions, in the manner and at the time set forth in the Indenture upon the occurrence of a completed default as in the Indenture provided. Bonds of this series shall be deemed to be paid and no longer outstanding under the Indenture to the extent the aggregate principal amount of bonds of the series exceeds the aggregate principal amount of the Revenue Bonds outstanding from time to time. The Trustee may rely on a certificate of the Company to this effect. No recourse shall be had for the payment of the principal of or premium, or interest if any, on this bond, or any part thereof, or for any claim based thereon or otherwise in respect thereof, or of the indebtedness represented thereby, or upon any obligation, covenant or agreement under the Indenture, against any incorporator, stockholder, officer or director, as such, past, present or future of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, whether by virtue of any Constitutional provision, statute or rule of law, or by the enforcement of any assessment or penalty or otherwise, all such liability of incorporators, stockholders, officers and 9 directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. The bonds of this series are issuable only as a single registered bond without coupons in a denomination equal to the aggregate principal amount of bonds of this series outstanding. If and to the extent this bond becomes transferable, the registered owner hereof, in person or by attorney duly authorized, may effectuate such transfer at an office or agency of the Company, in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio, upon surrender and cancellation of this bond and thereupon a new registered bond or bonds of the same series for a like principal amount, will be issued to the transferee in exchange therefor, as provided in the Indenture, and upon payment, if the Company shall require it, of the transfer charges therein prescribed. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. [END OF FORM OF BOND OF GUARANTEE SERIES B] WHEREAS, the Company and Trustee deem it advisable to enter into this Supplemental Indenture for the purposes of describing the form of the bonds of the 2003 Guarantee Series and establishing the redemption provisions thereof, and to authorize the establishment of the interest rate and maturity thereof in an Officer's Certificate to be delivered to the Trustee prior to the authentication of the bonds of the 2003 Guarantee Series. NOW, THEREFORE, it is hereby covenanted, decLared and agreed, by the Company, that all such bonds of the 2003 Guarantee Series are to be issued, authenticated and delivered, subject to this Supplemental Indenture and to the further covenants, conditions, uses and trusts in the Indenture set forth, and the parties hereto mutually agree as follows: SECTION 1. Bonds of Guarantee Series A and Bonds of Guarantee Series B shall be designated as the Company's "Mortgage Bonds Guarantee Series A of 2003 due 2033" and "Mortgage Bonds Guarantee Series B of 2003 due 2033," respectively. The bonds of Guarantee Series A and Guarantee Series B shall bear interest from the respective Initial Interest Accrual Dates as provided in the forms of the bond of the 2003 Guarantee Series hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. The interest rate and maturity date of the bonds of the 2003 Guarantee Series shall be as set forth in the respective forms of bond hereinabove set forth. Principal or redemption price of and interest on the bonds of the 2003 Guarantee Series shall be payable in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Definitive bonds of the 2003 Guarantee Series may be issued, originally or otherwise, only as registered bonds, substantially in the respective forms of bond hereinabove set forth, and in a single denomination equal to the aggregate principal amount thereof that is Outstanding. Delivery of a bond of the 2003 10 Guarantee Series to the Trustee for authentication shall be conclusive evidence that its serial number has been duly approved by the Company. The bonds of the 2003 Guarantee Series shall be redeemable as provided in the respective forms of bond hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. SECTION 2. Bonds of the 2003 Guarantee Series shall be deemed to be paid and no longer outstanding under the Indenture to the extent that the aggregate principal amount thereof exceeds the aggregate principal amount of related Revenue Bonds (as defined in the respective forms of bond hereinabove set forth) outstanding from time to time. The Trustee may rely on a certificate of the Company to this effect. SECTION 3. Bonds of the 2003 Guarantee Series are not transferable except in connection with the exercise of the rights and remedies of the holder thereof consequent upon an "Event of Default" as defined in the Indenture or as otherwise provided in the forms of bond hereinabove set forth. If and to the extent bonds of the 2003 Guarantee Series become transferable, such transfer may be accomplished by the registered owners thereof, in person or by attorney duly authorized, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio but only in the manner and upon the conditions prescribed in the Indenture and in the form of bond hereinabove recited. SECTION 4. Except as herein otherwise expressly provided, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this Supplemental Indenture; the Trustee shall not be responsible in any manner whatsoever for or in respect of the validity or sufficiency of this Supplemental Indenture or for or in respect of the recitals herein or in the bonds of the 2003 Guarantee Series (except the Trustee's authentication certificates), all of which are made by the Company solely; and this Supplemental Indenture is executed and accepted by the Trustee, subject to all the terms and conditions set forth in the Indenture, as fully to all intents and purposes as if the terms and conditions of the Indenture were herein set forth at length. SECTION 5. As supplemented by this Supplemental Indenture, the Indenture is in all respects ratified and confirmed, and the Indenture as herein defined, and this Supplemental Indenture, shall be read, taken and construed as one and the same instrument. Capitalized terms used and not otherwise defined herein shall have the meaning ascribed to them in the Indenture. SECTION 6. Nothing in this Supplemental Indenture contained shall or shall be construed to confer upon any person other than a holder of bonds issued under the Indenture, the Company and the Trustee any right or interest to avail himself of any benefit under any provision of the Indenture or of this Supplemental Indenture. SECTION 7. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. 11 IN WITNESS WHEREOF, OHIO EDISON COMPANY and THE BANK OF NEW YORK have caused these presents to be executed in their respective names by their respective Presidents or one of their Vice Presidents or Assistant Vice Presidents and their respective seals to be hereunto affixed and attested by their respective Corporate Secretaries or one of their Assistant Corporate Secretaries or Assistant Treasurers, all as of the day and year first above written. OHIO EDISON COMPANY By: ------------------------------- Harvey L. Wagner, Vice President and Controller [Seal] Attest: ---------------------------------------- David W. Whitehead, Corporate Secretary Signed, Sealed and Acknowledged on behalf of OHIO EDISON COMPANY in the presence of: - ----------------------------------- Julie A. Phillips - ----------------------------------- Amit D. Patel THE BANK OF NEW YORK By: ---------------------------------- Patricia Gallagher, Vice President [Seal] Attest: --------------------------------------- Julie Salovitch-Miller, Vice President Signed, Sealed and Acknowledged on behalf of The Bank of New York in the presence of: - ----------------------------------- Dorothy Miller - ----------------------------------- Cynthia Chaney 12 STATE OF OHIO ) : ss.: COUNTY OF SUMMIT ) On the 3rd day of March in the year 2003 before me, the undersigned, personally appeared Harvey L. Wagner and David W. Whitehead, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. ----------------------------------- Karen L. Pope Notary Public, State of Ohio My Commission Expires Jan. 16, 2005 Recorded in Stark County [SEAL] 13 STATE OF NEW YORK ) : ss.: COUNTY OF NEW YORK ) On the 3rd day of March in the year 2003 before me, the undersigned, personally appeared Patricia Gallagher and Julie Salovitch-Miller, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. -------------------------------- William J. Cassels Notary Public, State of New York No. 01CA5027729 Qualified in Bronx County Commission Expires May 18, 2006 [SEAL] 14 The Bank of New York hereby certifies that its precise name and address as Trustee hereunder are: The Bank of New York 101 Barclay Street City, County and State of New York 10286 THE BANK OF NEW YORK By: ---------------------------------- Patricia Gallagher, Vice President This instrument was prepared by FirstEnergy Corp. 15 + EX-4 16 oe_ex4-6.txt EX 4-6 8TH SI - ------------------------------------------------------------------------------- OHIO EDISON COMPANY with THE BANK OF NEW YORK, As Trustee ---------- EIGHTH SUPPLEMENTAL INDENTURE Providing among other things for MORTGAGE BONDS Floating Rate Series A of 2003 due 2003 --------- Dated as of August 1, 2003 - ------------------------------------------------------------------------------- SUPPLEMENTAL INDENTURE, dated as of August 1, 2003 between OHIO EDISON COMPANY, a corporation organized and existing under the laws of the State of Ohio (hereinafter called the "Company") and THE BANK OF NEW YORK, a banking corporation organized and existing under the laws of the State of New York, as Trustee under the Indenture hereinafter referred to. WHEREAS, the Company has heretofore executed and delivered to THE BANK OF NEW YORK, as Trustee (hereinafter called the "Trustee"), a certain General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, to secure bonds of the Company, issued and to be issued in series, from time to time, in the manner and subject to the conditions set forth in the said Indenture, which Indenture as heretofore and hereby supplemented is hereinafter referred to as the "Indenture"; and WHEREAS, the Company, by appropriate corporate action in conformity with the terms of the Indenture, has duly determined to create a new series of bonds under the Indenture, consisting of up to $450,000,000 in aggregate principal amount to be designated as "Mortgage Bonds Floating Rate Series A of 2003 due 2003" (hereinafter sometimes referred to as the "bonds of Floating Rate Series A"), which shall bear interest at the rate per annum set forth in, shall be subject to certain redemption rights and obligations set forth in, and will otherwise be in the form and have the terms and provisions provided for in this Supplemental Indenture and set forth in the form of such bonds below: [FORM OF BOND OF FLOATING RATE SERIES A] "THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"). THE HOLDER HEREOF, BY PURCHASING THIS SECURITY, AGREES FOR THE BENEFIT OF OHIO EDISON COMPANY (THE "COMPANY")THAT THIS SECURITY MAY NOT BE RESOLD, PLEDGED OR OTHERWISE TRANSFERRED OTHER THAN (A) (1) TO THE COMPANY, (2) IN A TRANSACTION ENTITLED TO AN EXEMPTION FROM REGISTRATION PROVIDED BY RULE 144 UNDER THE SECURITIES ACT, (3) SO LONG AS THIS SECURITY IS ELIGIBLE FOR RESALE PURSUANT TO RULE 144A UNDER THE SECURITIES ACT ("RULE 144A"), TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT THE RESALE, PLEDGE OR OTHER TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A (AS INDICATED BY THE BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS SECURITY), (4) IN AN OFFSHORE TRANSACTION IN ACCORDANCE WITH RULE 904 OF REGULATION S UNDER THE SECURITIES ACT (AS INDICATED BY THE BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS SECURITY), (5) TO AN INSTITUTION THAT IS AN "ACCREDITED INVESTOR" AS DEFINED IN RULE 501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT (AS INDICATED BY THE BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS SECURITY) THAT IS ACQUIRING THIS SECURITY FOR INVESTMENT PURPOSES AND NOT FOR DISTRIBUTION, AND A CERTIFICATE IN THE FORM ATTACHED TO THIS SECURITY IS DELIVERED BY THE TRANSFEREE TO THE COMPANY AND THE TRUSTEE, (6) IN ACCORDANCE WITH ANOTHER APPLICABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT (AND BASED UPON AN OPINION OF COUNSEL ACCEPTABLE TO THE COMPANY) OR (7) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND (B) IN EACH CASE IN ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF EACH STATE OF THE UNITED STATES. AN INSTITUTIONAL ACCREDITED INVESTOR HOLDING THIS SECURITY AGREES IT WILL FURNISH TO THE COMPANY AND THE TRUSTEE SUCH CERTIFICATES AND OTHER INFORMATION AS THEY MAY REASONABLY REQUIRE TO CONFIRM THAT ANY TRANSFER BY IT OF THIS SECURITY COMPLIES WITH THE FOREGOING RESTRICTIONS. THE HOLDER HEREOF, BY PURCHASING THIS SECURITY, REPRESENTS AND AGREES FOR THE BENEFIT OF THE COMPANY THAT IT IS (1) A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A OR (2) AN INSTITUTION THAT IS AN "ACCREDITED INVESTOR" AS DEFINED IN RULE 501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT AND THAT IT IS HOLDING THIS SECURITY FOR INVESTMENT PURPOSES AND NOT FOR DISTRIBUTION OR (3) A NON-U.S. PERSON OUTSIDE THE UNITED STATES WITHIN THE MEANING OF, OR AN ACCOUNT SATISFYING THE REQUIREMENTS OF PARAGRAPH (k)(2) OF RULE 902 UNDER, REGULATION S UNDER THE SECURITIES ACT." 2 "ANY TRANSFER OF THIS SECURITY IS FURTHER SUBJECT TO THE ISSUER'S RIGHT-OF-FIRST-REFUSAL AS SET FORTH MORE FULLY HEREIN." OHIO EDISON COMPANY MORTGAGE BONDS FLOATING RATE SERIES A OF 2003 DUE 2003 Due December 31, 2003 $_______________________ No._____ Stated Maturity: December 31, 2003 Initial Interest Accrual Date:_____, 2003 - --------------- ----------------------------- Interest Payment Dates: the last day of each Interest Period (as defined herein) - ---------------------- and at Stated Maturity. Regular Record Dates: the Business Day immediately preceding each Interest - ---------------------- Payment Date. OHIO EDISON COMPANY, a corporation of the State of Ohio (hereinafter called the Company), for value received, hereby promises to pay to ___________________________, or registered assigns, ____________________________ dollars at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or the City of Akron, Ohio, on December 31, 2003 in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, and to pay at said office or agency to the registered owner hereof, in like coin or currency, interest thereon from the Initial Interest Accrual Date (as listed above), or from the most recent Interest Payment Date (as listed above) to which payment has been made or duly provided for, at a rate per annum for each Interest Period equal to the Eurodollar Rate (as defined below) for such Interest Period plus the Applicable Margin (as defined below), payable on the applicable Interest Payment Date to the Person in whose name this bond is registered at the close of business on the Regular Record Date (whether or not a Business Day) immediately preceding such Interest Payment Date, on and until Stated Maturity (as listed above) or, in the case of any bonds of this series duly called for redemption, on and until the redemption date, or in the case of any default by the Company in the payment of the principal due on any bonds of this series, until the Company's obligation with respect to the payment of the principal shall be discharged as provided in the Indenture referred to on the reverse hereof. Payments of principal of and interest on this bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not become obligatory until The Bank of New York, the Trustee under the Indenture referred to on the reverse hereof, or its successor thereunder, shall have authenticated the form of certificate endorsed hereon. 3 IN WITNESS WHEREOF, Ohio Edison Company has caused this bond to be signed in its name by its President or a Vice President, by his or her signature or a facsimile thereof, and its corporate seal to be printed hereon, attested by its Corporate Secretary or an Assistant Corporate Secretary, by his or her signature or a facsimile thereof. Dated: OHIO EDISON COMPANY, By: ----------------------------- Title: Attest: - ------------------------------ Title: [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series designated therein, described in the within-mentioned Indenture. THE BANK OF NEW YORK, as Trustee By: ----------------------------------- Authorized Signatory 4 [FORM OF BOND OF FLOATING RATE SERIES A] [REVERSE] OHIO EDISON COMPANY MORTGAGE BONDS FLOATING RATE SERIES A OF 2003 DUE 2003 This bond is one of an issue of bonds of the Company, issuable in series, and is one of a series known as its Mortgage Bonds of the series designated in its title, all issued and to be issued under and equally secured (except as to any money, obligations or other instruments, or earnings thereon, deposited with the Trustee in accordance with the provisions of the Indenture hereinafter mentioned for the bonds of any particular series) by a General Mortgage Indenture and Deed of Trust, dated as of January 1, 1998, executed by the Company to The Bank of New York, as Trustee, as amended and supplemented by indentures supplemental thereto to which Indenture as so amended and supplemented (herein referred to as the "Indenture") reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights of the holders of the bonds in respect thereof and the terms and conditions upon which the bonds are secured. The bonds of this series are further entitled to the benefits of that certain Standby Bond Purchase Agreement, dated as of August 1, 2003 (the "Standby Purchase Agreement"), among the Company, the Purchasers from time to time parties thereto ("Purchasers") and Barclays Bank PLC, as administrative agent (the "Administrative Agent") thereunder, including without limitation, certain representations, warranties and covenants of the Company and certain Events of Default thereunder, to which Standby Purchase Agreement reference is hereby made. Pursuant to the terms of the Standby Purchase Agreement, certain rights and remedies affecting the bonds of this series and the rights of the holders thereof may be exercised only by the Purchasers or the Administrative Agent acting on behalf of the Purchasers and not by holders of bonds of this series that are not Purchasers. Capitalized terms used and not otherwise defined herein shall have the meanings given to them in the Standby Purchase Agreement and, if not defined therein, in the Indenture. Calculation of Interest. All computations of interest on the bonds of this series shall be made by the Administrative Agent on the basis of a year of 360 days for the actual number of days (including the first day but excluding the last day) occurring in the relevant Interest Period. Each determination by the Administrative Agent of an interest rate or the duration of an Interest Period applicable to the bonds of this series (or any of them) shall be conclusive and binding for all purposes, absent manifest error. The Administrative Agent has agreed to advise the Company, the Trustee and each Purchaser of each interest rate and the duration of each Interest Period from time to time applicable to the bonds of this series. The Trustee shall be under no duty to inquire into, may conclusively presume the correctness of, and shall by fully protected in acting upon the Administrative Agent's calculation of the Interest Rate. 5 Payments. Whenever any payment of principal of or interest on the bonds of this series shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of interest; provided, however, if such extension would cause payment of principal of or interest on bonds of this series to be made in the next following calendar month, such payment shall be made on the next preceding Business Day. Default Interest. If and for so long as an Event of Default shall have occurred and be continuing the unpaid principal amount of each Bond shall (to the fullest extent permitted by law) bear interest until paid in full at a rate per annum equal at all times to a rate equal to 2% above the rate then applicable to such Bond, payable upon demand. Optional Redemption. The Company may at any time and from time to time redeem in whole or ratably in part bonds of this series issued as part of the same Funding at a redemption price equal to the outstanding principal amount to be redeemed plus interest accrued to the date of such redemption on the principal so redeemed plus any amount payable in connection with such redemption pursuant to Section 8.04(b) of the Standby Purchase Agreement; provided, however, that each optional redemption of bonds of this series shall be in a principal amount equal to $25,000,000 or any integral multiple of $1,000,000 in excess thereof. Notice of any such optional redemption shall be provided by the Company to the Trustee and to the Administrative Agent under the Standby Purchase Agreement not later than 11:00 A.M. (New York time) on the third Eurodollar Business Day prior to such redemption. Mandatory Redemption. Upon delivery by the Administrative Agent to the Trustee of notice that an Event of Default under the Standby Purchase Agreement has occurred and is continuing, all of the bonds of this series shall be subject to immediate mandatory redemption in whole at a price equal to the aggregate principal amount of bonds of this series outstanding plus interest accrued on the bonds of this series to the date of such redemption plus any amount payable in connection with such redemption pursuant to Section 8.04(b) of the Standby Purchase Agreement. The bonds of this series are not otherwise redeemable prior to their maturity Notice of Redemption The Administrative Agent and each Purchaser have waived, and each holder of this bond, by its acceptance of this bond, hereby also waives any right to receive any notice of redemption from the Trustee prior to the occurrence of any redemption date for bonds of this series. Certain Definitions: As used herein: "Applicable Margin" means 150 basis points; provided, that if the Company's Reference Ratings shall fall below BBB-/Baa3 the Applicable Margin will increase to 300 basis points. For purposes of the foregoing, if the Reference Ratings assigned by Moody's and S&P are not comparable (i.e., a "split rating") by (x) one level, the lower of such Reference Ratings shall control or (y) two or more levels, the level corresponding to the Reference Rating one level above the lower Reference Rating shall control unless either is below BB+ or unrated (in the case of S&P) or Ba1 or unrated (in the case of Moody's), in which case the lower of the two Reference Ratings shall control. Any 6 change in the Applicable Margin will be effective as of the date on which S&P or Moody's, as the case may be, announces the applicable change in the Reference Rating. "Business Day" means a day of the year on which banks are not required or authorized to close in New York, New York or Akron, Ohio. "Eurodollar Business Day" means a Business Day on which dealings in U.S. dollars are carried on in the London interbank market. "Eurodollar Rate" means, for each Interest Period applicable to this bond, the quotient obtained by dividing (i) the interest rate per annum equal to the rate appearing on Telerate Page 3750 (or any successor page) as the London interbank offered rate for deposits in U.S. dollars at 11:00 A.M. (London time) two Eurodollar Business Days before the first day of such Interest Period for a period of one month or, if for any reason such rate is not available, the rate per annum rounded upward to the nearest whole multiple of 1/16 of 1% per annum, if such rate is not such a multiple at which deposits in U.S. dollars are offered by the principal office of the Administrative Agent in London to prime banks in the London interbank market at 11:00 a.m. (London time) two Eurodollar Business Days before the first day of such Interest Period for a period equal to one month, by (ii) 100% minus the Eurodollar Rate Reserve Percentage. "Eurodollar Rate Reserve Percentage" for each Interest Period applicable to this bond means the reserve percentage applicable during such Interest Period (or if more than one such percentage shall be so applicable, the daily average of such percentages for those days in such Interest Period during which any such percentage shall be so applicable) under regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any emergency, supplemental or other marginal reserve requirement) with respect to liabilities or assets consisting of or including Eurocurrency Liabilities having a term equal to such Interest Period. "Funding" means any purchase of bonds of this series made by the Purchasers simultaneously under the Standby Purchase Agreement. "Interest Period" means a period of one month commencing on the Initial Interest Accrual Date and, thereafter, each subsequent period of one month commencing on the last day of the immediately preceding Interest Period; provided, however, that: (i) any Interest Period that would otherwise end after December 31, 2003 shall instead end on December 31, 2003; (ii) Interest Periods commencing on the same date for bonds of this series purchased as part of the same Funding shall be coextensive; and (iii) whenever the last day of any Interest Period would otherwise occur on a day other than a Eurodollar Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Eurodollar Business Day, provided, that if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Eurodollar Business Day. 7 "Moody's" means Moody's Investors Service, Inc. or any successor thereto. "Reference Ratings" means the ratings assigned by S&P and Moody's to the first mortgage bonds or other senior secured non-credit enhanced debt of the Company. "S&P" means Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc., or any successor thereto. No recourse shall be had for the payment of the principal of or premium, or interest if any, on this bond, or any part thereof, or for any claim based thereon or otherwise in respect thereof, or of the indebtedness represented thereby, or upon any obligation, covenant or agreement under the Indenture, against any incorporator, stockholder, officer or director, as such, past, present or future of the Company or of any predecessor or successor corporation, either directly or through the Company or a predecessor or successor corporation, whether by virtue of any Constitutional provision, statute or rule of law, or by the enforcement of any assessment or penalty or otherwise, all such liability of incorporators, stockholders, officers and directors being released by the registered owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000,000 and integral multiples thereof. If and to the extent this bond becomes transferable, the registered owner hereof, in person or by attorney duly authorized, may, upon compliance with the next succeeding paragraph, effectuate such transfer at an office or agency of the Company, in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio, upon surrender and cancellation of this bond and thereupon a new registered bond or bonds of the same series for a like principal amount, will be issued to the transferee in exchange therefor, as provided in the Indenture, and upon payment, if the Company shall require it, of the transfer charges therein prescribed. The Company and the Trustee may deem and treat the person in whose name this bond is registered as the absolute owner for the purpose of receiving payment of or on account of the principal and interest due hereon and for all other purposes. No transfer of this bond shall be effected, except upon five days' prior written notice to the Company, which notice shall identify the transferor and transferee and the price at which this bond is proposed to be transferred. Not later than the Trustee's close of business on the fifth day following the Company's receipt of such notice (or if such fifth day is not a Business Day, then upon the next succeeding Business Day), the Company shall advise the Trustee and the transferor in writing that either: (A) the Company consents to such transfer, whereupon the Trustee shall register such transfer as set forth above and in the Indenture or (B) the Company elects to purchase this bond at a purchase price equal to the stated principal amount of this bond plus interest accrued thereon to the second Business Day following the date of such notice from the Company, whereupon the Company shall deliver such purchase price to the Trustee no later than 12:00 noon (New York City time) on such second Business Day, and the Trustee shall pay such purchase price over to the transferor against surrender of this bond to the Trustee for the account of the Company. In the event that the Company shall fail to communicate timely to the Trustee and the transferor its election to consent to such transfer or to purchase this bond as aforesaid, the Company shall be deemed to have consented to such transfer. Nothing contained in this paragraph shall be construed to deprive the Company of 9 any right to object to any transfer of this bond on the grounds that such transfer does not comply with the requirements of this bond, the Indenture or applicable law. Each holder shall be deemed to understand that the offer and sale of the bonds of this series have not been registered under the Securities Act of 1933 (the "Securities Act") and that the bonds of this series may not be offered or sold except as permitted in the following sentence. Each holder shall be deemed to agree, on its own behalf and on behalf of any accounts for which it is acting as hereinafter stated, that if such holder sells any bonds of this series, such holder will do so only (A) to the Company, (B) to a person whom it reasonably believes is a "qualified institutional buyer" within the meaning of Rule 144A under the Securities Act that purchases for its own account or for the account of a qualified institutional buyer to whom notice is given that the resale, pledge or transfer is being made in reliance on Rule 144A, (C) to an institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act) that, prior to such transfer, furnishes to the Trustee a signed letter containing certain representations and agreements relating to the restrictions on transfer of the bonds of this series, (D) in an offshore transaction in accordance with Rule 904 of Regulation S under the Securities Act, (E) pursuant to the exemption from registration provided by Rule 144 under the Securities Act (if available), or (F) pursuant to an effective registration statement under the Securities Act, and each holder is further deemed to agree to provide to any person purchasing any of the bonds of this series from it a notice advising such purchaser that resales of the bonds of this series are restricted as stated herein. Each holder shall be deemed to understand that, on any proposed resale of any bonds of this series pursuant to the exemption from registration under Rule 144 under the Securities Act, any holder making any such proposed resale will be required to furnish to the Trustee and Company such certifications, legal opinions and other information as the Trustee and Company may reasonably require to confirm that the proposed sale complies with the foregoing restrictions. [END OF FORM OF BOND OF FLOATING RATE SERIES A] 9 [CERTIFICATE OF TRANSFER] Mortgage Bonds Floating Rate Series A of 2003 due 2003 FOR VALUE RECEIVED, the undersigned sells, assigns and transfers unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE Name and address of assignee must be printed or typewritten. the within Security of the Company and does hereby irrevocably constitute and appoint__________________________________________________________ to transfer the said Security on the books of the within-named Company, with full power of substitution in the premises. The undersigned certifies that said Security is being resold, pledged or otherwise transferred as follows: (check one) |_| to the Company; |_| to a Person whom the undersigned reasonably believes is a qualified institutional buyer within the meaning of Rule 144A under the Securities Act of 1933, as amended (the "Securities Act") purchasing for its own account or for the account of a qualified institutional buyer to whom notice is given that the resale, pledge or other transfer is being made in reliance on Rule 144A; |_| in an offshore transaction in accordance with Rule 904 of Regulation S under the Securities Act; |_| to an institution that is an "accredited investor" as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act that is acquiring this Security for investment purposes and not for distribution; (attach a copy of an Accredited Investor Certificate in the form annexed signed by an authorized officer of the transferee) |_| as otherwise permitted by the non-registration legend appearing on this Security; or |_| as otherwise agreed by the Company, confirmed in writing to the Trustee, as follows: [describe] Signed: --------------------------------- Dated: --------------------------------- 10 WHEREAS, the Company deems it advisable to enter into this Supplemental Indenture for the purposes of describing the form of the bonds of the Floating Rate 2003 Series and establishing the redemption provisions thereof, the interest rate and maturity thereof. NOW, THEREFORE, it is hereby covenanted, decLared and agreed, by the Company, that all such bonds of the Floating Rate 2003 Series are to be issued, authenticated and delivered, from time to time, subject to this Supplemental Indenture and to the further covenants, conditions, uses and trusts in the Indenture set forth, and the parties hereto mutually agree as follows: SECTION 1. Bonds of Floating Rate 2003 Series shall be designated as the Company's "Mortgage Bonds Floating Rate Series of 2003 due 2003". The bonds of Floating Rate 2003 Series shall bear interest from the applicable Initial Interest Accrual Date set forth on the face of the bonds of Floating Rate 2003 Series or from the most recent Interest Payment Date set forth on the face of such bonds to which payment has been made or duly provided for. The interest rate and maturity date of the bonds of the Floating Rate 2003 Series shall be as set forth in the form of bond hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. Principal or redemption price of and interest on the bonds of the Floating Rate 2003 Series shall be payable in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. Interest on the bonds of the Floating Rate 2003 Series shall be calculated as provided in the form of bond hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. Definitive bonds of the Floating Rate 2003 Series may be issued, originally or otherwise, only as registered bonds, substantially in the form of bond hereinabove set forth, and in denominations of $1,000,000 and, if higher, in multiples of $1,000,000. Delivery of a bond of the Floating Rate 2003 Series to the Trustee for authentication shall be conclusive evidence that its serial number has been duly approved by the Company. The bonds of the Floating Rate 2003 Series shall be redeemable as provided in the form of bond hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. SECTION 2. Bonds of the Floating Rate 2003 Series have not been registered under the Securities Act and therefore may not be offered or sold except as permitted in the following sentence. Each holder shall be deemed to agree, on its own behalf and on behalf of any accounts for which it is acting as hereinafter stated, that if such holder sells any bonds of the Floating Rate 2003 Series, such holder will do so only (A) to the Company, (B) to a person whom it reasonably believes is a "qualified institutional buyer" within the 11 meaning of Rule 144A under the Securities Act that purchases for its own account or for the account of a qualified institutional buyer to whom notice is given that the resale, pledge or transfer is being made in reliance on Rule 144A, (C) to an institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act) that, prior to such transfer, furnishes to the Trustee a signed letter containing certain representations and agreements relating to the restrictions on transfer of the bonds of this series, (D) in an offshore transaction in accordance with Rule 904 of Regulation S under the Securities Act, (E) pursuant to the exemption from registration provided by Rule 144 under the Securities Act (if available), or (F) pursuant to an effective registration statement under the Securities Act, and each holder is further deemed to agree to provide to any person purchasing any of the bonds of the Floating Rate 2003 Series from it a notice advising such purchaser that resales of such bonds are restricted as stated herein. If and to the extent bonds of the Floating Rate 2003 Series become transferable, such transfer may be accomplished by the registered owners thereof, in person or by attorney duly authorized, at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio but only in the manner and upon the conditions prescribed in the Indenture and in the form of bond hereinabove recited. SECTION 3. No transfer of bonds of the Floating Rate 2003 Series shall be effected, except upon five days' prior written notice to the Company, which notice shall identify the transferor and transferee and the price at which such Bonds of the Floating Rate 2003 Series are proposed to be transferred. Not later than the Trustee's close of business on the fifth day following the Company's receipt of such notice (or if such fifth day is not a Business Day, then upon the next succeeding Business Day), the Company shall advise the Trustee and the transferor in writing that either: (A) the Company consents to such transfer, whereupon the Trustee shall register such transfer as set forth above and in the Indenture or (B) the Company elects to purchase such Bonds of the Floating Rate 2003 Series at a purchase price equal to the stated principal amount of such Bonds of the Floating Rate 2003 Series plus interest accrued thereon to the second Business Day following the date of such notice from the Company, whereupon the Company shall deliver such purchase price to the Trustee no later than 12:00 noon (New York City time) on such second Business Day, and the Trustee shall pay such purchase price over to the transferor against surrender of such Bonds of the Floating Rate 2003 Series to the Trustee for the account of the Company. In the event that the Company shall fail to communicate timely to the Trustee and the transferor its election to consent to such transfer or to purchase such Bonds of the Floating Rate 2003 Series as aforesaid, the Company shall be deemed to have consented to such transfer. Nothing contained in this paragraph shall be construed to deprive the Company of any right to object to any transfer of any Bonds of the Floating Rate 2003 Series on the grounds that such transfer does not comply with the requirements of such Bonds of the Floating Rate 2003 Series, the Indenture or applicable law. SECTION 4. Except as herein otherwise expressly provided, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this Supplemental Indenture; the Trustee shall not be responsible in any manner whatsoever for or in respect of the validity or sufficiency of this Supplemental Indenture or for or in respect of the recitals herein or in the bonds of the Floating Rate 2003 Series (except the Trustee's authentication certificates), all of which are made by the Company solely; and this Supplemental Indenture is executed and accepted by the Trustee, subject to all the terms and conditions set forth in the Indenture, as fully to all intents and purposes as if the terms and conditions of the Indenture were herein set forth at length. The Trustee may conclusively presume that the 12 obligation of the Company to pay the principal of or interest on the bonds of this series as the same shall become due and payable, whether at maturity, redemption, acceleration or otherwise, shall have been fully satisfied and discharged unless and until it shall have received a written notice from a duly authorized officer of the Administrative Agent stating that the payment of principal of or interest on the bonds of this series has not been fully paid when due and specifying the amount of funds required to make such payment. SECTION 5. As supplemented by this Supplemental Indenture, the Indenture is in all respects ratified and confirmed, and the Indenture as herein defined, and this Supplemental Indenture, shall be read, taken and construed as one and the same instrument. Capitalized terms used and not otherwise defined herein shall have the meaning ascribed to them in the Indenture. SECTION 6. Nothing in this Supplemental Indenture contained shall or shall be construed to confer upon any person other than a holder of bonds issued under the Indenture, the Company and the Trustee any right or interest to avail himself of any benefit under any provision of the Indenture or of this Supplemental Indenture. SECTION 7. This Supplemental Indenture may be simultaneously executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. 13 IN WITNESS WHEREOF, OHIO EDISON COMPANY and THE BANK OF NEW YORK have caused these presents to be executed in their respective names by their respective Presidents or one of their Vice Presidents or Assistant Vice Presidents and their respective seals to be hereunto affixed and attested by their respective Corporate Secretaries or one of their Assistant Corporate Secretaries or Assistant Treasurers, all as of the day and year first above written. OHIO EDISON COMPANY By: ---------------------------------- Harvey L. Wagner, Vice President and Controller [Seal] Attest: ------------------------------------------------ Edward J. Udovich, Assistant Corporate Secretary Signed, Sealed and Acknowledged on behalf of OHIO EDISON COMPANY in the presence of: - ------------------------------------------ Julie A. Phillips - ------------------------------------------ Diane L. Rapp THE BANK OF NEW YORK By: ----------------------------------------- Sirojni Dindial, Assistant Vice President Seal] Attest: ------------------------------------ Timothy J. Hea, Assistant Treasurer Signed, Sealed and Acknowledged on behalf of The Bank of New York in the presence of: - ------------------------------------------- Dorothy Miller - ------------------------------------------- Cynthia Chaney 14 STATE OF OHIO ) : ss.: COUNTY OF SUMMIT ) On the 7th day of August in the year 2003 before me, the undersigned, personally appeared Harvey L. Wagner and Edward J. Udovich, Vice President and Controller and Assistant Corporate Secretary, respectively, of Ohio Edison Company, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. -------------------------------------- Susie M. Hoisten, Notary Public Residence-Summit County Statewide Jurisdiction, Ohio My Commission Expires December 9, 2006 [SEAL] 15 STATE OF NEW YORK ) : ss.: COUNTY OF NEW YORK ) On the 7th day of August in the year 2003 before me, the undersigned, personally appeared Sirojni Dindial and Timothy J. Hea, Assistant Vice President and Assistant Treasurer,, respectively, of The Bank of New York, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. -------------------------------- William J. Cassels Notary Public, State of New York No. 01CA5027729 Qualified in Bronx County Commission Expires May 18, 2006 [SEAL] 16 The Bank of New York hereby certifies that its precise name and address as Trustee hereunder are: The Bank of New York 101 Barclay Street City, County and State of New York 10286 THE BANK OF NEW YORK By: ----------------------------------------- Sirojni Dindial, Assistant Vice President This instrument was prepared by FirstEnergy Corp. 17 EX-4 17 oe_ex4-7.txt EX 4-7 BANK OF NY INDENT - -------------------------------------------------------------------------------- OHIO EDISON COMPANY TO THE BANK OF NEW YORK as Trustee --------- Indenture (For Unsecured Debt Securities) Dated as of April 1, 2003 - -------------------------------------------------------------------------------- TABLE OF CONTENTS1 PARTIES 1 RECITAL OF THE COMPANY.........................................................1 Article One ----------- Definitions and Other Provisions of General Application ------------------------------------------------------- Section 101 Definitions..................................................1 - ----------- ------------ Section 102 Compliance Certificates and Opinions.........................9 - ----------- ------------------------------------- Section 103 Form of Documents Delivered to Trustee.......................9 - ----------- --------------------------------------- Section 104 Acts of Holders.............................................10 - ----------- ---------------- Section 105 Notices, etc. to Trustee and Company........................11 - ----------- ------------------------------------- Section 106 Notice to Holders of Securities; Waiver.....................12 - ----------- ---------------------------------------- Section 107 Conflict with Trust Indenture Act...........................13 - ----------- ---------------------------------- Section 108 Effect of Headings and Table of Contents....................13 - ----------- ----------------------------------------- Section 109 Successors and Assigns......................................13 - ----------- ----------------------- Section 110 Severability Clause.........................................13 - ----------- -------------------- Section 111 Benefits of Indenture.......................................13 - ----------- ---------------------- Section 112 Governing Law...............................................13 - ----------- -------------- Section 113 Legal Holidays..............................................13 - ----------- --------------- Article To ---------- Security Forms -------------- Section 201 Forms Generally.............................................14 - ----------- ---------------- Section 202 Form of Trustee's Certificate of Authentication.............14 - ----------- ------------------------------------------------ Article Three ------------- The Securities -------------- Section 301 Amount Unlimited; Issuable in Series........................14 - ----------- ------------------------------------- Section 302 Denominations...............................................18 - ----------- -------------- Section 303 Execution, Authentication, Delivery and Dating..............18 - ----------- ----------------------------------------------- - ------------------------- 1 Note: This table of contents shall not, for any purpose, be deemed to be part of the Indenture. i Section 304 Temporary Securities........................................20 - ----------- --------------------- Section 305 Registration, Registration of Transfer and Exchange.........21 - ----------- ---------------------------------------------------- Section 306 Mutilated, Destroyed, Lost and Stolen Securities............22 - ----------- ------------------------------------------------- Section 307 Payment of Interest; Interest Rights Preserved..............23 - ----------- ----------------------------------------------- Section 308 Persons Deemed Owners.......................................24 - ----------- ---------------------- Section 309 Cancellation by Security Registrar..........................24 - ----------- ----------------------------------- Section 310 Computation of Interest.....................................24 - ----------- ------------------------ Section 311 Payment to Be in Proper Currency............................24 - ----------- --------------------------------- Section 312 Extension of Interest Payment...............................25 - ----------- ------------------------------ Article Four ------------ Redemption of Securities ------------------------ Section 401 Applicability of Article....................................25 - ----------- ------------------------- Section 402 Election to Redeem; Notice to Trustee.......................25 - ----------- -------------------------------------- Section 403 Selection of Securities to Be Redeemed......................25 - ----------- --------------------------------------- Section 404 Notice of Redemption........................................26 - ----------- --------------------- Section 405 Securities Payable on Redemption Date.......................27 - ----------- -------------------------------------- Section 406 Securities Redeemed in Part.................................28 - ----------- ---------------------------- Article Five ------------ Sinking Funds ------------- Section 501 Applicability of Article....................................28 - ----------- ------------------------- Section 502 Satisfaction of Sinking Fund Payments with Securities.......28 - ----------- ------------------------------------------------------ Section 503 Redemption of Securities for Sinking Fund...................28 - ----------- ------------------------------------------ Article Six ----------- Covenants --------- Section 601 Payment of Principal, Premium and Interest..................29 - ----------- ------------------------------------------- Section 602 Maintenance of Office or Agency.............................29 - ----------- -------------------------------- Section 603 Money for Securities Payments to Be Held in Trust...........30 - ----------- -------------------------------------------------- Section 604 Corporate Existence.........................................31 - ----------- -------------------- Section 605 Maintenance of Properties...................................31 - ----------- -------------------------- Section 606 Annual Officer's Certificate as to Compliance...............31 - ----------- ---------------------------------------------- Section 607 Waiver of Certain Covenants.................................32 - ----------- ---------------------------- Section 608 Limitation on Liens.........................................32 - ----------- -------------------- Section 609 Limitation on Sale and Lease-Back Transactions..............34 - ----------- ----------------------------------------------- ii Article Seven ------------- Satisfaction and Discharge -------------------------- Section 702 Satisfaction and Discharge of Securities....................35 - ----------- ----------------------------------------- Section 702 Satisfaction and Discharge of Indenture.....................37 - ----------- ---------------------------------------- Section 703 Application of Trust Money..................................38 - ----------- --------------------------- Article Eight ------------- Events of Default; Remedies --------------------------- Section 801 Events of Default...........................................38 - ----------- ------------------ Section 802 Acceleration of Maturity; Rescission and Annulment..........39 - ----------- -------------------------------------------------- Section 803 Collection of Indebtedness and Suits for Enforcement by Trustee......................................40 - ----------- ---------------------------------------- Section 804 Trustee May File Proofs of Claim............................41 - ----------- --------------------------------- Section 805 Trustee May Enforce Claims Without Possession of Securities....................................42 - ----------- --------------------------------- Section 806 Applicaiton of Money Collected..............................42 - ----------- ------------------------------- Section 807 Limitation on Suits.........................................42 - ----------- -------------------- Section 808 Unconditional Right of Holders to Receive Principal, Premium and Interest........................................43 - ----------- --------------------------------------------------- Section 809 Restoration of Rights and Remedies..........................43 - ----------- ----------------------------------- Section 810 Rights and Remedies Cumulative..............................43 - ----------- ------------------------------- Section 811 Delay or Omission Not Waiver................................43 - ----------- ----------------------------- Section 812 Control by Holders of Securities............................43 - ----------- --------------------------------- Section 813 Waiver of Past Defaults.....................................44 - ----------- ------------------------ Section 814 Undertaking for Costs.......................................44 - ----------- ---------------------- Section 815 Waiver of Stay or Extension Laws............................44 - ----------- --------------------------------- Article Nine ------------ The Trustee ----------- Section 901 Certain Duties and Responsibilities.........................45 - ----------- ------------------------------------ Section 902 Notice of Defaults..........................................46 - ----------- ------------------- Section 903 Certain Rights of Trustee...................................46 - ----------- -------------------------- Section 904 Not Responsible for Recitals or Issuance of Securities...............................................47 - ----------- ------------------------------------------------------- Section 905 May Hold Securities.........................................47 - ----------- -------------------- Section 906 Money Held in Trust.........................................48 - ----------- -------------------- iii Section 907 Compensation and Reimbursement..............................48 - ----------- ------------------------------- Section 908 Disqualification; Conflicting Interests.....................49 - ----------- ---------------------------------------- Section 909 Corporate Trustee Required; Eligibility.....................49 - ----------- ---------------------------------------- Section 910 Resignation and Removal; Appointment of Successor...........49 - ----------- -------------------------------------------------- Section 911 Acceptance of Appointment by Successor......................51 - ----------- --------------------------------------- Section 912 Merger, Conversion, Consolidation or Succession to Business......................................52 - ----------- ------------------------------------. Section 913 Preferential Collection of Claims Against Company...........52 - ----------- -------------------------------------------------- Section 914 Co-trustees and Separate Trustees...........................53 - ----------- ---------------------------------- Section 915 Appointment of Authenticating Agent.........................54 - ----------- ------------------------------------ Article Ten ----------- Holders' Lists and Reports by Trustee and Company ------------------------------------------------- Section 1001 Lists of Holders............................................56 - ------------ ----------------- Section 1002 Reports by Trustee and Company..............................56 - ------------ ------------------------------- Article Eleven -------------- Consolidation, Merger, Conveyance or Other Transfer --------------------------------------------------- Section 1101 Company May Consolidate, etc. Only on Certain Terms.........56 - ------------ ---------------------------------------------------- Section 1102 Successor Person Substituted................................57 - ------------ ----------------------------- Article Twelve -------------- Supplemental Indentures ----------------------- Section 1201 Supplemental Indentures Without Consent of Holders..........57 - ------------ --------------------------------------------------- Section 1202 Supplemental Indentures With Consent of Holders.............59 - ------------ ------------------------------------------------ Section 1203 Execution of Supplemental Indentures........................60 - ------------ ------------------------------------- Section 1204 Effect of Supplemental Indentures...........................60 - ------------ ---------------------------------- Section 1205 Conformity With Trust Indenture Act.........................60 - ------------ ------------------------------------ Section 1206 Reference in Securities to Supplemental Indentures..........60 - ------------ --------------------------------------------------- Section 1207 Modification Without Supplemental Indenture.................61 - ------------ -------------------------------------------- Article Thirteen ---------------- Meetings of Holders; Action Without Meeting ------------------------------------------- Section 1301 Purposes for Which Meetings May Be Called...................61 - ------------ ------------------------------------------ iv Section 1302 Call, Notice and Place of Meetings..........................61 - ------------ ----------------------------------- Section 1303 Persons Entitled to Vote at Meetings........................62 - ------------ ------------------------------------- Section 1304 Quorum; Action..............................................62 - ------------ --------------- Section 1305 Attendance at Meetings; Determination of Voting Rights; Conduct and Adjournment of Meetings.................63 - ------------ ------------------------------------------------ Section 1306 Counting Votes and Recording Action of Meetings.............64 - ------------ ------------------------------------------------ Section 1307 Action Without Meeting......................................64 - ------------ ----------------------- Article Fourteen ---------------- Immunity of Incorporators, Shareholders, Officers and Directors --------------------------------------------------------------- Section 1401 Liability Solely Corporate..................................64 - ------------ --------------------------- v OHIO EDISON COMPANY Reconciliation and tie between Trust Indenture Act of 1939 and Indenture, dated as of April 1, 2003 Trust Indenture Act Section Indenture Section ss.310 (a)(1).............................................................909 (a)(2).............................................................909 (a)(3).............................................................914 (a)(4)..................................................Not Applicable (b)................................................................908 ...................................................................910 ss.311 (a)................................................................913 (b)................................................................913 (c)................................................................913 ss.312 (a)...............................................................1001 (b)...............................................................1001 (c)...............................................................1001 ss.313 (a)...............................................................1002 (b)...............................................................1002 (c)...............................................................1002 ss.314 (a)...............................................................1002 (a)(4).............................................................606 (b).....................................................Not Applicable (c)(1).............................................................102 (c)(2).............................................................102 (c)(3)..................................................Not Applicable (d).....................................................Not Applicable (e)................................................................102 ss.315 (a)................................................................901 ...................................................................903 (b)................................................................902 (c)................................................................901 (d)................................................................901 (e)................................................................814 ss.316 (a)................................................................812 ...................................................................813 (a)(1)(A)..........................................................802 ...................................................................812 (a)(1)(B)..........................................................813 (a)(2)..................................................Not Applicable (b)................................................................808 ss.317 (a)(1).............................................................803 (a)(2).............................................................804 (b)................................................................603 ss.318 (a)................................................................107 i INDENTURE, dated as of April 1, 2003 between OHIO EDISON COMPANY, a corporation duly organized and existing under the laws of the State of Ohio (herein called the "Company"), having its principal office at 76 South Main Street, Akron, Ohio 44308-1890, and THE BANK OF NEW YORK, a banking corporation duly organized and existing under the laws of the State of New York, having its principal corporate trust office at 101 Barclay Street, New York, New York, as Trustee (herein called the "Trustee"). -------- RECITAL OF THE COMPANY The Company has duly authorized the execution and delivery of this Indenture to provide for the issuance from time to time of its unsecured debentures, notes or other evidences of indebtedness (herein called the "Securities"), in an unlimited aggregate principal amount to be issued in one or - ------------ more series as contemplated herein; and all acts necessary to make this Indenture a valid agreement of the Company have been performed. For all purposes of this Indenture, except as otherwise expressly provided or unless the context otherwise requires, capitalized terms used herein shall have the meanings assigned to them in Article One of this Indenture. NOW, THEREFORE, THIS INDENTURE WITNESSETH: For and in consideration of the premises and the purchase of the Securities by the Holders thereof, it is mutually covenanted and agreed, for the equal and proportionate benefit of all Holders of the Securities or of any series thereof, as follows: ARTICLE ON ---------- DEFINITIONS AND OTHER PROVISIONS OF GENERAL APPLICATION ------------------------------------------------------- Section 101 Definitions. For all purposes of this Indenture, except as ----------- otherwise expressly provided or unless the context otherwise requires: (a) the terms defined in this Article have the meanings assigned to them in this Article and include the plural as well as the singular; (b) all terms used herein without definition which are defined in the Trust Indenture Act, either directly or by reference therein, have the meanings assigned to them therein; (c) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles in the United States, and, except as otherwise herein expressly provided, the term "generally accepted accounting principles" with respect to any computation required or permitted hereunder shall mean such accounting principles as are generally accepted in the United States at the date of such computation or, at the election of the Company from time to time, at the date of the execution and delivery of this Indenture; provided, however, that in ------------------ determining generally accepted accounting principles applicable to the Company, the Company shall, to the extent required, conform to any order, rule or regulation of any administrative agency, regulatory authority or other governmental body having jurisdiction over the Company; (d) any reference herein to an "Article" or "Section" refers to an "Article" or "Section", as the case may be, of this Indenture; and (e) the words "herein", "hereof" and "hereunder" and other words of similar import refer to this Indenture as a whole and not to any particular Article, Section or other subdivision. Certain terms, used principally in Article Nine, are defined in that Article. "Act", when used with respect to any Holder of a Security, has the --- meaning specified in Section 104. "Affiliate" of any specified Person means any other Person directly or --------- indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or through one or more intermediaries, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Authenticating Agent" means any Person (other than the Company or an --------------------- Affiliate of the Company) authorized by the Trustee pursuant to Section 915 to act on behalf of the Trustee to authenticate one or more series of Securities or Tranche thereof. "Authorized Officer" means the Chairman of the Board, the Vice Chairman ------------------ of the Board, the President, any Vice President, the Treasurer, any Assistant Treasurer, or any other officer or agent of the Company duly authorized by the Board of Directors to act in respect of matters relating to this Indenture. "Board of Directors" means either the board of directors of the Company ------------------ or any committee thereof duly authorized to act in respect of matters relating to this Indenture. "Board Resolution" means a copy of a resolution certified by the ----------------- Secretary or an Assistant Secretary of the Company to have been duly adopted by the Board of Directors and to be in full force and effect on the date of such certification, and delivered to the Trustee. "Business Day", when used with respect to a Place of Payment or any ------------- other particular location specified in the Securities or this Indenture, means any day, other than a Saturday or Sunday, which is not a day on which the Corporate Trust Office of the Trustee or banking institutions or trust companies in such Place of Payment or other location are generally authorized or required by law, regulation or executive order to remain closed, except as may be otherwise specified as contemplated by Section 301. "Capitalization" means the total of all the following items appearing -------------- on, or included in, the Company's consolidated balance sheet: (i) liabilities 2 for indebtedness maturing more than twelve (12) months from the date of determination; and (ii) common stock, preferred stock, Hybrid Preferred Securities, premium on capital stock, capital surplus, capital in excess of par value, and retained earnings (however the foregoing may be designated), less, to the extent not otherwise deducted, the cost of shares of the capital stock of the Company held in the Company's treasury. Subject to the foregoing, capitalization shall be determined in accordance with generally accepted accounting principles and practices applicable to the type of business in which the Company is engaged and may be determined as of a date not more than sixty (60) days prior to the happening of an event for which such determination is being made. "Commission" means the Securities and Exchange Commission, as from time ---------- to time constituted, created under the Securities Exchange Act of 1934, as amended, or, if at any time after the date of execution and delivery of this Indenture such Commission is not existing and performing the duties now assigned to it under the Trust Indenture Act, then the body, if any, performing such duties at such time. "Company" means the Person named as the "Company" in the first ------- paragraph of this Indenture until a successor Person shall have become such pursuant to the applicable provisions of this Indenture, and thereafter "Company" shall mean such successor Person. "Company Request" or "Company Order" means a written request or order ---------------- -------------- signed in the name of the Company by an Authorized Officer and delivered to the Trustee. "Corporate Trust Office" means the office of the Trustee at which at ------------------------ any particular time its corporate trust business shall be principally administered, which office at the date of execution and delivery of this instrument is located at 101 Barclay Street, Floor 8 West, New York, New York 10286 Attention Corporate Trust Division - Corporate Finance Unit. "Corporation" means a corporation, association, company, limited ----------- liability company, partnership, joint stock company or business or statutory trust. "Debt" means any outstanding debt for money borrowed evidenced by ---- notes, debentures, bonds or other securities. "Defaulted Interest" has the meaning specified in Section 307. ------------------ "Discount Security" means any Security which provides for an amount ------------------ less than the principal amount thereof to be due and payable upon a declaration of acceleration of the Maturity thereof pursuant to Section 802. "Dollar" or "$" means a dollar or other equivalent unit in such coin or ------ - currency of the United States as at the time shall be legal tender for the payment of public and private debts. "Eligible Obligations" means: -------------------- (a) with respect to Securities denominated in Dollars, Government Obligations; or 3 (b) with respect to Securities denominated in a currency other than Dollars or in a composite currency, such other obligations or instruments as shall be specified with respect to such Securities, as contemplated by Section 301. "Event of Default" has the meaning specified in Section 801. ---------------- "Governmental Authority" means the government of the United States or ----------------------- of any State or Territory thereof or of the District of Columbia or of any county, municipality or other political subdivision of any of the foregoing, or any department, agency, authority or other instrumentality of any of the foregoing. "Government Obligations" means: ---------------------- (a) direct obligations of, or obligations the principal of and interest on which are unconditionally guaranteed by, the United States and entitled to the benefit of the full faith and credit thereof; and (b) certificates, depositary receipts or other instruments which evidence a direct ownership interest in obligations described in clause (a) above or in any specific interest or principal payments due in respect thereof; provided, however, that the custodian of such obligations or specific interest - ------------------ or principal payments shall be a bank or trust company (which may include the Trustee or any Paying Agent) subject to Federal or state supervision or examination with a combined capital and surplus of at least $50,000,000; and provided, further, that except as may be otherwise required by law, such - ------------------ custodian shall be obligated to pay to the holders of such certificates, depositary receipts or other instruments the full amount received by such custodian in respect of such obligations or specific payments and shall not be permitted to make any deduction therefrom. "Holder" means a Person in whose name a Security is registered in the ------ Security Register. "Hybrid Preferred Securities" means any preferred securities issued by ---------------------------- a Hybrid Preferred Securities Subsidiary, where such preferred securities have the following characteristics: (i) such Hybrid Preferred Securities Subsidiary lends substantially all of the proceeds from the issuance of such preferred securities to the Company, or a wholly-owned Subsidiary of the Company, in exchange for Subordinated Indebtedness issued by the Company; (ii) such preferred securities contain terms providing for the deferral of interest payments corresponding to provisions providing for the deferral of interest payments on the related Subordinated Indebtedness; and (iii) the Company makes periodic interest payments on the related Subordinated Indebtedness, which interest payments are in turn used by the Hybrid Preferred Securities Subsidiary to make corresponding payments to the holders of the preferred securities. "Hybrid Preferred Securities Subsidiary" means any limited partnership --------------------------------------- or business trust (or similar entity) (i) all of the general partnership or 4 common equity interest of which is owned (either directly or indirectly through any wholly-owned Subsidiary of the Company or any consolidated Subsidiary of the Company) at all times by the Company, (ii) that has been formed for the purpose of issuing Hybrid Preferred Securities and (iii) substantially all of the assets of which consist at all times solely of Subordinated Indebtedness issued by the Company and payments made from time to time on such Subordinated Indebtedness. "Indenture" means this instrument as originally executed and delivered --------- and as it may from time to time be supplemented or amended by one or more indentures supplemental hereto entered into pursuant to the applicable provisions hereof and shall include the terms of a particular series of Securities established as contemplated by Section 301. "Interest", with respect to a Discount Security only, means interest, -------- if any, borne by such Security at a Stated Interest Rate. "Interest Payment Date", when used with respect to any Security, means --------------------- the Stated Maturity of an installment of interest on such Security. "Lien" means any mortgage, security interest, pledge or lien. ---- "Maturity", when used with respect to any Security, means the date on -------- which the principal of such Security or an installment of principal becomes due and payable as provided in such Security or in this Indenture, whether at the Stated Maturity, by declaration of acceleration, upon redemption, tender for purchase, or otherwise. "Net Tangible Assets" means the amount shown as total assets on the --------------------- Company's consolidated balance sheet, less (i) intangible assets including, without limitation, such items as goodwill, trademarks, trade names, patents, and unamortized debt discount and expense; (ii) current liabilities; and (iii) appropriate adjustments, if any, related to minority interests. Such amounts shall be determined in accordance with generally accepted accounting principles and practices applicable to the type of business in which the Company is engaged and may be determined as of a date not more than sixty (60) days prior to the happening of the event for which such determination is being made. "Officer's Certificate" means a certificate signed by an Authorized ---------------------- Officer and delivered to the Trustee. "Operating Property" means (i) any interest in real property owned by ------------------- the Company and (ii) any asset owned by the Company that is depreciable in accordance with generally accepted accounting principles. "Opinion of Counsel" means a written opinion of counsel, who may be ------------------- counsel for the Company, or other counsel acceptable to the Trustee. "Outstanding", when used with respect to Securities, means, as of the ----------- date of determination, all Securities theretofore authenticated and delivered under this Indenture, except: (a) Securities theretofore canceled or delivered to the Security Registrar for cancellation; 5 (b) Securities deemed to have been paid in accordance with Section 701; and (c) Securities which have been paid pursuant to Section 306 or in exchange for or in lieu of which other Securities have been authenticated and delivered pursuant to this Indenture, other than any such Securities in respect of which there shall have been presented to the Trustee proof satisfactory to it and the Company that such Securities are held by a bona fide purchaser or purchasers in whose hands such Securities are valid obligations of the Company; provided, however, that in determining whether or not the Holders of the - ------------------ requisite principal amount of the Securities Outstanding under this Indenture, or the Outstanding Securities of any series or Tranche, have given any request, demand, authorization, direction, notice, consent or waiver hereunder or whether or not a quorum is present at a meeting of Holders of Securities, (x) Securities owned by the Company or any other obligor upon the Securities or any Affiliate of the Company or of such other obligor (unless the Company, such Affiliate or such obligor owns all Securities Outstanding under this Indenture, or (except for the purposes of actions to be taken by Holders of (i) more than one series voting as a class under Section 812 or (ii) more than one series or more than one Tranche, as the case may be, voting as a class under Section 1202) all Outstanding Securities of each such series and each such Tranche, as the case may be, determined without regard to this clause (x)) shall be disregarded and deemed not to be Outstanding, except that, in determining whether the Trustee shall be protected in relying upon any such request, demand, authorization, direction, notice, consent or waiver or upon any such determination as to the presence of a quorum, only Securities which a Responsible Officer of the Trustee actually knows to be so owned shall be so disregarded; provided, however, that Securities so owned which have been pledged in good faith may be regarded as Outstanding if the pledgee establishes to the satisfaction of the Trustee the pledgee's right so to act with respect to such Securities and that the pledgee is not the Company or any other obligor upon the Securities or any Affiliate of the Company or of such other obligor; and (y) the principal amount of a Discount Security that shall be deemed to be Outstanding for such purposes shall be the amount of the principal thereof that would be due and payable as of the date of such determination upon a declaration of acceleration of the Maturity thereof pursuant to Section 802; provided, further, that, in the case of any Security the principal of which is - ------------------ payable from time to time without presentment or surrender, the principal amount of such Security that shall be deemed to be Outstanding at any time for all purposes of this Indenture shall be the original principal amount thereof less the aggregate amount of principal thereof theretofore paid. "Paying Agent" means any Person, including the Company, authorized by ------------ the Company to pay the principal of, and premium, if any, or interest, if any, on any Securities on behalf of the Company. "Periodic Offering" means an offering of Securities of a series from ------------------ time to time any or all of the specific terms of which Securities, including 6 without limitation the rate or rates of interest, if any, thereon, the Stated Maturity or Maturities thereof and the redemption provisions, if any, with respect thereto, are to be determined by the Company or its agents upon the issuance of such Securities. "Person" means any individual, corporation, joint venture, trust, ------ unincorporated organization or any Governmental Authority. "Place of Payment", when used with respect to the Securities of any ----------------- series, or any Tranche thereof, means the place or places, specified as contemplated by Section 301, at which, subject to Section 602, principal of and premium, if any, and interest, if any, on the Securities of such series or Tranche are payable. "Predecessor Security" of any particular Security means every previous --------------------- Security evidencing all or a portion of the same debt as that evidenced by such particular Security; and, for the purposes of this definition, any Security authenticated and delivered under Section 306 in exchange for or in lieu of a mutilated, destroyed, lost or stolen Security shall be deemed (to the extent lawful) to evidence the same debt as the mutilated, destroyed, lost or stolen Security. "Redemption Date", when used with respect to any Security to be ---------------- redeemed, means the date fixed for such redemption by or pursuant to this Indenture. "Redemption Price", when used with respect to any Security to be ----------------- redeemed, means the price at which it is to be redeemed pursuant to this Indenture. "Regular Record Date" for the interest payable on any Interest Payment ------------------- Date on the Securities of any series means the date specified for that purpose as contemplated by Section 301. "Required Currency" has the meaning specified in Section 311. ----------------- "Responsible Officer", when used with respect to the Trustee, means any ------------------- Vice President, Assistant Vice President, any Assistant Treasurer or other officer of the Trustee within the Corporate Trust Division - Corporate Finance Unit of the Trustee (or any successor such division or unit) in each case located at the Corporate Trust Office of the Trustee who has direct responsibility for the administration of this Indenture, and for the purposes of Sections 901(c)(2) and 902 shall also include any other officer of the Trustee to whom a matter arising under this Indenture has been referred by such Corporate Trust Office. "Sale and Lease-Back Transaction" means any arrangement with any Person ------------------------------- providing for the leasing to the Company of any Operating Property (except for leases for a term, including any renewal thereof, of not more than forty-eight (48) months), which Operating Property has been or is to be sold or transferred by the Company to such Person; provided, however, Sale and Lease-Back Transaction shall not include any arrangement (i) first entered into prior to the date of this Indenture and (ii) involving the exchange of any Operating Property for any property subject to an arrangement specified in the preceding clause (i). 7 "Securities" has the meaning stated in the first recital of this ---------- Indenture and more particularly means any securities authenticated and delivered under this Indenture. "Security Register" and "Security Registrar" have the respective ------------------ ------------------- meanings specified in Section 305. "Special Record Date" for the payment of any Defaulted Interest on the ------------------- Securities of any series means a date fixed by the Trustee pursuant to Section 307. "Stated Interest Rate" means a rate (whether fixed or variable) at ---------------------- which an obligation by its terms is stated to bear simple interest. Any calculation or other determination to be made under this Indenture by reference to the Stated Interest Rate on a Security shall be made without regard to the effective interest cost to the Company of such Security and without regard to the Stated Interest Rate on, or the effective cost to the Company of, any other indebtedness in respect of which the Company's obligations are evidenced or secured in whole or in part by such Security. "Stated Maturity", when used with respect to any obligation or any ---------------- installment of principal thereof or interest thereon, means the date on which the principal of such obligation or such installment of principal or interest is stated to be due and payable (without regard to any provisions for redemption, prepayment, acceleration, purchase or extension). "Subordinated Indebtedness" means any unsecured Debt of the Company (i) ------------------------- issued in exchange for the proceeds of Hybrid Preferred Securities and (ii) subordinated to the rights of the Holders hereunder. "Subsidiary" means a corporation more than 50% of the outstanding ---------- voting stock or other voting interest of which is owned, directly or indirectly, by the Company or by one or more other Subsidiaries, or by the Company and one or more other Subsidiaries. For the purposes of this definition, "voting stock" means stock that ordinarily has voting power for the election of directors, whether at all times or only so long as no senior class of stock has such voting power by reason of any contingency. "Tranche" means a group of Securities which (a) are of the same series ------- and (b) have identical terms except as to principal amount and/or date of issuance. "Trust Indenture Act" means, as of any time, the Trust Indenture Act of ------------------- 1939, or any successor statute, as in effect at such time. "Trustee" means the Person named as the "Trustee" in the first ------- paragraph of this Indenture until a successor Trustee shall have become such with respect to one or more series of Securities pursuant to the applicable provisions of this Indenture, and thereafter "Trustee" shall mean or include each Person who is then a Trustee hereunder, and if at any time there is more than one such Person, "Trustee" as used with respect to the Securities of any series shall mean the Trustee with respect to Securities of that series. "United States" means the United States of America, its Territories, -------------- its possessions and other areas subject to its political jurisdiction. "Value" means, with respect to a Sale and Lease-Back Transaction, as of ----- any particular time, the amount equal to the greater of (i) the net proceeds to 8 the Company from the sale or transfer of the Operating Property leased pursuant to the Sale and Lease-Back Transaction or (ii) the net book value of the Operating Property leased, as determined by the Company in accordance with generally accepted accounting principles, in either case multiplied by a fraction, the numerator of which shall be equal to the number of full years of the term of the lease that is part of such Sale and Lease-Back Transaction remaining at the time of determination and the denominator of which shall be equal to the number of full years of the term of such lease, without regard, in any case, to any renewal or extension options contained in such lease. Section 102 Compliance Certificates and Opinions. Except as otherwise ------------------------------------ expressly provided in this Indenture, upon any application or request by the Company to the Trustee to take any action under any provision of this Indenture, the Company shall, if requested by the Trustee, furnish to the Trustee an Officer's Certificate stating that, or stating in the opinion of the signer thereof that, all conditions precedent, if any, provided for in this Indenture relating to the proposed action (including any covenants compliance with which constitutes a condition precedent) have been complied with and an Opinion of Counsel stating that in the opinion of such counsel all such conditions precedent, if any, have been complied with, except that in the case of any such application or request as to which the furnishing of such documents is specifically required by any provision of this Indenture relating to such particular application or request, no additional certificate or opinion need be furnished. Every certificate or opinion with respect to compliance with a condition or covenant provided for in this Indenture shall include: (a) a statement that each Person signing such certificate or opinion has read such covenant or condition and the definitions herein relating thereto; (b) a brief statement as to the nature and scope of the examination or investigation upon which the statements or opinions contained in such certificate or opinion are based; (c) a statement that, in the opinion of each such Person, such Person has made such examination or investigation as is necessary to enable such Person to express an informed opinion as to whether or not such covenant or condition has been complied with; and (d) a statement as to whether, in the opinion of each such Person, such condition or covenant has been complied with. Section 103 Form of Documents Delivered to Trustee. In any case where -------------------------------------- several matters are required to be certified by, or covered by an opinion of, any specified Person, it is not necessary that all such matters be certified by, or covered by the opinion of, only one such Person, or that they be so certified or covered by only one document, but one such Person may certify or give an opinion with respect to some matters and one or more other such Persons as to other matters, and any such Person may certify or give an opinion as to such matters in one or several documents. Any certificate or opinion of an officer of the Company may be based, insofar as it relates to legal matters, upon a certificate or opinion of, or representations by, counsel, unless such officer knows, or in the exercise of 9 reasonable care should know, that the certificate or opinion or representations with respect to the matters upon which such officer's certificate or opinion are based are erroneous. Any such certificate or Opinion of Counsel may be based, insofar as it relates to factual matters, upon a certificate or opinion of, or representations by, an officer or officers of the Company stating that the information with respect to such factual matters is in the possession of the Company, unless such counsel knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations with respect to such matters are erroneous. Where any Person is required to make, give or execute two or more applications, requests, consents, certificates, statements, opinions or other instruments under this Indenture, they may, but need not, be consolidated and form one instrument. Whenever, subsequent to the receipt by the Trustee of any Board Resolution, Officer's Certificate, Opinion of Counsel or other document or instrument, a clerical, typographical or other inadvertent or unintentional error or omission shall be discovered therein, a new document or instrument may be substituted therefor in corrected form with the same force and effect as if originally filed in the corrected form and, irrespective of the date or dates of the actual execution and/or delivery thereof, such substitute document or instrument shall be deemed to have been executed and/or delivered as of the date or dates required with respect to the document or instrument for which it is substituted. Anything in this Indenture to the contrary notwithstanding, if any such corrective document or instrument indicates that action has been taken by or at the request of the Company which could not have been taken had the original document or instrument not contained such error or omission, the action so taken shall not be invalidated or otherwise rendered ineffective but shall be and remain in full force and effect, except to the extent that such action was a result of willful misconduct or bad faith. Without limiting the generality of the foregoing, any Securities issued under the authority of such defective document or instrument shall nevertheless be the valid obligations of the Company entitled to the benefits of this Indenture equally and ratably with all other Outstanding Securities, except as aforesaid. Section 104 Acts of Holders. (a) Any request, demand, authorization, --------------- direction, notice, consent, election, waiver or other action provided by this Indenture to be made, given or taken by Holders may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Holders in person or by an agent duly appointed in writing or, alternatively, may be embodied in and evidenced by the record of Holders voting in favor thereof, either in person or by proxies duly appointed in writing, at any meeting of Holders duly called and held in accordance with the provisions of Article Thirteen, or a combination of such instruments and any such record. Except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments or record or both are delivered to the Trustee and, where it is hereby expressly required, to the Company. Such instrument or instruments and any such record (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the "Act" of the Holders signing --- such instrument or instruments and so voting at any such meeting. Proof of execution of any such instrument or of a writing appointing any such agent, or of the holding by any Person of a Security, shall be sufficient for any purpose of this Indenture and (subject to Section 901) conclusive in favor of the Trustee and the Company, if made in the manner provided in this Section. The record of any meeting of Holders shall be proved in the manner provided in Section 1306. 10 (b) The fact and date of the execution by any Person of any such instrument or writing may be proved by the affidavit of a witness of such execution or by a certificate of a notary public or other officer authorized by law to take acknowledgments of deeds, certifying that the individual signing such instrument or writing acknowledged to him the execution thereof or may be proved in any other manner which the Trustee and the Company deem sufficient. Where such execution is by a signer acting in a capacity other than his individual capacity, such certificate or affidavit shall also constitute sufficient proof of his authority. (c) The principal amount (except as otherwise contemplated in clause (y) of the first proviso to the definition of Outstanding) and serial numbers of Securities held by any Person, and the date of holding the same, shall be proved by the Security Register. (d) Any request, demand, authorization, direction, notice, consent, election, waiver or other Act of a Holder shall bind every future Holder of the same Security and the Holder of every Security issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof in respect of anything done, omitted or suffered to be done by the Trustee or the Company in reliance thereon, whether or not notation of such action is made upon such Security. (e) Until such time as written instruments shall have been delivered to the Trustee with respect to the requisite percentage of principal amount of Securities for the action contemplated by such instruments, any such instrument executed and delivered by or on behalf of a Holder may be revoked with respect to any or all of such Securities by written notice by such Holder or any subsequent Holder, proven in the manner in which such instrument was proven. (f) Securities of any series, or any Tranche thereof, authenticated and delivered after any Act of Holders may, and shall if required by the Trustee, bear a notation in form approved by the Trustee as to any action taken by such Act of Holders. If the Company shall so determine, new Securities of any series, or any Tranche thereof, so modified as to conform, in the opinion of the Trustee and the Company, to such action may be prepared and executed by the Company and authenticated and delivered by the Trustee in exchange for Outstanding Securities of such series or Tranche. (g) If the Company shall solicit from Holders any request, demand, authorization, direction, notice, consent, waiver or other Act, the Company may, at its option, fix in advance a record date for the determination of Holders entitled to give such request, demand, authorization, direction, notice, consent, waiver or other Act, but the Company shall have no obligation to do so. If such a record date is fixed, such request, demand, authorization, direction, notice, consent, waiver or other Act may be given before or after such record date, but only the Holders of record at the close of business on the record date shall be deemed to be Holders for the purposes of determining whether Holders of the requisite proportion of the Outstanding Securities have authorized or agreed or consented to such request, demand, authorization, direction, notice, consent, waiver or other Act, and for that purpose the Outstanding Securities shall be computed as of the record date. Section 105 Notices, etc. to Trustee and Company. Any request, demand, ------------------------------------ authorization, direction, notice, consent, election, waiver or Act of Holders or 11 other document provided or permitted by this Indenture to be made upon, given or furnished to, or filed with, the Trustee by any Holder or by the Company, or the Company by the Trustee or by any Holder, shall be sufficient for every purpose hereunder (unless otherwise herein expressly provided) if in writing and delivered personally to an officer or other responsible employee of the addressee at the applicable location set forth below or at such other location as such party may from time to time designate by written notice, or transmitted by facsimile transmission or other direct written electronic means to such telephone number or other electronic communications address as the parties hereto shall from time to time designate by written notice, or transmitted by certified or registered mail, charges prepaid, to the applicable address set forth below or to such other address as either party hereto may from time to time designate by written notice: If to the Trustee, to: The Bank of New York 101 Barclay Street, Floor 8 West New York, New York 10286 Attention: Corporate Trust Division - Corporate Finance Unit Telephone: (212) 815-5445 Telecopy: (212) 815-5705 If to the Company, to: Ohio Edison Company 76 South Main Street Akron, Ohio 44308-1890 Attention: Treasurer Telephone: (330) 384-5889 Telecopy: (330) 384-3772 Any communication contemplated herein shall be deemed to have been made, given, furnished and filed if personally delivered, on the date of delivery, if transmitted by facsimile transmission or other direct written electronic means, on the date of receipt, and if transmitted by certified or registered mail, on the date of receipt. Section 106 Notice to Holders of Securities; Waiver. Except as -------------------------------------------- otherwise expressly provided herein, where this Indenture provides for notice to Holders of any event, such notice shall be sufficiently given, and shall be deemed given, to Holders if in writing and mailed, first-class postage prepaid, to each Holder affected by such event, at the address of such Holder as it appears in the Security Register, not later than the latest date, if any, and not earlier than the earliest date, if any, prescribed for the giving of such notice. In case by reason of the suspension of regular mail service or by reason of any other cause it shall be impracticable to give such notice to Holders by mail, then such notification as shall be made with the approval of the Trustee shall constitute a sufficient notification for every purpose 12 hereunder. In any case where notice to Holders is given by mail, neither the failure to mail such notice, nor any defect in any notice so mailed, to any particular Holder shall affect the sufficiency of such notice with respect to other Holders. Any notice required by this Indenture may be waived in writing by the Person entitled to receive such notice, either before or after the event otherwise to be specified therein, and such waiver shall be the equivalent of such notice. Waivers of notice by Holders shall be filed with the Trustee, but such filing shall not be a condition precedent to the validity of any action taken in reliance upon such waiver. Section 107 Conflict with Trust Indenture Act. If any provision of this --------------------------------- Indenture limits, qualifies or conflicts with another provision hereof which is required or deemed to be included in this Indenture by, or is otherwise governed by, any of the provisions of the Trust Indenture Act, such other provision shall control; and if any provision hereof otherwise conflicts with the Trust Indenture Act, the Trust Indenture Act shall control unless otherwise provided as contemplated by Section 301 with respect to any series of Securities. Section 108 Effect of Headings and Table of Contents. The Article and ---------------------------------------- Section headings in this Indenture and the Table of Contents are for convenience only and shall not affect the construction hereof. Section 109 Successors and Assigns. All covenants and agreements in ---------------------- this Indenture by the Company and Trustee shall bind their respective successors and assigns, whether so expressed or not. Section 110 Severability Clause. In case any provision in this ------------------- Indenture or the Securities shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. Section 111 Benefits of Indenture. Nothing in this Indenture or the --------------------- Securities, express or implied, shall give to any Person, other than the parties hereto, their successors hereunder and the Holders, any benefit or any legal or equitable right, remedy or claim under this Indenture. Section 112 Governing Law. This Indenture and the Securities shall be ------------------------------------------------ governed by and construed in accordance with the laws of the State of New York (including without limitation Section 5-1401 of the New York General Obligations Law or any successor to such statute) except to the extent that the Trust Indenture Act shall be applicable. Section 113 Legal Holidays. In any case where any Interest Payment --------------- Date, Redemption Date or Stated Maturity of any Security shall not be a Business Day at any Place of Payment, then (notwithstanding any other provision of this Indenture or of the Securities other than a provision in Securities of any series, or any Tranche thereof, or in the Board Resolution or Officer's Certificate which establishes the terms of the Securities of such series or Tranche, which specifically states that such provision shall apply in lieu of this Section) payment of interest or principal and premium, if any, need not be made at such Place of Payment on such date, but may be made on the next succeeding Business Day at such Place of Payment, with the same force and effect, and in the same amount, as if made on the Interest Payment Date or Redemption Date, or at the Stated Maturity, as the case may be, and, if such payment is made or duly provided for on such Business Day, no interest (or Interest, as applicable) shall accrue on the amount so payable for the period 13 from and after such Interest Payment Date, Redemption Date or Stated Maturity, as the case may be, to such Business Day. ARTICLE TWO SECURITY FORMS -------------- Section 201 Forms Generally. The definitive Securities of each series --------------- shall be in substantially the form or forms thereof established in the indenture supplemental hereto establishing such series or in a Board Resolution establishing such series, or in an Officer's Certificate pursuant to such supplemental indenture or Board Resolution, in each case with such appropriate insertions, omissions, substitutions and other variations as are required or permitted by this Indenture, and may have such letters, numbers or other marks of identification and such legends or endorsements placed thereon as may be required to comply with the rules of any securities exchange or as may, consistently herewith, be determined by the officers executing such Securities, as evidenced by their execution of such Securities. If the form or forms of Securities of any series are established in a Board Resolution or in an Officer's Certificate pursuant to a Board Resolution, such Board Resolution and Officer's Certificate, if any, shall be delivered to the Trustee at or prior to the delivery of the Company Order contemplated by Section 303 for the authentication and delivery of such Securities. Unless otherwise specified as contemplated by Section 301 or clause (g) of Section 1201, the Securities of each series shall be issuable in registered form without coupons. The definitive Securities shall be produced in such manner as shall be determined by the officers executing such Securities, as evidenced by their execution thereof. Section 202 Form of Trustee's Certificate of Authentication. The -------------------------------------------------- Trustee's certificate of authentication shall be in substantially the form set forth below: This is one of the Securities of the series designated therein referred to in the within-mentioned Indenture. Dated: ---------------------------------, as Trustee By: ----------------------------- Authorized Signatory ARTICLE THREE THE SECURITIES -------------- Section 301 Amount Unlimited; Issuable in Series. The aggregate ---------------- principal amount of Securities which may be authenticated and delivered under this Indenture is unlimited. 14 The Securities may be issued in one or more series. Subject to the last paragraph of this Section, prior to the authentication and delivery of Securities of any series there shall be established by specification in a supplemental indenture or in a Board Resolution, or in an Officer's Certificate pursuant to a supplemental indenture or a Board Resolution: (a) the title of the Securities of such series (which shall distinguish the Securities of such series from Securities of all other series); (b) any limit upon the aggregate principal amount of the Securities of such series which may be authenticated and delivered under this Indenture (except for Securities authenticated and delivered upon registration of transfer of, or in exchange for, or in lieu of, other Securities of such series pursuant to Section 304, 305, 306, 406 or 1206 and except for any Securities which, pursuant to Section 303, are deemed never to have been authenticated and delivered hereunder); (c) the Person or Persons (without specific identification) to whom interest on Securities of such series, or any Tranche thereof, shall be payable on any Interest Payment Date, if other than the Persons in whose names such Securities (or one or more Predecessor Securities) are registered at the close of business on the Regular Record Date for such interest; (d) the date or dates on which the principal of the Securities of such series, or any Tranche thereof, is payable or any formulary or other method or other means by which such date or dates shall be determined, by reference to an index or other fact or event ascertainable outside of this Indenture or otherwise (without regard to any provisions for redemption, prepayment, acceleration, purchase or extension); (e) the rate or rates at which the Securities of such series, or any Tranche thereof, shall bear interest, if any (including the rate or rates at which overdue principal shall bear interest, if different from the rate or rates at which such Securities shall bear interest prior to Maturity, and, if applicable, the rate or rates at which overdue premium or interest shall bear interest, if any), or any formulary or other method or other means by which such rate or rates shall be determined, by reference to an index or other fact or event ascertainable outside of this Indenture or otherwise; the date or dates from which such interest shall accrue; the Interest Payment Dates on which such interest shall be payable and the Regular Record Date, if any, for the interest payable on such Securities on any Interest Payment Date; the right of the Company, if any, to extend the interest payment periods and the duration of any such extension as contemplated by Section 312; and the basis of computation of interest, if other than as provided in Section 310; (f) the place or places at which or methods by which (1) the principal of and premium, if any, and interest, if any, on Securities of such series, or any Tranche thereof, shall be payable, (2) registration of transfer of Securities of such series, or any Tranche thereof, may be effected, (3) exchanges of Securities of such series, or any Tranche thereof, may be effected and (4) notices and demands to or upon the Company in respect of the Securities of such series, or any Tranche thereof, and this Indenture may be served; the Security Registrar and any Paying Agent or Paying Agents for such series or Tranche; and if such is the case, that the principal of such Securities shall be payable without presentment or surrender thereof; 15 (g) the period or periods within which, or the date or dates on which, the price or prices at which and the terms and conditions upon which the Securities of such series, or any Tranche thereof, may be redeemed, in whole or in part, at the option of the Company and any restrictions on such redemptions, including but not limited to a restriction on a partial redemption by the Company of the Securities of any series, or any Tranche thereof, resulting in delisting of such Securities from any national exchange; (h) the obligation or obligations, if any, of the Company to redeem or purchase the Securities of such series, or any Tranche thereof, pursuant to any sinking fund or other mandatory redemption provisions or at the option of a Holder thereof and the period or periods within which or the date or dates on which, the price or prices at which and the terms and conditions upon which such Securities shall be redeemed or purchased, in whole or in part, pursuant to such obligation, and applicable exceptions to the requirements of Section 404 in the case of mandatory redemption or redemption at the option of the Holder; (i) the denominations in which Securities of such series, or any Tranche thereof, shall be issuable if other than denominations of $1,000 and any integral multiple thereof; (j) the currency or currencies, including composite currencies, in which payment of the principal of and premium, if any, and interest, if any, on the Securities of such series, or any Tranche thereof, shall be payable (if other than in Dollars); (k) if the principal of or premium, if any, or interest, if any, on the Securities of such series, or any Tranche thereof, are to be payable, at the election of the Company or a Holder thereof, in a coin or currency other than that in which the Securities are stated to be payable, the period or periods within which and the terms and conditions upon which, such election may be made; (l) if the principal of or premium, if any, or interest, if any, on the Securities of such series, or any Tranche thereof, are to be payable, or are to be payable at the election of the Company or a Holder thereof, in securities or other property, the type and amount of such securities or other property, or the formulary or other method or other means by which such amount shall be determined, and the period or periods within which, and the terms and conditions upon which, any such election may be made; (m) if the amount payable in respect of principal of or premium, if any, or interest, if any, on the Securities of such series, or any Tranche thereof, may be determined with reference to an index or other fact or event ascertainable outside of this Indenture, the manner in which such amounts shall be determined to the extent not established pursuant to clause (e) of this paragraph; (n) if other than the principal amount thereof, the portion of the principal amount of Securities of such series, or any Tranche thereof, which shall be payable upon declaration of acceleration of the Maturity thereof pursuant to Section 802; (o) any Events of Default, in addition to those specified in Section 801, with respect to the Securities of such series, and any covenants of the 16 Company for the benefit of the Holders of the Securities of such series, or any Tranche thereof, in addition to those set forth in Article Six; (p) the terms, if any, pursuant to which the Securities of such series, or any Tranche thereof, may be converted into or exchanged for shares of capital stock or other securities of the Company or any other Person; (q) the obligations or instruments, if any, which shall be considered to be Eligible Obligations in respect of the Securities of such series, or any Tranche thereof, denominated in a currency other than Dollars or in a composite currency, and any additional or alternative provisions for the reinstatement of the Company's indebtedness in respect of such Securities after the satisfaction and discharge thereof as provided in Section 701; (r) if the Securities of such series, or any Tranche thereof, are to be issued in global form, (i) any limitations on the rights of the Holder or Holders of such Securities to transfer or exchange the same or to obtain the registration of transfer thereof, (ii) any limitations on the rights of the Holder or Holders thereof to obtain certificates therefor in definitive form in lieu of temporary form and (iii) any and all other matters incidental to such Securities; (s) if the Securities of such series, or any Tranche thereof, are to be issuable as bearer securities, any and all matters incidental thereto which are not specifically addressed in a supplemental indenture as contemplated by clause (g) of Section 1201; (t) to the extent not established pursuant to clause (r) of this paragraph, any limitations on the rights of the Holders of the Securities of such Series, or any Tranche thereof, to transfer or exchange such Securities or to obtain the registration of transfer thereof; and if a service charge will be made for the registration of transfer or exchange of Securities of such series, or any Tranche thereof, the amount or terms thereof; (u) any exceptions to Section 113, or variation in the definition of Business Day, with respect to the Securities of such series, or any Tranche thereof; (v) any collateral security, assurance or guarantee for the Securities of such series; (w) any non-applicability of Section 608 to the Securities of such series or any exceptions or modifications of Section 608 with respect to the Securities of such series; (x) any rights or duties of another Person to assume the obligations of the Company with respect to the Securities of such series (whether as joint obligor, primary obligor, secondary obligor or substitute obligor) and any rights or duties to discharge and release any obligor with respect to the Securities of such series or the Indenture to the extent related to such series; and (y) any other terms of the Securities of such series, or any Tranche thereof, not inconsistent with the provisions of this Indenture, including, without limitation, any terms required for or appropriate to (i) establishing one or more series of medium-term notes to be issued in a Periodic Offering or (ii) providing for the remarketing of the Securities of such series. 17 With respect to Securities of a series subject to a Periodic Offering, the indenture supplemental hereto or the Board Resolution which establishes such series, or the Officer's Certificate pursuant to such supplemental indenture or Board Resolution, as the case may be, may provide general terms or parameters for Securities of such series and provide either that the specific terms of Securities of such series, or any Tranche thereof, shall be specified in a Company Order or that such terms shall be determined by the Company or its agents in accordance with procedures specified in a Company Order as contemplated by the clause (b) of Section 303. Unless otherwise provided with respect to a series of Securities as contemplated in Section 301(b), the aggregate principal amount of a series of securities may be increased and additional Securities of such series may be issued up to the maximum aggregate principal amount authorized with respect to such series as increased. Section 302 Denominations. Unless otherwise provided as contemplated by ------------- Section 301 with respect to any series of Securities, or any Tranche thereof, the Securities of each series shall be issuable in denominations of $1,000 and any integral multiple thereof. Section 303 Execution, Authentication, Delivery and Dating. Unless ------------------------------------------------ otherwise provided as contemplated by Section 301 with respect to any series of Securities, or any Tranche thereof, the Securities shall be executed on behalf of the Company by an Authorized Officer and may have the corporate seal of the Company affixed thereto or reproduced thereon attested by any other Authorized Officer or by the Secretary or an Assistant Secretary of the Company. The signature of any or all of these officers on the Securities may be manual or facsimile. Securities bearing the manual or facsimile signatures of individuals who were at the time of execution Authorized Officers or the Secretary or an Assistant Secretary of the Company shall bind the Company, notwithstanding that such individuals or any of them have ceased to hold such offices prior to the authentication and delivery of such Securities or did not hold such offices at the date of such Securities. The Trustee shall authenticate and deliver Securities of a series, for original issue, at one time or from time to time in accordance with the Company Order referred to below, upon receipt by the Trustee of: (a) the instrument or instruments establishing the form or forms and terms of such series, as provided in Sections 201 and 301; (b) a Company Order requesting the authentication and delivery of such Securities and, to the extent that the terms of such Securities shall not have been established in an indenture supplemental hereto or in a Board Resolution, or in an Officer's Certificate pursuant to a supplemental indenture or Board Resolution, all as contemplated by Sections 201 and 301, either (i) establishing such terms or (ii) in the case of Securities of a series subject to a Periodic Offering, specifying procedures, acceptable to the Trustee, by which such terms are to be established (which procedures may provide, to the extent acceptable to the Trustee, for authentication and delivery pursuant to oral or electronic instructions from the Company or any agent or agents thereof, which oral instructions are to be promptly confirmed electronically or in writing), in 18 either case in accordance with the instrument or instruments delivered pursuant to clause (a) above; (c) the Securities of such series, executed on behalf of the Company by an Authorized Officer; (d) an Opinion of Counsel to the effect that: (i) the form or forms of such Securities have been duly authorized by the Company and have been established in conformity with the provisions of this Indenture; (ii) the terms of such Securities have been duly authorized by the Company and have been established in conformity with the provisions of this Indenture; and (iii) such Securities, when authenticated and delivered by the Trustee and issued and delivered by the Company in the manner and subject to any conditions specified in such Opinion of Counsel, will have been duly issued under this Indenture and will constitute valid and binding obligations of the Company enforceable against the Company in accordance with their terms and entitled to the benefits provided by this Indenture, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar laws relating to or affecting creditors' rights generally, by general equitable principles (regardless of whether considered in a proceeding in equity or at law) and by an implied covenant of good faith, fair dealing and reasonableness; provided, however, that, with respect to Securities of a series subject to a - ------------------ Periodic Offering, the Trustee shall be entitled to receive such Opinion of Counsel only once at or prior to the time of the first authentication of such Securities (provided that such Opinion of Counsel addresses the authentication and delivery of all Securities of such series) and that in lieu of the opinions described in clauses (ii) and (iii) above Counsel may opine that: (x) when the terms of such Securities shall have been established pursuant to a Company Order or Orders or pursuant to such procedures (acceptable to the Trustee) as may be specified from time to time by a Company Order or Orders, all as contemplated by and in accordance with the instrument or instruments delivered pursuant to clause (a) above, such terms will have been duly authorized by the Company and will have been established in conformity with the provisions of this Indenture; and (y) such Securities, when authenticated and delivered by the Trustee in accordance with this Indenture and the Company Order or Orders or specified procedures referred to in paragraph (x) above and issued and delivered by the Company in the manner and subject to any conditions specified in such Opinion of Counsel, will have been duly issued under this Indenture and will constitute valid and binding obligations of the Company enforceable against the Company in accordance with their terms and entitled to the benefits provided by this Indenture, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar laws relating to or affecting creditors' rights generally, by general 19 equitable principles (regardless of whether considered in a proceeding in equity or at law) and by an implied covenant of good faith, fair dealing and reasonableness. With respect to Securities of a series subject to a Periodic Offering, the Trustee may conclusively rely, as to the authorization by the Company of any of such Securities, the form, terms thereof and the legality, validity, binding effect and enforceability thereof, and compliance of the authentication and delivery thereof with the terms and conditions of this Indenture, upon the Opinion of Counsel and other documents delivered pursuant to Sections 201 and 301 and this Section, as applicable, at or prior to the time of the first authentication of Securities of such series unless and until such opinion or other documents have been superseded or revoked or expire by their terms. In connection with the authentication and delivery of Securities of a series subject to a Periodic Offering, the Trustee shall be entitled to assume that the Company's instructions to authenticate and deliver such Securities do not violate any applicable law or any applicable rule, regulation or order of any Governmental Authority having jurisdiction over the Company. If the form or terms of the Securities of any series have been established by or pursuant to a Board Resolution or an Officer's Certificate as permitted by Sections 201 or 301, the Trustee shall not be required to authenticate such Securities if the issuance of such Securities pursuant to this Indenture will materially or adversely affect the Trustee's own rights, duties or immunities under the Securities and this Indenture or otherwise in a manner which is not reasonably acceptable to the Trustee. Unless otherwise specified as contemplated by Section 301 with respect to any series of Securities, or any Tranche thereof, each Security shall be dated the date of its authentication. Unless otherwise specified as contemplated by Section 301 with respect to any series of Securities, no Security shall be entitled to any benefit under this Indenture or be valid or obligatory for any purpose unless there appears on such Security a certificate of authentication substantially in the form provided for herein executed by the Trustee or an Authenticating Agent by manual signature, and such certificate upon any Security shall be conclusive evidence, and the only evidence, that such Security has been duly authenticated and delivered hereunder and is entitled to the benefits of this Indenture. Notwithstanding the foregoing, if any Security shall have been authenticated and delivered hereunder to the Company, or any Person acting on its behalf, but shall never have been issued and sold by the Company, and the Company shall deliver such Security to the Trustee for cancellation as provided in Section 309 together with a written statement (which need not comply with Section 102 and need not be accompanied by an Opinion of Counsel) stating that such Security has never been issued and sold by the Company, for all purposes of this Indenture such Security shall be deemed never to have been authenticated and delivered hereunder and shall never be entitled to the benefits hereof. Section 304 Temporary Securities. Pending the preparation of definitive -------------------- Securities of any series, or any Tranche thereof, the Company may execute, and upon Company Order the Trustee shall authenticate and deliver, temporary Securities which are printed, lithographed, typewritten, mimeographed or otherwise produced, in any authorized denomination, substantially of the tenor of the definitive Securities in lieu of which they are issued, with such appropriate insertions, omissions, substitutions and other variations as the 20 officers executing such Securities may determine, as evidenced by their execution of such Securities; provided, however, that temporary Securities need ----------------- not recite specific redemption, sinking fund, conversion or exchange provisions. Unless otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, after the preparation of definitive Securities of such series or Tranche, the temporary Securities of such series or Tranche shall be exchangeable, without charge to the Holder thereof, for definitive Securities of such series or Tranche upon surrender of such temporary Securities at the office or agency of the Company maintained pursuant to Section 602 in a Place of Payment for such Securities. Upon such surrender of temporary Securities for such exchange, the Company shall, except as aforesaid, execute and the Trustee shall authenticate and deliver in exchange therefor definitive Securities of the same series and Tranche of authorized denominations and of like tenor and aggregate principal amount. Until exchanged in full as hereinabove provided, temporary Securities shall in all respects be entitled to the same benefits under this Indenture as definitive Securities of the same series and Tranche and of like tenor authenticated and delivered hereunder. Section 305 Registration, Registration of Transfer and Exchange. The --------------------------------------------------- Company shall cause to be kept in each office designated pursuant to Section 602, with respect to the Securities of each series, a register (all registers kept in accordance with this Section being collectively referred to as the "Security Register") in which, subject to such reasonable regulations as it may - ------------------- prescribe, the Company shall provide for the registration of Securities of such series, or any Tranche thereof, and the registration of transfer thereof. The Company shall designate one Person to maintain the Security Register for the Securities of each series on a consolidated basis, and such Person is referred to herein, with respect to such series, as the "Security Registrar." Anything ------------------- herein to the contrary notwithstanding, the Company may designate one or more of its offices as an office in which a register with respect to the Securities of one or more series shall be maintained, and the Company may designate itself the Security Registrar with respect to one or more of such series. The Security Register shall be open for inspection by the Trustee and the Company at all reasonable times. Except as otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, upon surrender for registration of transfer of any Security of such series or Tranche at the office or agency of the Company maintained pursuant to Section 602 in a Place of Payment for such series or Tranche, the Company shall execute, and the Trustee shall authenticate and deliver, in the name of the designated transferee or transferees, one or more new Securities of the same series and Tranche, of authorized denominations and of like tenor and aggregate principal amount. Except as otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, any Security of such series or Tranche may be exchanged at the option of the Holder, for one or more new Securities of the same series and Tranche, of authorized denominations and of like tenor and aggregate principal amount, upon surrender of the Securities to be exchanged at any such office or agency. Whenever any Securities are so surrendered for exchange, the Company shall execute, and the Trustee 21 shall authenticate and deliver, the Securities which the Holder making the exchange is entitled to receive. All Securities delivered upon any registration of transfer or exchange of Securities shall be valid obligations of the Company, evidencing the same debt, and entitled to the same benefits under this Indenture, as the Securities surrendered upon such registration of transfer or exchange. Every Security presented or surrendered for registration of transfer or for exchange shall (if so required by the Company, the Trustee or the Security Registrar) be duly endorsed or shall be accompanied by a written instrument of transfer in form satisfactory to the Company, the Trustee or the Security Registrar, as the case may be, duly executed by the Holder thereof or his attorney duly authorized in writing. Unless otherwise specified as contemplated by Section 301 with respect to Securities of any series, or any Tranche thereof, no service charge shall be made for any registration of transfer or exchange of Securities, but the Company may require payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer or exchange of Securities, other than exchanges pursuant to Section 304, 406 or 1206 not involving any transfer. The Company shall not be required to execute or to provide for the registration of transfer of or the exchange of (a) Securities of any series, or any Tranche thereof, during a period of 15 days immediately preceding the date notice is to be given identifying the serial numbers of the Securities of such series or Tranche called for redemption or (b) any Security so selected for redemption in whole or in part, except the unredeemed portion of any Security being redeemed in part. Section 306 Mutilated, Destroyed, Lost and Stolen Securities. If any ------------------------------------------------- mutilated Security is surrendered to the Trustee, the Company shall execute and the Trustee shall authenticate and deliver in exchange therefor a new Security of the same series and Tranche, and of like tenor and principal amount and bearing a number not contemporaneously outstanding. If there shall be delivered to the Company and the Trustee (a) evidence to their satisfaction of the ownership of and the destruction, loss or theft of any Security and (b) such security or indemnity as may be reasonably required by them to save each of them and any agent of either of them harmless, then, in the absence of notice to the Company or the Trustee that such Security is held by a Person purporting to be the owner of such Security, the Company shall execute and the Trustee shall authenticate and deliver, in lieu of any such destroyed, lost or stolen Security, a new Security of the same series and Tranche, and of like tenor and principal amount and bearing a number not contemporaneously outstanding. Notwithstanding the foregoing, in case any such mutilated, destroyed, lost or stolen Security has become or is about to become due and payable, the Company in its discretion may, instead of issuing a new Security, pay such Security. Upon the issuance of any new Security under this Section, the Company may require the payment of a sum sufficient to cover any tax or other 22 governmental charge that may be imposed in relation thereto and any other reasonable expenses (including the fees and expenses of the Trustee) connected therewith. Every new Security of any series issued pursuant to this Section in lieu of any destroyed, lost or stolen Security shall constitute an original additional contractual obligation of the Company, whether or not the destroyed, lost or stolen Security shall be at any time enforceable by anyone other than the Holder of such new Security, and any such new Security shall be entitled to all the benefits of this Indenture equally and proportionately with any and all other Securities of such series duly issued hereunder. The provisions of this Section are exclusive and shall preclude (to the extent lawful) all other rights and remedies with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities. Section 307 Payment of Interest; Interest Rights Preserved. Unless ------------------------------------------------- otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, interest on any Security which is payable, and is punctually paid or duly provided for, on any Interest Payment Date shall be paid to the Person in whose name that Security (or one or more Predecessor Securities) is registered at the close of business on the Regular Record Date for such interest. Subject to Section 312, any interest on any Security of any series which is payable, but is not punctually paid or duly provided for, on any Interest Payment Date (herein called "Defaulted Interest") shall forthwith cease to be payable to the Holder on the related Regular Record Date by virtue of having been such Holder, and such Defaulted Interest may be paid by the Company, at its election in each case, as provided in clause (a) or (b) below: (a) The Company may elect to make payment of any Defaulted Interest to the Persons in whose names the Securities of such series (or their respective Predecessor Securities) are registered at the close of business on a date (herein called a "Special Record Date") for the payment of such Defaulted Interest, which shall be fixed in the following manner. The Company shall notify the Trustee in writing of the amount of Defaulted Interest proposed to be paid on each Security of such series and the date of the proposed payment, and at the same time the Company shall deposit with the Trustee an amount of money equal to the aggregate amount proposed to be paid in respect of such Defaulted Interest or shall make arrangements satisfactory to the Trustee for such deposit on or prior to the date of the proposed payment, such money when deposited to be held in trust for the benefit of the Persons entitled to such Defaulted Interest as in this clause provided. Thereupon the Trustee shall fix a Special Record Date for the payment of such Defaulted Interest which shall be not more than 15 days and not less than 10 days prior to the date of the proposed payment and not less than 10 days after the receipt by the Trustee of the notice of the proposed payment. The Trustee shall promptly notify the Company of such Special Record Date and, in the name and at the expense of the Company, shall promptly cause notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor to be mailed, first-class postage prepaid, to each Holder of Securities of such series at the address of such Holder as it appears in the Security Register, not less than 10 days prior to such Special Record Date. Notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor having been so mailed, such Defaulted Interest shall be paid to the Persons in whose names the Securities of such series (or their respective 23 Predecessor Securities) are registered at the close of business on such Special Record Date. (b) The Company may make payment of any Defaulted Interest on the Securities of any series in any other lawful manner not inconsistent with the requirements of any securities exchange on which such Securities may be listed, and upon such notice as may be required by such exchange, if, after notice given by the Company to the Trustee of the proposed payment pursuant to this clause, such manner of payment shall be deemed practicable by the Trustee. Subject to the foregoing provisions of this Section and Section 305, each Security delivered under this Indenture upon registration of transfer of or in exchange for or in lieu of any other Security shall carry the rights to interest accrued and unpaid, and to accrue, which were carried by such other Security. Section 308 Persons Deemed Owners. Prior to due presentment of a ----------------------- Security for registration of transfer, the Company, the Trustee and any agent of the Company or the Trustee may treat the Person in whose name such Security is registered as the absolute owner of such Security for the purpose of receiving payment of principal of and premium, if any, and (subject to Sections 305 and 307) interest, if any, on such Security and for all other purposes whatsoever, whether or not such Security be overdue, and neither the Company, the Trustee nor any agent of the Company or the Trustee shall be affected by notice to the contrary. Section 309 Cancellation by Security Registrar. All Securities ------------------------------------- surrendered for payment, redemption, registration of transfer or exchange shall, if surrendered to any Person other than the Security Registrar, be delivered to the Security Registrar and, if not theretofore canceled, shall be promptly canceled by the Security Registrar. The Company may at any time deliver to the Security Registrar for cancellation any Securities previously authenticated and delivered hereunder which the Company may have acquired in any manner whatsoever or which the Company shall not have issued and sold, and all Securities so delivered shall be promptly canceled by the Security Registrar. No Securities shall be authenticated in lieu of or in exchange for any Securities canceled as provided in this Section, except as expressly permitted by this Indenture. All canceled Securities held by the Security Registrar shall be disposed of in accordance with the customary practices of the Security Registrar at the time in effect, and the Security Registrar shall not be required to destroy any such certificates. The Security Registrar shall promptly deliver a certificate of disposition to the Trustee and the Company unless, by a Company Order, similarly delivered, the Company shall direct that canceled Securities be returned to it. The Security Registrar shall promptly deliver evidence of any cancellation of a Security in accordance with this Section 309 to the Trustee and the Company. Section 310 Computation of Interest. Except as otherwise specified as ----------------------- contemplated by Section 301 for Securities of any series, or any Tranche thereof, interest on the Securities of each series shall be computed on the basis of a 360-day year consisting of twelve 30-day months and for any period shorter than a full month, on the basis of the actual number of days elapsed in such period. Section 311 Payment to Be in Proper Currency. In the case of the ---------------------------------- Securities of any series, or any Tranche thereof, denominated in any currency 24 other than Dollars or in a composite currency (the "Required Currency"), except ------------------- as otherwise specified with respect to such Securities as contemplated by Section 301, the obligation of the Company to make any payment of the principal thereof, or the premium or interest thereon, shall not be discharged or satisfied by any tender by the Company, or recovery by the Trustee, in any currency other than the Required Currency, except to the extent that such tender or recovery shall result in the Trustee timely holding the full amount of the Required Currency then due and payable. If any such tender or recovery is in a currency other than the Required Currency, the Trustee may take such actions as it considers appropriate to exchange such currency for the Required Currency. The costs and risks of any such exchange, including without limitation the risks of delay and exchange rate fluctuation, shall be borne by the Company, the Company shall remain fully liable for any shortfall or delinquency in the full amount of Required Currency then due and payable, and in no circumstances shall the Trustee be liable therefor except in the case of its negligence or willful misconduct. Section 312 Extension of Interest Payment. The Company shall have the ----------------------------- right at any time, so long as the Company is not in default in the payment of interest on the Securities of any series hereunder, to extend interest payment periods on all Securities of one or more series, if so specified as contemplated by Section 301 with respect to such Securities and upon such terms as may be specified as contemplated by Section 301 with respect to such Securities. ARTICLE FOUR REDEMPTION OF SECURITIES ------------------------ Section 401 Applicability of Article. Securities of any series, or any ------------------------ Tranche thereof, which are redeemable before their Stated Maturity shall be redeemable in accordance with their terms and (except as otherwise specified as contemplated by Section 301 for Securities of such series or Tranche) in accordance with this Article. Section 402 Election to Redeem; Notice to Trustee. The election of the ------------------ Company to redeem any Securities shall be evidenced by a Board Resolution or an Officer's Certificate. The Company shall, at least 45 days prior to the Redemption Date fixed by the Company (unless a shorter notice shall be satisfactory to the Trustee), notify the Trustee in writing of such Redemption Date and of the principal amount of such Securities to be redeemed. In the case of any redemption of Securities (a) prior to the expiration of any restriction on such redemption provided in the terms of such Securities or elsewhere in this Indenture or (b) pursuant to an election of the Company which is subject to a condition specified in the terms of such Securities, the Company shall furnish the Trustee with an Officer's Certificate evidencing compliance with such restriction or condition. Section 403 Selection of Securities to Be Redeemed. If less than all ---------------------------------------- the Securities of any series, or any Tranche thereof, are to be redeemed, the particular Securities to be redeemed shall be selected by the Trustee from the Outstanding Securities of such series or Tranche not previously called for redemption, by such method as shall be provided for any particular series, or, in the absence of any such provision, by such method as the Trustee shall deem fair and appropriate and which may provide for the selection for redemption of 25 portions (equal to the minimum authorized denomination for Securities of such series or Tranche or any integral multiple thereof) of the principal amount of Securities of such series or Tranche of a denomination larger than the minimum authorized denomination for Securities of such series or Tranche; provided, --------- however, that if, as indicated in an Officer's Certificate, the Company shall - ------- have offered to purchase all or any principal amount of the Securities then Outstanding of any series, or any Tranche thereof, and less than all of such Securities as to which such offer was made shall have been tendered to the Company for such purchase, the Trustee, if so directed by Company Order, shall select for redemption all or any principal amount of such Securities which have not been so tendered. The Trustee shall promptly notify the Company and the Security Registrar in writing of the Securities selected for redemption and, in the case of any Securities selected to be redeemed in part, the principal amount thereof to be redeemed. For all purposes of this Indenture, unless the context otherwise requires, all provisions relating to the redemption of Securities shall relate, in the case of any Securities redeemed or to be redeemed only in part, to the portion of the principal amount of such Securities which has been or is to be redeemed. Section 404 Notice of Redemption. Except as otherwise specified as -------------------- contemplated by Section 301 for Securities of any series, notice of redemption shall be given in the manner provided in Section 106 to the Holders of the Securities to be redeemed not less than 30 nor more than 60 days prior to the Redemption Date. Except as otherwise specified as contemplated by Section 301 for Securities of any series, all notices of redemption shall state: (a) the Redemption Date, (b) the Redemption Price (if known), (c) if less than all the Securities of any series or Tranche are to be redeemed, the identification of the particular Securities to be redeemed and the portion of the principal amount of any Security to be redeemed in part, (d) that on the Redemption Date the Redemption Price, together with accrued interest, if any, to the Redemption Date, will become due and payable upon each such Security to be redeemed and, if applicable, that interest thereon will cease to accrue on and after said date, (e) the place or places where such Securities are to be surrendered for payment of the Redemption Price and accrued interest, if any, unless it shall have been specified as contemplated by Section 301 with respect to such Securities that such surrender shall not be required, (f) whether the redemption is at the election of the Company, or is for a sinking or other fund, if such is the case, (g) the CUSIP, ISIN, or other similar number or numbers, if any, assigned to such Securities; provided, however, that such notice may state that 26 no representation is made as to the correctness of any or all of such numbers, in which case none of the Company, the Trustee or any agent of the Company or the Trustee shall have any liability in respect of the use of any such number on such notices, and the redemption of such Securities shall not be affected by any defect in or omission of such numbers, and (h) such other matters as the Company shall deem desirable or appropriate. Unless otherwise specified with respect to any Securities in accordance with Section 301, with respect to any notice of redemption of Securities at the election of the Company, unless, upon giving of such notice, such Securities shall be deemed to have been paid in accordance with Section 701, such notice may, if so provided in the Officer's Certificate or Board Resolution delivered to the Trustee pursuant to Section 402, state that such redemption shall be conditional upon the receipt by the Paying Agent or Agents for such Securities, on or prior to the date fixed for such redemption, of money sufficient to pay the Redemption Price on such Securities and that if such money shall not have been so received such notice shall be of no force or effect and the Company shall not be required to redeem such Securities. In the event that such notice of redemption contains such a condition and such money is not so received, the redemption shall not be made and within a reasonable time thereafter notice shall be given, in the manner in which the notice of redemption was given, that such money was not so received and such redemption was not required to be made. A failure by the Company to provide such moneys or make provision for the payment thereof shall not constitute an Event of Default under this Indenture. The Paying Agent or Agents for the Securities otherwise to have been redeemed shall thereupon promptly return to the Holders thereof any of such Securities which had been surrendered for payment upon such redemption. Notice of redemption of Securities to be redeemed at the election of the Company, and any notice of non-satisfaction of a condition for redemption as aforesaid, shall be given by the Company or, at the Company's request, by the Security Registrar in the name and at the expense of the Company. Notice of mandatory redemption of Securities shall be given by the Security Registrar in the name and at the expense of the Company. Section 405 Securities Payable on Redemption Date. Notice of redemption ------------------------------------- having been given as aforesaid, and the conditions, if any, set forth in such notice having been satisfied, the Securities or portions thereof so to be redeemed shall, on the Redemption Date, become due and payable at the Redemption Price therein specified, and from and after such date (unless, in the case of an unconditional notice of redemption, the Company shall default in the payment of the Redemption Price and accrued interest, if any) such Securities or portions thereof, if interest-bearing, shall cease to bear interest. Upon surrender of any such Security for redemption in accordance with such notice, such Security or portion thereof shall be paid by the Company at the Redemption Price, together with accrued interest, if any, to the Redemption Date; provided, however, that no such surrender shall be a condition to such payment if so specified as contemplated by Section 301 with respect to such Security; and provided, further, that except as otherwise specified as contemplated by Section 301 with respect to such Security, any installment of interest on any Security the Stated Maturity of which installment is on or prior to the Redemption Date shall be payable to the Holder of such Security, or one or more Predecessor Securities, registered as such at the close of business on the related Regular Record Date according to the terms of such Security and subject to the provisions of Section 307. 27 Section 406 Securities Redeemed in Part. Upon the surrender of any --------------------------- Security which is to be redeemed only in part at a Place of Payment therefor (with, if the Company or the Trustee so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company and the Trustee duly executed by, the Holder thereof or his attorney duly authorized in writing), the Company shall execute, and the Trustee shall authenticate and deliver to the Holder of such Security, without service charge, a new Security or Securities of the same series and Tranche, of any authorized denomination requested by such Holder and of like tenor and in aggregate principal amount equal to and in exchange for the unredeemed portion of the principal of the Security so surrendered. ARTICLE FIVE SINKING FUNDS ------------- Section 501 Applicability of Article. The provisions of this Article ------------------------- shall be applicable to any sinking fund for the retirement of the Securities of any series, or any Tranche thereof, except as otherwise specified as contemplated by Section 301 for Securities of such series or Tranche. The minimum amount of any sinking fund payment provided for by the terms of Securities of any series, or any Tranche thereof, is herein referred to as a "mandatory sinking fund payment", and any payment in excess of such minimum amount provided for by the terms of Securities of any series, or any Tranche thereof, is herein referred to as an "optional sinking fund payment". If provided for by the terms of Securities of any series, or any Tranche thereof, the cash amount of any sinking fund payment may be subject to reduction as provided in Section 502. Each sinking fund payment shall be applied to the redemption of Securities of the series or Tranche in respect of which it was made as provided for by the terms of such Securities. Section 502 Satisfaction of Sinking Fund Payments with Securities. The ----------------------------------------------------- Company (a) may deliver to the Trustee Outstanding Securities (other than any previously called for redemption) of a series or Tranche in respect of which a mandatory sinking fund payment is to be made and (b) may apply as a credit Securities of such series or Tranche which have been redeemed either at the election of the Company pursuant to the terms of such Securities, at the election of the Holder thereof if applicable, or through the application of permitted optional sinking fund payments pursuant to the terms of such Securities, in each case in satisfaction of all or any part of such mandatory sinking fund payment with respect to the Securities of such series; provided, however, that no Securities shall be applied in satisfaction of a mandatory sinking fund payment if such Securities shall have been previously so applied. Securities so applied shall be received and credited for such purpose by the Trustee at the Redemption Price specified in such Securities for redemption through operation of the sinking fund and the amount of such mandatory sinking fund payment shall be reduced accordingly. Section 503 Redemption of Securities for Sinking Fund. Not less than 45 ----------------------------------------- days prior to each mandatory sinking fund payment date for the Securities of any series, or any Tranche thereof, the Company shall deliver to the Trustee an Officer's Certificate specifying: 28 (a) the amount of the next succeeding mandatory sinking fund payment for such series or Tranche; (b) the amount, if any, of the optional sinking fund payment to be made together with such mandatory sinking fund payment; (c) the aggregate sinking fund payment; (d) the portion, if any, of such aggregate sinking fund payment which is to be satisfied by the payment of cash; and (e) the portion, if any, of such aggregate sinking fund payment which is to be satisfied by delivering and crediting Securities of such series or Tranche pursuant to Section 502 and stating the basis for such credit and that such Securities have not previously been so credited, and the Company shall also deliver to the Trustee any Securities to be so delivered. If the Company shall have not delivered such Officer's Certificate and, to the extent applicable, all such Securities, the next succeeding sinking fund payment for such series or Tranche shall be made entirely in cash in the amount of the mandatory sinking fund payment. Not less than 30 days before each such sinking fund payment date the Trustee shall select the Securities to be redeemed upon such sinking fund payment date in the manner specified in Section 403 and cause notice of the redemption thereof to be given in the name of and at the expense of the Company in the manner provided in Section 404. Such notice having been duly given, the redemption of such Securities shall be made upon the terms and in the manner stated in Sections 405 and 406. ARTICLE SIX COVENANTS --------- Section 601 Payment of Principal, Premium and Interest. The Company -------------------------------------------- shall pay the principal of and premium, if any, and interest, if any, on the Securities of each series in accordance with the terms of such Securities and this Indenture. Section 602 Maintenance of Office or Agency. The Company shall maintain ------------------------------- in each Place of Payment for the Securities of each series, or any Tranche thereof, an office or agency where payment of such Securities shall be made, where the registration of transfer or exchange of such Securities may be effected and where notices and demands to or upon the Company in respect of such Securities and this Indenture may be served. The Company shall give prompt written notice to the Trustee of the location, and any change in the location, of each such office or agency and prompt notice to the Holders of any such change in the manner specified in Section 106. If at any time the Company shall fail to maintain any such required office or agency in respect of Securities of any series, or any Tranche thereof, or shall fail to furnish the Trustee with the address thereof, payment of such Securities shall be made, registration of transfer or exchange thereof may be effected and notices and demands in respect thereof may be served at the Corporate Trust Office of the Trustee, and the Company hereby appoints the Trustee as its agent for all such purposes in any such event. 29 The Company may also from time to time designate one or more other offices or agencies with respect to the Securities of one or more series, or any Tranche thereof, for any or all of the foregoing purposes and may from time to time rescind such designations; provided, however, that, unless otherwise specified as contemplated by Section 301 with respect to the Securities of such series or Tranche, no such designation or rescission shall in any manner relieve the Company of its obligation to maintain an office or agency for such purposes in each Place of Payment for such Securities in accordance with the requirements set forth above. The Company shall give prompt written notice to the Trustee, and prompt notice to the Holders in the manner specified in Section 106, of any such designation or rescission and of any change in the location of any such other office or agency. Anything herein to the contrary notwithstanding, any office or agency required by this Section may be maintained at an office of the Company, in which event the Company shall perform all functions to be performed at such office or agency. Section 603 Money for Securities Payments to Be Held in Trust. If the ------------------------------------------------- Company shall at any time act as its own Paying Agent with respect to the Securities of any series, or any Tranche thereof, it shall, on or before each due date of the principal of and premium, if any, and interest, if any, on any of such Securities, segregate and hold in trust for the benefit of the Persons entitled thereto a sum sufficient to pay the principal and premium or interest so becoming due until such sums shall be paid to such Persons or otherwise disposed of as herein provided. The Company shall promptly notify the Trustee of any failure by the Company (or any other obligor on such Securities) to make any payment of principal of or premium, if any, or interest, if any, on such Securities. Whenever the Company shall have one or more Paying Agents for the Securities of any series, or any Tranche thereof, it shall, on or before each due date of the principal of and premium, if any, and interest, if any, on such Securities, deposit with such Paying Agents sums sufficient (without duplication) to pay the principal and premium or interest so becoming due, such sums to be held in trust for the benefit of the Persons entitled to such principal, premium or interest, and (unless such Paying Agent is the Trustee) the Company shall promptly notify the Trustee of any failure by it so to act. The Company shall cause each Paying Agent for the Securities of any series, or any Tranche thereof, other than the Company or the Trustee, to execute and deliver to the Trustee an instrument in which such Paying Agent shall agree with the Trustee, subject to the provisions of this Section, that such Paying Agent shall: (a) hold all sums held by it for the payment of the principal of and premium, if any, or interest, if any, on such Securities in trust for the benefit of the Persons entitled thereto until such sums shall be paid to such Persons or otherwise disposed of as herein provided; (b) give the Trustee notice of any failure by the Company (or any other obligor upon such Securities) to make any payment of principal of or premium, if any, or interest, if any, on such Securities; and 30 (c) at any time during the continuance of any such failure, upon the written request of the Trustee, forthwith pay to the Trustee all sums so held in trust by such Paying Agent and furnish to the Trustee such information as it possesses regarding the names and addresses of the Persons entitled to such sums. The Company may at any time pay, or by Company Order direct any Paying Agent to pay, to the Trustee all sums held in trust by the Company or such Paying Agent, such sums to be held by the Trustee upon the same trusts as those upon which such sums were held by the Company or such Paying Agent and, if so stated in a Company Order delivered to the Trustee, in accordance with the provisions of Article Seven; and, upon such payment by any Paying Agent to the Trustee, such Paying Agent shall be released from all further liability with respect to such money. Any money deposited with the Trustee or any Paying Agent, or then held by the Company, in trust for the payment of the principal of and premium, if any, or interest, if any, on any Security and remaining unclaimed for two years after such principal and premium, if any, or interest has become due and payable shall be paid to the Company on Company Request, or, if then held by the Company, shall be discharged from such trust; and, upon such payment or discharge, the Holder of such Security shall, as an unsecured general creditor and not as a Holder of an Outstanding Security, look only to the Company for payment of the amount so due and payable and remaining unpaid, and all liability of the Trustee or such Paying Agent with respect to such trust money, and all liability of the Company as trustee thereof, shall thereupon cease; provided, however, that the Trustee or such Paying Agent, before being required to make any such payment to the Company, may at the expense of the Company cause to be mailed, on one occasion only, notice to such Holder that such money remains unclaimed and that, after a date specified therein, which shall not be less than 30 days from the date of such mailing, any unclaimed balance of such money then remaining will be paid to the Company. Section 604 Corporate Existence. Subject to the rights of the Company -------------------- under Article Eleven, the Company shall do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence. Section 605 Maintenance of Properties. The Company shall cause (or, --------------------------- with respect to property owned in common with others, make reasonable effort to cause) all its properties used or useful in the conduct of its business to be maintained and kept in good condition, repair and working order and shall cause (or, with respect to property owned in common with others, make reasonable effort to cause) to be made all necessary repairs, renewals, replacements, betterments and improvements thereof, all as, in the judgment of the Company, may be necessary so that the business carried on in connection therewith may be properly conducted; provided, however, that nothing in this Section shall prevent the Company from discontinuing, or causing the discontinuance of, the operation and maintenance of any of its properties if such discontinuance is, in the judgment of the Company, desirable in the conduct of its business. Section 606 Annual Officer's Certificate as to Compliance. Not later ---------------------------------------------- than May 1 in each year, commencing May 1, 2004 the Company shall deliver to the Trustee an Officer's Certificate which need not comply with Section 102, executed by the principal executive officer, the principal financial officer or 31 the principal accounting officer of the Company, as to such officer's knowledge of the Company's compliance with all conditions and covenants under this Indenture, such compliance to be determined without regard to any period of grace or requirement of notice under this Indenture, and making any other statements as may be required by the provisions of Section 314(a)(4) of the Trust Indenture Act. Section 607 Waiver of Certain Covenants. The Company may omit in any ---------------------------- particular instance to comply with any term, provision or condition set forth in (a) Section 602 or any additional covenant or restriction specified with respect to the Securities of any series, or any Tranche thereof, as contemplated by Section 301, if before the time for such compliance the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series and Tranches with respect to which compliance with Section 602 or such additional covenant or restriction is to be omitted, considered as one class, shall, by Act of such Holders, either waive such compliance in such instance or generally waive compliance with such term, provision or condition and (b) Section 604, 605 or Article Eleven if before the time for such compliance the Holders of a majority in principal amount of Securities Outstanding under this Indenture shall, by Act of such Holders, either waive such compliance in such instance or generally waive compliance with such term, provision or condition; but, in the case of (a) or (b), no such waiver shall extend to or affect such term, provision or condition except to the extent so expressly waived, and, until such waiver shall become effective, the obligations of the Company and the duties of the Trustee in respect of any such term, provision or condition shall remain in full force and effect. Section 608 Limitation on Liens. (a) So long as any Securities of any ------------------- series are Outstanding, the Company may not issue, assume, guarantee or permit to exist any Debt that is secured by any Lien of or upon any of the Company's Operating Property, whether owned at the date hereof or subsequently acquired, without in any such case effectively securing the Outstanding Securities (together with, if the Company shall so determine, any of the Company's other indebtedness ranking equally with such Securities) equally and ratably with such Debt (but only so long as such Debt is so secured); provided, however, that the foregoing restriction shall not apply to: (1) Liens on any Operating Property existing at the time of its acquisition (which Liens may also extend to subsequent repairs, alterations and improvements to that Operating Property); (2) Liens on operating property of a corporation existing at the time such corporation is merged into or consolidated with, or at the time the corporation sells, leases or otherwise disposes of its properties (or of a division thereof) as or substantially as an entirety to, the Company; (3) Liens on Operating Property to secure the costs of acquisition, construction, development or substantial repair, alteration or improvement of property or to secure any Debt incurred to provide funds for any of such purposes or for reimbursement of funds previously expended for any of such purposes, provided such Liens are created or assumed contemporaneously with, or within eighteen (18) months after, such acquisition or the completion of such substantial repair or alteration, construction, development or substantial improvement; 32 (4) Liens in favor of any State of the United States or any department, agency or instrumentality or political subdivision of any State, or for the benefit of holders of securities issued by any such entity (or providers of credit enhancement with respect to such securities), to secure any Debt (including, without limitation, obligations of the Company with respect to industrial development, pollution control or similar revenue bonds) incurred for the purpose of financing or refinancing all or any part of the purchase price or the cost of substantially repairing or altering, constructing, developing or substantially improving property which at the time of such purchase, repair, alteration, construction, development or improvement was owned or operated by the Company; (5) Liens securing Debt outstanding as of the date of issuance of the first series of Securities issued under this Indenture; (6) Liens securing Debt maturing less than twelve (12) months from its issuance or incurrence and is not extendible at the option of the Company; (7) Liens on Operating Property which is the subject of a lease agreement designating the Company as lessee and all of its right, title and interest in such Operating Property and such lease agreement, whether or not such lease agreement is intended as security; (8) Liens for taxes and similar levies, deposits to secure performance or obligations under certain specified circumstances and laws, mechanics' and other similar Liens arising in the ordinary course of business, Liens created by or resulting from legal proceedings being contested in good faith, and certain other similar Liens arising in the ordinary course of business; (9) Liens under Section 906 hereof; or (10) any extension, renewal or replacement (or successive extensions, renewals or replacements), in whole or in part, of any Lien referred to in clauses (1) through (9), provided, however, that the principal amount of Debt secured thereby and not otherwise authorized by clauses (1) through (9), shall not exceed the principal amount of Debt, plus any premium or fee payable in connection with any such extension, renewal or replacement, so secured at the time of the extension, renewal or replacement. (b) Notwithstanding the provisions of Section 608(a), the Company may issue, assume or guarantee Debt secured by Liens which would otherwise be subject to the restrictions of Section 608(a) up to an aggregate principal amount which, together with the principal amount of all other Debt of the Company secured by Liens (other than Liens permitted by Section 608(a) that 33 would otherwise be subject to any of the foregoing restrictions) and the Value of all Sale and Lease-Back Transactions in existence at such time (other than any Sale and Lease-Back Transaction that, if such Sale and Lease-Back Transaction had been a Lien, would have been permitted by Section 608(a), other than Sale and Lease-Back Transactions permitted by Section 609 because the commitment by or on behalf of the purchaser was obtained no later than eighteen (18) months after the later of events described in (i) or (ii) of Section 609, and other than Sale and Lease-Back Transactions as to which application of amounts have been made in accordance with clause (z) of Section 609), does not exceed the greater of fifteen percent (15%) of Net Tangible Assets and fifteen percent (15%) of Capitalization. (c) If the Company shall issue, assume or guarantee any Debt secured by any Lien and if Section 608(a) requires that the Outstanding Securities be secured equally and ratably with such Debt, the Company will promptly execute, at its expense, any instruments necessary to so equally and ratably secure the Outstanding Securities and deliver the same to the Trustee along with: (i) An Officers' Certificate stating that the covenant of the Company contained in Section 608(a) has been complied with; and (ii) An Opinion of Counsel to the effect that the Company has complied with the covenant contained in Section 608(a), and that any instruments executed by the Company in the performance of such covenant comply with the requirements of such covenant. In the event that the Company shall hereafter secure Outstanding Securities equally and ratably with any other obligation or indebtedness pursuant to the provisions of this Section 608, the Company will, upon the request of the Trustee, enter into an indenture or agreement supplemental hereto and take such other action, if any, as the Trustee may reasonably request to enable it to enforce effectively the rights of the Holders of Outstanding Securities so secured, equally and ratably with such other obligation or indebtedness. Section 609 Limitation on Sale and Lease-Back Transactions. So long as ---------------------------------------------- any Securities are Outstanding, the Company shall not enter into or permit to exist, any Sale and Lease-Back Transaction with respect to any Operating Property if, in any case, the commitment by or on behalf of the purchaser is obtained more than eighteen (18) months after the later of (i) the completion of the acquisition, construction or development of such Operating Property or (ii) the placing in operation of such Operating Property or of such Operating Property as constructed or developed or substantially repaired, altered or improved, unless (x) the Company would be entitled pursuant to Section 608(a) to issue, assume, guarantee or permit to exist Debt secured by a Lien on such Operating Property without equally and ratably securing the Securities or (y) the Company would be entitled pursuant to Section 608(b), after giving effect to such Sale and Lease-Back Transaction, to incur $1.00 of additional Debt secured by Liens (other than Liens permitted by Section 608(a)) or (z) the Company shall apply or cause to be applied, in the case of a sale or transfer for cash, an amount equal to the net proceeds thereof (but not in excess of the net book value of such Operating Property at the date of such sale or transfer) and, in the case of a sale or transfer otherwise than for cash, an amount equal to the fair value (as determined by the Board of Directors of the Company) of the Operating Property so leased, to the retirement, within one hundred eighty (180) days after the effective date of such Sale and Lease-Back Transaction, of Securities (in accordance with their terms) or other Debt of the Company ranking senior to, or equally with, the Securities; provided, however, that the amount 34 to be applied to such retirement of Debt shall be reduced by an amount equal to the principal amount, plus any premium or fee paid in connection with any redemption in accordance with the terms of Debt voluntarily retired by the Company within such one hundred eighty (180) day period, excluding retirement pursuant to mandatory sinking fund or prepayment provisions and payments at Maturity. ARTICLE SEVEN SATISFACTION AND DISCHARGE -------------------------- Section 701 Satisfaction and Discharge of Securities. Any Security or ---------------------------------------- Securities, or any portion of the principal amount thereof, shall be deemed to have been paid for all purposes of this Indenture, and the entire indebtedness of the Company in respect thereof shall be deemed to have been satisfied and discharged, if there shall have been irrevocably deposited with the Trustee or any Paying Agent (other than the Company), in trust: (a) money in an amount which shall be sufficient, or (b) in the case of a deposit made prior to the Maturity of such Securities or portions thereof, Eligible Obligations, which shall not contain provisions permitting the redemption or other prepayment thereof at the option of the issuer thereof, the principal of and the interest on which when due, without any regard to reinvestment thereof, will provide moneys which, together with the money, if any, deposited with or held by the Trustee or such Paying Agent, shall be sufficient, or (c) a combination of (a) or (b) which shall be sufficient, to pay when due the principal of and premium, if any, and interest, if any, due and to become due on such Securities or portions thereof on or prior to Maturity; provided, however, that in the case of the provision for payment or redemption - ------------------ of less than all the Securities of any series or Tranche, such Securities or portions thereof shall have been selected by the Trustee as provided herein and, in the case of a redemption, the notice requisite to the validity of such redemption shall have been given or irrevocable authority shall have been given by the Company to the Trustee to give such notice, under arrangements satisfactory to the Trustee; and provided, further, that the Company shall have -------- delivered to the Trustee and such Paying Agent: (x) if such deposit shall have been made prior to the Maturity of such Securities, a Company Order stating that the money and Eligible Obligations deposited in accordance with this Section shall be held in trust, as provided in Section 703; and (y) if Eligible Obligations shall have been deposited, an Opinion of Counsel that the obligations so deposited constitute Eligible Obligations and do not contain provisions permitting the redemption or other prepayment at the option of the issuer thereof, and an opinion of an independent public accountant of nationally recognized standing, selected by the Company, to the effect that the requirements set forth in clause (b) above have been satisfied; and 35 (z) if such deposit shall have been made prior to the Maturity of such Securities, (i) an Officer's Certificate stating the Company's intention that, upon delivery of such Officer's Certificate, its indebtedness in respect of such Securities or portions thereof will have been satisfied and discharged as contemplated in this Section, and (ii) an Opinion of Counsel to the effect that, as a result of a change in law occurring or a ruling of the United States Internal Revenue Service issued after the date of issuance of such Securities, the Holders of such Securities, or portions of the principal amount thereof, will not recognize income, gain or loss for United States federal income tax purposes as a result of the satisfaction and discharge of the Company's indebtedness in respect thereof and will be subject to United States federal income tax on the same amounts, at the same times and in the same manner as if such satisfaction and discharge had not been effected. Upon the deposit of money or Eligible Obligations, or both, in accordance with this Section, together with the documents required by clauses (x), (y) and (z) above, the Trustee shall, upon receipt of a Company Request, acknowledge in writing that the Security or Securities or portions thereof with respect to which such deposit was made are deemed to have been paid for all purposes of this Indenture and that the entire indebtedness of the Company in respect thereof has been satisfied and discharged as contemplated in this Section. In the event that all of the conditions set forth in the preceding paragraph shall have been satisfied in respect of any Securities or portions thereof except that, for any reason, the Officer's Certificate and Opinion of Counsel specified in clause (z) shall not have been delivered, such Securities or portions thereof shall nevertheless be deemed to have been paid for all purposes of this Indenture, and the Holders of such Securities or portions thereof shall nevertheless be no longer entitled to the benefits of this Indenture or of any of the covenants of the Company under Article Six (except the covenants contained in Sections 602 and 603) or any other covenants made in respect of such Securities or portions thereof as contemplated by Section 301, but the indebtedness of the Company in respect of such Securities or portions thereof shall not be deemed to have been satisfied and discharged prior to Maturity for any other purpose, and the Holders of such Securities or portions thereof shall continue to be entitled to look to the Company for payment of the indebtedness represented thereby; and, upon Company Request, the Trustee shall acknowledge in writing that such Securities or portions thereof are deemed to have been paid for all purposes of this Indenture. If payment at Stated Maturity of less than all of the Securities of any series, or any Tranche thereof, is to be provided for in the manner and with the effect provided in this Section, the Security Registrar shall select such Securities, or portions of principal amount thereof, in the manner specified by Section 403 for selection for redemption of less than all the Securities of a series or Tranche. In the event that Securities which shall be deemed to have been paid for purposes of this Indenture, and, if such is the case, in respect of which the Company's indebtedness shall have been satisfied and discharged, all as provided in this Section do not mature and are not to be redeemed within the 60 day period commencing with the date of the deposit of moneys or Eligible Obligations, as aforesaid, the Company shall, as promptly as practicable, give a notice, in the same manner as a notice of redemption with respect to such Securities, to the Holders of such Securities to the effect that such deposit has been made and the effect thereof. 36 Notwithstanding that any Securities shall be deemed to have been paid for purposes of this Indenture, as aforesaid, the obligations of the Company and the Trustee in respect of such Securities under Sections 304, 305, 306, 404, 503 (as to notice of redemption), 602, 603, 907 and 915 and this Article Seven shall survive. The Company shall pay, and shall indemnify the Trustee or any Paying Agent with which Eligible Obligations shall have been deposited as provided in this Section against, any tax, fee or other charge imposed on or assessed against such Eligible Obligations or the principal or interest received in respect of such Eligible Obligations, including, but not limited to, any such tax payable by any entity deemed, for tax purposes, to have been created as a result of such deposit. Anything herein to the contrary notwithstanding, (a) if, at any time after a Security would be deemed to have been paid for purposes of this Indenture, and, if such is the case, the Company's indebtedness in respect thereof would be deemed to have been satisfied or discharged, pursuant to this Section (without regard to the provisions of this paragraph), the Trustee or any Paying Agent, as the case may be, shall be required to return the money or Eligible Obligations, or combination thereof, deposited with it as aforesaid to the Company or its representative under any applicable Federal or State bankruptcy, insolvency or other similar law, such Security shall thereupon be deemed retroactively not to have been paid and any satisfaction and discharge of the Company's indebtedness in respect thereof shall retroactively be deemed not to have been effected, and such Security shall be deemed to remain Outstanding and (b) any satisfaction and discharge of the Company's indebtedness in respect of any Security shall be subject to the provisions of the last paragraph of Section 603. Section 702 Satisfaction and Discharge of Indenture. This Indenture ---------------------------------------- shall upon Company Request, accompanied by an Officer's Certificate and an Opinion of Counsel in compliance with Section 102 of this Indenture, cease to be of further effect (except as hereinafter expressly provided), and the Trustee, at the expense of the Company, shall execute proper instruments acknowledging satisfaction and discharge of this Indenture, when (a) no Securities remain Outstanding hereunder; and (b) the Company has paid or caused to be paid all other sums payable hereunder by the Company; provided, however, that if, in accordance with the last paragraph of Section - ------------------ 701, any Security, previously deemed to have been paid for purposes of this Indenture, shall be deemed retroactively not to have been so paid, this Indenture shall thereupon be deemed retroactively not to have been satisfied and discharged, as aforesaid, and to remain in full force and effect, and the Company shall execute and deliver such instruments as the Trustee shall reasonably request to evidence and acknowledge the same. Notwithstanding the satisfaction and discharge of this Indenture as aforesaid, the obligations of the Company and the Trustee under Sections 304, 305, 306, 404, 503 (as to notice of redemption), 602, 603, 907 and 915 and this Article Seven shall survive. Upon satisfaction and discharge of this Indenture as provided in this Section, the Trustee shall assign, transfer and turn over to the Company, 37 subject to the lien provided by Section 907, any and all money, securities and other property then held by the Trustee for the benefit of the Holders of the Securities other than money and Eligible Obligations held by the Trustee pursuant to Section 703. Section 703 Application of Trust Money. Neither the Eligible ------------------------------ Obligations nor the money deposited pursuant to Section 701, nor the principal or interest payments on any such Eligible Obligations, shall be withdrawn or used for any purpose other than, and shall be held in trust for, the payment of the principal of and premium, if any, and interest, if any, on the Securities or portions of principal amount thereof in respect of which such deposit was made, all subject, however, to the provisions of Section 603; provided, however, that, ----------------- so long as there shall not have occurred and be continuing an Event of Default, any cash received from such principal or interest payments on such Eligible Obligations, if not then needed for such purpose, shall, to the extent practicable and upon Company Request, be invested in Eligible Obligations of the type described in clause (b) in the first paragraph of Section 701 maturing at such times and in such amounts as shall be sufficient, together with any other moneys and the principal of and interest on any other Eligible Obligations then held by the Trustee, to pay when due the principal of and premium, if any, and interest, if any, due and to become due on such Securities or portions thereof on and prior to the Maturity thereof, and interest earned from such reinvestment shall be paid over to the Company as received, free and clear of any trust, lien or pledge under this Indenture except the lien provided by Section 907; and provided, further, that, so long as there shall not have occurred and be - ------------------ continuing an Event of Default, any moneys held in accordance with this Section on the Maturity of all such Securities in excess of the amount required to pay the principal of and premium, if any, and interest, if any, then due on such Securities shall be paid over to the Company free and clear of any trust, lien or pledge under this Indenture except the lien provided by Section 907; and provided, further, that if an Event of Default shall have occurred and be - ------------------ continuing, moneys to be paid over to the Company pursuant to this Section shall be held until such Event of Default shall have been waived or cured. ARTICLE EIGHT EVENTS OF DEFAULT; REMEDIES --------------------------- Section 801 Events of Default. "Event of Default", wherever used herein ----------------- ---------------- with respect to Securities of any series, means any one of the following events: (a) failure to pay interest, if any, on any Security of such series within 30 days after the same becomes due and payable; provided, however, that a ----------------- valid extension of the interest payment period by the Company as contemplated in Section 312 of this Indenture shall not constitute a failure to pay interest for this purpose; or (b) failure to pay the principal of or premium, if any, on any Security of such series at its Maturity; or (c) 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 or which has expressly been included in this Indenture 38 solely for the benefit of one or more series of Securities other than such series) for a period of 90 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 Holders of at least 33% in principal amount of the Outstanding Securities of such series, 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 Holders of a principal amount of Securities of such series not less than the principal amount of Securities the Holders 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 the Trustee, or the Trustee and the Holders of such - ------------------ principal amount of Securities of such series, 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 (d) the entry by a court having jurisdiction in the premises of (1) 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 (2) 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 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 90 consecutive days; or (e) 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 (f) any other Event of Default with respect to Securities of such series as shall have been specified in the terms thereof as contemplated by Section 301(o). Section 802 Acceleration of Maturity; Rescission and Annulment. If an -------------------------------------------------- Event of Default due to the default in payment of principal of, or interest on, any series of Securities or due to the default in the performance or breach of any other covenant or warranty of the Company applicable to the Securities of such series but not applicable to all Outstanding Securities shall have occurred and be continuing, either the Trustee or the Holders of not less than 33% in principal amount of the Securities of such series may then declare the principal amount (or, if any of the Securities of such series are Discount Securities, 39 such portion of the principal amount as may be specified in the terms thereof as contemplated by Section 301) of all Securities of such series and interest accrued thereon to be due and payable immediately. If an Event of Default due to default in the performance of any other of the covenants or agreements herein applicable to all Outstanding Securities or an Event of Default specified in Section 801(d) or (e) shall have occurred and be continuing, either the Trustee or the Holders of not less than 33% in principal amount of all Securities then Outstanding (considered as one class), and not the Holders of the Securities of any one of such series, may declare the principal of all Securities and interest accrued thereon to be due and payable immediately. As a consequence of each such declaration (herein referred to as a declaration of acceleration) with respect to Securities of any series, the principal amount (or portion thereof in the case of Discount Securities) of such Securities and interest accrued thereon shall become due and payable immediately. At any time after such a declaration of acceleration with respect to Securities of any series shall have been made and before a judgment or decree for payment of the money due shall have been obtained by the Trustee as hereinafter in this Article provided, the Event or Events of Default giving rise to such declaration of acceleration shall, without further act, be deemed to have been waived, and such declaration and its consequences shall, without further act, be deemed to have been rescinded and annulled, if (a) the Company shall have paid or deposited with the Trustee a sum sufficient to pay (1) all overdue interest on all Securities of such series; (2) the principal of and premium, if any, on any Securities of such series which have become due otherwise than by such declaration of acceleration and interest thereon at the rate or rates prescribed therefor in such Securities; (3) to the extent that payment of such interest is lawful, interest upon overdue interest, if any, at the rate or rates prescribed therefor in such Securities; (4) all amounts due to the Trustee under Section 907; and (b) any other Event or Events of Default with respect to Securities of such series, other than the nonpayment of the principal of Securities of such series which shall have become due solely by such declaration of acceleration, shall have been cured or waived as provided in Section 813. No such rescission shall affect any subsequent Event of Default or impair any right consequent thereon. Section 803 Collection of Indebtedness and Suits for Enforcement by --------------------------------------------------------- Trustee. If an Event of Default described in clause (a) or (b) of Section 801 - ------- shall have occurred and be continuing, the Company shall, upon demand of the Trustee, pay to it, for the benefit of the Holders of the Securities of the 40 series with respect to which such Event of Default shall have occurred, the whole amount then due and payable on such Securities for principal and premium, if any, and interest, if any, and, to the extent permitted by law, interest on any overdue principal and interest, at the rate or rates prescribed therefor in such Securities, and, in addition thereto, such further amount as shall be sufficient to cover any amounts due to the Trustee under Section 907. If the Company shall fail to pay such amounts forthwith upon such demand, the Trustee, in its own name and as trustee of an express trust, may institute a judicial proceeding for the collection of the sums so due and unpaid, may prosecute such proceeding to judgment or final decree and may enforce the same against the Company or any other obligor upon such Securities and collect the moneys adjudged or decreed to be payable in the manner provided by law out of the property of the Company or any other obligor upon such Securities, wherever situated. If an Event of Default with respect to Securities of any series shall have occurred and be continuing, the Trustee may in its discretion proceed to protect and enforce its rights and the rights of the Holders of Securities of such series under the Indenture by such appropriate judicial proceedings as the Trustee shall deem most effectual to protect and enforce any such rights, whether for the specific enforcement of any covenant or agreement in this Indenture or in aid of the exercise of any power granted herein, or to enforce any other proper remedy. Section 804 Trustee May File Proofs of Claim. In case of the pendency ------------------------------- of any receivership, insolvency, liquidation, bankruptcy, reorganization, arrangement, adjustment, composition or other judicial proceeding relative to the Company or any other obligor upon the Securities or the property of the Company or of such other obligor or their creditors, the Trustee (irrespective of whether the principal of the Securities shall then be due and payable as therein expressed or by declaration or otherwise and irrespective of whether the Trustee shall have made any demand on the Company for the payment of overdue principal or interest) shall be entitled and empowered, by intervention in such proceeding or otherwise, (a) to file and prove a claim for the whole amount of principal, premium, if any, and interest, if any, owing and unpaid in respect of the Securities and to file such other papers or documents as may be necessary or advisable in order to have the claims of the Trustee (including any claim for amounts due to the Trustee under Section 907) and of the Holders allowed in such judicial proceeding, and (b) to collect and receive any moneys or other property payable or deliverable on any such claims and to distribute the same; and any custodian, receiver, assignee, trustee, liquidator, sequestrator or other similar official in any such judicial proceeding is hereby authorized by each Holder to make such payments to the Trustee and, in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amounts due it under Section 907. Nothing herein contained shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Holder any plan of reorganization, arrangement, adjustment or composition affecting the Securities or the rights of any Holder thereof or to authorize the Trustee to vote in respect of the claim of any Holder in any such proceeding. 41 Section 805 Trustee May Enforce Claims Without Possession of --------------------------------------------------------- Securities. All rights of action and claims under this Indenture or the - ---------- Securities may be prosecuted and enforced by the Trustee without the possession of any of the Securities or the production thereof in any proceeding relating thereto, and any such proceeding instituted by the Trustee shall be brought in its own name as trustee of an express trust, and any recovery of judgment shall, after provision for the payment of the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, be for the ratable benefit of the Holders in respect of which such judgment has been recovered. Section 806 Application of Money Collected. Any money or other property ------------------------------ collected by the Trustee pursuant to this Article and any money or other property distributable in respect of the Company's obligations under this Indenture after an Event of Default shall be applied in the following order, at the date or dates fixed by the Trustee and, in case of the distribution of such money on account of principal or premium, if any, or interest, if any, upon presentation of the Securities in respect of which or for the benefit of which such money shall have been collected and the notation thereon of the payment if only partially paid and upon surrender thereof if fully paid: (a) To the payment of all amounts due the Trustee (including any predecessor Trustee) under Section 907; (b) To the payment of the amounts then due and unpaid upon the Securities for principal of and premium, if any, and interest, if any, in respect of which or for the benefit of which such money has been collected, ratably, without preference or priority of any kind, according to the amounts due and payable on such Securities for principal, premium, if any, and interest, if any, respectively; and (c) To the payment of the remainder, if any, to the Company or to whomsoever may be lawfully entitled to receive the same or as a court of competent jurisdiction may direct. Section 807 Limitation on Suits. No Holder shall have any right to -------------------- institute any proceeding, judicial or otherwise, with respect to this Indenture, or for the appointment of a receiver or trustee, or for any other remedy hereunder, unless: (a) such Holder shall have previously given written notice to the Trustee of a continuing Event of Default with respect to the Securities of such series; (b) the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series in respect of which an Event of Default shall have occurred and be continuing, considered as one class, shall have made written request to the Trustee to institute proceedings in respect of such Event of Default in its own name as Trustee hereunder; (c) such Holder or Holders shall have offered to the Trustee reasonable indemnity against the costs, expenses and liabilities to be incurred in compliance with such request; 42 (d) the Trustee for 60 days after its receipt of such notice, request and offer of indemnity shall have failed to institute any such proceeding; and (e) no direction inconsistent with such written request shall have been given to the Trustee during such 60-day period by the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series in respect of which an Event of Default shall have occurred and be continuing, considered as one class; it being understood and intended that no one or more of such Holders shall have any right in any manner whatever by virtue of, or by availing of, any provision of this Indenture to affect, disturb or prejudice the rights of any other of such Holders or to obtain or to seek to obtain priority or preference over any other of such Holders or to enforce any right under this Indenture, except in the manner herein provided and for the equal and ratable benefit of all of such Holders. Section 808 Unconditional Right of Holders to Receive Principal, -------------------------------------------------------- Premium and Interest. Notwithstanding any other provision in this Indenture, the - -------------------- Holder of any Security shall have the right, which is absolute and unconditional, to receive payment of the principal of and premium, if any, and (subject to Sections 307 and 312) interest, if any, on such Security on the Stated Maturity or Maturities expressed in such Security (or, in the case of redemption, on the Redemption Date) and to institute suit for the enforcement of any such payment, and such rights shall not be impaired without the consent of such Holder. Section 809 Restoration of Rights and Remedies. If the Trustee or any ---------------------------------- Holder has instituted any proceeding to enforce any right or remedy under this Indenture and such proceeding shall have been discontinued or abandoned for any reason, or shall have been determined adversely to the Trustee or to such Holder, then and in every such case, subject to any determination in such proceeding, the Company, and Trustee and such Holder shall be restored severally and respectively to their former positions hereunder and thereafter all rights and remedies of the Trustee and such Holder shall continue as though no such proceeding had been instituted. Section 810 Rights and Remedies Cumulative. Except as otherwise --------------------------------- provided in the last paragraph of Section 306, no right or remedy herein conferred upon or reserved to the Trustee or to the Holders is intended to be exclusive of any other right or remedy, and every right and remedy shall, to the extent permitted by law, be cumulative and in addition to every other right and remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion or employment of any right or remedy hereunder, or otherwise, shall not prevent the concurrent assertion or employment of any other appropriate right or remedy. Section 811 Delay or Omission Not Waiver. No delay or omission of the ----------------- rustee or of any Holder to exercise any right or remedy accruing upon any Event of Default shall impair any such right or remedy or constitute a waiver of any such Event of Default or an acquiescence therein. Every right and remedy given by this Article or by law to the Trustee or to the Holders may be exercised from time to time, and as often as may be deemed expedient, by the Trustee or by the Holders, as the case may be. Section 812 Control by Holders of Securities. The Holders of a majority -------------------------------- in principal amount of the Outstanding Securities of such series shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred on 43 the Trustee, with respect to the Securities of such series; provided, however, ------------------ that if an Event of Default shall have occurred and be continuing with respect to more than one series of Securities, the Holders of a majority in aggregate principal amount of the Outstanding Securities of all such series, considered as one class, shall have the right to make such direction, and not the Holders of the Securities of any one of such series; and provided, further, that (a) such ------------------ direction shall not be in conflict with any rule of law or with this Indenture, and could not involve the Trustee in personal liability in circumstances where indemnity would not, in the Trustee's sole discretion, be adequate, and (b) the Trustee may take any other action, deemed proper by the Trustee, which is not inconsistent with any such direction. Section 813 Waiver of Past Defaults. The Holders of not less than a ------------------------ majority in principal amount of the Outstanding Securities of any series may on behalf of the Holders of all the Securities of such series waive any past default hereunder with respect to such series and its consequences, except a default (a) in the payment of the principal of or premium, if any, or interest, if any, on any Security of such series, or (b) in respect of a covenant or provision hereof which under Section 1202 cannot be modified or amended without the consent of the Holder of each Outstanding Security of such series affected. Upon any such waiver, such default shall cease to exist, and any and all Events of Default arising therefrom shall be deemed to have been cured, for every purpose of this Indenture; but no such waiver shall extend to any subsequent or other default or impair any right consequent thereon. Section 814 Undertaking for Costs. The Company and the Trustee agree, ---------------------- and each Holder by his acceptance thereof shall be deemed to have agreed, that any court may in its discretion require, in any suit for the enforcement of any right or remedy under this Indenture, or in any suit against the Trustee for any action taken, suffered or omitted by it as Trustee, the filing by any party litigant in such suit of an undertaking to pay the costs of such suit, and that such court may in its discretion assess reasonable costs, including reasonable attorneys' fees, against any party litigant in such suit, having due regard to the merits and good faith of the claims or defenses made by such party litigant; but the provisions of this Section shall not apply to any suit instituted by the Company, to any suit instituted by the Trustee, to any suit instituted by any Holder, or group of Holders, holding in the aggregate more than 10% in aggregate principal amount of the Outstanding Securities of all series in respect of which such suit may be brought, considered as one class, or to any suit instituted by any Holder for the enforcement of the payment of the principal of or premium, if any, or interest, if any, on any Security on or after the Stated Maturity or Maturities expressed in such Security (or, in the case of redemption, on or after the Redemption Date). Section 815 Waiver of Stay or Extension Laws. The Company covenants (to -------------------------------- the extent that it may lawfully do so) that it will not at any time insist upon, or plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay or extension law wherever enacted, now or at any time hereafter in 44 force, which may affect the covenants or the performance of this Indenture; and the Company (to the extent that it may lawfully do so) hereby expressly waives all benefit or advantage of any such law and covenants that it will not hinder, delay or impede the execution of any power herein granted to the Trustee, but will suffer and permit the execution of every such power as though no such law had been enacted. ARTICLE NINE THE TRUSTEE ----------- Section 901 Certain Duties and Responsibilities. (a) Except during the ----------------------------------- continuance of an Event of Default, (1) the Trustee undertakes to perform such duties and only such duties as are specifically set forth in this Indenture, and no implied covenants or obligations shall be read into this Indenture against the Trustee; and (2) in the absence of bad faith on its part, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon certificates or opinions furnished to the Trustee and conforming to the requirements of this Indenture; but in the case of any such certificates or opinions which by any provision hereof are specifically required to be furnished to the Trustee, the Trustee shall be under a duty to examine the same to determine whether or not they conform to the requirements of this Indenture (but need not confirm or investigate the accuracy of mathematical calculations or other facts stated therein). (b) In case an Event of Default has occurred and is continuing, the Trustee shall exercise such of the rights and powers vested in it by this Indenture, and use the same degree of care and skill in their exercise, as a prudent person would exercise or use under the circumstances in the conduct of his or her own affairs. (c) No provision of this Indenture shall be construed to relieve the Trustee from liability for its own negligent action, its own negligent failure to act, or its own willful misconduct, except that (1) this Subsection shall not be construed to limit the effect of Subsections (a) or (d) of this Section; (2) the Trustee shall not be liable for any error of judgment made in good faith by a Responsible Officer, unless it shall be proved that the Trustee was negligent in ascertaining the pertinent facts; and (3) the Trustee shall not be liable with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of the Holders of a majority in principal amount of the Outstanding Securities of any series, determined as provided in Sections 101 and 104, relating to the 45 time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred upon the Trustee, under this Indenture with respect to the Securities of such series. (d) No provision of this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder, or in the exercise of any of its rights or powers, if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. (e) Whether or not therein expressly so provided, every provision of this Indenture relating to the conduct or affecting the liability of or affording protection to the Trustee shall be subject to the provisions of this Section. Section 902 Notice of Defaults. The Trustee shall give notice of any ------------------- default hereunder known to the Trustee with respect to the Securities of any series to the Holders of Securities of such series in the manner and to the extent required to do so by the Trust Indenture Act, unless such default shall have been cured or waived; provided, however, that in the case of any default of ----------------- the character specified in Section 801(c), no such notice to Holders shall be given until at least 45 days after the occurrence thereof. For the purpose of this Section and clause (h) of Section 903, the term "default" means any event which is, or after notice or lapse of time, or both, would become, an Event of Default. Section 903 Certain Rights of Trustee. Subject to the provisions of ------------------------- Section 901 and to the applicable provisions of the Trust Indenture Act: (a) the Trustee may conclusively rely and shall be fully protected in acting or refraining from acting upon any resolution, certificate, Officer's Certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, other evidence of indebtedness or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties; (b) any request or direction of the Company mentioned herein shall be sufficiently evidenced by a Company Request or Company Order, or as otherwise expressly provided herein, and any resolution of the Board of Directors may be sufficiently evidenced by a Board Resolution; (c) whenever in the administration of this Indenture the Trustee shall deem it desirable that a matter be proved or established prior to taking, suffering or omitting any action hereunder, the Trustee (unless other evidence be herein specifically prescribed) may, in the absence of bad faith on its part, conclusively rely upon an Officer's Certificate; (d) the Trustee may consult with counsel and the advice of such counsel or any Opinion of Counsel shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by it hereunder in good faith and in reliance thereon; (e) the Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture at the request or direction of any Holder pursuant to this Indenture, unless such Holder shall have offered to 46 the Trustee reasonable security or indemnity against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction; (f) the Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, other evidence of indebtedness or other paper or document, but the Trustee, in its discretion, may make such further inquiry or investigation into such facts or matters as it may see fit, and, if the Trustee shall determine to make such further inquiry or investigation, it shall (subject to applicable legal requirements) be entitled to examine, during normal business hours, the books, records and premises of the Company, personally or by agent or attorney; (g) the Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through agents or attorneys, and the Trustee shall not be responsible for any misconduct or negligence on the part of any agent or attorney appointed with due care by it hereunder; (h) the Trustee shall not be charged with knowledge of any default (as defined in Section 902) or Event of Default, as the case may be, with respect to the Securities of any series for which it is acting as Trustee unless either (1) a Responsible Officer of the Trustee shall have actual knowledge that such default or Event of Default, as the case may be, exists and constitutes a default or Event of Default under this Indenture or (2) written notice of such default or Event of Default, as the case may be, shall have been given in the manner provided in Section 105 hereof to the Trustee by the Company, any other obligor on such Securities or by any Holder of such Securities and such notice refers to such Securities and this Indenture; (i) the rights, privileges, protections, immunities and benefits given to the Trustee, including, without limitation, its right to be indemnified, are extended to, and shall be enforceable by, the Trustee in each of its capacities hereunder; and (j) the Trustee shall not be liable for any action it takes or omits to take in good faith which it reasonably believes to be authorized or within its rights or powers. Section 904 Not Responsible for Recitals or Issuance of Securities. The ------------------------------------------------------ recitals contained herein and in the Securities (except the Trustee's certificates of authentication) shall be taken as the statements of the Company, and neither the Trustee nor any Authenticating Agent assumes responsibility for their correctness. The Trustee makes no representations as to the validity or sufficiency of this Indenture or of the Securities. Neither the Trustee nor any Authenticating Agent shall be accountable for the use or application by the Company of Securities or the proceeds thereof. Section 905 May Hold Securities. Each of the Trustee, any ---------------------- Authenticating Agent, any Paying Agent, any Security Registrar or any other agent of the Company, in its individual or any other capacity, may become the owner or pledgee of Securities and, subject to Sections 908 and 913, may otherwise deal with the Company with the same rights it would have if it were not the Trustee, Authenticating Agent, Paying Agent, Security Registrar or such other agent. 47 Section 906 Money Held in Trust. Money held by the Trustee in trust ------------------- hereunder need not be segregated from other funds, except to the extent required by law. The Trustee shall be under no liability for interest on any money received by it hereunder except as expressly provided herein or otherwise agreed with, and for the sole benefit of, the Company. Section 907 Compensation and Reimbursement. The Company shall ------------------------------ (a) pay to the Trustee from time to time such compensation for all services rendered by it hereunder (which compensation shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust) as the Company and the Trustee shall agree in writing; (b) except as otherwise expressly provided herein, reimburse the Trustee upon its request for all reasonable expenses, disbursements and advances reasonably incurred or made by the Trustee in accordance with any provision of this Indenture (including the reasonable compensation and the expenses and disbursements of its agents and counsel), except to the extent that any such expense, disbursement or advance may be attributable to the Trustee's gross negligence or wilful misconduct; and (c) indemnify the Trustee for, and hold it harmless from and against, any loss, liability or expense reasonably incurred by it arising out of or in connection with the acceptance or administration of the trust or trusts hereunder or the performance of its duties hereunder, including the reasonable costs and expenses of defending itself against any claim or liability in connection with the exercise or performance of any of its powers or duties hereunder, except to the extent any such loss, liability or expense may be attributable to its gross negligence or wilful misconduct. As security for the performance of the obligations of the Company under this Section, the Trustee shall have a lien prior to the Securities upon all property and funds held or collected by the Trustee as such, other than property and funds held in trust under Section 703 (except as otherwise provided in Section 703). In addition to and without prejudice to the rights provided to the Trustee under any of the provisions of this Indenture, when the Trustee incurs expenses or renders services in connection with an Event of Default specified in Section 801(d) or Section 801(e), the expenses (including the reasonable charges and expenses of its counsel) and the compensation for the services are intended to constitute expenses of administration under any applicable Federal or State bankruptcy, insolvency or other similar law. "Trustee" for purposes of this Section shall include any predecessor ------- Trustee; provided, however, that the negligence, wilful misconduct or bad faith ----------------- of any Trustee hereunder shall not affect the rights of any other Trustee hereunder. The provisions of this Section 907 shall survive the discharge of the Company's obligation in respect of any Securities, including under Article Seven, the termination of this Indenture for any reason and the resignation or removal of any Trustee. 48 Section 908 Disqualification; Conflicting Interests. If the Trustee ----------------------------------------- shall have or acquire any conflicting interest within the meaning of the Trust Indenture Act, it shall either eliminate such conflicting interest or resign to the extent, in the manner and with the effect, and subject to the conditions, provided in the Trust Indenture Act and this Indenture. For purposes of Section 310(b)(1) of the Trust Indenture Act and to the fullest extent permitted thereby, the Trustee, in its capacity as trustee in respect of the Securities of any series, shall not be deemed to have a conflicting interest arising from its capacity as trustee in respect of the Securities of any other series. Nothing herein shall prevent the Trustee from filing with the Commission the application referred to in the second to last paragraph of Section 310(b) of the Trust Indenture Act. Section 909 Corporate Trustee Required; Eligibility. There shall at --------------------------------------- all times be a Trustee hereunder which shall be (a) a corporation organized and doing business under the laws of the United States, any State or Territory thereof or the District of Columbia, authorized under such laws to exercise corporate trust powers, having a combined capital and surplus of at least $50,000,000 and subject to supervision or examination by Federal or State authority, or (b) if and to the extent permitted by the Commission by rule, regulation or order upon application, a corporation or other Person organized and doing business under the laws of a foreign government, authorized under such laws to exercise corporate trust powers, having a combined capital and surplus of at least $50,000,000 or the Dollar equivalent of the applicable foreign currency and subject to supervision or examination by authority of such foreign government or a political subdivision thereof substantially equivalent to supervision or examination applicable to United States institutional trustees, and, in either case, qualified and eligible under this Article and the Trust Indenture Act. If such corporation publishes reports of condition at least annually, pursuant to law or to the requirements of such supervising or examining authority, then for the purposes of this Section, the combined capital and surplus of such corporation shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time the Trustee shall cease to be eligible in accordance with the provisions of this Section, it shall resign immediately in the manner and with the effect hereinafter specified in this Article. Section 910 Resignation and Removal; Appointment of Successor. (a) No ------------------------------------------------- resignation or removal of the Trustee and no appointment of a successor Trustee pursuant to this Article shall become effective until the acceptance of appointment by the successor Trustee in accordance with the applicable requirements of Section 911. (b) The Trustee may resign at any time with respect to the Securities of one or more series by giving written notice thereof to the Company. If the instrument of acceptance by a successor Trustee required by Section 911 shall not have been delivered to the Trustee within 30 days after the giving of such notice of resignation, the resigning Trustee may petition any court of competent jurisdiction for the appointment of a successor Trustee with respect to the Securities of such series. 49 (c) The Trustee may be removed at any time with respect to the Securities of any series by Act of the Holders of a majority in principal amount of the Outstanding Securities of such series delivered to the Trustee and to the Company. (d) If at any time: (1) the Trustee shall fail to comply with Section 908 after written request therefor by the Company or by any Holder who has been a bona fide Holder for at least six months, or (2) the Trustee shall cease to be eligible under Section 909 and shall fail to resign after written request therefor by the Company or by any such Holder, or (3) the Trustee shall become incapable of acting or shall be adjudged a bankrupt or insolvent or a receiver of the Trustee or of its property shall be appointed or any public officer shall take charge or control of the Trustee or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, then, in any such case, (x) the Company by a Board Resolution may remove the Trustee with respect to all Securities or (y) subject to Section 814, any Holder who has been a bona fide Holder for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the removal of the Trustee with respect to all Securities and the appointment of a successor Trustee or Trustees. (e) If the Trustee shall resign, be removed or become incapable of acting, or if a vacancy shall occur in the office of Trustee for any cause (other than as contemplated in clause (y) in Subsection (d) of this Section), with respect to the Securities of one or more series, the Company shall promptly appoint a successor Trustee or Trustees with respect to the Securities of that or those series (it being understood that any such successor Trustee may be appointed with respect to the Securities of one or more or all of such series and that at any time there shall be only one Trustee with respect to the Securities of any particular series) and shall comply with the applicable requirements of Section 911. If, within one year after such resignation, removal or incapability, or the occurrence of such vacancy, a successor Trustee with respect to the Securities of any series shall be appointed by Act of the Holders of a majority in principal amount of the Outstanding Securities of such series delivered to the Company and the retiring Trustee, the successor Trustee so appointed shall, forthwith upon its acceptance of such appointment in accordance with the applicable requirements of Section 911, become the successor Trustee with respect to the Securities of such series and to that extent supersede the successor Trustee appointed by the Company. If no successor Trustee with respect to the Securities of any series shall have been so appointed by the Company or the Holders and accepted appointment in the manner required by Section 911, any Holder who has been a bona fide Holder of a Security of such series for at least six months may, on behalf of itself and all others similarly situated, petition any court of competent jurisdiction for the appointment of a successor Trustee with respect to the Securities of such series. 50 (f) So long as no event which is, or after notice or lapse of time, or both, would become, an Event of Default shall have occurred and be continuing, and except with respect to a Trustee appointed by Act of the Holders of a majority in principal amount of the Outstanding Securities pursuant to Subsection (e) of this Section, if the Company shall have delivered to the Trustee (i) a Board Resolution appointing a successor Trustee, effective as of a date specified therein, and (ii) an instrument of acceptance of such appointment, effective as of such date, by such successor Trustee in accordance with Section 911, the Trustee shall be deemed to have resigned as contemplated in Subsection (b) of this Section, the successor Trustee shall be deemed to have been appointed by the Company pursuant to Subsection (e) of this Section and such appointment shall be deemed to have been accepted as contemplated in Section 911, all as of such date, and all other provisions of this Section and Section 911 shall be applicable to such resignation, appointment and acceptance except to the extent inconsistent with this Subsection (f). (g) The Company (or, should the Company fail so to act promptly, the successor trustee at the expense of the Company) shall give notice of each resignation and each removal of the Trustee with respect to the Securities of any series and each appointment of a successor Trustee with respect to the Securities of any series by mailing written notice of such event by first-class mail, postage prepaid, to all Holders of Securities of such series as their names and addresses appear in the Security Register. Each notice shall include the name of the successor Trustee with respect to the Securities of such series and the address of its corporate trust office. Section 911 Acceptance of Appointment by Successor. (a) In case of the -------------------------------------- appointment hereunder of a successor Trustee with respect to the Securities of all series, every such successor Trustee so appointed shall execute, acknowledge and deliver to the Company and to the retiring Trustee an instrument accepting such appointment, and thereupon the resignation or removal of the retiring Trustee shall become effective and such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee; but, on the request of the Company or the successor Trustee, such retiring Trustee shall, upon payment of all sums owed to it, execute and deliver an instrument transferring to such successor Trustee all the rights, powers and trusts of the retiring Trustee and shall duly assign, transfer and deliver to such successor Trustee all property and money held by such retiring Trustee hereunder, subject nevertheless to its lien provided for in Section 907. (b) In case of the appointment hereunder of a successor Trustee with respect to the Securities of one or more (but not all) series, the Company, the retiring Trustee and each successor Trustee with respect to the Securities of one or more series shall execute and deliver an indenture supplemental hereto wherein each successor Trustee shall accept such appointment and which (1) shall contain such provisions as shall be necessary or desirable to transfer and confirm to, and to vest in, each successor Trustee all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series to which the appointment of such successor Trustee relates, (2) if the retiring Trustee is not retiring with respect to all Securities, shall contain such provisions as shall be deemed necessary or desirable to confirm that all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series as to which the retiring 51 Trustee is not retiring shall continue to be vested in the retiring Trustee and (3) shall add to or change any of the provisions of this Indenture as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one Trustee, it being understood that nothing herein or in such supplemental indenture shall constitute such Trustees co-trustees of the same trust and that each such Trustee shall be trustee of a trust or trusts hereunder separate and apart from any trust or trusts hereunder administered by any other such Trustee; and upon the execution and delivery of such supplemental indenture the resignation or removal of the retiring Trustee shall become effective to the extent provided therein and each such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series to which the appointment of such successor Trustee relates; but, on request of the Company or any successor Trustee, such retiring Trustee, upon payment of all sums owed to it, shall duly assign, transfer and deliver to such successor Trustee all property and money held by such retiring Trustee hereunder with respect to the Securities of that or those series to which the appointment of such successor Trustee relates, subject nevertheless to its lien provided for in Section 907. (c) Upon request of any such successor Trustee, the Company shall execute any instruments which fully vest in and confirm to such successor Trustee all such rights, powers and trusts referred to in Subsection (a) or (b) of this Section, as the case may be. (d) No successor Trustee shall accept its appointment unless at the time of such acceptance such successor Trustee shall be qualified and eligible under this Article. Section 912 Merger, Conversion, Consolidation or Succession to --------------------------------------------------------- Business. Any Person into which the Trustee may be merged or converted or with - -------- which it may be consolidated, or any Person resulting from any merger, conversion or consolidation to which the Trustee shall be a party, or any Person succeeding to all or substantially all the corporate trust business of the Trustee, shall be the successor of the Trustee hereunder, provided such Person shall be otherwise qualified and eligible under this Article, without the execution or filing of any paper or any further act on the part of any of the parties hereto. In case any Securities shall have been authenticated, but not delivered, by the Trustee then in office, any successor by merger, conversion or consolidation to such authenticating Trustee may adopt such authentication and deliver the Securities so authenticated with the same effect as if such successor Trustee had itself authenticated such Securities. Section 913 Preferential Collection of Claims Against Company. If the ------------------------------------------------- Trustee shall be or become a creditor of the Company or any other obligor upon the Securities (other than by reason of a relationship described in Section 311(b) of the Trust Indenture Act), the Trustee shall be subject to any and all applicable provisions of the Trust Indenture Act regarding the collection of claims against the Company or such other obligor. For purposes of Section 311(b) of the Trust Indenture Act: (a) the term "cash transaction" means any transaction in which full payment for goods or securities sold is made within seven days after delivery of the goods or securities in currency or in checks or other orders drawn upon banks or bankers and payable upon demand; (b) the term "self-liquidating paper" means any draft, bill of exchange, acceptance or obligation which is made, drawn, negotiated or incurred by the Company for the purpose of financing the purchase, processing, 52 manufacturing, shipment, storage or sale of goods, wares or merchandise and which is secured by documents evidencing title to, possession of, or a lien upon, the goods, wares or merchandise or the receivables or proceeds arising from the sale of the goods, wares or merchandise previously constituting the security, provided the security is received by the Trustee simultaneously with the creation of the creditor relationship with the Company arising from the making, drawing, negotiating or incurring of the draft, bill of exchange, acceptance or obligation. Section 914 Co-trustees and Separate Trustees. At any time or times, --------------------------------- for the purpose of meeting the legal requirements of any applicable jurisdiction, the Company and the Trustee shall have power to appoint, and, upon the written request of the Trustee or of the Holders of at least 33% in principal amount of the Securities then Outstanding, the Company shall for such purpose join with the Trustee in the execution and delivery of all instruments and agreements necessary or proper to appoint, one or more Persons approved by the Trustee either to act as co-trustee, jointly with the Trustee, or to act as separate trustee, in either case with such powers as may be provided in the instrument of appointment, and to vest in such Person or Persons, in the capacity aforesaid, any property, title, right or power deemed necessary or desirable, subject to the other provisions of this Section. If the Company does not join in such appointment within 15 days after the receipt by it of a request so to do, or if an Event of Default shall have occurred and be continuing, the Trustee alone shall have power to make such appointment. Should any written instrument or instruments from the Company be required by any co-trustee or separate trustee so appointed to more fully confirm to such co-trustee or separate trustee such property, title, right or power, any and all such instruments shall, on request, be executed, acknowledged and delivered by the Company. Every co-trustee or separate trustee shall, to the extent permitted by law, but to such extent only, be appointed subject to the following conditions: (a) the Securities shall be authenticated and delivered, and all rights, powers, duties and obligations hereunder in respect of the custody of securities, cash and other personal property held by, or required to be deposited or pledged with, the Trustee hereunder, shall be exercised solely, by the Trustee; (b) the rights, powers, duties and obligations hereby conferred or imposed upon the Trustee in respect of any property covered by such appointment shall be conferred or imposed upon and exercised or performed either by the Trustee or by the Trustee and such co-trustee or separate trustee jointly, as shall be provided in the instrument appointing such co-trustee or separate trustee, except to the extent that under any law of any jurisdiction in which any particular act is to be performed, the Trustee shall be incompetent or unqualified to perform such act, in which event such rights, powers, duties and obligations shall be exercised and performed by such co-trustee or separate trustee; (c) the Trustee at any time, by an instrument in writing executed by it, with the concurrence of the Company, may accept the resignation of or remove any co-trustee or separate trustee appointed under this Section, and, if an Event of Default shall have occurred and be continuing, the Trustee shall have power to accept the resignation of, or remove, any such co-trustee or separate 53 trustee without the concurrence of the Company. Upon the written request of the Trustee, the Company shall join with the Trustee in the execution and delivery of all instruments and agreements necessary or proper to effectuate such resignation or removal. A successor to any co-trustee or separate trustee so resigned or removed may be appointed in the manner provided in this Section; (d) no co-trustee or separate trustee hereunder shall be personally liable by reason of any act or omission of the Trustee, or any other such trustee hereunder; and the Trustee shall not be personally liable by reason of any act or omission of any other such trustee hereunder; and (e) any Act of Holders delivered to the Trustee shall be deemed to have been delivered to each such co-trustee and separate trustee. Section 915 Appointment of Authenticating Agent. The Trustee may -------------------------------------- appoint an Authenticating Agent or Agents with respect to the Securities of one or more series, or Tranche thereof, which shall be authorized to act on behalf of the Trustee to authenticate Securities of such series or Tranche issued upon original issuance and upon exchange, registration of transfer or partial redemption thereof or pursuant to Section 306, and Securities so authenticated shall be entitled to the benefits of this Indenture and shall be valid and obligatory for all purposes as if authenticated by the Trustee hereunder. Wherever reference is made in this Indenture to the authentication and delivery of Securities by the Trustee or the Trustee's certificate of authentication, such reference shall be deemed to include authentication and delivery on behalf of the Trustee by an Authenticating Agent and a certificate of authentication executed on behalf of the Trustee by an Authenticating Agent. Each Authenticating Agent shall be acceptable to the Company and shall at all times be a corporation organized and doing business under the laws of the United States, any State or territory thereof or the District of Columbia, authorized under such laws to act as Authenticating Agent, having a combined capital and surplus of not less than $50,000,000 and subject to supervision or examination by Federal or State authority. If such Authenticating Agent publishes reports of condition at least annually, pursuant to law or to the requirements of said supervising or examining authority, then for the purposes of this Section, the combined capital and surplus of such Authenticating Agent shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time an Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, such Authenticating Agent shall resign immediately in the manner and with the effect specified in this Section. Any corporation into which an Authenticating Agent may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which such Authenticating Agent shall be a party, or any corporation succeeding to the corporate agency or corporate trust business of an Authenticating Agent, shall continue to be an Authenticating Agent, provided such corporation shall be otherwise eligible under this Section, without the execution or filing of any paper or any further act on the part of the Trustee or the Authenticating Agent. An Authenticating Agent may resign at any time by giving written notice thereof to the Trustee and to the Company. The Trustee may at any time terminate the agency of an Authenticating Agent by giving written notice thereof to such 54 Authenticating Agent and to the Company. Upon receiving such a notice of resignation or upon such a termination, or in case at any time such Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, the Trustee may appoint a successor Authenticating Agent which shall be acceptable to the Company. Any successor Authenticating Agent upon acceptance of its appointment hereunder shall become vested with all the rights, powers and duties of its predecessor hereunder, with like effect as if originally named as an Authenticating Agent. No successor Authenticating Agent shall be appointed unless eligible under the provisions of this Section. The Company agrees to pay to each Authenticating Agent from time to time reasonable compensation for its services under this Section. The provisions of Sections 308, 904 and 905 shall be applicable to each Authenticating Agent. If an appointment with respect to the Securities of one or more series shall be made pursuant to this Section, the Securities of such series may have endorsed thereon, in addition to the Trustee's certificate of authentication, an alternate certificate of authentication substantially in the following form: This is one of the Securities of the series designated therein referred to in the within-mentioned Indenture. Dated: ------------------------------------------------ As Trustee By ------------------------------------------------ As Authenticating Agent By ------------------------------------------------ Authorized Signatory If all of the Securities of a series may not be originally issued at one time, and if the Trustee does not have an office capable of authenticating Securities upon original issuance located in a Place of Payment where the Company wishes to have Securities of such series authenticated upon original issuance, the Trustee, if so requested by the Company in writing (which writing need not comply with Section 102 and need not be accompanied by an Opinion of Counsel), shall appoint, in accordance with this Section and in accordance with such procedures as shall be acceptable to the Trustee, an Authenticating Agent having an office in a Place of Payment designated by the Company with respect to such series of Securities. 55 ARTICLE TEN HOLDERS' LISTS AND REPORTS BY TRUSTEE AND COMPANY ------------------------------------------------- Section 1001 Lists of Holders. Semiannually, not later than January 1 ---------------- and July 1 in each year, commencing January 1, 2003 and at such other times as the Trustee may request in writing, the Company shall furnish or cause to be furnished to the Trustee information as to the names and addresses of the Holders, and the Trustee shall preserve such information and similar information received by it in any other capacity and afford to the Holders access to information so preserved by it, all to such extent, if any, and in such manner as shall be required by the Trust Indenture Act; provided, however, that no such list need be furnished so long as the Trustee shall be the Security Registrar. Section 1002 Reports by Trustee and Company. Not later than July 15 in ------------------------------ each year, commencing with the year 2003, the Trustee shall transmit to the Holders, the Commission and each securities exchange upon which any Securities are listed, a report, dated as of the next preceding May 15, with respect to any events and other matters described in Section 313(a) of the Trust Indenture Act, in such manner and to the extent required by the Trust Indenture Act. The Trustee shall transmit to the Holders, the Commission and each securities exchange upon which any Securities are listed, and the Company shall file with the Trustee (within 30 days after filing with the Commission in the case of reports which pursuant to the Trust Indenture Act must be filed with the Commission and furnished to the Trustee) and transmit to the Holders, such other information, reports and other documents, if any, at such times and in such manner, as shall be required by the Trust Indenture Act. The Company shall notify the Trustee of the listing of any Securities on any securities exchange. Delivery of such reports, information and documents filed with the Commission pursuant to the Securities Exchange Act of 1934, as amended, to the Trustee is for informational purposes only, and the Trustee's receipt of such shall not constitute notice or constructive notice of any information contained therein or determinable from information contained therein, including the Company's compliance with any of its covenants hereunder (as to which the Trustee is entitled to rely exclusively on Officer's Certificates). ARTICLE ELEVEN CONSOLIDATION, MERGER, CONVEYANCE OR OTHER TRANSFER --------------------------------------------------- Section 1101 Company May Consolidate, etc. Only on Certain Terms. The ------------------------ Company shall not consolidate with or merge into any other Person, or convey or otherwise transfer or lease its properties and assets substantially as an entirety to any Person, unless (a) the Person formed by such consolidation or into which the Company is merged or the Person which acquires by conveyance or transfer, or which leases, the properties and assets of the Company substantially as an entirety shall be a Person organized and validly existing under the laws of the United States, any State thereof or the District of Columbia, and shall expressly assume, by an indenture supplemental hereto, executed and delivered to the Trustee, in form satisfactory to the Trustee, the due and punctual payment of the principal of and premium, if any, and interest, if any, on all Outstanding Securities and the performance of every covenant of this Indenture on the part of the Company to be performed or observed; 56 (b) immediately after giving effect to such transaction no Event of Default, and no event which, after notice or lapse of time or both, would become an Event of Default, shall have occurred and be continuing; and (c) the Company shall have delivered to the Trustee an Officer's Certificate and an Opinion of Counsel, each stating that such consolidation, merger, conveyance, or other transfer or lease and such supplemental indenture comply with this Article and that all conditions precedent herein provided for relating to such transactions have been complied with. Section 1102 Successor Person Substituted. Upon any consolidation by ----------------------------- the Company with or merger by the Company into any other Person or any conveyance, or other transfer or lease of the properties and assets of the Company substantially as an entirety in accordance with Section 1101, the successor Person formed by such consolidation or into which the Company is merged or the Person to which such conveyance, transfer or lease is made shall succeed to, and be substituted for, and may exercise every right and power of, the Company under this Indenture with the same effect as if such successor Person had been named as the Company herein, and thereafter, except in the case of a lease, the predecessor Person shall be relieved of and released from all obligations and covenants under this Indenture and the Securities Outstanding hereunder. ARTICLE TWELVE SUPPLEMENTAL INDENTURES ----------------------- Section 1201 Supplemental Indentures Without Consent of Holders. ------------------------------------------------------- Without the consent of any Holders, the Company and the Trustee, at any time and from time to time, may enter into one or more indentures supplemental hereto, in form satisfactory to the Trustee, for any of the following purposes: (a) to evidence the succession of another Person to the Company and the assumption by any such successor of the covenants of the Company herein and in the Securities, all as provided in Article Eleven; or (b) to add one or more covenants of the Company or other provisions for the benefit of all Holders or for the benefit of the Holders of, or to remain in effect only so long as there shall be Outstanding, Securities of one or more specified series, or one or more specified Tranches thereof, or to surrender any right or power herein conferred upon the Company; or (c) to add any additional Events of Default with respect to all or any series of Securities Outstanding hereunder; or (d) to change or eliminate any provision of this Indenture or to add any new provision to this Indenture; provided, however, that if such change, elimination or addition shall adversely affect the interests of the Holders of Securities of any series or Tranche Outstanding on the date of such indenture supplemental hereto in any material respect, such change, elimination or addition shall become effective with respect to such series or Tranche only 57 pursuant to the provisions of Section 1202 hereof or when no Security of such series or Tranche remains Outstanding; or (e) to provide collateral security for all but not part of the Securities; or (f) to establish the form or terms of Securities of any series or Tranche as contemplated by Sections 201 and 301; or (g) to provide for the authentication and delivery of bearer securities and coupons appertaining thereto representing interest, if any, thereon and for the procedures for the registration, exchange and replacement thereof and for the giving of notice to, and the solicitation of the vote or consent of, the holders thereof, and for any and all other matters incidental thereto; or (h) to evidence and provide for the acceptance of appointment hereunder by a separate or successor Trustee or co-trustee with respect to the Securities of one or more series and to add to or change any of the provisions of this Indenture as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one Trustee, pursuant to the requirements of Section 911(b); or (i) to provide for the procedures required to permit the Company to utilize, at its option, a noncertificated system of registration for all, or any series or Tranche of, the Securities; or (j) to change any place or places where (1) the principal of and premium, if any, and interest, if any, on all or any series of Securities, or any Tranche thereof, shall be payable, (2) all or any series of Securities, or any Tranche thereof, may be surrendered for registration of transfer, (3) all or any series of Securities, or any Tranche thereof, may be surrendered for exchange and (4) notices and demands to or upon the Company in respect of all or any series of Securities, or any Tranche thereof, and this Indenture may be served; or (k) to cure any ambiguity, to correct or supplement any provision herein which may be defective or inconsistent with any other provision herein, or to make any other changes to the provisions hereof or to add other provisions with respect to matters or questions arising under this Indenture, provided that such other changes or additions shall not adversely affect the interests of the Holders of Securities of any series or Tranche in any material respect. Without limiting the generality of the foregoing, if the Trust Indenture Act as in effect at the date of the execution and delivery of this Indenture or at any time thereafter shall be amended and (x) if any such amendment shall require one or more changes to any provisions hereof or the inclusion herein of any additional provisions, or shall by operation of law be deemed to effect such changes or incorporate such provisions by reference or otherwise, this Indenture shall be deemed to have been amended so as to conform to such amendment to the Trust Indenture Act, and the Company and the Trustee may, without the consent of any Holders, enter into an indenture supplemental hereto to effect or evidence such changes or additional provisions; or 58 (y) if any such amendment shall permit one or more changes to, or the elimination of, any provisions hereof which, at the date of the execution and delivery hereof or at any time thereafter, are required by the Trust Indenture Act to be contained herein, the Company and the Trustee may, without the consent of any Holders, enter into an indenture supplemental hereto to effect such change or elimination herein. Section 1202 Supplemental Indentures With Consent of Holders. With the ----------------------------------------------- consent of the Holders of a majority in aggregate principal amount of the Securities of all series then Outstanding under this Indenture, considered as one class, by Act of said Holders delivered to the Company and the Trustee, the Company, when authorized by a Board Resolution, and the Trustee may enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to, or changing in any manner or eliminating any of the provisions of, this Indenture or modifying in any manner the rights of the Holders of Securities of such series under the Indenture; provided, however, that if there ----------------- shall be Securities of more than one series Outstanding hereunder and if a proposed supplemental indenture shall directly affect the rights of the Holders of Securities of one or more, but less than all, of such series, then the consent only of the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series so directly affected, considered as one class, shall be required; and provided, further, that if the Securities of any series shall have been issued in more than one Tranche and if the proposed supplemental indenture shall directly affect the rights of the Holders of Securities of one or more, but less than all, of such Tranches, then the consent only of the Holders of a majority in aggregate principal amount of the Outstanding Securities of all Tranches so directly affected, considered as one class, shall be required; and provided, further, that no such supplemental ------------------ indenture shall: (a) change the Stated Maturity of the principal of, or any installment of principal of or interest on, any Security, or reduce the principal amount thereof or the rate of interest thereon (or the amount of any installment of interest thereon) or change the method of calculating such rate or reduce any premium payable upon the redemption thereof, or reduce the amount of the principal of a Discount Security that would be due and payable upon a declaration of acceleration of the Maturity thereof pursuant to Section 802, or change the coin or currency (or other property), in which any Security or any premium or the interest thereon is payable, or impair the right to institute suit for the enforcement of any such payment on or after the Stated Maturity of any Security (or, in the case of redemption, on or after the Redemption Date), without, in any such case, the consent of the Holder of such Security, or (b) reduce the percentage in principal amount of the Outstanding Securities of any series, or any Tranche thereof, the consent of the Holders of which is required for any such supplemental indenture, or the consent of the Holders of which is required for any waiver of compliance with any provision of this Indenture or of any default hereunder and its consequences, or reduce the requirements of Section 1304 for quorum or voting, without, in any such case, the consent of the Holders of each Outstanding Security of such series or Tranche, or (c) modify any of the provisions of this Section, Section 607 or Section 813 with respect to the Securities of any series, or any Tranche thereof, except to increase the percentages in principal amount referred to in this Section or such other Sections or to provide that other provisions of this 59 Indenture cannot be modified or waived without the consent of the Holder of each Outstanding Security affected thereby; provided, however, that this clause shall not be deemed to require the consent of any Holder with respect to changes in the references to "the Trustee" and concomitant changes in this Section, or the deletion of this proviso, in accordance with the requirements of Sections 911(b), 914 and 1201(h). A supplemental indenture which changes or eliminates any covenant or other provision of this Indenture which has expressly been included solely for the benefit of one or more particular series of Securities, or one or more Tranches thereof, or which modifies the rights of the Holders of Securities of such series with respect to such covenant or other provision, shall be deemed not to affect the rights under this Indenture of the Holders of Securities of any other series or Tranche. It shall not be necessary for any Act of Holders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such Act shall approve the substance thereof. A waiver by a Holder of such Holder's right to consent under this Section shall be deemed to be a consent of such Holder. Section 1203 Execution of Supplemental Indentures. In executing, or ------------------------------------- accepting the additional trusts created by, any supplemental indenture permitted by this Article or the modifications thereby of the trusts created by this Indenture, the Trustee shall be entitled to receive, and (subject to Section 901) shall be fully protected in relying upon, an Opinion of Counsel stating that the execution of such supplemental indenture is authorized or permitted by this Indenture. The Trustee may, but shall not be obligated to, enter into any such supplemental indenture which affects the Trustee's own rights, duties, immunities or liabilities under this Indenture or otherwise. Section 1204 Effect of Supplemental Indentures. Upon the execution of --------------------------------- any supplemental indenture under this Article, this Indenture shall be modified in accordance therewith, and such supplemental indenture shall form a part of this Indenture for all purposes; and every Holder of Securities theretofore or thereafter authenticated and delivered hereunder shall be bound thereby. Any supplemental indenture permitted by this Article may restate this Indenture in its entirety, and, upon the execution and delivery thereof, any such restatement shall supersede this Indenture as theretofore in effect for all purposes. Section 1205 Conformity With Trust Indenture Act. Unless otherwise ------------------------------------- provided as contemplated by Section 301 with respect to any series of Securities, every supplemental indenture executed pursuant to this Article shall conform to the requirements of the Trust Indenture Act as then in effect. Section 1206 Reference in Securities to Supplemental Indentures. ------------------------------------------------------- Securities of any series, or any Tranche thereof, authenticated and delivered after the execution of any supplemental indenture pursuant to this Article may, and shall if required by the Trustee, bear a notation in form approved by the Trustee as to any matter provided for in such supplemental indenture. If the Company shall so determine, new Securities of any series, or any Tranche thereof, so modified as to conform, in the opinion of the Trustee and the Company, to any such supplemental indenture may be prepared and executed by the Company and authenticated and delivered by the Trustee in exchange for Outstanding Securities of such series or Tranche. 60 Section 1207 Modification Without Supplemental Indenture. If the terms ------------------------------------------- of any particular series of Securities shall have been established in a Board Resolution or an Officer's Certificate as contemplated by Section 301, and not in an indenture supplemental hereto, additions to, changes in or the elimination of any of such terms may be effected by means of a supplemental Board Resolution or Officer's Certificate, as the case may be, delivered to, and accepted by, the Trustee; provided, however, that such supplemental Board Resolution or Officer's ----------------- Certificate shall not be accepted by the Trustee or otherwise be effective unless all conditions set forth in this Indenture which would be required to be satisfied if such additions, changes or elimination were contained in a supplemental indenture shall have been appropriately satisfied. Upon the acceptance thereof by the Trustee, any such supplemental Board Resolution or Officer's Certificate shall be deemed to be a "supplemental indenture" for purposes of Sections 1204 and 1206. ARTICLE THIRTEEN MEETINGS OF HOLDERS; ACTION WITHOUT MEETING ------------------------------------------- Section 1301 Purposes for Which Meetings May Be Called. A meeting of ------------------------------------------ Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, may be called at any time and from time to time pursuant to this Article to make, give or take any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be made, given or taken by Holders of Securities of such series or Tranches. Section 1302 Call, Notice and Place of Meetings. The Trustee may at any ---------------------------------- time call a meeting of Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, for any purpose specified in Section 1301, to be held at such time and at such place in the Borough of Manhattan, The City of New York, as the Trustee shall determine, or, with the approval of the Company, at any other place. Notice of every such meeting, setting forth the time and the place of such meeting and in general terms the action proposed to be taken at such meeting, shall be given, in the manner provided in Section 106, not less than 21 nor more than 180 days prior to the date fixed for the meeting. (b) If the Trustee shall have been requested to call a meeting of the Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, by the Company or by the Holders of 33% in aggregate principal amount of all of such series and Tranches, considered as one class, for any purpose specified in Section 1301, by written request setting forth in reasonable detail the action proposed to be taken at the meeting, and the Trustee shall not have given the notice of such meeting within 21 days after receipt of such request or shall not thereafter proceed to cause the meeting to be held as provided herein, then the Company or the Holders of Securities of such series and Tranches in the amount above specified, as the case may be, may determine the time and the place in the Borough of Manhattan, The City of New York, or in such other place as shall be determined or approved by the Company, for such meeting and may call such meeting for such purposes by giving notice thereof as provided in Subsection (a) of this Section. (c) Any meeting of Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, shall be valid without notice if the 61 Holders of all Outstanding Securities of such series or Tranches are present in person or by proxy and if representatives of the Company and the Trustee are present, or if notice is waived in writing before or after the meeting by the Holders of all Outstanding Securities of such series, or any Tranche or Tranches thereof, or by such of them as are not present at the meeting in person or by proxy, and by the Company and the Trustee. Section 1303 Persons Entitled to Vote at Meetings. To be entitled to ------------------------------------ vote at any meeting of Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, a Person shall be (a) a Holder of one or more Outstanding Securities of such series or Tranches, or (b) a Person appointed by an instrument in writing as proxy for a Holder or Holders of one or more Outstanding Securities of such series or Tranches by such Holder or Holders. The only Persons who shall be entitled to attend any meeting of Holders of Securities of any series or Tranche shall be the Persons entitled to vote at such meeting and their counsel, any representatives of the Trustee and its counsel and any representatives of the Company and its counsel. Section 1304 Quorum; Action. The Persons entitled to vote a majority in ------------------- aggregate principal amount of the Outstanding Securities of the series and Tranches with respect to which a meeting shall have been called as hereinbefore provided, considered as one class, shall constitute a quorum for a meeting of Holders of Securities of such series and Tranches; provided, however, that if any action is to be taken at such meeting which this Indenture expressly provides may be taken by the Holders of a specified percentage, which is less than a majority, in principal amount of the Outstanding Securities of such series and Tranches, considered as one class, the Persons entitled to vote such specified percentage in principal amount of the Outstanding Securities of such series and Tranches, considered as one class, shall constitute a quorum. In the absence of a quorum within one hour of the time appointed for any such meeting, the meeting shall, if convened at the request of Holders of Securities of such series and Tranches, be dissolved. In any other case the meeting may be adjourned for such period as may be determined by the chairman of the meeting prior to the adjournment of such meeting. In the absence of a quorum at any such adjourned meeting, such adjourned meeting may be further adjourned for such period as may be determined by the chairman of the meeting prior to the adjournment of such adjourned meeting. Except as provided by Section 1305(e), notice of the reconvening of any meeting adjourned for more than 30 days shall be given as provided in Section 1302(a) not less than 10 days prior to the date on which the meeting is scheduled to be reconvened. Notice of the reconvening of an adjourned meeting shall state expressly the percentage, as provided above, of the principal amount of the Outstanding Securities of such series and Tranches which shall constitute a quorum. Except as limited by Section 1202, any resolution presented to a meeting or adjourned meeting duly reconvened at which a quorum is present as aforesaid may be adopted only by the affirmative vote of the Holders of a majority in aggregate principal amount of the Outstanding Securities of the series and Tranches with respect to which such meeting shall have been called, considered as one class; provided, however, that, except as so limited, any ------------------ resolution with respect to any action which this Indenture expressly provides may be taken by the Holders of a specified percentage, which is less than a majority, in principal amount of the Outstanding Securities of such series and 62 Tranches, considered as one class, may be adopted at a meeting or an adjourned meeting duly reconvened and at which a quorum is present as aforesaid by the affirmative vote of the Holders of such specified percentage in principal amount of the Outstanding Securities of such series and Tranches, considered as one class. Any resolution passed or decision taken at any meeting of Holders of Securities duly held in accordance with this Section shall be binding on all the Holders of Securities of the series and Tranches with respect to which such meeting shall have been held, whether or not present or represented at the meeting. Section 1305 Attendance at Meetings; Determination of Voting Rights; ---------------------- ------------------------------- Conduct and Adjournment of Meetings. (a) Attendance at meetings of Holders of - ------------------------------------- Securities may be in person or by proxy; and, to the extent permitted by law, any such proxy shall remain in effect and be binding upon any future Holder of the Securities with respect to which it was given unless and until specifically revoked by the Holder or future Holder of such Securities before being voted. (b) Notwithstanding any other provisions of this Indenture, the Trustee may make such reasonable regulations as it may deem advisable for any meeting of Holders of Securities in regard to proof of the holding of such Securities and of the appointment of proxies and in regard to the appointment and duties of inspectors of votes, the submission and examination of proxies, certificates and other evidence of the right to vote, and such other matters concerning the conduct of the meeting as it shall deem appropriate. Except as otherwise permitted or required by any such regulations, the holding of Securities shall be proved in the manner specified in Section 104 and the appointment of any proxy shall be proved in the manner specified in Section 104. Such regulations may provide that written instruments appointing proxies, regular on their face, may be presumed valid and genuine without the proof specified in Section 104 or other proof. (c) The Trustee shall, by an instrument in writing, appoint a temporary chairman of the meeting, unless the meeting shall have been called by the Company or by Holders as provided in Section 1302(b), in which case the Company or the Holders of Securities of the series and Tranches calling the meeting, as the case may be, shall in like manner appoint a temporary chairman. A permanent chairman and a permanent secretary of the meeting shall be elected by vote of the Persons entitled to vote a majority in aggregate principal amount of the Outstanding Securities of all series and Tranches represented at the meeting, considered as one class. (d) At any meeting each Holder or proxy shall be entitled to one vote for each $1 principal amount of Securities held or represented by him; provided, however, that no vote shall be cast or counted at any meeting in - ------------------ respect of any Security challenged as not Outstanding and ruled by the chairman of the meeting to be not Outstanding. The chairman of the meeting shall have no right to vote, except as a Holder of a Security or proxy. (e) Any meeting duly called pursuant to Section 1302 at which a quorum is present may be adjourned from time to time by Persons entitled to vote a majority in aggregate principal amount of the Outstanding Securities of all series and Tranches represented at the meeting, considered as one class; and the meeting may be held as so adjourned without further notice. 63 Section 1306 Counting Votes and Recording Action of Meetings. The vote ----------------------------------------------- upon any resolution submitted to any meeting of Holders shall be by written ballots on which shall be subscribed the signatures of the Holders or of their representatives by proxy and the principal amounts and serial numbers of the Outstanding Securities, of the series and Tranches with respect to which the meeting shall have been called, held or represented by them. The permanent chairman of the meeting shall appoint two inspectors of votes who shall count all votes cast at the meeting for or against any resolution and who shall make and file with the secretary of the meeting their verified written reports of all votes cast at the meeting. A record of the proceedings of each meeting of Holders shall be prepared by the secretary of the meeting and there shall be attached to said record the original reports of the inspectors of votes on any vote by ballot taken thereat and affidavits by one or more persons having knowledge of the facts setting forth a copy of the notice of the meeting and showing that said notice was given as provided in Section 1302 and, if applicable, Section 1304. Each copy shall be signed and verified by the affidavits of the permanent chairman and secretary of the meeting and one such copy shall be delivered to the Company, and another to the Trustee to be preserved by the Trustee, the latter to have attached thereto the ballots voted at the meeting. Any record so signed and verified shall be conclusive evidence of the matters therein stated. Section 1307 Action Without Meeting. In lieu of a vote of Holders at a ---------------------- meeting as hereinbefore contemplated in this Article, any request, demand, authorization, direction, notice, consent, waiver or other action may be made, given or taken by Holders by written instruments as provided in Section 104. ARTICLE FOURTEEN IMMUNITY OF INCORPORATORS, SHAREHOLDERS, OFFICERS AND DIRECTORS --------------------------------------------------------------- Section 1401 Liability Solely Corporate. No recourse shall be had for --------------------------- the payment of the principal of or premium, if any, or interest, if any, on any Securities, or any part thereof, or for any claim based thereon or otherwise in respect thereof, or of the indebtedness represented thereby, or upon any obligation, covenant or agreement under this Indenture, against any incorporator, shareholder, officer or director, as such, past, present or future of the Company or of any predecessor or successor corporation (either directly or through the Company or a predecessor or successor corporation), whether by virtue of any constitutional provision, statute or rule of law, or by the enforcement of any assessment or penalty or otherwise; it being expressly agreed and understood that this Indenture and all the Securities are solely corporate obligations, and that no personal liability whatsoever shall attach to, or be incurred by, any incorporator, shareholder, officer or director, past, present or future, of the Company or of any predecessor or successor corporation, either directly or indirectly through the Company or any predecessor or successor corporation, because of the indebtedness hereby authorized or under or by reason of any of the obligations, covenants or agreements contained in this Indenture or in any of the Securities or to be implied herefrom or therefrom, and that any such personal liability is hereby expressly waived and released as a condition of, and as part of the consideration for, the execution of this Indenture and the issuance of the Securities. ------------------------- This instrument may be executed in any number of counterparts, each of which so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument. 64 IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be duly executed, all as of the day and year first above written. OHIO EDISON COMPANY By: ------------------------------------------- Randy Scilla Assistant Treasurer THE BANK OF NEW YORK, as Trustee By: ------------------------------------------- Patricia Gallagher Vice President 65 EX-12 18 oe_ex12-2.txt OE FIXED CHARGE RATIO EXHIBIT 12.2 Page 1 OHIO EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, ----------------------------------------------------- 1999 2000 2001 2002 2003 -------- ------- ------- ------- ------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items......................... $297,689 $336,456 $350,212 $356,159 $292,925 Interest and other charges, before reduction for amounts capitalized..................................... 225,358 211,364 187,890 144,170 116,868 Provision for income taxes................................ 191,835 212,580 239,135 255,915 241,173 Interest element of rentals charged to income (a)......... 113,804 109,497 104,507 102,469 107,611 -------- -------- --------- --------- --------- Earnings as defined..................................... $828,686 $869,897 $881,744 $858,713 $758,577 ======== ======== ======== ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K: Interest on long-term debt................................ $178,217 $165,409 $150,632 $119,123 $ 91,068 Other interest expense.................................... 31,971 31,451 22,754 14,598 22,069 Subsidiaries' preferred stock dividend requirements....... 15,170 14,504 14,504 10,449 3,731 Adjustments to subsidiaries' preferred stock dividends to state on a pre-income tax basis...................... 2,770 2,296 2,481 2,661 3,014 Interest element of rentals charged to income (a)......... 113,804 109,497 104,507 102,469 107,611 -------- -------- -------- -------- -------- Fixed charges as defined................................ $341,932 $323,157 $294,878 $249,300 $227,493 ======== ======== ======== ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES .................................................. 2.42 2.69 2.99 3.44 3.33 ==== ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 91
EXHIBIT 12.2 Page 2 OHIO EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, ------------------------------------------------------------- 1999 2000 2001 2002 2003 -------- -------- -------- -------- ------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items........................... $297,689 $336,456 $350,212 $356,159 $292,925 Interest and other charges, before reduction for amounts capitalized....................................... 225,358 211,364 187,890 144,170 116,868 Provision for income taxes.................................. 191,835 212,580 239,135 255,915 241,173 Interest element of rentals charged to income (a)........... 113,804 109,497 104,507 102,469 107,611 -------- -------- -------- -------- -------- Earnings as defined....................................... $828,686 $869,897 $881,744 $858,713 $758,577 ======== ======== ======== ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS): Interest on long-term debt.................................. $178,217 $165,409 $150,632 $119,123 $ 91,068 Other interest expense...................................... 31,971 31,451 22,754 14,598 22,069 Preferred stock dividend requirements....................... 26,717 25,628 25,206 16,959 6,463 Adjustments to preferred stock dividends to state on a pre-income tax basis........................ 9,859 8,976 9,412 7,034 5,264 Interest element of rentals charged to income (a)........... 113,804 109,497 104,507 102,469 107,611 -------- -------- -------- -------- -------- Fixed charges as defined plus preferred stock dividend requirements (pre-income tax basis)............ $360,568 $340,961 $312,511 $260,183 $232,475 ======== ======== ======== ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS) ..................................... 2.30 2.55 2.82 3.30 3.26 ==== ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined.
92 EX-13 19 oe_ex13-1.txt EX 13-1 OE ANNUAL REPORT OHIO EDISON COMPANY 2003 ANNUAL REPORT TO STOCKHOLDERS Ohio Edison Company is a wholly owned electric utility operating subsidiary of FirstEnergy Corp. Ohio Edison engages in the generation, distribution and sale of electric energy to communities in an area of 7,500 square miles in central and northeastern Ohio and, through its wholly owned Pennsylvania Power Company subsidiary, 1,500 square miles in western Pennsylvania. It also engages in the sale, purchase and interchange of electric energy with other electric companies. Contents Page - -------- ---- Selected Financial Data............................................ 1 Management's Discussion and Analysis............................... 2-13 Consolidated Statements of Income.................................. 14 Consolidated Balance Sheets........................................ 15 Consolidated Statements of Capitalization.......................... 16-17 Consolidated Statements of Common Stockholder's Equity............. 18 Consolidated Statements of Preferred Stock......................... 18 Consolidated Statements of Cash Flows.............................. 19 Consolidated Statements of Taxes................................... 20 Notes to Consolidated Financial Statements......................... 21-39 Reports of Independent Auditors.................................... 40-41
OHIO EDISON COMPANY SELECTED FINANCIAL DATA 2003 2002 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------- (In thousands) Operating Revenues.......................... $2,925,832 $2,948,675 $3,056,464 $2,726,708 $2,686,949 --------------------------------------------------------------- Operating Income............................ $ 335,727 $ 453,831 $ 466,819 $ 482,321 $ 473,042 --------------------------------------------------------------- Income Before Cumulative Effect of Accounting Change........................ $ 292,925 $ 356,159 $ 350,212 $ 336,456 $ 297,689 ----------- ---------------------------------------------------- Net Income.................................. $ 324,645 $ 356,159 $ 350,212 $ 336,456 $ 297,689 --------------------------------------------------------------- Earnings on Common Stock.................... $ 321,913 $ 349,649 $ 339,510 $ 325,332 $ 286,142 --------------------------------------------------------------- Total Assets................................ $7,316,930 $7,790,041 $7,915,953 $8,154,151 $8,700,746 --------------------------------------------------------------- Capitalization as of December 31: Common Stockholder's Equity.............. $2,582,970 $2,839,255 $2,671,001 $2,556,992 $2,624,460 Preferred Stock: Not Subject to Mandatory Redemption.... 100,070 100,070 200,070 200,070 200,070 Subject to Mandatory Redemption........ -- 13,500 134,250 135,000 140,000 Long-Term Debt........................... 1,179,789 1,219,347 1,614,996 2,000,622 2,175,812 --------------------------------------------------------------- Total Capitalization................... $3,862,829 $4,172,172 $4,620,317 $4,892,684 $5,140,342 --------------------------------------------------------------- Capitalization Ratios: Common Stockholder's Equity.............. 66.9% 68.1% 57.8% 52.3% 51.1% Preferred Stock: Not Subject to Mandatory Redemption.... 2.6 2.4 4.3 4.1 3.9 Subject to Mandatory Redemption........ -- 0.3 2.9 2.7 2.7 Long-Term Debt........................... 30.5 29.2 35.0 40.9 42.3 --------------------------------------------------------------- Total Capitalization................... 100.0% 100.0% 100.0% 100.0% 100.0% --------------------------------------------------------------- Distribution Kilowatt-Hour Deliveries (Millions): Residential.............................. 10,009 10,233 9,646 9,432 9,483 Commercial............................... 8,105 7,994 7,967 8,221 8,238 Industrial............................... 10,658 10,672 10,995 11,631 11,310 Other.................................... 160 154 152 151 151 --------------------------------------------------------------- Total.................................... 28,932 29,053 28,760 29,435 29,182 --------------------------------------------------------------- Customers Served: Residential.............................. 1,044,419 1,041,825 1,033,414 1,014,379 1,016,793 Commercial............................... 127,856 119,771 118,469 116,931 115,581 Industrial............................... 1,182 4,500 4,573 4,569 4,627 Other.................................... 1,752 1,756 1,664 1,606 1,539 --------------------------------------------------------------- Total.................................... 1,175,209 1,167,852 1,158,120 1,137,485 1,138,540 --------------------------------------------------------------- Number of Employees ........................ 1,521 1,569 1,618 1,647 2,734
1 OHIO EDISON COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the continuing availability and operation of generating units, the inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage, a denial of or material change to the Company's Application related to its Rate Stabilization Plan, and other similar factors. Restatements - ------------ We restated our financial statements for the year ended December 31, 2002, to reflect a change in the method of amortizing the costs associated with the Ohio transition plan. Financial comparisons described below reflect the effect of these restatements on 2002 financial results. Results of Operations - --------------------- Earnings on common stock in 2003 decreased to $321.9 million from $349.6 million in 2002 and $339.5 million in 2001. The earnings decrease in 2003 primarily resulted from increased nuclear outage related costs, increased amortization of the Ohio transition regulatory assets and reduced operating revenues. These items were partially offset by reduced nuclear fuel expenses as a result of the additional nuclear outages, reduced financing costs and an after tax credit of $31.7 million from the cumulative effect of an accounting change due to the adoption of SFAS 143, "Accounting for Asset Retirement Obligations." Income before the cumulative effect was $292.9 million in 2003, compared to $356.2 million for 2002 and $350.2 million for 2001. Operating revenues decreased by $22.8 million or 0.7% in 2003 compared with 2002 due to cooler-than-normal temperatures in the second and third quarters of 2003 and increased sales by alternative suppliers. The lower revenues primarily resulted from reduced generation sales revenues, which included all retail customer categories - residential, commercial and industrial. Kilowatt-hour sales to retail customers declined by 8.1% in 2003 from the prior year, reducing generation sales revenue by $98.0 million. Electric generation services provided to retail customers by alternative suppliers as a percent of total kilowatt-hours delivered in the Company's franchise area increased 6.1 percentage points in 2003 from last year. Operating revenues decreased by $107.8 million or 3.5% in 2002 compared with 2001. The lower revenues reflected the effects of a sluggish national economy on our service area, shopping by Ohio customers for alternative energy providers and changes in wholesale revenues. Retail kilowatt-hour sales declined by 8.7% in 2002 from the prior year, with declines in all customer sectors (residential, commercial and industrial), resulting in a $73.1 million reduction in generation sales revenue. Our lower generation kilowatt-hour sales resulted primarily from customer choice in Ohio. Sales of electric generation by alternative suppliers as a percent of total sales delivered in our franchise area increased to 20.9% in 2002 from 12.5% in 2001, while our share of electric generation sales in our franchise areas decreased by 8.4% compared to the prior year. Distribution revenues from electricity throughput increased by $35.3 million in 2003 for all retail customer classes compared with 2002, primarily due to higher unit prices partially offset by the effects of slightly lower distribution deliveries in 2003. Distribution deliveries increased 1.0% in 2002 compared with 2001, which increased revenues from electricity throughput by $18.5 million in 2002 from the prior year. The higher distribution deliveries resulted from additional residential demand due to warmer summer weather that was offset in part by the effect that continued sluggishness in the economy had on demand by commercial and industrial customers. Operating revenues were further reduced in 2003 as a result of the Ohio transition plan incentives provided to customers to promote customer shopping for alternative suppliers - $8.1 million of additional credits in 2003 compared to 2 $27.6 million of additional credits in 2002 from 2001. These reductions in revenues are deferred for future recovery under the Company's transition plan and do not materially affect current period earnings. Sales revenues from wholesale customers increased by $46.7 million in 2003 compared with 2002. This reflected the effect of higher unit prices, which was partially offset by lower kilowatt-hour sales to the wholesale market due to reduced nuclear generation available for sale to FirstEnergy Solutions (FES), an affiliated company. Sales revenues from wholesale customers decreased by $18.0 million in 2002 compared to 2001, due to a decline in market prices. Changes in electric generation sales and distribution deliveries in 2003 compared to 2002 are summarized in the following table: Changes in Kilowatt-Hour Sales 2003 2002 ---------------------------------------------------------------------- Increase (Decrease) Electric Generation: Retail............................... (8.1)% (8.7)% Wholesale............................ (10.5)% 10.6% - -------------------------------------------------------------------- Total Electric Generation Sales........ (9.2)% (0.6)% =================================================================== Distribution Deliveries: Residential.......................... (2.2)% 6.1% Commercial........................... 1.4% 0.3% Industrial........................... (0.1)% (2.9)% - --------------------------------------------------------------------- Total Distribution Deliveries.......... (0.4)% 1.0% ================================================================== Operating Expenses and Taxes Total operating expenses and taxes increased by $95.3 million in 2003 and decreased by $94.8 million in 2002 from 2001. The following table presents changes from the prior year by expense category. Operating Expenses and Taxes - Changes 2003 2002 --------------------------------------------------------------------- Increase (Decrease) (In millions) Fuel and purchased power..................... $(19.9) $ (109.6) Nuclear operating costs...................... 80.2 (28.9) Other operating costs........................ 1.3 51.3 -------------------------------------------------------------------- Total operation and maintenance expenses... 61.6 (87.2) Provision for depreciation and amortization.. 52.6 (39.4) General taxes................................ (6.9) 23.5 Income taxes................................. (12.0) 8.3 -------------------------------------------------------------------- Total operating expenses and taxes......... $ 95.3 $(94.8) ===================================================================== Lower fuel costs in 2003 compared to 2002 resulted from reduced nuclear generation - down 10.5%. In 2003, the kilowatt-hour purchase requirements were lower than in 2002 because of reduced electric generation sales - those cost reductions were partially offset by the effect of higher unit costs. Higher nuclear operating costs in 2003 were driven by three nuclear refueling outages in 2003 - Beaver Valley Unit 1 (100% interest), Beaver Valley Unit 2 (55.62% interest) and the Perry Plant (35.24% interest) in 2003 compared with one refueling outage at Beaver Valley Unit 2 in 2002. The Beaver Valley Unit 1 and Perry refueling outages earlier in 2003 included additional unplanned work, which extended the length of the outages and increased their cost. Charges for depreciation and amortization increased by $52.6 million in 2003 compared to 2002 primarily from increased amortization of the Ohio transition regulatory assets ($57.9 million) and reduced transition plan regulatory asset deferrals ($27.3 million) in 2003. Partially offsetting these increases were higher shopping incentive deferrals ($8.1 million) and lower charges resulting from the implementation of SFAS 143 ($18.5 million), "Accounting for Asset Retirement Obligations." In 2002, depreciation and amortization decreased by $39.4 million compared to 2001 primarily due to higher shopping incentive deferrals and tax-related deferrals under the Ohio transition plan. General taxes decreased by $6.9 million in 2003 from 2002 principally due to settled property tax claims partially offset by higher kilowatt-hour taxes in Ohio. In 2002, general taxes increased by $23.5 million in 2002 from 2001 principally due to additional property taxes and the absence in 2002 of a one-time benefit of $15 million resulting from the successful resolution of certain property tax issues in the prior year. 3 Other Income Other income increased by $25.1 million in 2003 from the prior year, primarily due to the absence in 2003 of adjustments recorded in 2002 related to low-income housing investments. Net Interest Charges Net interest charges continued to trend lower, decreasing by $29.7 million in 2003 and by $44.8 million in 2002. We continued to redeem and refinance outstanding debt and preferred stock during 2003 - net redemptions and refinancing activities totaled $245.1 million and $542.0 million, respectively, and will result in annualized savings of $20.2 million. Cumulative Effect of Accounting Change Results for 2003 include an after-tax credit to net income of $31.7 million recorded upon the adoption of SFAS 143 in January 2003. We identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond at the Bruce Mansfield Plant. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $133.7 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $25.2 million. The cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $54.1 million increase to income, or $31.7 million net of income taxes. Capital Resources and Liquidity - ------------------------------- Our improving financial position reflects ongoing efforts to increase competitiveness and enhance shareholder value. We have continued to strengthen our financial position over the past five years by improving our fixed charge coverage ratios. Our mortgage indenture ratio, which is used to measure our ability to issue first mortgage bonds, increased from 6.21 in 1997 to 15.92 in 2003, which enhances our financial flexibility. Over the same period, our charter ratio, a measure of our ability to issue preferred stock, improved from 2.35 to 4.68 and our common stockholder's equity as a percentage of capitalization rose from approximately 48% at the end of 1997 to 66.9% at the end of 2003. Over the last five years, we have reduced the average cost of long-term debt from 7.77% in 1997 to 4.51% at the end of 2003. Changes in Cash Position As of December 31, 2003, we had $1.9 million of cash and cash equivalents, compared with $20.5 million as of December 31, 2002. The major sources for changes in these balances are summarized below. Cash Flows From Operating Activities Our consolidated net cash from operating activities is provided by our regulated energy services. Net cash provided from operating activities was $1.1 billion in 2003 and 2002 and $0.7 billion in 2001. Cash flows provided from 2003, 2002 and 2001 operating activities are as follows: Operating Cash Flows 2003 2002 2001 ---------------------------------------------------------------------- (In millions) Cash earnings (1)................ $ 689 $ 713 $743 Working capital and other........ 423 344 (75) ----------------------------------------------------------------------- Total............................ $1,112 $1,057 $668 ====================================================================== (1) Includes net income, depreciation and amortization, deferred income taxes, investment tax credits and major noncash charges. Net cash provided from operating activities increased $55 million in 2003 compared to 2002 due to a $79 million reduction in working capital requirements partially offset by a $24 million decrease from cash earnings. The change in net use of working capital primarily represents increases in accounts payable partially offset by decreased accounts receivable and higher tax accruals in 2003. Cash Flows From Financing Activities In 2003 and 2002, the net cash used for financing activities of $981.8 million and $598.6 million, respectively, primarily reflects the redemptions of debt and the payment of common stock dividends to FirstEnergy. The following table provides details regarding new issues and redemptions during 2003 and 2002: 4 Securities Issued or Redeemed 2003 2002 - ---------------------------------------------------------------------- (In millions) New Issues Pollution Control Notes............... $ -- $ 15 Unsecured Notes....................... 325 -- Long-Term Revolving Credit............ 40 -- - ---------------------------------------------------------------------- $ 365 $ 15 Redemptions First Mortgage Bonds.................. $ 410 $280 Pollution Control Notes............... 30 15 Secured Notes......................... 62 127 Preferred Stock....................... 1 221 Other, principally redemption premiums 17 4 - ---------------------------------------------------------------------- $ 520 $647 Short-term Borrowings, Net (use)/source of cash $(225) $162 - ---------------------------------------------------------------------- We had approximately $368.4 million of cash and temporary investments and approximately $182.9 million of short-term indebtedness at the end of 2003. Available borrowing capability under bilateral bank facilities totaled $142 million as of December 31, 2003. The Company and its wholly owned utility subsidiary, Pennsylvania Power Company (Penn), referred to as "Companies" had the capability to issue $2.1 billion of additional first mortgage bonds on the basis of property additions and retired bonds, although unsecured senior note indentures entered into by the Company in 2003 limit its ability to issue secured debt, including FMBs, subject to certain exceptions. Based upon applicable earnings coverage tests the Companies could issue a total of $2.6 billion of preferred stock (assuming no additional debt was issued) as of the end of 2003. We have the ability to borrow from our regulated affiliates and FirstEnergy to meet our short-term working capital requirements. FirstEnergy Service Company administers this money pool and tracks surplus funds of FirstEnergy and its regulated subsidiaries, as well as proceeds available from bank borrowings. Available bank borrowings include $1.75 billion from FirstEnergy's and the Company's revolving credit facilities. Companies receiving a loan under the money pool agreements must repay the principal amount of such a loan, together with accrued interest, within 364 days of borrowing the funds. The rate of interest is the same for each company receiving a loan from the pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47%. Our access to capital markets and costs of financing are dependent on the ratings of our securities and that of our holding company, FirstEnergy. The following table shows our securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. Ratings of Securities - ------------------------------------------------------------------------- Securities S&P Moody's Fitch - ------------------------------------------------------------------------- FirstEnergy Senior unsecured BB+ Baa3 BBB- Ohio Edison Senior secured BBB Baa1 BBB+ Senior unsecured BB+ Baa2 BBB Preferred stock BB Ba1 BBB- Penn Senior secured BBB- Baa1 BBB+ Senior unsecured (1) BB+ Baa2 BBB Preferred stock BB Ba1 BBB- - ------------------------------------------------------------------------- (1) Penn's only senior unsecured debt obligations are pollution control revenue refunding bonds issued in the name of the Ohio Air Quality Development Authority to which this rating applies. On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." Fitch affirmed the Companies' ratings. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy, and all of the securities of its electric utility operating companies. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." 5 On December 23, 2003, Standard & Poor's (S&P) lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". Except for OE's senior secured issue rating, which was left unchanged, all other subsidiary ratings were lowered one notch as well. The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions of the ratings included uncertainty regarding the timing of the Ohio Rate Plan filing (see Regulatory Matters), the pending final report on the August 14th blackout (see Power Outage), the outcome of the remedial phase of litigation relating to the Sammis plant (see Environmental Matters), and the extended Davis-Besse outage (the Companies have no ownership interest in Davis-Besse) and the related pending subpoena. S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of the credit ratings in December 2003 triggered cash and letter-of-credit collateral calls of FirstEnergy in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2. The ratings of OE and Penn were confirmed. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows From Investing Activities Net cash flows used in investing activities totaled $148 million in 2003 and $443 million in 2002. These net cash flows used for investing resulted from property additions for both years and notes to associated companies for 2002, which were offset in part by a reduction of the PNBV Capital Trust investment. Expenditures for property additions primarily include expenditures supporting our distribution of electricity. Our cash requirements in 2004 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without increasing our net debt and preferred stock outstanding. Available borrowing capacity under short-term credit facilities will be used to manage working capital requirements. Over the next three years, we expect to meet our contractual obligations with cash from operations. Thereafter, we expect to use a combination of cash from operations and funds from the capital markets. Our capital spending for the period 2004-2006 is expected to be about $438 million (excluding nuclear fuel) of which approximately $174 million applies to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $82 million, of which approximately $48 million relates to 2004. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $85 million and $43 million, respectively, as the nuclear fuel is consumed. Contractual Obligations - ----------------------- Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows:
2005- 2007- Contractual Obligations Total 2004 2006 2008 Thereafter - ---------------------------------------------------------------------------------------------------------------- (In millions) Long-term debt................... $1,639 $123 $182 $185 $1,149 Short-term borrowings............ 183 183 -- -- -- Preferred stock (1).............. 14 1 2 11 -- Capital leases (2)............... 15 4 9 1 1 Operating leases (2)............. 1,237 79 163 184 811 Purchases (3).................... 289 47 82 63 97 - -------------------------------------------------------------------------------------------------------------- Total....................... $3,377 $437 $438 $444 $2,058 - -------------------------------------------------------------------------------------------------------------- (1) Subject to mandatory redemption. (2) Operating lease payments are net of capital trust receipts of $591.0 million (see Note 2). (3) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing.
Off-Balance Sheet Arrangements - ------------------------------ Obligations not included on our Consolidated Balance Sheet primarily consist of sale and leaseback arrangements involving Perry Unit 1 and Beaver Valley Unit 2, which are reflected in the operating lease payments disclosed above (see Note 2 - Leases). The present value of these sale and leaseback operating lease commitments, net of trust investments, was $689 million as of December 31, 2003. Interest Rate Risk - ------------------ Our exposure to fluctuations in market interest rates is reduced since a significant portion of our debt has fixed interest rates, as noted in the following table which presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio, debt obligations and preferred stock with mandatory redemption provisions.
Comparison of Carrying Value to Fair Value - ------------------------------------------------------------------------------------------------------------------- There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - ------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets Investments Other Than Cash and Cash Equivalents- Fixed Income............... $308 $186 $37 $39 $ 17 $654 $1,241 $1,303 Average interest rate...... 7.8% 7.9% 8.1% 8.3% 8.2% 7.4% 7.6% ____________________________________________________________________________________________________________________ Liabilities Long-term Debt and Other Long-Term Obligations: Fixed rate.................... $123 $137 $ 5 $ 6 $179 $468 $ 918 $ 956 Average interest rate ..... 7.5% 7.2% 7.9% 7.9% 4.1% 6.0% 6.1% Variable rate................. $ 40 $681 $ 721 $ 721 Average interest rate...... 2.2% 2.3% 2.3% Preferred Stock Subject to Mandatory Redemption....... $ 1 $ 1 $ 1 $11 $ 14 $ 14 Average dividend rate...... 7.6% 7.6% 7.6% 7.6% 7.6% Short-term Borrowings......... $183 $ 183 $ 183 Average interest rate...... 1.2% 1.2% - -------------------------------------------------------------------------------------------------------------------
Equity Price Risk - ----------------- Included in our nuclear decommissioning trust investments are marketable equity securities carried at their market value of approximately $209 million and $148 million as of December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges would result in a $21 million reduction in fair value as of December 31, 2003 (see Note 1(L) - Cash and Financial Instruments). Outlook - ------- Our industry continues to transition to a more competitive environment. In 2001, all our customers could select alternative energy suppliers. We continue to deliver power to residential homes and businesses through our existing distribution systems, which remain regulated. Customer rates have been restructured into separate components to support customer choice. In Ohio and Pennsylvania, we have a continuing responsibility to provide power to those customers not choosing to receive power from an alternative energy supplier subject to certain limits. Adopting new approaches to regulation and experiencing new forms of competition have created new uncertainties. Regulatory Matters Ohio- Beginning on January 1, 2001, Ohio customers were able to choose their electricity suppliers. Ohio customer rates were restructured to establish separate charges for transmission, distribution, transition cost recovery and a generation-related component. When one of our Ohio customers elects to obtain power from an alternative supplier, we reduce the customer's bill with a "generation shopping credit," based on the regulated generation component (plus an incentive for OE customers), and the customer receives a generation charge from the alternative supplier. OE has continuing PLR responsibility to its franchise customers through December 31, 2005. Regulatory assets are costs which have been authorized by the Public Utilities Commission of Ohio (PUCO), the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy Regulatory Commission (FERC) for recovery from customers in future periods and, without such authorization, would have been charged to income when incurred. All of our regulatory assets are expected 7 to continue to be recovered under the provisions of our transition plan as discussed below. Our regulatory assets are as follows: Regulatory Assets as of December 31, - --------------------------------------------------------- Company 2003 2002 - --------------------------------------------------------- (In millions) Ohio Edison................ $1,450 $1,787 Penn....................... 28 151 - -------------------------------------------------------- Consolidated Total...... $1,478 $1,938 ======================================================== As part of our Ohio transition plan, we are obligated to supply electricity to customers who do not choose an alternative supplier. The Company is also required to provide 560 megawatts (MW) of low cost supply to unaffiliated alternative suppliers who serve customers within its service area. Our competitive retail sales affiliate, FES, acts as an alternate supplier for a portion of the load in its franchise area. On October 21, 2003, FirstEnergy's Ohio regulated subsidiaries filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate generation supply at stable prices, and continuing our support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for our Ohio customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of our support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, we are requesting: o Extension of the transition cost amortization period from 2006 to 2007; o Deferral of interest costs on the accumulated shopping incentives and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates under certain limited conditions. On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 23, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S.-Canada Power System Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. Pennsylvania- In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed 8 Rulemaking Order has closed. We are currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of and Penn's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. We are unable to predict the outcome of the investigation or the impact of the PPUC Order. Environmental Matters We believe we are in material compliance with current sulfur dioxide (SO2) and nitrogen oxide (NOx) reduction requirements under the Clean Air Act Amendments of 1990. In 1998, the Environmental Protection Agency (EPA) finalized regulations requiring additional NOx reductions from the Companies' Ohio and Pennsylvania facilities. Various regulatory and judicial actions have since sought to further define NOx reduction requirements. We continue to evaluate our compliance plans and other compliance options. Violations of federally approved SO2 regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. We cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a Compliance Order to nine utilities covering 44 power plants, including the W. H. Sammis Plant. In addition, the U.S. Department of Justice filed eight civil complaints against various investor-owned utilities, which included a complaint against the Companies in the U.S. District Court for the Southern District of Ohio. The NOV and complaint allege violations of the Clean Air Act based on operation and maintenance of the W. H. Sammis Plant dating back to 1984. The complaint requests permanent injunctive relief to require the installation of "best available control technology" and civil penalties of up to $27,500 per day of violation. On August 7, 2003, the United States District Court for the Southern District of Ohio ruled that 11 projects undertaken at the W. H. Sammis Plant between 1984 and 1998 required pre-construction permits under the Clean Air Act. The ruling concludes the liability phase of the case, which deals with applicability of Prevention of Significant Deterioration provisions of the Clean Air Act. The remedy phase, which is currently scheduled to be ready for trial beginning July 19, 2004, will address civil penalties and what, if any, actions should be taken to further reduce emissions at the plant. In the ruling, the Court indicated that the remedies it "may consider and impose involved a much broader, equitable analysis, requiring the Court to consider air quality, public health, economic impact, and employment consequences. The Court may also consider the less than consistent efforts of the EPA to apply and further enforce the Clean Air Act." The potential penalties that may be imposed, as well as the capital expenditures necessary to comply with substantive remedial measures that may be required, could have a material adverse impact on the Company's financial condition and results of operations. Management is unable to predict the ultimate outcome of this matter and no liability has been accrued as of December 31, 2003. As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. We cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Companies are lower than many regional competitors due to our diversified generation sources which includes the low or non-CO2 emitting gas-fired and nuclear generators. 9 Power Outage On August 14, 2003, various states in the northeast United States and southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest ISO and PJM Interconnection) to provide effective diagnostic support. We believe that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. We remain convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the Federal Energy Regulatory Commission (FERC) ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which are described above. Critical Accounting Policies - ---------------------------- Significant Accounting Policies We prepare our consolidated financial statements in accordance with accounting principles that are generally accepted in the United States (GAAP). Application of these principles often requires a high degree of judgment, estimates and assumptions that affect financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting these specific factors. Our more significant accounting policies are described below. Regulatory Accounting We are subject to regulation that sets the prices (rates) we are permitted to charge our customers based on the costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. As a result of the changing regulatory framework in Ohio and Pennsylvania, a significant amount of regulatory assets have been recorded - $1.5 billion as of December 31, 2003. We regularly review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for kilowatt-hours that have been delivered but not yet billed through the end of the accounting period. The determination of unbilled revenues requires management to make various estimates including: o Net energy generated or purchased for retail load o Losses of energy over distribution lines o Allocations to distribution companies within the FirstEnergy system o Mix of kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers 10 Pension and Other Postretirement Benefits Accounting FirstEnergy's reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions are dependent upon numerous factors resulting from actual plan experience and certain assumptions. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions FirstEnergy makes to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, FirstEnergy reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. FirstEnergy's assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by their pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. FirstEnergy's pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and their pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, our accrued pension costs as of June 30, 2003 increased by $67 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $85 million, recording an increase of $5 million in an intangible asset and crediting OCI by $53 million (offsetting previously recorded deferred tax benefits by $37 million). The remaining balance in OCI of $62 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $81 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, FirstEnergy will not be required to fund their pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. FirstEnergy's pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 1(J)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining their trend rate assumptions, FirstEnergy included the specific provisions of their health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in their health care plans, and projections of future medical trend rates. The effect on FirstEnergy's pension and OPEB costs and liabilities from changes in key assumptions are as follows:
Increase in Costs from Adverse Changes in Key Assumptions - ------------------------------------------------------------------------------------------------ Assumption Adverse Change Pension OPEB Total - ------------------------------------------------------------------------------------------------ (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 5 $ 15 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% na $26 $ 26 Increase in Minimum Liability - ----------------------------- Discount rate................ Decrease by 0.25% $104 na $104 - ----------------------------------------------------------------------------------------------
Ohio Transition Cost Amortization In connection with our Ohio transition plan, the PUCO determined allowable transition costs based on amounts recorded on the regulatory books of the Ohio electric utilities. These costs exceeded those deferred or capitalized on the Company's balance sheet prepared under GAAP since they included certain costs which have not yet been incurred. We use an effective interest method for amortizing its transition costs, often referred to as a "mortgage-style" amortization. The interest rate under this method is equal to the rate of return authorized by the PUCO in the transition plan for each respective company. In computing the transition cost amortization, we include only the portion of the transition revenues associated with transition costs included on the balance sheet prepared under GAAP. Revenues collected for the off balance sheet costs and the return associated with these costs are recognized as income when received. Long-Lived Assets In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. Nuclear Decommissioning In accordance with SFAS 143, we recognize ARO for the future decommissioning of our nuclear power plants. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. The scenarios consider settlement of the ARO at the expiration of the nuclear power plants' current license and settlement based on an extended license term. New Accounting Standards and Interpretations Adopted - ---------------------------------------------------- FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, we adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. We will adopt FIN 46R for all other types of entities effective March 31, 2004. We currently have transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. Upon adoption of FIN 46R effective December 31, 2003, we consolidated the PNBV Capital Trust (PNBV) which was created in 1996 to refinance debt in connection with sale and leaseback transactions. Consolidation of PNBV changed the trust investment of $361 million to an investment in collateralized lease bonds of $372 million. The $11 million increase represents the minority interest in the total assets of the trust. In reviewing the sale and leaseback arrangements, the Company also evaluated its interest in the owner trusts that acquired interests in the Perry Plant and Beaver Valley Unit 2. The Company was determined not to be the primary beneficiary of any of these owner trusts and was therefore not required to consolidate these entities. The leases are accounted for as operating leases in accordance with GAAP and their related obligations are disclosed in Note 2. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, 12 certain financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, we reclassified as debt the preferred stock of consolidated subsidiaries subject to mandatory redemption with a carrying value of approximately $14 million as of December 31, 2003. Prior to the adoption of SFAS 150, subsidiary preferred dividends on our Consolidated Statements of Income were included in net interest charges. Therefore, the application of SFAS 150 did not require the reclassification of such preferred dividends to net interest charges. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, we implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(F) and 1(I) for further discussions of SFAS 143. EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" In November 2003, the EITF reached consensus that certain quantitative and qualitative disclosures are required for debt and equity securities classified as available-for-sale or held-to-maturity. The guidance requires the disclosure of the aggregate amount of unrealized losses and the aggregate related fair value for investments with unrealized losses that have not been recognized as other-than-temporary impairments. We adopted the disclosure requirements of EITF Issue No. 03-1 as of December 31, 2003 (See Note 7(C)). 13
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------ (In thousands) OPERATING REVENUES (Note 1(K)).......................................... $2,925,832 $2,948,675 $3,056,464 ---------- ---------- ---------- OPERATING EXPENSES AND TAXES: Fuel and purchased power (Note 1(K))................................. 966,892 986,737 1,096,317 Nuclear operating costs.............................................. 432,315 352,129 381,047 Other operating costs (Note 1(K)).................................... 365,720 364,436 313,177 ---------- ---------- ---------- Total operation and maintenance expenses........................... 1,764,927 1,703,302 1,790,541 Provision for depreciation and amortization.......................... 438,121 385,520 424,920 General taxes........................................................ 170,078 177,021 153,506 Income taxes......................................................... 216,979 229,001 220,678 ---------- ---------- ---------- Total operating expenses and taxes................................. 2,590,105 2,494,844 2,589,645 ---------- ---------- ---------- OPERATING INCOME........................................................ 335,727 453,831 466,819 OTHER INCOME (Note 1(K))................................................ 67,991 42,859 68,681 ---------- ---------- ---------- INCOME BEFORE NET INTEREST CHARGES...................................... 403,718 496,690 535,500 ---------- ---------- ---------- NET INTEREST CHARGES: Interest on long-term debt........................................... 91,068 119,123 150,632 Allowance for borrowed funds used during construction and capitalized interest.............................. (6,075) (3,639) (2,602) Other interest expense............................................... 22,069 14,598 22,754 Subsidiaries' preferred stock dividend requirements.................. 3,731 10,449 14,504 ---------- ---------- ---------- Net interest charges............................................... 110,793 140,531 185,288 ---------- ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE.................... 292,925 356,159 350,212 Cumulative effect of accounting change (net of income taxes of $22,389,000) (Note 1(I))........................................... 31,720 -- -- ---------- ---------- ---------- NET INCOME.............................................................. 324,645 356,159 350,212 PREFERRED STOCK DIVIDEND REQUIREMENTS................................... 2,732 6,510 10,702 ---------- ---------- ---------- EARNINGS ON COMMON STOCK................................................ $ 321,913 $ 349,649 $ 339,510 ========== ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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OHIO EDISON COMPANY CONSOLIDATED BALANCE SHEETS As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------ (In thousands) ASSETS UTILITY PLANT: In service...................................................................... $5,269,042 $4,989,056 Less-Accumulated provision for depreciation..................................... 2,578,899 2,484,162 ---------- ---------- 2,690,143 2,504,894 ---------- ---------- Construction work in progress- Electric plant................................................................ 145,380 122,741 Nuclear Fuel.................................................................. 554 23,481 ---------- ---------- 145,934 146,222 ---------- ---------- 2,836,077 2,651,116 ---------- ---------- OTHER PROPERTY AND INVESTMENTS: Investments in lease obligation bonds (Note 2).................................. 383,510 402,565 Letter of credit collateralization (Note 2)..................................... 277,763 277,763 Nuclear plant decommissioning trusts............................................ 376,367 293,190 Long-term notes receivable from associated companies (Note 3(B)................. 508,594 503,827 Other........................................................................... 59,102 74,220 ---------- ---------- 1,605,336 1,551,565 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents....................................................... 1,883 20,512 Receivables- Customers (less accumulated provisions of $8,747,000 and $5,240,000, respectively, for uncollectible accounts)................................... 280,538 296,548 Associated companies.......................................................... 436,991 592,218 Other (less accumulated provision of $2,282,000 and $1,000,000 for uncollectible accounts)..................................................... 28,308 30,057 Notes receivable from associated companies...................................... 366,501 437,669 Materials and supplies, at average cost- Owned......................................................................... 79,813 58,022 Under consignment............................................................. -- 19,753 Prepayments and other........................................................... 14,390 11,804 ---------- ---------- 1,208,424 1,466,583 ---------- ---------- DEFERRED CHARGES: Regulatory assets............................................................... 1,477,969 1,937,709 Property taxes.................................................................. 59,279 59,035 Unamortized sale and leaseback costs............................................ 65,631 72,294 Other........................................................................... 64,214 51,739 ---------- ---------- 1,667,093 2,120,777 ---------- ---------- $7,316,930 $7,790,041 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholder's equity..................................................... $2,582,970 $2,839,255 Preferred stock not subject to mandatory redemption............................. 60,965 60,965 Preferred stock of consolidated subsidiary- Not subject to mandatory redemption........................................... 39,105 39,105 Subject to mandatory redemption (Note 3(F))................................... -- 13,500 Long-term debt and other long-term obligations - Preferred stock of consolidated subsidiary subject to mandatory redemption (Note 3(F)) ..................................................... 12,750 -- Other......................................................................... 1,167,039 1,219,347 ---------- ---------- 3,862,829 4,172,172 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt and preferred stock............................ 466,589 563,267 Short-term borrowings - Associated companies.......................................................... 11,334 225,345 Other......................................................................... 171,540 182,317 Accounts payable- Associated companies.......................................................... 271,262 145,981 Other......................................................................... 7,979 18,015 Accrued taxes................................................................... 560,345 466,064 Accrued interest................................................................ 18,714 28,209 Other........................................................................... 58,680 74,562 ---------- ---------- 1,566,443 1,703,760 ---------- ---------- NONCURRENT LIABILITIES: Accumulated deferred income taxes............................................... 867,691 1,017,629 Accumulated deferred investment tax credits..................................... 75,820 88,449 Asset retirement obligation..................................................... 317,702 -- Nuclear plant decommissioning costs............................................. -- 280,858 Retirement benefits............................................................. 331,829 247,531 Other........................................................................... 294,616 279,642 ---------- ---------- 1,887,658 1,914,109 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Notes 2 and 5)...................................... ---------- ---------- $7,316,930 $7,790,041 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
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OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDER'S EQUITY: Common stock, without par value, authorized 175,000,000 shares-100 shares outstanding ................................................................... $2,098,729 $2,098,729 Accumulated other comprehensive loss (Note 3(G))................................. (38,693) (59,495) Retained earnings (Note 3(A)).................................................... 522,934 800,021 ---------- ---------- Total common stockholder's equity............................................ 2,582,970 2,839,255 ---------- ---------- Number of Shares Optional Outstanding Redemption Price ---------------- -------------------- 2003 2002 Per Share Aggregate ---- ---- --------- --------- PREFERRED STOCK (Note 3(D)): Cumulative, $100 par value- Authorized 6,000,000 shares Not Subject to Mandatory Redemption: 3.90%................................ 152,510 152,510 $103.63 $15,804 15,251 15,251 4.40%................................ 176,280 176,280 108.00 19,038 17,628 17,628 4.44%................................ 136,560 136,560 103.50 14,134 13,656 13,656 4.56%................................ 144,300 144,300 103.38 14,917 14,430 14,430 ------- ------- ------- ---------- ---------- Total Not Subject to Mandatory Redemption............. 609,650 609,650 $63,893 60,965 60,965 ======= ======= ======= ---------- ---------- PREFERRED STOCK OF CONSOLIDATED SUBSIDIARY (Note 3(D)): Pennsylvania Power Company- Cumulative, $100 par value- Authorized 1,200,000 shares Not Subject to Mandatory Redemption: 4.24%................................ 40,000 40,000 $103.13 $ 4,125 4,000 4,000 4.25%................................ 41,049 41,049 105.00 4,310 4,105 4,105 4.64%................................ 60,000 60,000 102.98 6,179 6,000 6,000 7.75%................................ 250,000 250,000 100.00 25,000 25,000 25,000 ------- ------- ------- ---------- ---------- Total Not Subject to Mandatory Redemption....................... 391,049 391,049 $39,614 39,105 39,105 ======= ======= ======= ---------- ---------- Subject to Mandatory Redemption (Note 3(F)): 7.625%**............................. -- 142,500 -- 14,250 Redemption Within One Year**......... (750) ------- ------- ---------- ---------- Total Subject to Mandatory Redemption -- 142,500 -- 13,500 ======= ======= ---------- ----------
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OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont'd) As of December 31, 2003 2002 2003 2002 2003 2002 - ----------------------------------------------------------------------------------------------------------------- (In thousands) LONG-TERM DEBT (Note 3(E)): First mortgage bonds: Ohio Edison Company- Pennsylvania Power Company- 8.625% due 2003........ -- 150,000 9.740% due 2004-2019. 15,617 16,591 6.875% due 2005........ 80,000 80,000 7.500% due 2003...... -- 40,000 8.750% due 2022........ -- 50,960 6.375% due 2004...... 20,500 20,500 7.625% due 2023........ -- 75,000 6.625% due 2004...... 14,000 14,000 7.875% due 2023........ -- 93,500 8,500% due 2022...... 27,250 27,250 ------- ------- 7.625% due 2023...... 6,500 6,500 ------- ------- Total first mortgage bonds.. 80,000 449,460 83,867 124,841 163,867 574,301 ------- ------- ------- ------- ---------- ---------- Secured notes: Ohio Edison Company- Pennsylvania Power Company- 7.680% due 2005........ 109,081 162,504 5.400% due 2013...... 1,000 1,000 *1.050% due 2015........ 19,000 19,000 5.400% due 2017...... 10,600 10,600 6.750% due 2015........ 40,000 40,000 *1.100% due 2017...... 17,925 17,925 *3.250% due 2015........ 50,000 -- 5.900% due 2018...... 16,800 16,800 7.050% due 2020........ 60,000 60,000 *1.100% due 2021...... 14,482 14,482 *1.100% due 2021........ 443 443 6.150% due 2023...... 12,700 12,700 5.375% due 2028........ 13,522 13,522 *1.200% due 2027...... 10,300 10,300 5.625% due 2029........ 50,000 50,000 5.375% due 2028...... 1,734 1,734 5.950% due 2029........ 56,212 56,212 5.450% due 2028...... 6,950 6,950 *1.050% due 2030........ 60,400 60,400 6.000% due 2028...... 14,250 14,250 *1.100% due 2031........ 69,500 69,500 5.950% due 2029...... 238 238 ------- ------- *1.100% due 2033........ 57,100 57,100 5.450% due 2033........ 14,800 14,800 *2.250% due 2033........ 50,000 -- Limited Partnerships- 7.37% weighted average interest rate due 2004-2010. .......... 21,432 29,513 ------- ------- Total secured notes......... 671,490 632,994 106,979 106,979 778,469 739,973 ------- ------- ------- ------- ---------- ---------- Unsecured notes: Ohio Edison Company- Pennsylvania Power Company- *2.238% due 2005........ 40,000 -- *5.900% due 2033...... 5,200 5,200 4.000% due 2008........ 175,000 -- *2.500% due 2029...... 14,500 14,500 ------- ------- *1.120% due 2014........ 50,000 50,000 5.450% due 2015........ 150,000 -- 4.850% due 2015........ -- 50,000 *5.800% due 2016........ 47,725 47,725 *1.340% due 2018........ 33,000 33,000 *1.300% due 2018........ 23,000 23,000 *1.300% due 2023........ 50,000 50,000 4.300% due 2033........ -- 50,000 *4.650% due 2033........ 108,000 108,000 4.400% due 2033........ -- 30,000 ------- ------- Total unsecured notes....... 676,725 441,725 19,700 19,700 696,425 461,425 ------- ------- ------- ------- ---------- ---------- Preferred stock subject to mandatory redemption**............................................ 13,500 -- ---------- ---------- Capital lease obligations (Note 2)........................................................... 6,829 8,249 ---------- ---------- Net unamortized discount on debt............................................................. (12,712) (2,084) ---------- ---------- Long-term debt due within one year**......................................................... (466,589) (562,517) ---------- ---------- Total long-term debt and long-term obligations**............................................ 1,179,789 1,219,347 ---------- ---------- TOTAL CAPITALIZATION........................................................................ $3,862,829 $4,172,172 ========== ========== * Denotes variable rate issue with December 31, 2003 interest rate shown. ** The December 31, 2003 balance for preferred stock subject to mandatory redemption is classified as debt under SFAS 150 (see Note 6). The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
17
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY Accumulated Other Comprehensive Number Carrying Comprehensive Retained Income of Shares Value Income (Loss) Earnings ------------- --------- -------- ------------- -------- (Dollars in thousands) Balance, January 1, 2001....................... 100 $2,098,729 $ -- $458,263 Net income.................................. $350,212 350,212 ======== Cash dividends on preferred stock........... (10,703) Cash dividends on common stock.............. (225,500) - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001..................... 100 2,098,729 -- 572,272 Net income.................................. $356,159 356,159 Minimum liability for unfunded retirement benefits, net of $(45,525,000) of income taxes ............................. (64,585) (64,585) Unrealized gain on investments, net of $3,582,000 of income taxes................ 5,090 5,090 -------- Comprehensive income........................ $296,664 ======== Cash dividends on preferred stock........... (6,510) Cash dividends on common stock.............. (121,900) - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002..................... 100 2,098,729 (59,495) 800,021 Net income.................................. $324,645 324,645 Minimum liability for unfunded retirement benefits, net of $2,014,000 of income taxes ............................. 2,674 2,674 Unrealized gain on investments, net of $12,337,000 of income taxes............... 18,128 18,128 -------- Comprehensive income........................ $345,447 ======== Cash dividends on preferred stock........... (2,732) Cash dividends on common stock.............. (599,000) - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003..................... 100 $2,098,729 $(38,693) $522,934 ===================================================================================================================
CONSOLIDATED STATEMENTS OF PREFERRED STOCK Not Subject to Subject to Mandatory Redemption Mandatory Redemption -------------------- -------------------- Number Par Number Par of Shares Value of Shares Value --------- ----- --------- ----- (Dollars in thousands) Balance, January 1, 2001......... 5,000,699 $200,070 5,000,000 $ 140,000 Redemptions- 8.45% Series................ (50,000) (5,000) ------------------------------------------------------------------------------------ Balance, December 31, 2001....... 5,000,699 200,070 4,950,000 135,000 Redemptions - 7.75% Series................ (4,000,000) (100,000) 9.00% Series................ (4,800,000) (120,000) 7.625% Series................ (7,500) (750) ------------------------------------------------------------------------------------- Balance, December 31, 2002....... 1,000,699 100,070 142,500 14,250 Redemptions - 7.625% Series................ (7,500) (750) ------------------------------------------------------------------------------------- Balance, December 31, 2003....... 1,000,699 $100,070 135,000 $ 13,500* ===================================================================================== * December 31, 2003 balance for preferred stock subject to mandatory redemption is classified as debt under SFAS 150 (see Note 6). The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
18
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income............................................................... $ 324,645 $ 356,159 $ 350,212 Adjustments to reconcile net income to net cash from operating activities: Provision for depreciation and amortization......................... 438,121 385,520 424,920 Nuclear fuel and lease amortization................................. 39,317 47,597 45,417 Cumulative effect of accounting change.............................. (54,109) -- -- Deferred income taxes, net.......................................... (73,541) (61,987) (63,945) Investment tax credits, net......................................... (14,747) (13,732) (13,346) Receivables......................................................... 170,492 (41,584) (61,246) Materials and supplies.............................................. (2,038) (9,930) 64,177 Accounts payable.................................................... 132,983 182,229 (53,588) Other (Note 7)...................................................... 150,499 212,929 (24,912) ---------- ---------- --------- Net cash provided from operating activities....................... 1,111,622 1,057,201 667,689 ---------- ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Long-term debt........................................................ 365,000 14,500 111,584 Short-term borrowings, net............................................ -- 161,836 -- Redemptions and Repayments- Preferred stock....................................................... (750) (220,750) (5,000) Long-term debt........................................................ (519,506) (425,742) (233,158) Short-term borrowings, net............................................ (224,788) -- (69,606) Dividend Payments- Common stock.......................................................... (599,000) (121,900) (225,500) Preferred stock....................................................... (2,732) (6,510) (10,703) ---------- ---------- --------- Net cash used for financing activities............................ (981,776) (598,566) (432,383) ---------- ---------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Property additions....................................................... (189,019) (148,967) (145,427) Loan payments from (to) associated companies............................. 66,401 (327,876) (261,044) Sale of assets to associated companies................................... -- -- 154,596 Other (Note 7)........................................................... (25,857) 34,132 2,888 ---------- ---------- --------- Net cash used for investing activities............................ (148,475) (442,711) (248,987) ---------- ---------- --------- Net increase (decrease) in cash and cash equivalents..................... (18,629) 15,924 (13,681) Cash and cash equivalents at beginning of year........................... 20,512 4,588 18,269 ---------- ---------- --------- Cash and cash equivalents at end of year................................. $ 1,883 $ 20,512 $ 4,588 ========== ========== ========= SUPPLEMENTAL CASH FLOWS INFORMATION: Cash Paid During the Year- Interest (net of amounts capitalized)............................... $ 103,632 $ 118,535 $ 180,263 ========== ========== ========= Income taxes........................................................ $ 250,564 $ 126,558 $ 240,882 ========== ========== ========= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
19
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF TAXES For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------ (In thousands) GENERAL TAXES: Real and personal property............................................. $ 51,074 $ 65,709 $ 45,132 State gross receipts*.................................................. 18,028 18,516 45,271 Ohio kilowatt-hour excise*............................................. 91,296 85,762 55,795 Social security and unemployment....................................... 6,992 5,438 4,159 Other.................................................................. 2,688 1,596 3,149 -------- ---------- ---------- Total general taxes............................................... $170,078 $ 177,021 $ 153,506 ======== ========== ========== PROVISION FOR INCOME TAXES: Currently payable- Federal............................................................. $270,345 $ 280,587 $ 265,305 State............................................................... 81,505 55,796 51,121 -------- ---------- ---------- 351,850 336,383 316,426 -------- ---------- ---------- Deferred, net- Federal............................................................. (57,503) (44,552) (56,105) State............................................................... (16,038) (22,184) (7,840) -------- ---------- ---------- (73,541) (66,736) (63,945) -------- ---------- ---------- Investment tax credit amortization..................................... (14,747) (13,732) (13,346) -------- ---------- ---------- Total provision for income taxes.................................. $263,562 $ 255,915 $ 239,135 ======== ========== ========== INCOME STATEMENT CLASSIFICATION OF PROVISION FOR INCOME TAXES: Operating income....................................................... $216,979 $ 229,001 $ 220,678 Other income........................................................... 24,194 26,914 18,457 Cumulative effect of accounting change................................. 22,389 -- -- -------- ---------- ---------- Total provision for income taxes.................................. $263,562 $ 255,915 $ 239,135 ======== ========== ========== RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes.......................... $588,207 $ 612,074 $ 589,347 ======== ========== ========== Federal income tax expense at statutory rate........................... $205,872 $ 214,225 $ 206,271 Increases (reductions) in taxes resulting from- Amortization of investment tax credits.............................. (14,747) (13,732) (13,346) State income taxes, net of federal income tax benefit............... 42,554 21,848 28,133 Amortization of tax regulatory assets............................... 33,219 30,659 32,020 Other, net.......................................................... (3,336) 2,915 (13,943) -------- ---------- ---------- Total provision for income taxes.................................. $263,562 $ 255,915 $ 239,135 ======== ========== ========== ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: Property basis differences............................................. $406,783 $ 397,930 $ 374,138 Allowance for equity funds used during construction.................... 30,493 34,407 36,587 Regulatory transition charge........................................... 345,723 527,502 675,652 Customer receivables for future income taxes........................... 44,382 49,486 54,600 Deferred sale and leaseback costs...................................... (67,837) (71,830) (77,099) Unamortized investment tax credits..................................... (29,031) (33,421) (38,680) Deferred gain for asset sale to affiliated company..................... 53,010 70,812 85,311 Other comprehensive income............................................. (27,219) (41,570) -- Other (Note 7)......................................................... 111,387 84,313 64,886 -------- ---------- ---------- Net deferred income tax liability................................. $867,691 $1,017,629 $1,175,395 ======== ========== ========== * Collected from customers through regulated rates and included in revenue on the Consolidated Statements of Income. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include Ohio Edison Company (Company) and its wholly owned subsidiaries. Pennsylvania Power Company (Penn) is the Company's principal operating subsidiary. The Company is a wholly owned subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the issued and outstanding common shares of its other principal electric utility operating subsidiaries, including The Cleveland Electric Illuminating Company (CEI), The Toledo Edison Company (TE), American Transmission Systems, Inc. (ATSI), Jersey Central Power & Light Company (JCP&L), Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec). The Company and Penn (Companies) follow the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the Public Utilities Commission of Ohio (PUCO), the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. The Company's consolidated financial statements for the year ended December 31, 2002 were restated to reflect a change in the method of amortizing costs being recovered under the Ohio transition plan. Certain prior year amounts have been reclassified to conform with the current year presentation, as described further in Note 1(F). (A) CONSOLIDATION- The Company consolidates all majority-owned subsidiaries, over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) over which the Company has the ability to exercise significant influence, but not control, are accounted for on the equity basis. (B) REVENUES- The Companies' principal business is providing electric service to customers in central and northeastern Ohio and western Pennsylvania. The Companies' retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. Receivables from customers include sales to residential, commercial and industrial customers located in the Companies' service area and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of the Companies' customers. Total customer receivables were $281 million (billed - $165 million and unbilled - $116 million) and $297 million (billed - $169 million and unbilled - $128 million) as of December 31, 2003 and 2002, respectively. (C) REGULATORY MATTERS- Ohio- In July 1999, Ohio's electric utility restructuring legislation, which allowed Ohio electric customers to select their generation suppliers beginning January 1, 2001, was signed into law. Among other things, the legislation provided for a 5% reduction on the generation portion of residential customers' bills and the opportunity to recover transition costs, including regulatory assets, from January 1, 2001 through December 31, 2005 (market development period). The period for the recovery of regulatory assets only can be extended up to December 31, 2010. The PUCO was authorized to determine the level of transition cost recovery, as well as the recovery period for the regulatory assets portion of those costs, in considering each Ohio electric utility's transition plan application. In July 2000, the PUCO approved FirstEnergy's transition plan for the Company, CEI and TE (Ohio Companies) as modified by a settlement agreement with major parties to the transition plan. The application of Statement of Financial Accounting Standards No. (SFAS) 71 , "Accounting for the Effects of Certain Types of Regulation" to the Company's generation business was discontinued with the issuance of the PUCO transition plan order, as described further below. Major provisions of the settlement agreement consisted of approval of recovery of the Company's generation-related transition costs as filed of $1.6 billion net of deferred income taxes and transition costs related to regulatory assets as filed of $1.0 billion net of deferred income taxes, with recovery through no later than 2006 for the Company except where a longer period of recovery is provided for in the settlement agreement. The generation-related transition costs include $1.0 billion, net of deferred income taxes, of impaired generating assets recognized as regulatory assets as described further below and $1.2 billion, net of deferred income taxes, of above market operating lease costs. 21 Also as part of the settlement agreement, FirstEnergy is giving preferred access over its subsidiaries to nonaffiliated marketers, brokers and aggregators to 560 megawatts (MW) of generation capacity through 2005 at established prices for sales to the Company's retail customers. Customer prices are frozen through the five-year market development period, which runs through the end of 2005, except for certain limited statutory exceptions, including the 5% reduction referred to above. In February 2003, the Company was authorized increases in annual revenues aggregating approximately $41 million to recover its higher tax costs resulting from the Ohio deregulation legislation. The Company's customers choosing alternative suppliers receive an additional incentive applied to the shopping credit (generation component) of 45% for residential customers, 30% for commercial customers and 15% for industrial customers. The amount of the incentive is deferred for future recovery from customers. Subject to approval by the PUCO, recovery will be accomplished by extending the transition cost recovery period. On October 21, 2003, the Ohio Companies filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate supply and continuing FirstEnergy's support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for the Ohio Companies' customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of FirstEnergy's support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, OE is requesting: o Extension of the transition cost amortization period from 2006 to 2007; o Deferral of interest costs on the accumulated shopping incentive and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates only under certain limited conditions. On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 23, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S.-Canada Power System Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. Pennsylvania- Pennsylvania enacted its electric utility competition law in 1996 with the phase-in of customer choice for generation suppliers completed as of January 1, 2001. In 1998, the PPUC authorized a rate restructuring plan for Penn, which essentially resulted in the deregulation of Penn's generation business. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the 22 Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. Penn is currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of Penn's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. The investigation is to determine whether Penn's reliability performance has deteriorated to a point below the level of service reliability that existed prior to the implementation of electric restructuring in Pennsylvania. Hearings will be held in August in this investigation and the Administrative Law Judge has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. Penn is unable to predict the outcome of the investigation or the impact of the PPUC Order. Transition Cost Amortization - The Company amortizes transition costs (see Regulatory Matters - Ohio) using the effective interest method. Under the current Ohio transition plan, total transition cost amortization is expected to approximate the following for 2004 through 2006. (In millions) --------------------------------- 2004.................. $471 2005.................. 553 2006.................. 146 --------------------------------- The decrease in amortization in 2006 results from the termination of generation-related transition cost recovery under the Ohio transition plan. Regulatory Assets- The Companies recognize, as regulatory assets, costs which the FERC, PUCO and PPUC have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are expected to continue to be recovered from customers under the Companies' respective transition and rate restructuring plans. Based on those plans, the Companies continue to bill and collect cost-based rates for their transmission and distribution services, which remain regulated; accordingly, it is appropriate that the Companies continue the application of SFAS 71 to those operations. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2003 2002 - ------------------------------------------------------------------------------ (In millions) Regulatory transition charge...................... $1,331 $1,761 Customer shopping incentives...................... 140 79 Customer receivables for future income taxes...... 115 127 Loss on reacquired debt........................... 29 28 Employee postretirement benefit costs............. 6 9 Nuclear decommissioning costs..................... (72) -- Component removal costs (Note 1(F))............... (72) (67) Other............................................. 1 1 - ------------------------------------------------------------------------------ Total........................................... $1,478 $1,938 ============================================================================== Regulatory Accounting for Generation Operations- The application of SFAS 71 was discontinued with respect to the Companies' generation operations. The SEC issued interpretive guidance regarding asset impairment measurement providing that any supplemental regulated cash flows such as a competitive transition charge (CTC) should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. Consistent with the SEC guidance, $1.2 billion of impaired plant investments were recognized by the Company as regulatory assets recoverable as transition costs through future regulatory cash flows and $227 million were recognized for Penn related to its 1998 impairment of its nuclear generating unit investments to be recovered through a CTC over a seven-year transition period. 23 Net assets included in utility plant relating to the operations for which the application of SFAS 71 was discontinued, compared to the respective company's total assets as of December 31, 2003 were $976 million and $6.59 billion, respectively, for the Company and $92 million and $921 million, respectively, for Penn. (D) UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction (except for the Companies' nuclear generating units which were adjusted to fair value) including payroll and related costs such as taxes, employee benefits, administrative and general costs, and interest costs incurred to place the assets in service. The Companies' accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. The Companies provide for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The annual composite rate for the Company's electric plant was approximately 2.8% in 2003 and 2.7% in 2002 and 2001. The annual composite rate for Penn's electric plant was approximately 2.6% in 2003 and 2.9% in 2002 and 2001. Nuclear Fuel - Nuclear fuel is recorded at original cost, which includes material, enrichment, fabrication and interest costs incurred prior to reactor load. The Companies amortize the cost of nuclear fuel based on the rate of consumption. (E) COMMON OWNERSHIP OF GENERATING FACILITIES- The Companies, together with CEI and TE, own and/or lease, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Companies' portions of operating expenses associated with jointly owned facilities are included in the corresponding operating expenses on the Consolidated Statements of Income. The amounts reflected on the Consolidated Balance Sheet under utility plant as of December 31, 2003 include the following:
Companies' Utility Accumulated Construction Ownership/ Plant Provision for Work in Leasehold Generating Units in Service Depreciation Progress Interest - ------------------------------------------------------------------------------------------------------------- (In millions) W. H. Sammis #7.................. $ 335 $ 165 $ -- 68.80% Bruce Mansfield #1, #2 and #3.... 991 529 -- 67.18% Beaver Valley #1 and #2.......... 192 35 110 77.81% Perry............................ 357 352 8 35.24% - ------------------------------------------------------------------------------------------------------------- Total....................... $1,875 $1,081 $118 =============================================================================================================
(F) ASSET RETIREMENT OBLIGATION- In January 2003, the Companies implemented SFAS 143, "Accounting for Asset Retirement Obligations", which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. The Companies identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond related to the Bruce Mansfield Plant. The ARO liability as of the date of adoption of SFAS 143 was $297.6 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. Accretion during 2003 was $20.1 million, bringing the ARO liability as of December 31, 2003 to $317.7 million. The ARO includes the Companies' obligation for nuclear decommissioning of the Beaver Valley and Perry generating facilities. The Companies' share of the obligation to decommission these units was developed based on site specific studies performed by an independent engineer. The Companies utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Companies maintain nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $376.4 million. In accordance with SFAS 143, the Companies ceased the accounting practice of depreciating non-regulated generation assets using a cost of removal component in the depreciation rates. That practice recognized accumulated 24 depreciation in excess of the historical cost of an asset because the removal cost would exceed the estimated salvage value. Beginning in 2003, the cost of removal related to non-regulated generation assets is charged to expense rather than to the accumulated provision for depreciation. In accordance with SFAS 71, the cost of removal on regulated plant assets continues to be accounted for as a component of depreciation rates and is recognized as a regulatory liability. The following table provides the effect on income as if SFAS 143 had been applied during 2002 and 2001. Effect of the Change in Accounting Principle Applied Retroactively 2002 2001 - ------------------------------------------------------------------------------ (In millions) Reported net income.................................... $356 $350 Increase (Decrease): Elimination of decommissioning expense................. 30 30 Depreciation of asset retirement cost.................. (1) (1) Accretion of ARO liability............................. (11) (10) Non-regulated generation cost of removal component, net 5 4 Income tax effect...................................... (9) (9) - ------------------------------------------------------------------------------- Net earnings increase.................................. 14 14 - ------------------------------------------------------------------------------ Net income adjusted.................................... $370 $364 ============================================================================== The following table provides the year-end balance of the ARO for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 -------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002 $278.8 Accretion in 2002 18.8 -------------------------------------------------------- Ending balance as of December 31, 2002 $297.6 -------------------------------------------------------- (G) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 3(C)). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date resulting in substantially no intrinsic value. If FirstEnergy had accounted for employee stock options under the fair value method of SFAS 123, "Accounting for Stock Compensation," a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 - ----------------------------------------------------------------- Valuation assumptions: Expected option term (years). 7.9 8.1 8.3 Expected volatility.......... 26.91% 23.31% 23.45% Expected dividend yield...... 5.09% 4.36% 5.00% Risk-free interest rate...... 3.67% 4.60% 4.67% Fair value per option.......... $5.09 $6.45 $4.97 - ----------------------------------------------------------------- The effects of applying fair value accounting to the Companies' stock options would not materially affect net income. (H) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. The Companies are included in FirstEnergy's consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with the Companies recognizing any tax losses or credits they contribute to the consolidated +return. 25 (I) CUMULATIVE EFFECT OF ACCOUNTING CHANGE- Results for 2003 include an after-tax credit to net income of $31.7 million recorded upon the adoption of SFAS 143 in January 2003. The Companies identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond at the Bruce Mansfield Plant. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $133.7 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $25.2 million. The ARO liability at the date of adoption was $297.6 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, the Companies had recorded decommissioning liabilities of $281 million. Penn expects substantially all of its nuclear decommissioning costs to be recoverable in rates over time. Therefore, Penn recognized a regulatory liability of $69 million upon adoption of SFAS 143 for the transition amounts related to establishing the ARO for nuclear decommissioning. The remaining cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, resulted in a $54.1 million increase to income, or $31.7 million net of income taxes. (J) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of the Companies' employees. The trusteed plans provide defined benefits based on years of service and compensation levels. FirstEnergy's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Companies recognize the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. The following sets forth the funded status of the plans and amounts recognized in the FirstEnergy's Consolidated Balance Sheets as of December 31: 26
Obligations and Funded Status Pension Benefits Other Benefits ----------------- ---------------- As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition.......................... -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------ Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $2,077 ====== ====== ======= ====== Change in fair value of plan assets Fair value of plan assets at beginning of year................................. $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------ Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ====== Funded status............................ $ (847) $ (977) $(1,831) (1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit)............................... 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ ------- ------ Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ====== Amounts Recognized in the Consolidated Balance Sheets As of December 31 ----------------------------------------- Accrued benefit cost..................... $ (438) $ (548) $(975) $(867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ------ ------ ----- ------ Net amount recognized.................... $ 144 $ 287 $(975) $(867) ====== ====== ===== ===== Companies' share of net amount recognized............................. $ 53 $ 57 $(249) $(171) ====== ====== ===== ===== Increase (decrease) in minimum liability included in other comprehensive income (net of tax)........................... $ (145) $ 444 $ -- $ -- Weighted-Average Assumptions Used to Determine Benefit Obligations As of December 31 ----------------------------------------- Discount rate........................... 6.25% 6.75% 6.25% 6.75% Rate of compensation increase........... 3.50% 3.50% Allocation of Plan Assets As of December 31 ----------------------------------------- Asset Category Equity securities..................... 70% 61% 71% 58% Debt securities....................... 27 35 22 29 Real estate........................... 2 2 -- -- Other................................. 1 2 7 13 --- --- --- -- Total................................. 100% 100% 100% 100% === === === === Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 ----------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889
FirstEnergy's net pension and other postretirement benefit costs for the three years ended December 31, 2003 were computed as follows: 27
Pension Benefits Other Benefits ---------------- -------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 --------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset)................................ -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ----- ----- ----- ---- ---- ---- Net periodic cost (income).............. $ 142 $ (29) $ (24) $177 $114 $ 92 ===== ===== ===== ==== ==== ==== Companies' share of net benefit costs... $ 24 $ 3 $ (3) $ 43 $ 15 $ 16 ===== ===== ===== ==== ==== ==== Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31 Discount rate.......................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets............................... 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase.......... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy. Assumed health care cost trend rates As of December 31 2003 2002 - ------------------------------------------------------------------------------ Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2008-2010 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Increase Point Decrease ------------------------------------------------------------------------------ (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, the accrued pension costs for the Companies as of June 30, 2003 increased by $67 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of their pension plan assets, the Companies reduced their minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $85 million, recording an increase of $5 million in an intangible asset and crediting OCI by $53 million (offsetting previously recorded deferred tax benefits by $37 million). The remaining balance in OCI of $62 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $81 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. 28 (K) TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and other income include transactions with affiliated companies, primarily ATSI, FirstEnergy Solutions Corp. (FES) and FirstEnergy Service Company (FESC). The Ohio transition plan, as discussed in the "Regulatory Matters" section, resulted in the corporate separation of FirstEnergy's regulated and unregulated operations in 2001. FES operates the generation businesses of the Companies, CEI and TE. As a result, the Companies entered into power supply agreements (PSA) whereby FES purchases all of the Companies' nuclear generation and the Companies purchase their power from FES to meet their "provider of last resort" obligations. The primary affiliated companies transactions are as follows: 2003 2002 2001 - ----------------------------------------------------------------------------- (In millions) Operating Revenues: PSA revenues from FES................ $384 $329 $ 356 Generating units rent from FES....... 178 178 179 Ground lease with ATSI............... 12 12 12 Operating Expenses: Purchased power under PSA............ 902 912 1,026 Transmission expense................. 65 85 61 FESC support services................ 116 141 147 Other Income: Interest income from ATSI............ 16 16 16 Interest income from FES............. 12 12 12 - ------------------------------------------------------------------------------ FirstEnergy does not bill directly or allocate any of its costs to any subsidiary company. Costs are allocated to the Companies from FESC, a subsidiary of FirstEnergy and a "mutual service company" as defined in Rule 93 of the Public Utility Holding Company Act of 1935 (PUHCA). The majority of costs are directly billed or assigned at no more than cost as determined by PUHCA Rule 91. The remaining costs are for services that are provided on behalf of more than one company, or costs that cannot be precisely identified and are allocated using formulas that are filed annually with the SEC on Form U-13-60. The current allocation or assignment formulas used and their bases include multiple factor formulas: each company's proportionate amount of FirstEnergy's aggregate direct payroll, number of employees, asset balances, revenues, number of customers, other factors and specific departmental charge ratios. Management believes that these allocation methods are reasonable. (L) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Consolidated Balance Sheets at cost, which approximates their fair market value. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Consolidated Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31:
2003 2002 - ---------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value - ---------------------------------------------------------------------------------------------------- (In millions) Long-term debt................................. $1,639 $1,677 $1,776 $1,861 Preferred stock*............................... $ 14 $ 14 $ 14 $ 14 Investments other than cash and cash equivalents: Debt securities: - Maturity (5-10 years)..................... $ 550 $ 534 $ 570 $ 539 - Maturity (more than 10 years)............. 469 548 458 532 Equity securities........................... -- -- 12 12 All other................................... 430 430 361 361 - ---------------------------------------------------------------------------------------------------- $1,449 $1,512 $1,401 $1,444 ==================================================================================================== * The December 31, 2003 amount is classified as debt under SFAS 150.
The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end 29 of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Companies' ratings. The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. The Companies have no securities held for trading purposes. See Note 7 for discussion of SFAS 115 activity related to available-for-sale securities. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "All other" in the table above) consist of equity securities ($209 million) and fixed income securities ($167 million) as of December 31, 2003. In 2001, unrealized gains and losses applicable to the decommissioning trusts were recognized in the trust investment with a corresponding change to the decommissioning liability. In 2003 and 2002, unrealized gains and losses applicable to the Company's decommissioning trusts were offset to OCI in accordance with SFAS 115, as fluctuations in the fair value of the trusts will eventually affect earnings. Realized gains (losses) are recognized as additions (reductions) to trust asset balances with an offset to earnings. For 2003 and 2002, net realized gains (losses) were approximately $5.1 million and $(3.4) million, respectively, and interest and dividend income totaled approximately $10.0 million and $8.9 million, respectively. 2. LEASES The Companies lease certain generating facilities, office space and other property and equipment under cancelable and noncancelable leases. The Company sold portions of its ownership interest in Perry Unit 1 and Beaver Valley Unit 2 and entered into operating leases on the portions sold for basic lease terms of approximately 29 years. During the terms of the leases, the Company continues to be responsible, to the extent of its individual combined ownership and leasehold interests, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. The Company has the right, at the end of the respective basic lease terms, to renew the leases for up to two years. The Company also has the right to purchase the facilities at the expiration of the basic lease term or any renewal term at a price equal to the fair market value of the facilities. The basic rental payments are adjusted when applicable federal tax law changes. OES Finance, Incorporated, a wholly owned subsidiary of the Company, maintains deposits pledged as collateral to secure reimbursement obligations relating to certain letters of credit supporting the Company's obligations to lessors under the Beaver Valley Unit 2 sale and leaseback arrangements. The deposits of approximately $278 million pledged to the financial institution providing those letters of credit are the sole property of OES Finance and are investments which are classified as "Held to Maturity." In the event of liquidation, OES Finance, as a separate corporate entity, would have to satisfy its obligations to creditors before any of its assets could be made available to the Company as sole owner of OES Finance common stock. Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 2003, are summarized as follows: 2003 2002 2001 - ------------------------------------------------------------------ (In millions) Operating leases Interest element......... $ 96.4 $100.9 $102.7 Other.................... 41.2 34.6 31.6 Capital leases Interest element......... 1.7 1.6 1.9 Other.................... 1.4 1.3 1.9 - ------------------------------------------------------------------ Total rentals............ $140.7 $138.4 $138.1 ================================================================== 30
The future minimum lease payments as of December 31, 2003, are: Operating Leases ----------------------------------- Capital Lease PNBV Capital Leases Payments Trust Net --------------------------------------------------------------------------------------------- (In millions) 2004...................................... $ 4.3 $ 137.8 $ 58.5 $ 79.3 2005...................................... 4.3 138.8 56.6 82.2 2006...................................... 4.3 139.9 59.5 80.4 2007...................................... 0.3 139.3 59.9 79.4 2008...................................... 0.3 139.6 34.9 104.7 Years thereafter.......................... 1.5 1,133.0 321.6 811.4 --------------------------------------------------------------------------------------------- Total minimum lease payments.............. 15.0 $1,828.4 $591.0 $1,237.4 ======== ====== ======== Executory costs........................... 5.3 ------------------------------------------------- Net minimum lease payments................ 9.7 Interest portion.......................... 2.9 ------------------------------------------------- Present value of net minimum lease payments.......................... 6.8 Less current portion...................... 1.5 ------------------------------------------------- Noncurrent portion........................ $ 5.3 =================================================
The Company invested in the PNBV Capital Trust, which was established to purchase a portion of the lease obligation bonds issued on behalf of lessors in the Company's Perry Unit 1 and Beaver Valley Unit 2 sale and leaseback transactions. The PNBV capital trust arrangement effectively reduces lease costs related to those transactions. 3. CAPITALIZATION: (A) RETAINED EARNINGS- Under the Company's first mortgage indenture, the Company's consolidated retained earnings unrestricted for payment of cash dividends on the Company's common stock were $519.0 million as of December 31, 2003. (B) EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)- An ESOP Trust funds most of the matching contribution for FirstEnergy's 401(k) savings plan. All of the Companies' full-time employees eligible for participation in the 401(k) savings plan are covered by the ESOP. The ESOP borrowed $200 million from the Company and acquired 10,654,114 shares of the Company's common stock (subsequently converted to FirstEnergy common stock) through market purchases. The ESOP loan is included in Other Property and Investments on the Consolidated Balance Sheets as of December 31, 2003 and 2002 as an investment with FirstEnergy related to the FirstEnergy savings plan. Dividends on ESOP shares are used to service the debt. Shares are released from the ESOP on a pro rata basis as debt service payments are made. As of December 31, 2003, the Company had approximately $49 million receivable from FirstEnergy representing reductions to the outstanding loan balance from the ESOP Trust that were paid to FirstEnergy since 1998 that were intended to be remitted to the Company; that receivable will be paid in March 2004. (C) STOCK COMPENSATION PLANS- FirstEnergy administers the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Several other stock compensation plans have been acquired through the mergers with GPU and Centerior - GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan), 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan) and Centerior Equity Plan. No further stock-based compensation can be awarded under these plans. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 2003 2002 2001 - ---------------------------------------------------------------------------- Restricted common shares granted...... -- 36,922 133,162 Weighted average market price ........ n/a (1) $36.04 $35.68 Weighted average vesting period (years).............................. n/a (1) 3.2 3.7 Dividends restricted.................. n/a (1) Yes -- (2) --------------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares; MYR Plan dividends are paid as unrestricted cash on 128,662 shares 31 Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price - ------------------------------------------------------------------------------ Balance, January 1, 2001.............. 5,021,862 24.09 (473,314 options exercisable)......... 24.11 Options granted..................... 4,240,273 28.11 Options exercised................... 694,403 24.24 Options forfeited................... 120,044 28.07 Balance, December 31, 2001............ 8,447,688 26.04 (1,828,341 options exercisable)....... 24.83 Options granted..................... 3,399,579 34.48 Options exercised................... 1,018,852 23.56 Options forfeited................... 392,929 28.19 Balance, December 31, 2002............ 10,435,486 28.95 (1,400,206 options exercisable)....... 26.07 Options granted..................... 3,981,100 29.71 Options exercised................... 455,986 25.94 Options forfeited................... 311,731 29.09 Balance, December 31, 2003............ 13,648,869 29.27 (1,919,662 options exercisable)....... 29.67 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. Options outstanding by plan and range of exercise price as of December 31, 2003 were as follows: Range of Options FirstEnergy Program Exercise Prices Outstanding ----------------------------------------------------------------------- FE plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU plan $23.75 - $35.92 501,734 Other plans 27,673 ---------------------------------------------------------------------- Total 13,648,869 ====================================================================== No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 1(G) - "Stock-Based Compensation." (D) PREFERRED AND PREFERENCE STOCK- All preferred stock may be redeemed by the Companies in whole, or in part, with 30-60 days' notice. The Company has eight million authorized and unissued shares of preference stock having no par value. (E) LONG-TERM DEBT- Each of the Companies has a first mortgage indenture under which it issues first mortgage bonds secured by a direct first mortgage lien on substantially all of its property and franchises, other than specifically excepted property. The Company also has a 1998 general mortgage under which it issues mortgage bonds based upon the pledge of a like amount of first mortgage bonds as security. These mortgage bonds therefore effectively enjoy the same lien on that 32 property. The Companies have various debt covenants under their respective financing arrangements. The most restrictive of their debt covenants relate to the nonpayment of interest and/or principal on debt which could trigger a default and the maintenance of minimum fixed charge ratios and debt to capitalization ratios. There also exists cross-default provisions among financing arrangements of FirstEnergy and the Companies. Based on the amount of bonds authenticated by the respective mortgage bond trustees through December 31, 2003, the Companies' annual sinking fund requirements for all bonds issued under the various mortgage indentures of the Companies amounts to $39 million. The Companies expect to deposit funds with their respective mortgage bond trustees in 2004 that will then be withdrawn upon the surrender for cancellation of a like principal amount of bonds, specifically authenticated for such purposes against unfunded property additions or against previously retired bonds. This method can result in minor increases in the amount of the annual sinking fund requirement. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) --------------------------------------------- 2004............................... $464 2005............................... 227 2006............................... 5 2007............................... 6 2008............................... 229 ------------------------------------------ Included in the table above are amounts for various variable interest rate long-term debt which have provisions by which individual debt holders have the option to "put back" or require the respective debt issuer to redeem their debt at those times when the interest rate may change prior to its maturity date. These amounts are $341.7 million, $50 million and $50 million in 2004, 2005 and 2008, respectively, which represents the next date at which the debt holders may exercise this provision. The Companies' obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds. Certain pollution control revenue bonds are entitled to the benefit of irrevocable bank letters of credit of $171.5 million and noncancelable municipal bond insurance policies of $288.9 million to pay principal of, or interest on, the pollution control revenue bonds. To the extent that drawings are made under the letters of credit or policies, the Companies are entitled to a credit against their obligation to repay those bonds. The Companies pay annual fees of 1.375% to 1.50% of the amounts of the letters of credit to the issuing banks and are obligated to reimburse the banks for any drawings thereunder. The Company had unsecured borrowings of $40 million as of December 31, 2003 under a $250 million long-term revolving credit facility agreement which expires May 12, 2005. The Company currently pays an annual facility fee of 0.20% on the total credit facility amount. The Company had no unsecured borrowings as of December 31, 2003 under a $125 million long-term revolving credit facility which expires October 23, 2006. The Company currently pays an annual facility fee of 0.25% on the total credit facility amount. The fees are subject to change based on changes to the Company's credit ratings. (F) LONG-TERM DEBT: PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- Effective July 1, 2003, upon adoption of SFAS 150 (see Note 6), the Companies reclassified as debt Penn's preferred stock subject to mandatory redemption. Prior year amounts were not reclassified. Penn's 7.625% series has an annual sinking fund requirement for 7,500 shares. The Companies' preferred shares are retired at $100 per share plus accrued dividends. Annual sinking fund requirements are approximately $750,000 in each year 2004 through 2006 and $11.25 million in 2007. (G) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholder's equity except those resulting from transactions with FirstEnergy. As of December 31, 2003, accumulated other comprehensive loss consisted of a minimum liability for unfunded retirement benefits of $(61.9) million and unrealized gains on investments in securities available for sale of $23.2 million. 4. SHORT-TERM BORROWINGS AND BANK LINES OF CREDIT: Short-term borrowings outstanding as of December 31, 2003, consisted of $21.9 million of bank borrowings and $149.7 million of OES Capital, Incorporated commercial paper. OES Capital is a wholly owned subsidiary of the 33 Company whose borrowings are secured by customer accounts receivable. OES Capital can borrow up to $170 million under a receivables financing agreement at rates based on certain bank commercial paper and is required to pay an annual fee of 0.50% on the amount of the entire finance limit. The receivables financing agreement expires in October 2004. As of December 31, 2003, the Company also had total short-term borrowings of $11.3 million from its affiliates. The weighted average interest rates on short-term borrowings outstanding as of December 31, 2003 and 2002, were 1.16% and 1.63%, respectively. The Company has lines of credit with domestic banks that provide for borrowings of up to $159 million under various interest rate options. Short-term borrowings may be made under these lines of credit on its unsecured notes. To assure the availability of these lines, the Company is required to pay annual commitment fees of 0.20%. These lines expire at various times during 2004. 5. COMMITMENTS AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- The Companies' current forecast reflects expenditures of approximately $438 million for property additions and improvements from 2004-2006, of which approximately $174 million is applicable to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $82 million, of which approximately $48 million applies to 2004. During the same periods, the Companies' nuclear fuel investments are expected to be reduced by approximately $85 million and $43 million, respectively, as the nuclear fuel is consumed. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on their ownership and leasehold interests in the Beaver Valley Station and the Perry Plant, the Companies' maximum potential assessment under the industry retrospective rating plan (assuming the other affiliate co-owners contribute their proportionate shares of any assessments under the retrospective rating plan) would be $192.0 million per incident but not more than $19.1 million in any one year for each incident. The Companies are also insured as to their respective interests in Beaver Valley and Perry under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Companies have also obtained approximately $537 million of insurance coverage for replacement power costs for their respective interests in Beaver Valley and Perry. Under these policies, the Companies can be assessed a maximum of approximately $29.1 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Companies intend to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Companies' plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Companies' insurance policies, or to the extent such insurance becomes unavailable in the future, the Companies would remain at risk for such costs. (C) ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Companies with regard to air and water quality and other environmental matters. The effects of compliance on the Companies with regard to environmental matters could have a material adverse effect on the Companies' earnings and competitive position. These environmental regulations affect the Companies' earnings and competitive position to the extent that they compete with companies that are not subject to such regulations and therefore do not bear the risk of costs associated with compliance, or failure to comply, with such regulations. Overall, the Companies believe they are in material compliance with existing regulations but are unable to predict future change in regulatory policies and what, if any, the effects of such change would be. In accordance with the Ohio transition plan discussed in "Regulatory Matters" in Note 1(C), generation operations and any related additional capital expenditures for environmental compliance are the responsibility of FirstEnergy's competitive services business unit. Clean Air Act Compliance The Companies are required to meet federally approved sulfur dioxide (SO2) regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The Environmental Protection Agency (EPA) has an interim enforcement policy for SO2 34 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Companies cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. The Companies are complying with SO2 reduction requirements under the Clean Air Act Amendments of 1990 by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or using emission allowances. NOx reductions required by the 1990 Amendments are being achieved through combustion controls and the generation of more electricity at lower-emitting plants. In September 1998, the EPA finalized regulations requiring additional NOx reductions from the Companies' Ohio and Pennsylvania facilities. The EPA's NOx Transport Rule imposes uniform reductions of NOx emissions (an approximate 85% reduction in utility plant NOx emissions from projected 2007 emissions) across a region of nineteen states (including Ohio and Pennsylvania) and the District of Columbia based on a conclusion that such NOx emissions are contributing significantly to ozone pollution in the eastern United States. State Implementation Plans (SIP) must comply by May 31, 2004 with individual state NOx budgets established by the EPA. Pennsylvania submitted a SIP that required compliance with the NOx budgets at the Companies' Pennsylvania facilities by May 1, 2003. The Companies' Pennsylvania facilities complied with the NOx budgets in 2003 and all facilities will comply with the NOx budgets in 2004 and thereafter. Ohio submitted a SIP that requires compliance with the NOx budgets at the Companies' Ohio facilities by May 31, 2004. National Ambient Air Quality Standards In July 1997, the EPA promulgated changes in the National Ambient Air Quality Standard (NAAQS) for ozone and proposed a new NAAQS for fine particulate matter. On December 17, 2003, the EPA proposed the "Interstate Air Quality Rule" covering a total of 29 states (including Ohio and Pennsylvania) and the District of Columbia based on proposed findings that air pollution emissions from 29 eastern states and the District of Columbia significantly contribute to nonattainment of the NAAQS for fine particles and/or the "8-hour" ozone NAAQS in other states. The EPA has proposed the Interstate Air Quality Rule to "cap-and-trade" NOx and SO2 emissions in two phases (Phase I in 2010 and Phase II in 2015). According to the EPA, SO2 emissions would be reduced by approximately 3.6 million tons in 2010, across states covered by the rule, with reductions ultimately reaching more than 5.5 million tons annually. NOx emission reductions would measure about 1.5 million tons in 2010 and 1.8 million tons in 2015. The future cost of compliance with these proposed regulations may be substantial and will depend if and how they are ultimately implemented by the states in which the Companies operate affected facilities. Mercury Emissions In December 2000, the EPA announced it would proceed with the development of regulations regarding hazardous air pollutants from electric power plants, identifying mercury as the hazardous air pollutant of greatest concern. On December 15, 2003, the EPA proposed two different approaches to reduce mercury emissions from coal-fired power plants. The first approach would require plants to install controls known as "maximum achievable control technologies" (MACT) based on the type of coal burned. According to the EPA, if implemented, the MACT proposal would reduce nationwide mercury emissions from coal-fired power plants by fourteen tons to approximately thirty-four tons per year. The second approach proposes a cap-and-trade program that would reduce mercury emissions in two distinct phases. Initially, mercury emissions would be reduced by 2010 as a "co-benefit" from implementation of SO2 and NOx emission caps under the EPA's proposed Interstate Air Quality Rule. Phase II of the mercury cap-and-trade program would be implemented in 2018 to cap nationwide mercury emissions from coal-fired power plants at fifteen tons per year. The EPA has agreed to choose between these two options and issue a final rule by December 15, 2004. The future cost of compliance with these regulations may be substantial. W. H. Sammis Plant In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a Compliance Order to nine utilities covering 44 power plants, including the W. H. Sammis Plant. In addition, the U.S. Department of Justice filed eight civil complaints against various investor-owned utilities, which included a complaint against the Companies in the U.S. District Court for the Southern District of Ohio. The NOV and complaint allege violations of the Clean Air Act based on operation and maintenance of the W. H. Sammis Plant dating back to 1984. The complaint requests permanent injunctive relief to require the installation of "best available control technology" and civil penalties of up to $27,500 per day of violation. On August 7, 2003, the United States District Court for the Southern District of Ohio ruled that 11 projects undertaken at the W. H. Sammis Plant between 1984 and 1998 required pre-construction permits under the Clean Air Act. The ruling concludes the liability phase of the case, which deals with applicability of Prevention of Significant Deterioration provisions of the Clean Air Act. The remedy phase, which is currently scheduled to be ready for trial beginning July 19, 2004, will address civil penalties and what, if any, actions should be taken to further reduce emissions at the plant. In the ruling, the Court indicated that the remedies it "may consider and impose involved a much broader, equitable analysis, requiring the Court to consider air quality, public health, economic impact, and employment consequences. The Court may also consider the less than consistent efforts of the EPA to apply and further enforce the Clean Air Act." The potential penalties that may be imposed, as well as the capital expenditures necessary to comply with substantive remedial measures that may be required, could have a material adverse impact on the Companies' financial condition 35 and results of operations. Management is unable to predict the ultimate outcome of this matter and no liability has been accrued as of December 31, 2003. Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but it failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. The Companies cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Companies is lower than many regional competitors due to the Companies' diversified generation sources which includes low or non-CO2 emitting gas-fired and nuclear generators. Clean Water Act Various water quality regulations, the majority of which are the result of the federal Clean Water Act and its amendments, apply to the Companies' plants. In addition, Ohio and Pennsylvania have water quality standards applicable to the Companies' operations. As provided in the Clean Water Act, authority to grant federal National Pollutant Discharge Elimination System water discharge permits can be assumed by a state. Ohio and Pennsylvania have assumed such authority. (D) LEGAL MATTERS- Various lawsuits, claims and proceedings related to the Companies' normal business operations are pending against FirstEnergy and its subsidiaries. On August 14, 2003, eight states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report falls far short of providing a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. 36 6. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS: FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, the Companies adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. The Companies will adopt FIN 46R for all other types of entities effective March 31, 2004. The Company currently has transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. Upon adoption of FIN 46R effective December 31, 2003, the Company consolidated the PNBV Capital Trust (PNBV) which was created in 1996 to refinance debt in connection with sale and leaseback transactions. Consolidation of PNBV changed the trust investment of $361 million to an investment in collateralized lease bonds of $372 million. The $11 million increase represents the minority interest in the total assets of the trust. In reviewing the sale and leaseback arrangements, the Company also evaluated its interest in the owner trusts that acquired interests in the Perry Plant and Beaver Valley Unit 2. The Company was determined not to be the primary beneficiary of any of these owner trusts and was therefore not required to consolidate these entities. The leases are accounted for as operating leases in accordance with GAAP and their related obligations are disclosed in Note 2. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, the Company reclassified as debt the preferred stock of consolidated subsidiaries subject to mandatory redemption with a carrying value of approximately $14 million as of December 31, 2003. Prior to the adoption of SFAS 150, subsidiary preferred dividends on the Company's Consolidated Statements of Income were included in net interest charges. Therefore, the application of SFAS 150 did not require the reclassification of such preferred dividends to net interest charges. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, the Companies implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(F) and 1(I) for further discussions of SFAS 143. EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" In November 2003, the EITF reached consensus that certain quantitative and qualitative disclosures are required for debt and equity securities classified as available-for-sale or held-to-maturity. The guidance requires the disclosure of the aggregate amount of unrealized losses and the aggregate related fair value for investments with unrealized losses that have not been recognized as other-than-temporary impairments. The Company has adopted the disclosure requirements of EITF Issue No. 03-1 as of December 31, 2003 (See Note 7(C)). 7. OTHER INFORMATION: The following financial data provides supplemental unaudited information to the consolidated financial statements previously reported in 2001: 37 (A) Consolidated Statements of Cash Flows (Unaudited) 2003 2002 2001 ---- ---- ---- (In thousands) Other Cash Flows From Operating Activities: Accrued taxes........................... $ 94,281 $208,945 $ 26,606 Accrued interest........................ (9,495) (4,844) (1,053) Prepayments and other................... (2,586) 38,737 26,393 All other............................... 68,299 (29,909) (76,858) ----------------------------------------------------------------------------- Total-Other........................... $150,499 $212,929 $(24,912) ============================================================================== Other Cash Flows from Investing Activities: Asset retirements and transfers......... $ 2,095 $ 7,476 $ 15,528 Nuclear decommissioning trust investments........................... (83,178) (15,688) (15,816) Other investments....................... 55,127 18,820 3,209 All other............................... 99 23,524 (33) ----------------------------------------------------------------------------- Total-Other........................... $(25,857) $ 34,132 $ 2,888 ============================================================================== (B) Consolidated Statements of Taxes (Unaudited) 2003 2002 2001 ---- ---- ---- (In thousands) Other Accumulated Deferred Income Taxes at December 31: Retirement Benefits..................... $(29,676) $ 20,969 $ 24,591 All other............................... 141,063 63,344 40,295 - ------------------------------------------------------------------------------ Total-Other........................... $111,387 $ 84,313 $ 64,886 ============================================================================== (C) SFAS 115 Activity Investments other than cash and cash equivalents in the table in Note 1(L) - Cash and Financial Instruments include available-for-sale securities, at fair value, with the following net results: 2003* 2002* - --------------------------------------------------------------- (In millions) Unrealized gains (losses)........... $ 30.7 $(17.5) Proceeds from sales................. 142.3 71.5 Realized gains (losses)............. 3.9 (3.1) - --------------------------------------------------------------- * Includes the available-for-sale securities of the Companies' decommissioning trusts. As of December 31, 2003 accumulated other comprehensive income (loss) for available-for-sale securities consisted of investments with net unrealized gains of $48.1 million and net unrealized losses of $6.8 million. The following table provides details for the available-for-sale securities with net unrealized losses as of December 31, 2003.
Less Than 12 Months 12 Months or More Total -------------------- -------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Security Type Value Losses Value Losses Value Losses - ------------------------------------------------------------------------------------------------------- (In millions) Equity Securities....... 3.7 1.1 21.0 5.6 24.7 6.7 Debt Securities......... 15.1 0.1 0.1 -- 15.2 0.1 - ----------------------------------------------------------------------------------------------------- Total............... 18.8 1.2 21.1 5.6 39.9 6.8 - -------------------------------------------------------------------------------------------------------
All of the aggregate unrealized losses related to available-for-sale securities in the table above are considered to be temporary in nature. These securities are primarily held by the Company's nuclear decommissioning trusts. The Company has the ability and intent to hold these securities for the period necessary to fund their cost. 38 8. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 2003 and 2002.
March 31, June 30, September 30, December 30, Three Months Ended 2003 2003 2003 2003(a) - ------------------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues............................... $742.8 $673.7 $774.9 $734.4 Operating Expenses and Taxes..................... 672.7 609.7 686.9 620.8 - ------------------------------------------------------------------------------------------------------------------- Operating Income................................. 70.1 64.0 88.0 113.6 Other Income..................................... 13.5 15.4 16.5 22.6 Net Interest Charges............................. 26.5 34.1 23.6 26.6 - ------------------------------------------------------------------------------------------------------------------- Income Before Cumulative Effect of Accounting Change........................................ 57.1 45.3 80.9 109.6 Cumulative Effect of Accounting Change (Net of Income Taxes)................................. 31.7 -- -- -- Net Income....................................... $ 88.8 $ 45.3 $ 80.9 $109.6 =================================================================================================================== Earnings on Common Stock......................... $ 88.1 $ 44.7 $ 80.1 $109.0 =================================================================================================================== March 31, June 30, September 30, December 31, Three Months Ended 2002 2002 2002 2002 - ------------------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues............................... $707.8 $744.5 $813.3 $683.1 Operating Expenses and Taxes..................... 600.4 611.1 664.5 618.8 - ------------------------------------------------------------------------------------------------------------------- Operating Income................................. 107.4 133.4 148.8 64.3 Other Income..................................... 0.5 15.1 14.2 13.0 Net Interest Charges............................. 41.2 35.9 33.7 29.8 - ------------------------------------------------------------------------------------------------------------------- Net Income....................................... $ 66.7 $112.6 $129.3 $ 47.5 =================================================================================================================== Earnings on Common Stock......................... $ 64.0 $110.1 $128.6 $ 46.9 =================================================================================================================== (a) Net income for the three months ended December 31, 2003, was increased by $3.5 million due to adjustments that were subsequently capitalized to construction projects in the fourth quarter. The adjustments included $0.6 million, $1.0 million and $1.9 million of costs charged to expense in the first, second and third quarters, respectively. Management concluded that the adjustments were not material to the consolidated financial statements for any quarter of 2003.
39 Report of Independent Auditors To the Stockholders and Board of Directors of Ohio Edison Company: In our opinion, the accompanying consolidated balance sheets and consolidated statements of capitalization and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of Ohio Edison Company (a wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. The consolidated financial statements of Ohio Edison Company and subsidiaries for the year ended December 31, 2001, prior to the revision described in Note 1(F), were audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on those financial statements in their report dated March 18, 2002. As discussed in Note 1(F) to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003. As discussed in Note 6 to the consolidated financial statements, the Company changed its method of accounting for the consolidation of variable interest entities as of December 31, 2003. As discussed above, the consolidated financial statements of Ohio Edison Company and subsidiaries for the year ended December 31, 2001 were audited by other independent auditors who have ceased operations. As described in Note 1(F) to the consolidated financial statements, the financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, which was adopted by the Company as of January 1, 2003. We audited the transitional disclosures described in Note 1(F). In our opinion, the transitional disclosures for 2001 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 consolidated financial statements of the Company other than with respect to such transitional disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 40 The following report is a copy of a report previously issued by Arthur Andersen LLP (Andersen). This report has not been reissued by Andersen and Andersen did not consent to the incorporation by reference of this report into any of the Company's registration statements. As discussed in Note 1(F) to the consolidated financial statements, the Company has revised its consolidated financial statements for the year ended December 31, 2001 to include the transitional disclosures required by Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations." The Andersen report does not extend to these changes. The revisions to the 2001 financial statements related to these transitional disclosures were reported on by PricewaterhouseCoopers LLP, as stated in their report appearing herein. Report of Independent Public Accountants To the Stockholders and Board of Directors of Ohio Edison Company: We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of Ohio Edison Company (an Ohio corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes for each of the three years in the period ended December 31, 2001. 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 in accordance with auditing standards generally accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Ohio Edison Company and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 41 EX-21 20 oe_ex21-1.txt EX 21-1 OE - LIST OF SUBS EXHIBIT 21.1 OHIO EDISON COMPANY LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 2003 Pennsylvania Power Company - Incorporated in Pennsylvania OES Ventures, Incorporated - Incorporated in Ohio OES Capital, Incorporated - Incorporated in Delaware OES Finance, Incorporated - Incorporated in Ohio OES Nuclear, Incorporated - Incorporated in Ohio Ohio Edison Financing Trust - Incorporated in Delaware Ohio Edison Financing Trust II - Incorporated in Delaware Statement of Differences ------------------------ Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 2003, is not included in the printed document. EX-23 21 oe_ex23-1.txt EX 23-1 OE-PWC CONSENT EXHIBIT 23.1 OHIO EDISON COMPANY CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 33-49413, 33-51139, 333-01489 and 333-05277) of Ohio Edison Company of our report dated February 25, 2004 relating to the consolidated financial statements, which appears in the Annual Report to Stockholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 25, 2004 relating to the financial statement schedules, which appear in this Form 10-K. PricewaterhouseCoopers LLP Cleveland, Ohio March 11, 2004 106 EX-4 22 cei_ex4-8.txt EX 4-8 JPMORGAN INDENTURE EXECUTION COPY - ------------------------------------------------------------------------------- THE CLEVELAND ELECTRIC ILLUMINATING COMPANY TO JPMORGAN CHASE BANK as Trustee --------- Indenture (For Unsecured Debt Securities) Dated as of December 1, 2003 - ------------------------------------------------------------------------------- TABLE OF CONTENTS1 PARTIES.......................................................................1 RECITAL OF THE COMPANY........................................................1 Article One ----------- Definitions and Other Porvisions of General Application ------------------------------------------------------- Section 101 Definitions.................................................1 - ----------- ------------ Section 102 Compliance Certificates and Opinions........................9 - ----------- ------------------------------------- Section 103 Form of Documents Delivered to Trustee......................9 - ----------- --------------------------------------- Section 104 Acts of Holders............................................10 - ----------- ---------------- Section 105 Notices, etc. to Trustee and Company.......................12 - ----------- ------------------------------------- Section 106 Notice to Holders of Securities; Waiver....................13 - ----------- ---------------------------------------- Section 107 Conflict with Trust Indenture Act..........................13 - ----------- ---------------------------------- Section 108 Effect of Headings and Table of Contents...................13 - ----------- ----------------------------------------- Section 109 Successors and Assigns.....................................13 - ----------- ----------------------- Section 110 Severability Clause........................................13 - ----------- -------------------- Section 111 Benefits of Indenture......................................13 - ----------- ---------------------- Section 112 Governing Law..............................................14 - ----------- -------------- Section 113 Legal Holidays.............................................14 - ----------- --------------- Article Two ----------- Security Forms -------------- Section 201 Forms Generally............................................14 - ----------- ---------------- Section 202 Form of Trustee's Certificate of Authentication............14 - ----------- ----------------------------------------------- Article Three ------------- The Securities -------------- Section 301 Amount Unlimited; Issuable in Series.......................15 - ----------- ------------------------------------- Section 302 Denominations..............................................18 - ----------- -------------- Section 303 Execution, Authentication, Delivery and Dating.............18 - ----------- ----------------------------------------------- - ------------------ 1 Note: This table of contents shall not, for any purpose, be deemed to be part of the Indenture. i Section 304 Temporary Securities.......................................21 - ----------- --------------------- Section 305 Registration, Registration of Transfer and Exchange........21 - ----------- ---------------------------------------------------- Section 306 Mutilated, Destroyed, Lost and Stolen Securities...........22 - ----------- ------------------------------------------------- Section 307 Payment of Interest; Interest Rights Preserved.............23 - ----------- ----------------------------------------------- Section 308 Persons Deemed Owners......................................24 - ----------- ---------------------- Section 309 Cancellation by Security Registrar.........................24 - ----------- ----------------------------------- Section 310 Computation of Interest....................................25 - ----------- ------------------------ Section 311 Payment to Be in Proper Currency...........................25 - ----------- --------------------------------- Section 312 Extension of Interest Payment..............................25 - ----------- ------------------------------ Article Four ------------ Redemption of Securities ------------------------ Section 401 Applicability of Article...................................25 - ----------- ------------------------- Section 402 Election to Redeem; Notice to Trustee......................26 - ----------- -------------------------------------- Section 403 Selection of Securities to Be Redeemed.....................26 - ----------- --------------------------------------- Section 404 Notice of Redemption.......................................26 - ----------- --------------------- Section 405 Securities Payable on Redemption Date......................28 - ----------- -------------------------------------- Section 406 Securities Redeemed in Part................................28 - ----------- ---------------------------- Article Five ------------ Sinking Funds ------------- Section 501 Applicability of Article...................................28 - ----------- ------------------------- Section 502 Satisfaction of Sinking Fund Payments with Securities......29 - ----------- ------------------------------------------------------ Section 503 Redemption of Securities for Sinking Fund..................29 - ----------- ------------------------------------------ Article Six ----------- Covenants --------- Section 601 Payment of Principal, Premium and Interest.................30 - ----------- ------------------------------------------- Section 602 Maintenance of Office or Agency............................30 - ----------- -------------------------------- Section 603 Money for Securities Payments to Be Held in Trust..........30 - ----------- -------------------------------------------------- Section 604 Corporate Existence........................................32 - ----------- -------------------- Section 605 Maintenance of Properties..................................32 - ----------- -------------------------- Section 606 Annual Officer's Certificate as to Compliance..............32 - ----------- ---------------------------------------------- Section 607 Waiver of Certain Covenants................................32 - ----------- ---------------------------- Section 608 Limitation on Liens........................................32 - ----------- -------------------- Section 609 Limitation on Sale and Lease-Back Transactions.............35 - ----------- ----------------------------------------------- ii Article Seven ------------- Satisfaction and Discharge -------------------------- Section 701 Satisfaction and Discharge of Securities...................35 - ----------- ----------------------------------------- Section 702 Satisfaction and Discharge of Indenture....................38 - ----------- ---------------------------------------- Section 703 Application of Trust Money.................................38 - ----------- --------------------------- Article Eight ------------- Events of Default; Remedies --------------------------- Section 801 Events of Default..........................................39 - ----------- ------------------ Section 802 Acceleration of Maturity; Rescission and Annulment.........40 - ----------- --------------------------------------------------- Section 803 Collection of Indebtedness and Suits for Enforcement by Trustee.....................................41 - ----------- ---------------------------------------- Section 804 Trustee May File Proofs of Claim...........................42 - ----------- --------------------------------- Section 805 Trustee May Enforce Claims Without Possession of Securities..............................................42 - ----------- ---------------------------------------------- Section 806 Application of Money Collected.............................42 - ----------- ------------------------------- Section 807 Limitation on Suits........................................43 - ----------- -------------------- Section 808 Unconditional Right of Holders to Receive Principal, Premium and Interest.......................................43 - ----------- ---------------------------------------------------- Section 809 Restoration of Rights and Remedies.........................44 - ----------- ----------------------------------- Section 810 Rights and Remedies Cumulative.............................44 - ----------- ------------------------------- Section 811 Delay or Omission Not Waiver...............................44 - ----------- ----------------------------- Section 812 Control by Holders of Securities...........................44 - ----------- --------------------------------- Section 813 Waiver of Past Defaults....................................44 - ----------- ------------------------ Section 814 Undertaking for Costs......................................45 - ----------- ---------------------- Section 815 Waiver of Stay or Extension Laws...........................45 - ----------- --------------------------------- Article Nine ------------ The Trustee ----------- Section 901 Certain Duties and Responsibilities........................45 - ----------- ------------------------------------ Section 902 Notice of Defaults.........................................47 - ----------- ------------------- Section 903 Certain Rights of Trustee..................................47 - ----------- -------------------------- Section 904 Not Responsible for Recitals or Issuance of Securities.....48 - ----------- ------------------------------------------------------- Section 905 May Hold Securities........................................48 - ----------- -------------------- Section 906 Money Held in Trust........................................48 - ----------- -------------------- iii Section 907 Compensation and Reimbursement.............................48 - ----------- ------------------------------- Section 908 Disqualification; Conflicting Interests....................49 - ----------- ---------------------------------------- Section 909 Corporate Trustee Required; Eligibility....................50 - ----------- ---------------------------------------- Section 910 Resignation and Removal; Appointment of Successor..........50 - ----------- -------------------------------------------------- Section 911 Acceptance of Appointment by Successor.....................52 - ----------- --------------------------------------- Section 912 Merger, Conversion, Consolidation or Succession to Business 53 - ----------- --------------------------------------------------- Section 913 Preferential Collection of Claims Against Company..........53 - ----------- -------------------------------------------------- Section 914 Co-trustees and Separate Trustees..........................53 - ----------- ---------------------------------- Section 915 Appointment of Authenticating Agent........................55 - ----------- ------------------------------------ Article Ten ----------- Holders' Lists and Reports by Trustee and Company ------------------------------------------------- Section 1001 Lists of Holders...........................................56 - ------------ ----------------- Section 1002 Reports by Trustee and Company.............................57 - ------------ ------------------------------- Article Eleven -------------- Consolidation, Merger, Conveyance or Other Transfer --------------------------------------------------- Section 1101 Company May Consolidate, etc. Only on Certain Terms........57 - ------------ ---------------------------------------------------- Section 1102 Successor Person Substituted...............................57 - ------------ ----------------------------- Article Twelve -------------- Supplemental Indentures ----------------------- Section 1201 Supplemental Indentures Without Consent of Holders.........58 - ------------ --------------------------------------------------- Section 1202 Supplemental Indentures With Consent of Holders............59 - ------------ ------------------------------------------------ Section 1203 Execution of Supplemental Indentures.......................61 - ------------ ------------------------------------- Section 1204 Effect of Supplemental Indentures..........................61 - ------------ ---------------------------------- Section 1205 Conformity With Trust Indenture Act........................61 - ------------ ------------------------------------ Section 1206 Reference in Securities to Supplemental Indentures.........61 - ------------ --------------------------------------------------- Section 1207 Modification Without Supplemental Indenture................61 - ------------ -------------------------------------------- Article Thirteen ---------------- Meetings of Holders; Action Without Meeting ------------------------------------------- Section 1301 Purposes for Which Meetings May Be Called..................62 - ------------ ------------------------------------------ iv Section 1302 Call, Notice and Place of Meetings.........................62 - ------------ ----------------------------------- Section 1303 Persons Entitled to Vote at Meetings.......................62 - ------------ ------------------------------------- Section 1304 Quorum; Action.............................................63 - ------------ --------------- Section 1305 Attendance at Meetings; Determination of Voting Rights; Conduct and Adjournment of Meetings........................63 - ------------ -------------------------------------------------------- Section 1306 Counting Votes and Recording Action of Meetings............64 - ------------ ------------------------------------------------ Section 1307 Action Without Meeting.....................................65 - ------------ ----------------------- Article Fourteen ---------------- Immunity of Incorporators, Shareholders, Officers and Directors --------------------------------------------------------------- Section 1401 Liability Solely Corporate.................................65 - ------------ --------------------------- v THE CLEVELAND ELECTRIC ILLUMINATING COMPANY Reconciliation and tie between Trust Indenture Act of 1939 and Indenture, dated as of December 1, 2003 Trust Indenture Act Section Indenture Section ss.310 (a)(1)........................................................909 (a)(2)........................................................909 (a)(3)........................................................914 (a)(4).............................................Not Applicable (b)...........................................................908 ..............................................................910 ss.311 (a)...........................................................913 (b)...........................................................913 (c)...........................................................913 ss.312 (a)..........................................................1001 (b)..........................................................1001 (c)..........................................................1001 ss.313 (a)..........................................................1002 (b)..........................................................1002 (c)..........................................................1002 ss.314 (a)..........................................................1002 (a)(4)........................................................606 (b)................................................Not Applicable (c)(1)........................................................102 (c)(2)........................................................102 (c)(3).............................................Not Applicable (d)................................................Not Applicable (e)...........................................................102 ss.315 (a)...........................................................901 ..............................................................903 (b)...........................................................902 (c)...........................................................901 (d)...........................................................901 (e)...........................................................814 ss.316 (a)...........................................................812 ..............................................................813 (a)(1)(A).....................................................802 ..............................................................812 (a)(1)(B).....................................................813 (a)(2).............................................Not Applicable (b)...........................................................808 ss.317 (a)(1)........................................................803 (a)(2)........................................................804 (b)...........................................................603 ss.318 (a)...........................................................107 i INDENTURE, dated as of December 1, 2003 between THE CLEVELAND ELECTRIC ILLUMINATING COMPANY, a corporation duly organized and existing under the laws of the State of Ohio (herein called the "Company"), having its principal office ------- at 76 South Main Street, Akron, Ohio 44308-1890, and JPMORGAN CHASE BANK, a corporation duly organized and existing under the laws of the State of New York, having its principal corporate trust office at 4 New York Plaza, New York, New York, 10004, as Trustee (herein called the "Trustee"). ------- RECITAL OF THE COMPANY The Company has duly authorized the execution and delivery of this Indenture to provide for the issuance from time to time of its unsecured debentures, notes or other evidences of indebtedness (herein called the "Securities"), in an unlimited aggregate principal amount to be issued in one or more series as contemplated herein; and all acts necessary to make this Indenture a valid agreement of the Company have been performed. For all purposes of this Indenture, except as otherwise expressly provided or unless the context otherwise requires, capitalized terms used herein shall have the meanings assigned to them in Article One of this Indenture. NOW, THEREFORE, THIS INDENTURE WITNESSETH: For and in consideration of the premises and the purchase of the Securities by the Holders thereof, it is mutually covenanted and agreed, for the equal and proportionate benefit of all Holders of the Securities or of any series thereof, as follows: ARTICLE ONE DEFINITIONS AND OTHER PROVISIONS OF GENERAL APPLICATION ------------------------------------------------------- Section 101 Definitions. For all purposes of this Indenture, except as ----------- otherwise expressly provided or unless the context otherwise requires: (a) the terms defined in this Article have the meanings assigned to them in this Article and include the plural as well as the singular; (b) all terms used herein without definition which are defined in the Trust Indenture Act, either directly or by reference therein, have the meanings assigned to them therein; (c) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles in the United States, and, except as otherwise herein expressly provided, the term "generally accepted accounting principles" with respect to any computation required or permitted hereunder shall mean such accounting principles as are generally accepted in the United States at the date of such computation or, at the election of the Company from time to time, at the date of the execution and delivery of this Indenture; provided, however, that in determining generally ------------------ accepted accounting principles applicable to the Company, the Company shall, to the extent required, conform to any order, rule or regulation of any administrative agency, regulatory authority or other governmental body having jurisdiction over the Company; (d) any reference herein to an "Article" or "Section" refers to an "Article" or "Section", as the case may be, of this Indenture; and (e) the words "herein", "hereof" and "hereunder" and other words of similar import refer to this Indenture as a whole and not to any particular Article, Section or other subdivision. "Act", when used with respect to any Holder of a Security, has the --- meaning specified in Section 104. "Affiliate" of any specified Person means any other Person directly or --------- indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or through one or more intermediaries, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Authenticating Agent" means any Person (other than the Company or an --------------------- Affiliate of the Company) authorized by the Trustee pursuant to Section 915 to act on behalf of the Trustee to authenticate one or more series of Securities or Tranches thereof. "Authorized Officer" means the Chairman of the Board, the Vice Chairman ------------------ of the Board, the President, any Vice President, the Treasurer, any Assistant Treasurer, or any other officer or agent of the Company duly authorized by the Board of Directors to act in respect of matters relating to this Indenture. "Board of Directors" means either the board of directors of the Company ------------------ or any committee thereof duly authorized to act in respect of matters relating to this Indenture. "Board Resolution" means a copy of a resolution certified by the ----------------- Secretary or an Assistant Secretary of the Company to have been duly adopted by the Board of Directors and to be in full force and effect on the date of such certification, and delivered to the Trustee. "Business Day", when used with respect to a Place of Payment or any ------------- other particular location specified in the Securities or this Indenture, means any day, other than a Saturday or Sunday, which is not a day on which the Corporate Trust Office of the Trustee or banking institutions or trust companies in such Place of Payment or other location are generally authorized or required by law, regulation or executive order to remain closed, except as may be otherwise specified as contemplated by Section 301. "Capitalization" means the total of all the following items appearing -------------- on, or included in, the Company's consolidated balance sheet: (i) liabilities for indebtedness maturing more than twelve (12) months from the date of determination; and (ii) common stock, preferred stock, Hybrid Preferred 2 value, and retained earnings (however the foregoing may be designated), less, to the extent not otherwise deducted, the cost of shares of the capital stock of the Company held in the Company's treasury. Subject to the foregoing, capitalization shall be determined in accordance with generally accepted accounting principles and practices applicable to the type of business in which the Company is engaged and may be determined as of a date not more than sixty (60) days prior to the happening of an event for which such determination is being made. "Commission" means the Securities and Exchange Commission, as from time ---------- to time constituted, created under the Securities Exchange Act of 1934, as amended, or, if at any time after the date of execution and delivery of this Indenture such Commission is not existing and performing the duties now assigned to it under the Trust Indenture Act, then the body, if any, performing such duties at such time. "Company" means the Person named as the "Company" in the first ------- ------- paragraph of this Indenture until a successor Person shall have become such pursuant to the applicable provisions of this Indenture, and thereafter "Company" shall mean such successor Person. ------- "Company Request" or "Company Order" means a written request or order ---------------- -------------- signed in the name of the Company by an Authorized Officer and delivered to the Trustee. "Corporate Trust Office" means the office of the Trustee at which at ------------------------ any particular time its corporate trust business shall be principally administered, which office at the date of execution and delivery of this instrument is located at 4 New York Plaza, New York, New York 10004, Attention: Institutional Trust Services. "Corporation" means a corporation, association, company, limited ----------- liability company, partnership, joint stock company or business or statutory trust. "Debt" means any outstanding debt for money borrowed evidenced by ---- notes, debentures, bonds or other securities. "Defaulted Interest" has the meaning specified in Section 307. ------------------ "Discount Security" means any Security which provides for an amount ------------------ less than the principal amount thereof to be due and payable upon a declaration of acceleration of the Maturity thereof pursuant to Section 802. "Dollar" or "$" means a dollar or other equivalent unit in such coin or ------ - currency of the United States as at the time shall be legal tender for the payment of public and private debts. "Eligible Obligations" means: -------------------- (a) with respect to Securities denominated in Dollars, Government Obligations; or 3 (b) with respect to Securities denominated in a currency other than Dollars or in a composite currency, such other obligations or instruments as shall be specified with respect to such Securities, as contemplated by Section 301. "Event of Default" has the meaning specified in Section 801. ---------------- "Governmental Authority" means the government of the United States or ---------------------- of any State or Territory thereof or of the District of Columbia or of any county, municipality or other political subdivision of any of the foregoing, or any department, agency, authority or other instrumentality of any of the foregoing. "Government Obligations" means: ---------------------- (a) direct obligations of, or obligations the principal of and interest on which are unconditionally guaranteed by, the United States and entitled to the benefit of the full faith and credit thereof; and (b) certificates, depositary receipts or other instruments which evidence a direct ownership interest in obligations described in clause (a) above or in any specific interest or principal payments due in respect thereof; provided, however, that the custodian of such obligations or specific interest - ------------------ or principal payments shall be a bank or trust company (which may include the Trustee or any Paying Agent) subject to Federal or state supervision or examination with a combined capital and surplus of at least $50,000,000; and provided, further, that except as may be otherwise required by law, such - ------------------ custodian shall be obligated to pay to the holders of such certificates, depositary receipts or other instruments the full amount received by such custodian in respect of such obligations or specific payments and shall not be permitted to make any deduction therefrom. "Holder" means a Person in whose name a Security is registered in the ------ Security Register. "Hybrid Preferred Securities" means any preferred securities issued by ---------------------------- a Hybrid Preferred Securities Subsidiary, where such preferred securities have the following characteristics: (i) such Hybrid Preferred Securities Subsidiary lends substantially all of the proceeds from the issuance of such preferred securities to the Company, or a wholly-owned Subsidiary of the Company, in exchange for Subordinated Indebtedness issued by the Company; (ii) such preferred securities contain terms providing for the deferral of interest payments corresponding to provisions providing for the deferral of interest payments on the related Subordinated Indebtedness; and (iii) the Company makes periodic interest payments on the related Subordinated Indebtedness, which interest payments are in turn used by the Hybrid Preferred Securities Subsidiary to make corresponding payments to the holders of the preferred securities. "Hybrid Preferred Securities Subsidiary" means any limited partnership --------------------------------------- or business or statutory trust (or similar entity) (i) all of the general partnership or common equity interest of which is owned (either directly or 4 indirectly through any wholly-owned Subsidiary of the Company or any consolidated Subsidiary of the Company) at all times by the Company, (ii) that has been formed for the purpose of issuing Hybrid Preferred Securities and (iii) substantially all of the assets of which consist at all times solely of Subordinated Indebtedness issued by the Company and payments made from time to time on such Subordinated Indebtedness. "Indenture" means this instrument as originally executed and delivered --------- and as it may from time to time be supplemented or amended by one or more indentures supplemental hereto entered into pursuant to the applicable provisions hereof and shall include the terms of a particular series of Securities established as contemplated by Section 301. "Interest", with respect to a Discount Security only, means interest, -------- if any, borne by such Security at a Stated Interest Rate. "Interest Payment Date", when used with respect to any Security, means --------------------- the Stated Maturity of an installment of interest on such Security. "Lien" means any mortgage, security interest, pledge or lien. ---- "Maturity", when used with respect to any Security, means the date on -------- which the principal of such Security or an installment of principal becomes due and payable as provided in such Security or in this Indenture, whether at the Stated Maturity, by declaration of acceleration, upon redemption, tender for purchase, or otherwise. "Net Tangible Assets" means the amount shown as total assets on the --------------------- Company's consolidated balance sheet, less (i) intangible assets including, without limitation, such items as goodwill, trademarks, trade names, patents, and unamortized debt discount and expense and other regulatory assets carried as an asset on the Company's consolidated balance sheet; (ii) current liabilities; and (iii) appropriate adjustments, if any, related to minority interests. Such amounts shall be determined in accordance with generally accepted accounting principles and practices applicable to the type of business in which the Company is engaged and may be determined as of a date not more than sixty (60) days prior to the happening of the event for which such determination is being made. "Officer's Certificate" means a certificate signed by an Authorized ---------------------- Officer and delivered to the Trustee. "Operating Property" means (i) any interest in real property owned by ------------------- the Company and (ii) any asset owned by the Company that is depreciable in accordance with generally accepted accounting principles. "Opinion of Counsel" means a written opinion of counsel, who may be ------------------- counsel for the Company, or other counsel acceptable to the Trustee. "Outstanding", when used with respect to Securities, means, as of the ----------- date of determination, all Securities theretofore authenticated and delivered under this Indenture, except: 5 (a) Securities theretofore canceled or delivered to the Security Registrar for cancellation; (b) Securities deemed to have been paid in accordance with Section 701; and (c) Securities which have been paid pursuant to Section 306 or in exchange for or in lieu of which other Securities have been authenticated and delivered pursuant to this Indenture, other than any such Securities in respect of which there shall have been presented to the Trustee proof satisfactory to it and the Company that such Securities are held by a bona fide purchaser or purchasers in whose hands such Securities are valid obligations of the Company; provided, however, that in determining whether or not the Holders of the - -------- ------- requisite principal amount of the Securities Outstanding under this Indenture, or the Outstanding Securities of any series or Tranche, have given any request, demand, authorization, direction, notice, consent or waiver hereunder or whether or not a quorum is present at a meeting of Holders of Securities, (x) Securities owned by the Company or any other obligor upon the Securities or any Affiliate of the Company or of such other obligor (unless the Company, such Affiliate or such obligor owns all Securities Outstanding under this Indenture, or (except for the purposes of actions to be taken by Holders of (i) more than one series voting as a class under Section 812 or (ii) more than one series or more than one Tranche, as the case may be, voting as a class under Section 1202) all Outstanding Securities of each such series and each such Tranche, as the case may be, determined without regard to this clause (x)) shall be disregarded and deemed not to be Outstanding, except that, in determining whether the Trustee shall be protected in relying upon any such request, demand, authorization, direction, notice, consent or waiver or upon any such determination as to the presence of a quorum, only Securities which a Responsible Officer of the Trustee actually knows to be so owned shall be so disregarded; provided, however, that Securities so owned ----------------- which have been pledged in good faith may be regarded as Outstanding if the pledgee establishes to the satisfaction of the Trustee the pledgee's right so to act with respect to such Securities and that the pledgee is not the Company or any other obligor upon the Securities or any Affiliate of the Company or of such other obligor; and (y) the principal amount of a Discount Security that shall be deemed to be Outstanding for such purposes shall be the amount of the principal thereof that would be due and payable as of the date of such determination upon a declaration of acceleration of the Maturity thereof pursuant to Section 802; provided, further, that, in the case of any Security the principal of which is\ - -------- ------- payable from time to time without presentment or surrender, the principal amount of such Security that shall be deemed to be Outstanding at any time for all purposes of this Indenture shall be the original principal amount thereof less the aggregate amount of principal thereof theretofore paid. "Paying Agent" means any Person, including the Company, authorized by ------------ the Company to pay the principal of, and premium, if any, or interest, if any, on any Securities on behalf of the Company. 6 "Periodic Offering" means an offering of Securities of a series from ------------------ time to time any or all of the specific terms of which Securities, including without limitation the rate or rates of interest, if any, thereon, the Stated Maturity or Maturities thereof and the redemption provisions, if any, with respect thereto, are to be determined by the Company or its agents upon the issuance of such Securities. "Person" means any individual, corporation, joint venture, trust, ------ unincorporated organization or any Governmental Authority. "Place of Payment", when used with respect to the Securities of any ----------------- series, or any Tranche thereof, means the place or places, specified as contemplated by Section 301, at which, subject to Section 602, principal of and premium, if any, and interest, if any, on the Securities of such series or Tranche are payable. "Predecessor Security" of any particular Security means every previous --------------------- Security evidencing all or a portion of the same debt as that evidenced by such particular Security; and, for the purposes of this definition, any Security authenticated and delivered under Section 306 in exchange for or in lieu of a mutilated, destroyed, lost or stolen Security shall be deemed (to the extent lawful) to evidence the same debt as the mutilated, destroyed, lost or stolen Security. "Redemption Date", when used with respect to any Security to be ---------------- redeemed, means the date fixed for such redemption by or pursuant to this Indenture. "Redemption Price", when used with respect to any Security to be ----------------- redeemed, means the price at which it is to be redeemed pursuant to this Indenture. "Regular Record Date" for the interest payable on any Interest Payment ------------------- Date on the Securities of any series means the date specified for that purpose as contemplated by Section 301. "Required Currency" has the meaning specified in Section 311. ----------------- "Responsible Officer", when used with respect to the Trustee, means any ------------------- Vice President, Assistant Vice President, any Assistant Treasurer or other officer of the Trustee within the Institutional Trust Services department of the Trustee (or any successor such department) in each case located at the Corporate Trust Office of the Trustee who has direct responsibility for the administration of this Indenture, and for the purposes of Sections 901(c)(2) and 902 shall also include any other officer of the Trustee to whom a matter arising under this Indenture has been referred by such Corporate Trust Office. "Sale and Lease-Back Transaction" means any arrangement with any Person ------------------------------- providing for the leasing to the Company of any Operating Property (except for leases for a term, including any renewal thereof, of not more than forty-eight (48) months), which Operating Property has been or is to be sold or transferred by the Company to such Person; provided, however, Sale and Lease-Back Transaction shall not include any arrangement first entered into prior to the date of this Indenture and involving the exchange of any Operating Property for any property subject to any such arrangement. 7 "Securities" has the meaning stated in the first recital of this ---------- Indenture and more particularly means any securities authenticated and delivered under this Indenture. "Security Register" and "Security Registrar" have the respective ------------------ meanings specified in Section 305. "Special Record Date" for the payment of any Defaulted Interest on the ------------------- Securities of any series means a date fixed by the Trustee pursuant to Section 307. "Stated Interest Rate" means a rate (whether fixed or variable) at ---------------------- which an obligation by its terms is stated to bear simple interest. Any calculation or other determination to be made under this Indenture by reference to the Stated Interest Rate on a Security shall be made without regard to the effective interest cost to the Company of such Security and without regard to the Stated Interest Rate on, or the effective cost to the Company of, any other indebtedness in respect of which the Company's obligations are evidenced or secured in whole or in part by such Security. "Stated Maturity", when used with respect to any obligation or any ---------------- installment of principal thereof or interest thereon, means the date on which the principal of such obligation or such installment of principal or interest is stated to be due and payable (without regard to any provisions for redemption, prepayment, acceleration, purchase or extension). "Subordinated Indebtedness" means any unsecured Debt of the Company (i) ------------------------- issued in exchange for the proceeds of Hybrid Preferred Securities and (ii) subordinated to the rights of the Holders hereunder. "Subsidiary" means a corporation more than 50% of the outstanding ---------- voting stock or other voting interest of which is owned, directly or indirectly, by the Company or by one or more other Subsidiaries, or by the Company and one or more other Subsidiaries. For the purposes of this definition, "voting stock" means stock that ordinarily has voting power for the election of directors, whether at all times or only so long as no senior class of stock has such voting power by reason of any contingency. "Tranche" means a group of Securities which (a) are of the same series ------- and (b) have identical terms except as to principal amount and/or date of issuance. "Trust Indenture Act" means, as of any time, the Trust Indenture Act of ------------------- 1939, or any successor statute, as in effect at such time. "Trustee" means the Person named as the "Trustee" in the first ------- paragraph of this Indenture until a successor Trustee shall have become such with respect to one or more series of Securities pursuant to the applicable provisions of this Indenture, and thereafter "Trustee" shall mean or include each Person who is then a Trustee hereunder, and if at any time there is more than one such Person, "Trustee" as used with respect to the Securities of any series shall mean the Trustee with respect to Securities of that series. "United States" means the United States of America, its Territories, -------------- its possessions and other areas subject to its political jurisdiction. 8 "Value" means, with respect to a Sale and Lease-Back Transaction, as of ----- any particular time, the amount equal to the greater of (i) the net proceeds to the Company from the sale or transfer of the Operating Property leased pursuant to the Sale and Lease-Back Transaction or (ii) the net book value of the Operating Property leased, as determined by the Company in accordance with generally accepted accounting principles, in either case multiplied by a fraction, the numerator of which shall be equal to the number of full years of the term of the lease that is part of such Sale and Lease-Back Transaction remaining at the time of determination and the denominator of which shall be equal to the number of full years of the term of such lease, without regard, in any case, to any renewal or extension options contained in such lease. Section 102 Compliance Certificates and Opinions. Except as otherwise ------------------------------------ expressly provided in this Indenture, upon any application or request by the Company to the Trustee to take any action under any provision of this Indenture, the Company shall furnish to the Trustee an Officer's Certificate stating that, or stating in the opinion of the signer thereof that, all conditions precedent, if any, provided for in this Indenture relating to the proposed action (including any covenants compliance with which constitutes a condition precedent) have been complied with and an Opinion of Counsel stating that in the opinion of such counsel all such conditions precedent, if any, have been complied with, except that in the case of any such application or request as to which the furnishing of such documents is specifically required by any provision of this Indenture relating to such particular application or request, no additional certificate or opinion need be furnished. Every certificate or opinion with respect to compliance with a condition or covenant provided for in this Indenture shall include: (a) a statement that each Person signing such certificate or opinion has read such covenant or condition and the definitions herein relating thereto; (b) a brief statement as to the nature and scope of the examination or investigation upon which the statements or opinions contained in such certificate or opinion are based; (c) a statement that, in the opinion of each such Person, such Person has made such examination or investigation as is necessary to enable such Person to express an informed opinion as to whether or not such covenant or condition has been complied with; and (d) a statement as to whether, in the opinion of each such Person, such condition or covenant has been complied with. Section 103 Form of Documents Delivered to Trustee. In any case where -------------------------------------- several matters are required to be certified by, or covered by an opinion of, any specified Person, it is not necessary that all such matters be certified by, or covered by the opinion of, only one such Person, or that they be so certified or covered by only one document, but one such Person may certify or give an opinion with respect to some matters and one or more other such Persons as to other matters, and any such Person may certify or give an opinion as to such matters in one or several documents. 9 Any certificate or opinion of an officer of the Company may be based, insofar as it relates to legal matters, upon a certificate or opinion of, or representations by, counsel, unless such officer knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations with respect to the matters upon which such officer's certificate or opinion are based are erroneous. Any such certificate or Opinion of Counsel may be based, insofar as it relates to factual matters, upon a certificate or opinion of, or representations by, an officer or officers of the Company stating that the information with respect to such factual matters is in the possession of the Company, unless such counsel knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations with respect to such matters are erroneous. Where any Person is required to make, give or execute two or more applications, requests, consents, certificates, statements, opinions or other instruments under this Indenture, they may, but need not, be consolidated and form one instrument. Whenever, subsequent to the receipt by the Trustee of any Board Resolution, Officer's Certificate, Opinion of Counsel or other document or instrument, a clerical, typographical or other inadvertent or unintentional error or omission shall be discovered therein, a new document or instrument may be substituted therefor in corrected form with the same force and effect as if originally filed in the corrected form and, irrespective of the date or dates of the actual execution and/or delivery thereof, such substitute document or instrument shall be deemed to have been executed and/or delivered as of the date or dates required with respect to the document or instrument for which it is substituted. Anything in this Indenture to the contrary notwithstanding, if any such corrective document or instrument indicates that action has been taken by or at the request of the Company which could not have been taken had the original document or instrument not contained such error or omission, the action so taken shall not be invalidated or otherwise rendered ineffective but shall be and remain in full force and effect, except to the extent that such action was a result of willful misconduct or bad faith. Without limiting the generality of the foregoing, any Securities issued under the authority of such defective document or instrument shall nevertheless be the valid obligations of the Company entitled to the benefits of this Indenture equally and ratably with all other Outstanding Securities, except as aforesaid. Section 104 Acts of Holders. (a) Any request, demand, authorization, direction, --------------- notice, consent, election, waiver or other action provided by this Indenture to be made, given or taken by Holders may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Holders in person or by an agent duly appointed in writing or, alternatively, may be embodied in and evidenced by the record of Holders voting in favor thereof, either in person or by proxies duly appointed in writing, at any meeting of Holders duly called and held in accordance with the provisions of Article Thirteen, or a combination of such instruments and any such record. Except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments or record or both are delivered to the Trustee and, where it is hereby expressly required, to the Company. Such instrument or instruments and any such record (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the "Act" of the Holders signing such instrument or instruments and so voting at any such meeting. Proof of execution of any such instrument or of a writing appointing any such agent, or of the holding by any Person of a 10 Security, shall be sufficient for any purpose of this Indenture and (subject to Section 901) conclusive in favor of the Trustee and the Company, if made in the manner provided in this Section. The record of any meeting of Holders shall be proved in the manner provided in Section 1306. (b) The fact and date of the execution by any Person of any such instrument or writing may be proved by the affidavit of a witness of such execution or by a certificate of a notary public or other officer authorized by law to take acknowledgments of deeds, certifying that the individual signing such instrument or writing acknowledged to him the execution thereof or may be proved in any other manner which the Trustee and the Company deem sufficient. Where such execution is by a signer acting in a capacity other than his individual capacity, such certificate or affidavit shall also constitute sufficient proof of his authority. (c) The principal amount (except as otherwise contemplated in clause (y) of the first proviso to the definition of Outstanding) and serial numbers of Securities held by any Person, and the date of holding the same, shall be proved by the Security Register. (d) Any request, demand, authorization, direction, notice, consent, election, waiver or other Act of a Holder shall bind every future Holder of the same Security and the Holder of every Security issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof in respect of anything done, omitted or suffered to be done by the Trustee or the Company in reliance thereon, whether or not notation of such action is made upon such Security. (e) Until such time as written instruments shall have been delivered to the Trustee with respect to the requisite percentage of principal amount of Securities for the action contemplated by such instruments, any such instrument executed and delivered by or on behalf of a Holder may be revoked with respect to any or all of such Securities by written notice by such Holder or any subsequent Holder, proven in the manner in which such instrument was proven. (f) Securities of any series, or any Tranche thereof, authenticated and delivered after any Act of Holders may, and shall if required by the Trustee, bear a notation in form approved by the Trustee as to any action taken by such Act of Holders. If the Company shall so determine, new Securities of any series, or any Tranche thereof, so modified as to conform, in the opinion of the Trustee and the Company, to such action may be prepared and executed by the Company and authenticated and delivered by the Trustee in exchange for Outstanding Securities of such series or Tranche. (g) If the Company shall solicit from Holders any request, demand, authorization, direction, notice, consent, waiver or other Act, the Company may, at its option, fix in advance a record date for the determination of Holders entitled to give such request, demand, authorization, direction, notice, consent, waiver or other Act, but the Company shall have no obligation to do so. If such a record date is fixed, such request, demand, authorization, direction, notice, consent, waiver or other Act may be given before or after such record date, but only the Holders of record at the close of business on the record date shall be deemed to be Holders for the purposes of determining whether Holders of the requisite proportion of the Outstanding Securities have authorized or agreed or consented to such request, demand, authorization, direction, notice, consent, waiver or other Act, and for that purpose the Outstanding Securities shall be computed as of the record date. 11 Section 105 Notices, etc. to Trustee and Company. Any request, demand, ------------------------------------ authorization, direction, notice, consent, election, waiver or Act of Holders or other document provided or permitted by this Indenture to be made upon, given or furnished to, or filed with, the Trustee by any Holder or by the Company, or the Company by the Trustee or by any Holder, shall be sufficient for every purpose hereunder (unless otherwise herein expressly provided) if in writing and delivered personally to an officer or other responsible employee of the addressee at the applicable location set forth below or at such other location as such party may from time to time designate by written notice, or transmitted by facsimile transmission or other direct written electronic means, acceptable to the Trustee, to such telephone number or other electronic communications address as the parties hereto shall from time to time designate by written notice, or transmitted by certified or registered mail, charges prepaid, to the applicable address set forth below or to such other address as either party hereto may from time to time designate by written notice: If to the Trustee, to: JPMorgan Chase Bank 4 New York Plaza--15th Floor New York, New York 10004 Attention: Institutional Trust Services Trust Financial Management Telephone: (212) 623-6884 Telecopy: (212) 623-6205 With a copy to: J.P. Morgan Trust Company 50 Rowes Wharf--4th Floor Boston, Massachusetts 02110 Attention: James P. Freeman Vice President Telephone: (617) 310-0534 Telecopy: (617) 310-0335 If to the Company, to: The Cleveland Electric Illuminating Company c/o FirstEnergy Corp. 76 South Main Street Akron, Ohio 44308-1890 Attention: Treasurer Telephone: (330) 384-5889 Telecopy: (330) 384-3772 12 Any communication contemplated herein shall be deemed to have been made, given, furnished and filed if personally delivered, on the date of delivery, if transmitted by facsimile transmission or other direct written electronic means, on the date of receipt, and if transmitted by certified or registered mail, on the date of receipt. Section 106 Notice to Holders of Securities; Waiver. Except as ------------------------------------------- otherwise expressly provided herein, where this Indenture provides for notice to Holders of any event, such notice shall be sufficiently given, and shall be deemed given, to Holders if in writing and mailed, first-class postage prepaid, to each Holder affected by such event, at the address of such Holder as it appears in the Security Register, not later than the latest date, if any, and not earlier than the earliest date, if any, prescribed for the giving of such notice. In case by reason of the suspension of regular mail service or by reason of any other cause it shall be imp racticable to give such notice to Holders by mail, then such notification as shall be made with the approval of the Trustee shall constitute a sufficient notification for every purpose hereunder. In any case where notice to Holders is given by mail, neither the failure to mail such notice, nor any defect in any notice so mailed, to any particular Holder shall affect the sufficiency of such notice with respect to other Holders. Any notice required by this Indenture may be waived in writing by the Person entitled to receive such notice, either before or after the event otherwise to be specified therein, and such waiver shall be the equivalent of such notice. Waivers of notice by Holders shall be filed with the Trustee, but such filing shall not be a condition precedent to the validity of any action taken in reliance upon such waiver. Section 107 Conflict with Trust Indenture Act.If any provision of this --------------------------------- Indenture limits, qualifies or conflicts with another provision hereof which is required or deemed to be included in this Indenture by, or is otherwise governed by, any of the provisions of the Trust Indenture Act, such other provision shall control; and if any provision hereof otherwise conflicts with the Trust Indenture Act, the Trust Indenture Act shall control unless otherwise provided as contemplated by Section 301 with respect to any series of Securities. Section 108 Effect of Headings and Table of Contents. The Article and ---------------------------------------- Section headings in this Indenture and the Table of Contents are for convenience only and shall not affect the construction hereof. Section 109 Successors and Assigns. All covenants and agreements in ----------------------- this Indenture by the Company and Trustee shall bind their respective successors and assigns, whether so expressed or not. Section 110 Severability Clause. In case any provision in this -------------------- Indenture or the Securities shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. Section 111 Benefits of Indenture. Nothing in this Indenture or the ---------------------- Securities, express or implied, shall give to any Person, other than the parties hereto, their successors hereunder and the Holders, any benefit or any legal or equitable right, remedy or claim under this Indenture. 13 Section 112 Governing Law. This Indenture and the Securities shall be ------------- governed by and construed in accordance with the laws of the State of New York (including without limitation Section 5-1401 of the New York General Obligations Law or any successor to such statute) except to the extent that the Trust Indenture Act shall be applicable. Section 113 Legal Holidays. In any case where any Interest Payment --------------- Date, Redemption Date or Stated Maturity of any Security shall not be a Business Day at any Place of Payment, then (notwithstanding any other provision of this Indenture or of the Securities other than a provision in Securities of any series, or any Tranche thereof, or in the Board Resolution or Officer's Certificate which establishes the terms of the Securities of such series or Tranche, which specifically states that such provision shall apply in lieu of this Section) payment of interest or principal and premium, if any, need not be made at such Place of Payment on such date, but may be made on the next succeeding Business Day at such Place of Payment, with the same force and effect, and in the same amount, as if made on the Interest Payment Date or Redemption Date, or at the Stated Maturity, as the case may be, and, if such payment is made or duly provided for on such Business Day, no interest (or Interest, as applicable) shall accrue on the amount so payable for the period from and after such Interest Payment Date, Redemption Date or Stated Maturity, as the case may be, to such Business Day. ARTICLE TWO SECURITY FORMS -------------- Section 201 Forms Generally. The definitive Securities of each series -------------- shall be in substantially the form or forms thereof established in the indenture supplemental hereto establishing such series or in a Board Resolution establishing such series, or in an Officer's Certificate pursuant to such supplemental indenture or Board Resolution, in each case with such appropriate insertions, omissions, substitutions and other variations as are required or permitted by this Indenture, and may have such letters, numbers or other marks of identification and such legends or endorsements placed thereon as may be required to comply with the rules of any securities exchange or as may, consistently herewith, be determined by the officers executing such Securities, as evidenced by their execution of such Securities. If the form or forms of Securities of any series are established in a Board Resolution or in an Officer's Certificate pursuant to a Board Resolution, such Board Resolution and Officer's Certificate, if any, shall be delivered to the Trustee at or prior to the delivery of the Company Order contemplated by Section 303 for the authentication and delivery of such Securities. Unless otherwise specified as contemplated by Section 301 or clause (g) of Section 1201, the Securities of each series shall be issuable in registered form without coupons. The definitive Securities shall be produced in such manner as shall be determined by the officers executing such Securities, as evidenced by their execution thereof. Section 202 Form of Trustee's Certificate of Authentication. Th --------------------------------------------------- Trustee's certificate of authentication shall be in substantially the form set forth below: This is one of the Securities of the series designated therein referred to in the within-mentioned Indenture. 14 Dated: JPMorgan Chase Bank, as Trustee By: ----------------------------- Authorized Officer ARTICLE THREE THE SECURITIES -------------- Section 301 Amount Unlimited; Issuable in Series. The aggregate ---------------------------------------- principal amount of Securities which may be authenticated and delivered under this Indenture is unlimited. The Securities may be issued in one or more series. Subject to the last paragraph of this Section, prior to the authentication and delivery of Securities of any series there shall be established by specification in a supplemental indenture or in a Board Resolution, or in an Officer's Certificate pursuant to a supplemental indenture or a Board Resolution: (a) the title of the Securities of such series (which shall distinguish the Securities of such series from Securities of all other series); (b) any limit upon the aggregate principal amount of the Securities of such series which may be authenticated and delivered under this Indenture (except for Securities authenticated and delivered upon registration of transfer of, or in exchange for, or in lieu of, other Securities of such series pursuant to Section 304, 305, 306, 406 or 1206 and except for any Securities which, pursuant to Section 303, are deemed never to have been authenticated and delivered hereunder); (c) the Person or Persons (without specific identification) to whom interest on Securities of such series, or any Tranche thereof, shall be payable on any Interest Payment Date, if other than the Persons in whose names such Securities (or one or more Predecessor Securities) are registered at the close of business on the Regular Record Date for such interest; (d) the date or dates on which the principal of the Securities of such series, or any Tranche thereof, is payable or any formulary or other method or other means by which such date or dates shall be determined, by reference to an index or other fact or event ascertainable outside of this Indenture or otherwise (without regard to any provisions for redemption, prepayment, acceleration, purchase or extension); (e) the rate or rates at which the Securities of such series, or any Tranche thereof, shall bear interest, if any (including the rate or rates at which overdue principal shall bear interest, if different from the rate or rates at which such Securities shall bear interest prior to Maturity, and, if applicable, the rate or rates at which overdue premium or interest shall bear 15 interest, if any), or any formulary or other method or other means by which such rate or rates shall be determined, by reference to an index or other fact or event ascertainable outside of this Indenture or otherwise; the date or dates from which such interest shall accrue; the Interest Payment Dates on which such interest shall be payable and the Regular Record Date, if any, for the interest payable on such Securities on any Interest Payment Date; the right of the Company, if any, to extend the interest payment periods and the duration of any such extension as contemplated by Section 312; and the basis of computation of interest, if other than as provided in Section 310; (f) the place or places at which or methods by which (1) the principal of and premium, if any, and interest, if any, on Securities of such series, or any Tranche thereof, shall be payable, (2) registration of transfer of Securities of such series, or any Tranche thereof, may be effected, (3) exchanges of Securities of such series, or any Tranche thereof, may be effected and (4) notices and demands to or upon the Company in respect of the Securities of such series, or any Tranche thereof, and this Indenture may be served; the Security Registrar and any Paying Agent or Paying Agents for such series or Tranche; and if such is the case, that the principal of such Securities shall be payable without presentment or surrender thereof; (g) the period or periods within which, or the date or dates on which, the price or prices at which and the terms and conditions upon which the Securities of such series, or any Tranche thereof, may be redeemed, in whole or in part, at the option of the Company and any restrictions on such redemptions, including but not limited to a restriction on a partial redemption by the Company of the Securities of any series, or any Tranche thereof, resulting in delisting of such Securities from any national exchange; (h) the obligation or obligations, if any, of the Company to redeem or purchase the Securities of such series, or any Tranche thereof, pursuant to any sinking fund or other mandatory redemption provisions or at the option of a Holder thereof and the period or periods within which or the date or dates on which, the price or prices at which and the terms and conditions upon which such Securities shall be redeemed or purchased, in whole or in part, pursuant to such obligation, and applicable exceptions to the requirements of Section 404 in the case of mandatory redemption or redemption at the option of the Holder; (i) the denominations in which Securities of such series, or any Tranche thereof, shall be issuable if other than denominations of $1,000 and any integral multiple thereof; (j) the currency or currencies, including composite currencies, in which payment of the principal of and premium, if any, and interest, if any, on the Securities of such series, or any Tranche thereof, shall be payable (if other than in Dollars); (k) if the principal of or premium, if any, or interest, if any, on the Securities of such series, or any Tranche thereof, are to be payable, at the election of the Company or a Holder thereof, in a coin or currency other than that in which the Securities are stated to be payable, the period or periods within which and the terms and conditions upon which, such election may be made; (l) if the principal of or premium, if any, or interest, if any, on the Securities of such series, or any Tranche thereof, are to be payable, or are 16 to be payable at the election of the Company or a Holder thereof, in securities or other property, the type and amount of such securities or other property, or the formulary or other method or other means by which such amount shall be determined, and the period or periods within which, and the terms and conditions upon which, any such election may be made; (m) if the amount payable in respect of principal of or premium, if any, or interest, if any, on the Securities of such series, or any Tranche thereof, may be determined with reference to an index or other fact or event ascertainable outside of this Indenture, the manner in which such amounts shall be determined to the extent not established pursuant to clause (e) of this paragraph; (n) if other than the principal amount thereof, the portion of the principal amount of Securities of such series, or any Tranche thereof, which shall be payable upon declaration of acceleration of the Maturity thereof pursuant to Section 802; (o) any Events of Default, in addition to those specified in Section 801, with respect to the Securities of such series, and any covenants of the Company for the benefit of the Holders of the Securities of such series, or any Tranche thereof, in addition to those set forth in Article Six; (p) the terms, if any, pursuant to which the Securities of such series, or any Tranche thereof, may be converted into or exchanged for shares of capital stock or other securities of the Company or any other Person; (q) the obligations or instruments, if any, which shall be considered to be Eligible Obligations in respect of the Securities of such series, or any Tranche thereof, denominated in a currency other than Dollars or in a composite currency, and any additional or alternative provisions for the reinstatement of the Company's indebtedness in respect of such Securities after the satisfaction and discharge thereof as provided in Section 701; (r) if the Securities of such series, or any Tranche thereof, are to be issued in global form, (i) any limitations on the rights of the Holder or Holders of such Securities to transfer or exchange the same or to obtain the registration of transfer thereof, (ii) any limitations on the rights of the Holder or Holders thereof to obtain certificates therefor in definitive form in lieu of temporary form and (iii) any and all other matters incidental to such Securities; (s) if the Securities of such series, or any Tranche thereof, are to be issuable as bearer securities, any and all matters incidental thereto which are not specifically addressed in a supplemental indenture as contemplated by clause (g) of Section 1201; (t) to the extent not established pursuant to clause (r) of this paragraph, any limitations on the rights of the Holders of the Securities of such Series, or any Tranche thereof, to transfer or exchange such Securities or to obtain the registration of transfer thereof; and if a service charge will be made for the registration of transfer or exchange of Securities of such series, or any Tranche thereof, the amount or terms thereof; (u) any exceptions to Section 113, or variation in the definition of Business Day, with respect to the Securities of such series, or any Tranche thereof; 17 (v) any collateral security, assurance or guarantee for the Securities of such series; (w) any non-applicability of Section 608 to the Securities of such series or any exceptions or modifications of Section 608 with respect to the Securities of such series; (x) any rights or duties of another Person to assume the obligations of the Company with respect to the Securities of such series (whether as joint obligor, primary obligor, secondary obligor or substitute obligor) and any rights or duties to discharge and release any obligor with respect to the Securities of such series or the Indenture to the extent related to such series; and (y) any other terms of the Securities of such series, or any Tranche thereof, not inconsistent with the provisions of this Indenture, including, without limitation, any terms required for or appropriate to (i) establishing one or more series of medium-term notes to be issued in a Periodic Offering or (ii) providing for the remarketing of the Securities of such series. With respect to Securities of a series subject to a Periodic Offering, the indenture supplemental hereto or the Board Resolution which establishes such series, or the Officer's Certificate pursuant to such supplemental indenture or Board Resolution, as the case may be, may provide general terms or parameters for Securities of such series and provide either that the specific terms of Securities of such series, or any Tranche thereof, shall be specified in a Company Order or that such terms shall be determined by the Company or its agents in accordance with procedures specified in a Company Order as contemplated by the clause (b) of Section 303. Unless otherwise provided with respect to a series of Securities as contemplated in Section 301(b), the aggregate principal amount of a series of securities may be increased and additional Securities of such series may be issued up to the maximum aggregate principal amount authorized with respect to such series as increased. Section 302 Denominations. Unless otherwise provided as contemplated by ------------- Section 301 with respect to any series of Securities, or any Tranche thereof, the Securities of each series shall be issuable in denominations of $1,000 and any integral multiple thereof. Section 303 Execution, Authentication, Delivery and Dating. Unless ------------------------------------------------ otherwise provided as contemplated by Section 301 with respect to any series of Securities, or any Tranche thereof, the Securities shall be executed on behalf of the Company by an Authorized Officer and may have the corporate seal of the Company affixed thereto or reproduced thereon attested by any other Authorized Officer or by the Secretary or an Assistant Secretary of the Company. The signature of any or all of these officers on the Securities may be manual or facsimile. Securities bearing the manual or facsimile signatures of individuals who were at the time of execution Authorized Officers or the Secretary or an Assistant Secretary of the Company shall bind the Company, notwithstanding that such individuals or any of them have ceased to hold such offices prior to the authentication and delivery of such Securities or did not hold such offices at the date of such Securities. 18 The Trustee shall authenticate and deliver Securities of a series, for original issue, at one time or from time to time in accordance with the Company Order referred to below, upon receipt by the Trustee of: (a) the instrument or instruments establishing the form or forms and terms of such series, as provided in Sections 201 and 301; (b) a Company Order requesting the authentication and delivery of such Securities and, to the extent that the terms of such Securities shall not have been established in an indenture supplemental hereto or in a Board Resolution, or in an Officer's Certificate pursuant to a supplemental indenture or Board Resolution, all as contemplated by Sections 201 and 301, either (i) establishing such terms or (ii) in the case of Securities of a series subject to a Periodic Offering, specifying procedures, acceptable to the Trustee, by which such terms are to be established (which procedures may provide, to the extent acceptable to the Trustee, for authentication and delivery pursuant to oral or electronic instructions from the Company or any agent or agents thereof, which oral or electronic instructions are to be promptly confirmed in writing), in either case in accordance with the instrument or instruments delivered pursuant to clause (a) above; (c) the Securities of such series, executed on behalf of the Company by an Authorized Officer; (d) an Opinion of Counsel to the effect that: (i) the form or forms of such Securities have been duly authorized by the Company and have been established in conformity with the provisions of this Indenture; (ii) the terms of such Securities have been duly authorized by the Company and have been established in conformity with the provisions of this Indenture; and (iii) such Securities, when authenticated and delivered by the Trustee and issued and delivered by the Company in the manner and subject to any conditions specified in such Opinion of Counsel, will have been duly issued under this Indenture and will constitute valid and binding obligations of the Company enforceable against the Company in accordance with their terms and entitled to the benefits provided by this Indenture, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar laws relating to or affecting creditors' rights generally, by general equitable principles (regardless of whether considered in a proceeding in equity or at law) and by an implied covenant of good faith, fair dealing and reasonableness; provided, however, that, with respect to Securities of a series subject to a - -------- ------- Periodic Offering, the Trustee shall be entitled to receive such Opinion of Counsel only once at or prior to the time of the first authentication of such Securities (provided that such Opinion of Counsel addresses the authentication and delivery of all Securities of such series) and that in lieu of the opinions described in clauses (ii) and (iii) above Counsel may opine that: 19 (x) when the terms of such Securities shall have been established pursuant to a Company Order or Orders or pursuant to such procedures (acceptable to the Trustee) as may be specified from time to time by a Company Order or Orders, all as contemplated by and in accordance with the instrument or instruments delivered pursuant to clause (a) above, such terms will have been duly authorized by the Company and will have been established in conformity with the provisions of this Indenture; and (y) such Securities, when authenticated and delivered by the Trustee in accordance with this Indenture and the Company Order or Orders or specified procedures referred to in paragraph (x) above and issued and delivered by the Company in the manner and subject to any conditions specified in such Opinion of Counsel, will have been duly issued under this Indenture and will constitute valid and binding obligations of the Company enforceable against the Company in accordance with their terms and entitled to the benefits provided by this Indenture, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar laws relating to or affecting creditors' rights generally, by general equitable principles (regardless of whether considered in a proceeding in equity or at law) and by an implied covenant of good faith, fair dealing and reasonableness. With respect to Securities of a series subject to a Periodic Offering, the Trustee may conclusively rely, as to the authorization by the Company of any of such Securities, the form, terms thereof and the legality, validity, binding effect and enforceability thereof, and compliance of the authentication and delivery thereof with the terms and conditions of this Indenture, upon the Opinion of Counsel and other documents delivered pursuant to Sections 201 and 301 and this Section, as applicable, at or prior to the time of the first authentication of Securities of such series unless and until such opinion or other documents have been superseded or revoked or expire by their terms. In connection with the authentication and delivery of Securities of a series subject to a Periodic Offering, the Trustee shall be entitled to assume that the Company's instructions to authenticate and deliver such Securities do not violate any applicable law or any applicable rule, regulation or order of any Governmental Authority having jurisdiction over the Company. If the form or terms of the Securities of any series have been established by or pursuant to a Board Resolution or an Officer's Certificate as permitted by Sections 201 or 301, the Trustee shall not be required to authenticate such Securities if the issuance of such Securities pursuant to this Indenture will materially or adversely affect the Trustee's own rights, duties or immunities under the Securities and this Indenture or otherwise in a manner which is not reasonably acceptable to the Trustee. Unless otherwise specified as contemplated by Section 301 with respect to any series of Securities, or any Tranche thereof, each Security shall be dated the date of its authentication. Unless otherwise specified as contemplated by Section 301 with respect to any series of Securities, no Security shall be entitled to any benefit under this Indenture or be valid or obligatory for any purpose unless there appears on such Security a certificate of authentication substantially in the form provided for herein executed by the Trustee or an Authenticating Agent by manual 20 signature of an Authorized Officer, and such certificate upon any Security shall be conclusive evidence, and the only evidence, that such Security has been duly authenticated and delivered hereunder and is entitled to the benefits of this Indenture. Notwithstanding the foregoing, if any Security shall have been authenticated and delivered hereunder to the Company, or any Person acting on its behalf, but shall never have been issued and sold by the Company, and the Company shall deliver such Security to the Trustee for cancellation as provided in Section 309 together with a written statement (which need not comply with Section 102 and need not be accompanied by an Opinion of Counsel) stating that such Security has never been issued and sold by the Company, for all purposes of this Indenture such Security shall be deemed never to have been authenticated and delivered hereunder and shall never be entitled to the benefits hereof. Section 304 Temporary Securities. Pending the preparation of definitive -------------------- Securities of any series, or any Tranche thereof, the Company may execute, and upon Company Order the Trustee shall authenticate and deliver, temporary Securities which are printed, lithographed, typewritten, mimeographed or otherwise produced, in any authorized denomination, substantially of the tenor of the definitive Securities in lieu of which they are issued, with such appropriate insertions, omissions, substitutions and other variations as any officer executing such Securities may determine, as evidenced by such officer's execution of such Securities; provided, however, that temporary Securities need not recite specific redemption, sinking fund, conversion or exchange provisions. Unless otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, after the preparation of definitive Securities of such series or Tranche, the temporary Securities of such series or Tranche shall be exchangeable, without charge to the Holder thereof, for definitive Securities of such series or Tranche upon surrender of such temporary Securities at the office or agency of the Company maintained pursuant to Section 602 in a Place of Payment for such Securities. Upon such surrender of temporary Securities for such exchange, the Company shall, except as aforesaid, execute and the Trustee shall authenticate and deliver in exchange therefor definitive Securities of the same series and Tranche of authorized denominations and of like tenor and aggregate principal amount. Until exchanged in full as hereinabove provided, temporary Securities shall in all respects be entitled to the same benefits under this Indenture as definitive Securities of the same series and Tranche and of like tenor authenticated and delivered hereunder. Section 305 Registration, Registration of Transfer and Exchange. The ---------------------------------------------------- Company shall cause to be kept in one of the offices designated pursuant to Section 602, with respect to the Securities of each series, a register (all registers kept in accordance with this Section being collectively referred to as the "Security Register") in which, subject to such reasonable regulations as it ----------------- may prescribe, the Company shall provide for the registration of Securities of such series, or any Tranche thereof, and the registration of transfer thereof. The Company shall designate one Person to maintain the Security Register for the Securities of each series on a consolidated basis, and such Person is referred to herein, with respect to such series, as the "Security Registrar." Anything ------------------- herein to the contrary notwithstanding, the Company may designate one or more of its offices as an office in which a register with respect to the Securities of one or more series shall be maintained, and the Company may designate itself the Security Registrar with respect to one or more of such series, provided that there may only be one Security Register for the Securities of each series. The 21 Security Register shall be open for inspection by the Trustee and the Company at all reasonable times. Except as otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, upon surrender for registration of transfer of any Security of such series or Tranche at the office or agency of the Company maintained pursuant to Section 602 in a Place of Payment for such series or Tranche, the Company shall execute, and the Trustee shall authenticate and deliver, in the name of the designated transferee or transferees, one or more new Securities of the same series and Tranche, of authorized denominations and of like tenor and aggregate principal amount. Except as otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, any Security of such series or Tranche may be exchanged at the option of the Holder, for one or more new Securities of the same series and Tranche, of authorized denominations and of like tenor and aggregate principal amount, upon surrender of the Securities to be exchanged at any such office or agency. Whenever any Securities are so surrendered for exchange, the Company shall execute, and the Trustee shall authenticate and deliver, the Securities which the Holder making the exchange is entitled to receive. All Securities delivered upon any registration of transfer or exchange of Securities shall be valid obligations of the Company, evidencing the same debt, and entitled to the same benefits under this Indenture, as the Securities surrendered upon such registration of transfer or exchange. Every Security presented or surrendered for registration of transfer or for exchange shall (if so required by the Company, the Trustee or the Security Registrar) be duly endorsed or shall be accompanied by a written instrument of transfer in form satisfactory to the Company, the Trustee or the Security Registrar, as the case may be, duly executed by the Holder thereof or his attorney duly authorized in writing. Unless otherwise specified as contemplated by Section 301 with respect to Securities of any series, or any Tranche thereof, no service charge shall be made for any registration of transfer or exchange of Securities, but the Company may require payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer or exchange of Securities, other than exchanges pursuant to Section 304, 406 or 1206 not involving any transfer. The Company shall not be required to execute or to provide for the registration of transfer of or the exchange of (a) Securities of any series, or any Tranche thereof, during a period of 15 days immediately preceding the date notice is to be given identifying the serial numbers of the Securities of such series or Tranche called for redemption or (b) any Security so selected for redemption in whole or in part, except the unredeemed portion of any Security being redeemed in part. Section 306 Mutilated, Destroyed, Lost and Stolen Securities. If any ------------------------------------------------- mutilated Security is surrendered to the Trustee, the Company shall execute and 22 the Trustee shall authenticate and deliver in exchange therefor a new Security of the same series and Tranche, and of like tenor and principal amount and bearing a number not contemporaneously outstanding. If there shall be delivered to the Company and the Trustee (a) evidence to their satisfaction of the ownership of and the destruction, loss or theft of any Security and (b) such security or indemnity as may be reasonably required by them to save each of them and any agent of either of them harmless, then, in the absence of notice to the Company or the Trustee that such Security is held by a Person purporting to be the owner of such Security, the Company shall execute and the Trustee shall authenticate and deliver, in lieu of any such destroyed, lost or stolen Security, a new Security of the same series and Tranche, and of like tenor and principal amount and bearing a number not contemporaneously outstanding. Notwithstanding the foregoing, in case any such mutilated, destroyed, lost or stolen Security has become or is about to become due and payable, the Company in its discretion may, instead of issuing a new Security, pay such Security. Upon the issuance of any new Security under this Section, the Company may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and any other reasonable expenses (including the fees and expenses of the Trustee) connected therewith. Every new Security of any series issued pursuant to this Section in lieu of any destroyed, lost or stolen Security shall constitute an original additional contractual obligation of the Company, whether or not the destroyed, lost or stolen Security shall be at any time enforceable by anyone other than the Holder of such new Security, and any such new Security shall be entitled to all the benefits of this Indenture equally and proportionately with any and all other Securities of such series duly issued hereunder. The provisions of this Section are exclusive and shall preclude (to the extent lawful) all other rights and remedies with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities. Section 307 Payment of Interest; Interest Rights Preserved. Unless ------------------------------------------------- otherwise specified as contemplated by Section 301 with respect to the Securities of any series, or any Tranche thereof, interest on any Security which is payable, and is punctually paid or duly provided for, on any Interest Payment Date shall be paid to the Person in whose name that Security (or one or more Predecessor Securities) is registered at the close of business on the Regular Record Date for such interest. Subject to Section 312, any interest on any Security of any series which is payable, but is not punctually paid or duly provided for, on any Interest Payment Date (herein called "Defaulted Interest") shall forthwith cease ------------------ to be payable to the Holder on the related Regular Record Date by virtue of having been such Holder, and such Defaulted Interest may be paid by the Company, at its election in each case, as provided in clause (a) or (b) below: (a) The Company may elect to make payment of any Defaulted Interest to the Persons in whose names the Securities of such series (or their respective Predecessor Securities) are registered at the close of business on a date 23 (herein called a "Special Record Date") for the payment of such Defaulted --------------------- nterest, which shall be fixed in the following manner. The Company shall notify the Trustee in writing of the amount of Defaulted Interest proposed to be paid on each Security of such series and the date of the proposed payment, and at the same time the Company shall deposit with the Trustee an amount of money equal to the aggregate amount proposed to be paid in respect of such Defaulted Interest or shall make arrangements satisfactory to the Trustee for such deposit on or prior to the date of the proposed payment, such money when deposited to be held in trust for the benefit of the Persons entitled to such Defaulted Interest as in this clause provided. Thereupon the Trustee shall fix a Special Record Date for the payment of such Defaulted Interest which shall be not more than 15 days and not less than 10 days prior to the date of the proposed payment and not less than 10 days after the receipt by the Trustee of the notice of the proposed payment. The Trustee shall promptly notify the Company of such Special Record Date and, in the name and at the expense of the Company, shall promptly cause notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor to be mailed, first-class postage prepaid, to each Holder of Securities of such series at the address of such Holder as it appears in the Security Register, not less than 10 days prior to such Special Record Date. Notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor having been so mailed, such Defaulted Interest shall be paid to the Persons in whose names the Securities of such series (or their respective Predecessor Securities) are registered at the close of business on such Special Record Date. (b) The Company may make payment of any Defaulted Interest on the Securities of any series in any other lawful manner not inconsistent with the requirements of any securities exchange on which such Securities may be listed, and upon such notice as may be required by such exchange, if, after notice given by the Company to the Trustee of the proposed payment pursuant to this clause, such manner of payment shall be deemed practicable by the Trustee. Subject to the foregoing provisions of this Section and Section 305, each Security delivered under this Indenture upon registration of transfer of or in exchange for or in lieu of any other Security shall carry the rights to interest accrued and unpaid, and to accrue, which were carried by such other Security. Section 308 Persons Deemed Owners. Prior to due presentment of a --------------------------- Security for registration of transfer, the Company, the Trustee and any agent of the Company or the Trustee may treat the Person in whose name such Security is registered as the absolute owner of such Security for the purpose of receiving payment of principal of and premium, if any, and (subject to Sections 305 and 307) interest, if any, on such Security and for all other purposes whatsoever, whether or not such Security be overdue, and neither the Company, the Trustee nor any agent of the Company or the Trustee shall be affected by notice to the contrary. Section 309 Cancellation by Security Registrar. All Securities -------------------------------------- surrendered for payment, redemption, credit against a sinking fund, registration of transfer or exchange shall, if surrendered to any Person other than the Security Registrar, be delivered to the Security Registrar and, if not theretofore canceled, shall be promptly canceled by the Security Registrar. The Company may at any time deliver to the Security Registrar for cancellation any Securities previously authenticated and delivered hereunder which the Company may have acquired in any manner whatsoever or which the Company shall not have 24 issued and sold, and all Securities so delivered shall be promptly canceled by the Security Registrar. No Securities shall be authenticated in lieu of or in exchange for any Securities canceled as provided in this Section, except as expressly permitted by this Indenture. All canceled Securities held by the Security Registrar shall be disposed of in accordance with the customary practices of the Security Registrar at the time in effect, and the Security Registrar shall not be required to destroy any such certificates. The Security Registrar shall promptly deliver a certificate of disposition to the Trustee and the Company unless, by a Company Order, similarly delivered, the Company shall direct that canceled Securities be returned to it. The Security Registrar shall promptly deliver evidence of any cancellation of a Security in accordance with this Section 309 to the Trustee and the Company. Section 310 Computation of Interest. Except as otherwise specified as ----------------------- contemplated by Section 301 for Securities of any series, or any Tranche thereof, interest on the Securities of each series shall be computed on the basis of a 360-day year consisting of twelve 30-day months and for any period shorter than a full month, on the basis of the actual number of days elapsed in such period. Section 311 Payment to Be in Proper Currency. In the case of the ----------------------------------- Securities of any series, or any Tranche thereof, denominated in any currency other than Dollars or in a composite currency (the "Required Currency"), except ----------------- as otherwise specified with respect to such Securities as contemplated by Section 301, the obligation of the Company to make any payment of the principal thereof, or the premium or interest thereon, shall not be discharged or satisfied by any tender by the Company, or recovery by the Trustee, in any currency other than the Required Currency, except to the extent that such tender or recovery shall result in the Trustee timely holding the full amount of the Required Currency then due and payable. If any such tender or recovery is in a currency other than the Required Currency, the Trustee may take such actions as it considers appropriate to exchange such currency for the Required Currency. The costs and risks of any such exchange, including without limitation the risks of delay and exchange rate fluctuation, shall be borne by the Company, the Company shall remain fully liable for any shortfall or delinquency in the full amount of Required Currency then due and payable, and in no circumstances shall the Trustee be liable therefor except in the case of its negligence or willful misconduct. Section 312 Extension of Interest Payment. The Company shall have the ------------------------------ right at any time, so long as the Company is not in default in the payment of interest on the Securities of any series hereunder, to extend interest payment periods on all Securities of one or more series, if so specified as contemplated by Section 301 with respect to such Securities and upon such terms as may be specified as contemplated by Section 301 with respect to such Securities. ARTICLE FOUR REDEMPTION OF SECURITIES ------------------------ Section 401 Applicability of Article. Securities of any series,or any ------------------------ Tranche thereof, which are redeemable before their Stated Maturity shall be redeemable in accordance with their terms and (except as otherwise specified as contemplated by Section 301 for Securities of such series or Tranche) in accordance with this Article. 25 Section 402 Election to Redeem; Notice to Trustee. The election of the ------------------------------------- Company to redeem any Securities shall be evidenced by a Board Resolution or an Officer's Certificate. The Company shall, at least 45 days prior to the Redemption Date fixed by the Company (unless a shorter notice shall be satisfactory to the Trustee), notify the Trustee in writing of such Redemption Date and of the principal amount of such Securities to be redeemed. In the case of any redemption of Securities (a) prior to the expiration of any restriction on such redemption provided in the terms of such Securities or elsewhere in this Indenture or (b) pursuant to an election of the Company which is subject to a condition specified in the terms of such Securities, the Company shall furnish the Trustee with an Officer's Certificate evidencing compliance with such restriction or condition. Section 403 Selection of Securities to Be Redeemed. If less than all ---------------------------------------- the Securities of any series, or any Tranche thereof, are to be redeemed, the particular Securities to be redeemed shall be selected by the Trustee from the Outstanding Securities of such series or Tranche not previously called for redemption, by such method as shall be provided for any particular series, or, in the absence of any such provision, by such method as the Trustee shall deem fair and appropriate and which may provide for the selection for redemption of portions (equal to the minimum authorized denomination for Securities of such series or Tranche or any integral multiple thereof) of the principal amount of Securities of such series or Tranche of a denomination larger than the minimum authorized denomination for Securities of such series or Tranche; provided, however, that if, as indicated in an Officer's Certificate, the Company shall have offered to purchase all or any principal amount of the Securities then Outstanding of any series, or any Tranche thereof, and less than all of such Securities as to which such offer was made shall have been tendered to the Company for such purchase, the Trustee, if so directed by Company Order, shall select for redemption all or any principal amount of such Securities which have not been so tendered." The Trustee shall promptly notify the Company and the Security Registrar in writing of the Securities selected for redemption and, in the case of any Securities selected to be redeemed in part, the principal amount thereof to be redeemed. For all purposes of this Indenture, unless the context otherwise requires, all provisions relating to the redemption of Securities shall relate, in the case of any Securities redeemed or to be redeemed only in part, to the portion of the principal amount of such Securities which has been or is to be redeemed. Section 404 Notice of Redemption. Except as otherwise specified as --------------------- contemplated by Section 301 for Securities of any series, notice of redemption shall be given in the manner provided in Section 106 to the Holders of the Securities to be redeemed not less than 30 nor more than 60 days prior to the Redemption Date. Except as otherwise specified as contemplated by Section 301 for Securities of any series, all notices of redemption shall state: (a) the Redemption Date, (b) the Redemption Price (if known), 26 (c) if less than all the Securities of any series or Tranche are to be redeemed, the identification of the particular Securities to be redeemed and the portion of the principal amount of any Security to be redeemed in part, (d) that on the Redemption Date the Redemption Price, together with accrued interest, if any, to the Redemption Date, will become due and payable upon each such Security to be redeemed and, if applicable, that interest thereon will cease to accrue on and after said date, (e) the place or places where such Securities are to be surrendered for payment of the Redemption Price and accrued interest, if any, unless it shall have been specified as contemplated by Section 301 with respect to such Securities that such surrender shall not be required, (f) whether the redemption is at the election of the Company, or is for a sinking or other fund, if such is the case, (g) the CUSIP, ISIN, or other similar number or numbers, if any, assigned to such Securities; provided, however, that such notice may state that no representation is made as to the correctness of any or all of such numbers, in which case none of the Company, the Trustee or any agent of the Company or the Trustee shall have any liability in respect of the use of any such number on such notices, and the redemption of such Securities shall not be affected by any defect in or omission of such numbers, and (h) such other matters as the Company shall deem desirable or appropriate. Unless otherwise specified with respect to any Securities in accordance with Section 301, with respect to any notice of redemption of Securities at the election of the Company, unless, upon giving of such notice, such Securities shall be deemed to have been paid in accordance with Section 701, such notice may, if so provided in the Officer's Certificate or Board Resolution delivered to the Trustee pursuant to Section 402, state that such redemption shall be conditional upon the receipt by the Paying Agent or Agents for such Securities, on or prior to the date fixed for such redemption, of money sufficient to pay the Redemption Price on such Securities and that if such money shall not have been so received such notice shall be of no force or effect and the Company shall not be required to redeem such Securities. In the event that such notice of redemption contains such a condition and such money is not so received, the redemption shall not be made and within a reasonable time thereafter notice shall be given, in the manner in which the notice of redemption was given, that such money was not so received and such redemption was not required to be made. A failure by the Company to provide such moneys or make provision for the payment thereof shall not constitute an Event of Default under this Indenture. The Paying Agent or Agents for the Securities otherwise to have been redeemed shall thereupon promptly return to the Holders thereof any of such Securities which had been surrendered for payment upon such redemption. Notice of redemption of Securities to be redeemed at the election of the Company, and any notice of non-satisfaction of a condition for redemption as aforesaid, shall be given by the Company or, at the Company's request, by the 27 Security Registrar in the name and at the expense of the Company. Notice of mandatory redemption of Securities shall be given by the Security Registrar in the name and at the expense of the Company. Section 405 Securities Payable on Redemption Date. Notice of redemption ------------------------------------- having been given as aforesaid, and the conditions, if any, set forth in such notice having been satisfied, the Securities or portions thereof so to be redeemed shall, on the Redemption Date, become due and payable at the Redemption Price therein specified, and from and after such date (unless, in the case of an unconditional notice of redemption, the Company shall default in the payment of the Redemption Price and accrued interest, if any) such Securities or portions thereof, if interest-bearing, shall cease to bear interest. Upon surrender of any such Security for redemption in accordance with such notice, such Security or portion thereof shall be paid by the Company at the Redemption Price, together with accrued interest, if any, to the Redemption Date; provided, however, that no such surrender shall be a condition to such payment if so specified as contemplated by Section 301 with respect to such Security; and provided, further, that except as otherwise specified as contemplated by Section 301 with respect to such Security, any installment of interest on any Security the Stated Maturity of which installment is on or prior to the Redemption Date shall be payable to the Holder of such Security, or one or more Predecessor Securities, registered as such at the close of business on the related Regular Record Date according to the terms of such Security and subject to the provisions of Section 307. Section 406 Securities Redeemed in Part. Upon the surrender of an ---------------------------- Security which is to be redeemed only in part at a Place of Payment therefor (with, if the Company or the Trustee so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company and the Trustee duly executed by, the Holder thereof or his attorney duly authorized in writing), the Company shall execute, and the Trustee shall authenticate and deliver to the Holder of such Security, without service charge, a new Security or Securities of the same series and Tranche, of any authorized denomination requested by such Holder and of like tenor and in aggregate principal amount equal to and in exchange for the unredeemed portion of the principal of the Security so surrendered. ARTICLE FIVE SINKING FUNDS ------------- Section 501 Applicability of Article. The provisions of this Article ------------------------- shall be applicable to any sinking fund for the retirement of the Securities of any series, or any Tranche thereof, except as otherwise specified as contemplated by Section 301 for Securities of such series or Tranche. The minimum amount of any sinking fund payment provided for by the terms of Securities of any series, or any Tranche thereof, is herein referred to as a "mandatory sinking fund payment", and any payment in excess of such minimum amount provided for by the terms of Securities of any series, or any Tranche thereof, is herein referred to as an "optional sinking fund payment". If provided for by the terms of Securities of any series, or any Tranche thereof, the cash amount of any sinking fund payment may be subject to reduction as provided in Section 502. Each sinking fund payment shall be applied to the redemption of Securities of the series or Tranche in respect of which it was made as provided for by the terms of such Securities. 28 Section 502 Satisfaction of Sinking Fund Payments with Securities. The ----------------------------------------------------- Company (a) may deliver to the Trustee Outstanding Securities (other than any previously called for redemption) of a series or Tranche in respect of which a mandatory sinking fund payment is to be made and (b) may apply as a credit Securities of such series or Tranche which have been redeemed either at the election of the Company pursuant to the terms of such Securities, at the election of the Holder thereof if applicable, or through the application of permitted optional sinking fund payments pursuant to the terms of such Securities, in each case in satisfaction of all or any part of such mandatory sinking fund payment with respect to the Securities of such series; provided, -------- however, that no Securities shall be applied in satisfaction of a mandatory - ------- sinking fund payment if such Securities shall have been previously so applied. Securities so applied shall be received and credited for such purpose by the Trustee at the Redemption Price specified in such Securities for redemption through operation of the sinking fund and the amount of such mandatory sinking fund payment shall be reduced accordingly. Section 503 Redemption of Securities for Sinking Fund. Not less than 45 ----------------------------------------- days prior to each mandatory sinking fund payment date for the Securities of any series, or any Tranche thereof, the Company shall deliver to the Trustee an Officer's Certificate specifying: (a) the amount of the next succeeding mandatory sinking fund payment for such series or Tranche; (b) the amount, if any, of the optional sinking fund payment to be made together with such mandatory sinking fund payment; (c) the aggregate sinking fund payment; (d) the portion, if any, of such aggregate sinking fund payment which is to be satisfied by the payment of cash; and (e) the portion, if any, of such aggregate sinking fund payment which is to be satisfied by delivering and crediting Securities of such series or Tranche pursuant to Section 502 and stating the basis for such credit and that such Securities have not previously been so credited, and the Company shall also deliver to the Trustee any Securities to be so delivered. If the Company shall have not delivered such Officer's Certificate and, to the extent applicable, all such Securities, the next succeeding sinking fund payment for such series or Tranche shall be made entirely in cash in the amount of the mandatory sinking fund payment. Not less than 30 days before each such sinking fund payment date the Trustee shall select the Securities to be redeemed upon such sinking fund payment date in the manner specified in Section 403 and cause notice of the redemption thereof to be given in the name of and at the expense of the Company in the manner provided in Section 404. Such notice having been duly given, the redemption of such Securities shall be made upon the terms and in the manner stated in Sections 405 and 406. 29 ARTICLE SIX COVENANTS --------- Section 601 Payment of Principal, Premium and Interest. The Company ---------------------- shall pay the principal of and premium, if any, and interest, if any, on the Securities of each series in accordance with the terms of such Securities and this Indenture. Section 602 Maintenance of Office or Agency. The Company shall maintain ------------------------------- in each Place of Payment for the Securities of each series, or any Tranche thereof, an office or agency where payment of such Securities shall be made, where the registration of transfer or exchange of such Securities may be effected and where notices and demands to or upon the Company in respect of such Securities and this Indenture may be served. The Company shall give prompt written notice to the Trustee of the location, and any change in the location, of each such office or agency and prompt notice to the Holders of any such change in the manner specified in Section 106. If at any time the Company shall fail to maintain any such required office or agency in respect of Securities of any series, or any Tranche thereof, or shall fail to furnish the Trustee with the address thereof, payment of such Securities shall be made, registration of transfer or exchange thereof may be effected and notices and demands in respect thereof may be served at the Corporate Trust Office of the Trustee, and the Company hereby appoints the Trustee as its agent for all such purposes in any such event. The Company may also from time to time designate one or more other offices or agencies with respect to the Securities of one or more series, or any Tranche thereof, for any or all of the foregoing purposes and may from time to time rescind such designations; provided, however, that, unless otherwise ------------------ specified as contemplated by Section 301 with respect to the Securities of such series or Tranche, no such designation or rescission shall in any manner relieve the Company of its obligation to maintain an office or agency for such purposes in each Place of Payment for such Securities in accordance with the requirements set forth above. The Company shall give prompt written notice to the Trustee, and prompt notice to the Holders in the manner specified in Section 106, of any such designation or rescission and of any change in the location of any such other office or agency. Anything herein to the contrary notwithstanding, any office or agency required by this Section may be maintained at an office of the Company, in which event the Company shall perform all functions to be performed at such office or agency. Section 603 Money for Securities Payments to Be Held in Trust. If the ------------------------------------------------- Company shall at any time act as its own Paying Agent with respect to the Securities of any series, or any Tranche thereof, it shall, on or before each due date of the principal of and premium, if any, and interest, if any, on any of such Securities, segregate and hold in trust for the benefit of the Persons entitled thereto a sum sufficient to pay the principal and premium or interest so becoming due until such sums shall be paid to such Persons or otherwise disposed of as herein provided. The Company shall promptly notify the Trustee of any failure by the Company (or any other obligor on such Securities) to make any payment of principal of or premium, if any, or interest, if any, on such Securities. 30 Whenever the Company shall have one or more Paying Agents for the Securities of any series, or any Tranche thereof, it shall, on or before each due date of the principal of and premium, if any, and interest, if any, on such Securities, deposit with such Paying Agents sums sufficient (without duplication) to pay the principal and premium or interest so becoming due, such sums to be held in trust for the benefit of the Persons entitled to such principal, premium or interest, and (unless such Paying Agent is the Trustee) the Company shall promptly notify the Trustee of any failure by it so to act. The Company shall cause each Paying Agent for the Securities of any series, or any Tranche thereof, other than the Company or the Trustee, to execute and deliver to the Trustee an instrument in which such Paying Agent shall agree with the Trustee, subject to the provisions of this Section, that such Paying Agent shall: (a) hold all sums held by it for the payment of the principal of and premium, if any, or interest, if any, on such Securities in trust for the benefit of the Persons entitled thereto until such sums shall be paid to such Persons or otherwise disposed of as herein provided; (b) give the Trustee notice of any failure by the Company (or any other obligor upon such Securities) to make any payment of principal of or premium, if any, or interest, if any, on such Securities; and (c) at any time during the continuance of any such failure, upon the written request of the Trustee, forthwith pay to the Trustee all sums so held in trust by such Paying Agent and furnish to the Trustee such information as it possesses regarding the names and addresses of the Persons entitled to such sums. The Company may at any time pay, or by Company Order direct any Paying Agent to pay, to the Trustee all sums held in trust by the Company or such Paying Agent, such sums to be held by the Trustee upon the same trusts as those upon which such sums were held by the Company or such Paying Agent and, if so stated in a Company Order delivered to the Trustee, in accordance with the provisions of Article Seven; and, upon such payment by any Paying Agent to the Trustee, such Paying Agent shall be released from all further liability with respect to such money. Any money deposited with the Trustee or any Paying Agent, or then held by the Company, in trust for the payment of the principal of and premium, if any, or interest, if any, on any Security and remaining unclaimed for two years after such principal and premium, if any, or interest has become due and payable shall be paid to the Company on Company Request, or, if then held by the Company, shall be discharged from such trust; and, upon such payment or discharge, the Holder of such Security shall, as an unsecured general creditor and not as a Holder of an Outstanding Security, look only to the Company for payment of the amount so due and payable and remaining unpaid, and all liability of the Trustee or such Paying Agent with respect to such trust money, and all liability of the Company as trustee thereof, shall thereupon cease; provided, -------- however, that the Trustee or such Paying Agent, before being required to make - ------- any such payment to the Company, may at the expense of the Company cause to be mailed, on one occasion only, notice to such Holder that such money remains 31 unclaimed and that, after a date specified therein, which shall not be less than 30 days from the date of such mailing, any unclaimed balance of such money then remaining will be paid to the Company. Section 604 Corporate Existence. Subject to the rights of the Company -------------------- under Article Eleven, the Company shall do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence. Section 605 Maintenance of Properties. The Company shall cause (or, --------------------------- with respect to property owned in common with others, make reasonable effort to cause) all its properties used or useful in the conduct of its business to be maintained and kept in good condition, repair and working order and shall cause (or, with respect to property owned in common with others, make reasonable effort to cause) to be made all necessary repairs, renewals, replacements, betterments and improvements thereof, all as, in the judgment of the Company, may be necessary so that the business carried on in connection therewith may be properly conducted; provided, however, that nothing in this Section shall ------------------ prevent the Company from discontinuing, or causing the discontinuance of, the operation and maintenance of any of its properties if such discontinuance is, in the judgment of the Company, desirable in the conduct of its business. Section 606 Annual Officer's Certificate as to Compliance. Not later ---------------------------------------------- than December 1 in each year, commencing December 1, 2004 the Company shall deliver to the Trustee an Officer's Certificate which need not comply with Section 102, executed by the principal executive officer, the principal financial officer or the principal accounting officer of the Company, as to such officer's knowledge of the Company's compliance with all conditions and covenants under this Indenture, such compliance to be determined without regard to any period of grace or requirement of notice under this Indenture, and making any other statements as may be required by the provisions of Section 314(a)(4) of the Trust Indenture Act. Section 607 Waiver of Certain Covenants. The Company may omit in any --------------------------- particular instance to comply with any term, provision or condition set forth in (a) any additional covenant or restriction specified with respect to the Securities of any series, or any Tranche thereof, as contemplated by Section 301, if before the time for such compliance the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series and Tranches with respect to which compliance with such additional covenant or restriction is to be omitted, considered as one class, shall, by Act of such Holders, either waive such compliance in such instance or generally waive compliance with such term, provision or condition and (b) Section 604, 605 or Article Eleven if before the time for such compliance the Holders of a majority in principal amount of Securities Outstanding under this Indenture shall, by Act of such Holders, either waive such compliance in such instance or generally waive compliance with such term, provision or condition; but, in the case of (a) or (b), no such waiver shall extend to or affect such term, provision or condition except to the extent so expressly waived, and, until such waiver shall become effective, the obligations of the Company and the duties of the Trustee in respect of any such term, provision or condition shall remain in full force and effect. Section 608 Limitation on Liens. (a) So long as any Securities of any ------------------- series are Outstanding, the Company may not issue, assume, guarantee or permit to exist any Debt that is secured by any Lien of or upon any of the Company's Operating Property, whether owned at the date hereof or subsequently acquired, 32 without in any such case effectively securing the Outstanding Securities (together with, if the Company shall so determine, any of the Company's other indebtedness ranking equally with such Securities) equally and ratably with such Debt (but only so long as such Debt is so secured); provided, however, that the foregoing restriction shall not apply to: (1) Liens on any Operating Property existing at the time of its acquisition (which Liens may also extend to subsequent repairs, alterations and improvements to that Operating Property); (2) Liens on operating property of a corporation existing at the time such corporation is merged into or consolidated with, or at the time the corporation sells, leases or otherwise disposes of its properties (or of a division thereof) as or substantially as an entirety to, the Company; (3) Liens on Operating Property to secure the costs of acquisition, construction, development or substantial repair, alteration or improvement of property or to secure any Debt incurred to provide funds for any of such purposes or for reimbursement of funds previously expended for any of such purposes, provided such Liens are created or assumed contemporaneously with, or within eighteen (18) months after, such acquisition or the completion of such substantial repair or alteration, construction, development or substantial improvement; (4) Liens in favor of any State of the United States or any department, agency or instrumentality or political subdivision of any State, or for the benefit of holders of securities issued by any such entity (or providers of credit enhancement with respect to such securities), to secure any Debt (including, without limitation, obligations of the Company with respect to industrial development, pollution control or similar revenue bonds) incurred for the purpose of financing or refinancing all or any part of the purchase price or the cost of substantially repairing or altering, constructing, developing or substantially improving property which at the time of such purchase, repair, alteration, construction, development or improvement was owned or operated by the Company; (5) Liens securing Debt outstanding as of the date of issuance of the first series of Securities issued under this Indenture; (6) Liens securing Debt maturing less than twelve (12) months from its issuance or incurrence and is not extendible at the option of the Company; (7) Liens on Operating Property which is the subject of a lease agreement designating the Company as lessee and all of its right, title and interest in such Operating Property and such lease agreement, whether or not such lease agreement is intended as security; 33 (8) Liens for taxes, assessments, governmental charges and levies to the extent not past due; pledges or deposits to secure performance or obligations under workmen's compensation laws or similar legislation, and statutory obligations of the Company; Liens imposed by law, such as materialmen's, mechanics', carriers', workmen's and repairmen's Liens, Liens created by or resulting from legal proceedings being contested in good faith and other similar Liens arising in the ordinary course of business securing obligations which are not overdue or which have been fully bonded and are being contested in good faith; (9) Liens under Section 907 hereof; or (10) any extension, renewal or replacement (or successive extensions, renewals or replacements), in whole or in part, of any Lien referred to in clauses (1) through (9), provided, however, that the principal amount of Debt secured thereby and not otherwise authorized by clauses (1) through (9), shall not exceed the principal amount of Debt, plus any premium or fee payable in connection with any such extension, renewal or replacement, so secured at the time of the extension, renewal or replacement. (b) Notwithstanding the provisions of Section 608(a), the Company may issue, assume or guarantee Debt secured by Liens which would otherwise be subject to the restrictions of Section 608(a) up to an aggregate principal amount which, together with the principal amount of all other Debt of the Company secured by Liens (other than Liens permitted by Section 608(a)(1) through (10)) and the Value of all Sale and Lease-Back Transactions in existence at such time (other than any Sale and Lease-Back Transaction in which the Operating Property involved would have been permitted to be subject to a Lien permitted by Section 608(a), other than Sale and Lease-Back Transactions permitted by Section 609 because the commitment by or on behalf of the purchaser was obtained no later than eighteen (18) months after the later of events described in (i) or (ii) of Section 609, and other than Sale and Lease-Back Transactions as to which application of amounts have been made in accordance with clause (z) of Section 609), does not exceed the greater of fifteen percent (15%) of Net Tangible Assets and fifteen percent (15%) of Capitalization. (c) If the Company shall issue, assume or guarantee any Debt secured by any Lien and if Section 608(a) requires that the Outstanding Securities be secured equally and ratably with such Debt, the Company will promptly execute, at its expense, any instruments necessary to so equally and ratably secure the Outstanding Securities and deliver the same to the Trustee along with: (i) An Officers' Certificate stating that the covenant of the Company contained in Section 608(a) has been complied with; and (ii) An Opinion of Counsel to the effect that the Company has complied with the covenant contained in Section 608(a), and that any instruments executed by the Company in the performance of such covenant comply with the requirements of such covenant. 34 In the event that the Company shall hereafter secure Outstanding Securities equally and ratably with any other obligation or indebtedness pursuant to the provisions of this Section 608, the Company will, upon the request of the Trustee, enter into an indenture or agreement supplemental hereto and take such other action, if any, as the Trustee may reasonably request to enable it to enforce effectively the rights of the Holders of Outstanding Securities so secured, equally and ratably with such other obligation or indebtedness. Section 609 Limitation on Sale and Lease-Back Transactions. So long as ---------------------------------------------- any Securities are Outstanding, the Company shall not enter into or permit to exist, any Sale and Lease-Back Transaction with respect to any Operating Property if, in any case, the commitment by or on behalf of the purchaser is obtained more than eighteen (18) months after the later of (i) the completion of the acquisition, construction or development of such Operating Property or (ii) the placing in operation of such Operating Property or of such Operating Property as constructed or developed or substantially repaired, altered or improved, unless (x) the Company would be entitled pursuant to Section 608(a) to issue, assume, guarantee or permit to exist Debt secured by a Lien on such Operating Property without equally and ratably securing the Securities or (y) the Company would be entitled pursuant to Section 608(b), after giving effect to such Sale and Lease-Back Transaction, to incur $1.00 of additional Debt secured by Liens (other than Liens permitted by Section 608(a)) or (z) the Company shall apply or cause to be applied, in the case of a sale or transfer for cash, an amount equal to the net proceeds thereof (but not in excess of the net book value of such Operating Property at the date of such sale or transfer) and, in the case of a sale or transfer otherwise than for cash, an amount equal to the fair value (as determined by the Board of Directors of the Company) of the Operating Property so leased, to the retirement, within one hundred eighty (180) days after the effective date of such Sale and Lease-Back Transaction, of Securities (in accordance with their terms) or other Debt of the Company ranking senior to, or equally with, the Securities; provided, however, that the amount to be applied to such retirement of Debt shall be reduced by an amount equal to the principal amount, plus any premium or fee paid in connection with any redemption in accordance with the terms of Debt voluntarily retired by the Company within such one hundred eighty (180) day period, excluding retirement pursuant to mandatory sinking fund or prepayment provisions and payments at Maturity. ARTICLE SEVEN SATISFACTION AND DISCHARGE -------------------------- Section 701 Satisfaction and Discharge of Securities. Any Security or ---------------------------------------- Securities, or any portion of the principal amount thereof, shall be deemed to have been paid for all purposes of this Indenture, and the entire indebtedness of the Company in respect thereof shall be deemed to have been satisfied and discharged, if there shall have been irrevocably deposited with the Trustee or any Paying Agent (other than the Company), in trust: (a) money in an amount which shall be sufficient, or (b) in the case of a deposit made prior to the Maturity of such Securities or portions thereof, Eligible Obligations, which shall not contain provisions permitting the redemption or other prepayment thereof at the option 35 of the issuer thereof, the principal of and the interest on which when due, without any regard to reinvestment thereof, will provide moneys which, together with the money, if any, deposited with or held by the Trustee or such Paying Agent, shall be sufficient, or (c) a combination of (a) or (b) which shall be sufficient, to pay when due the principal of and premium, if any, and interest, if any, due and to become due on such Securities or portions thereof on or prior to Maturity; provided, however, that in the case of the provision for payment or redemption of less than all the Securities of any series or Tranche, such Securities or portions thereof shall have been selected by the Trustee as provided herein and, in the case of a redemption, the notice requisite to the validity of such redemption shall have been given or irrevocable authority shall have been given by the Company to the Trustee to give such notice, under arrangements satisfactory to the Trustee; and provided, further, that the Company shall have delivered to the Trustee and such Paying Agent: (x) if such deposit shall have been made prior to the Maturity of such Securities, a Company Order stating that the money and Eligible Obligations deposited in accordance with this Section shall be held in trust, as provided in Section 703; and (y) if Eligible Obligations shall have been deposited, an Opinion of Counsel that the obligations so deposited constitute Eligible Obligations and do not contain provisions permitting the redemption or other prepayment at the option of the issuer thereof, and an opinion of an independent public accountant of nationally recognized standing, selected by the Company, to the effect that the requirements set forth in clause (b) above have been satisfied; and (z) if such deposit shall have been made prior to the Maturity of such Securities, (i) an Officer's Certificate stating the Company's intention that, upon delivery of such Officer's Certificate, its indebtedness in respect of such Securities or portions thereof will have been satisfied and discharged as contemplated in this Section, and (ii) an Opinion of Counsel to the effect that, as a result of a change in law occurring or a ruling of the United States Internal Revenue Service issued after the date of issuance of such Securities, the Holders of such Securities, or portions of the principal amount thereof, will not recognize income, gain or loss for United States federal income tax purposes as a result of the satisfaction and discharge of the Company's indebtedness in respect thereof and will be subject to United States federal income tax on the same amounts, at the same times and in the same manner as if such satisfaction and discharge had not been effected. Upon the deposit of money or Eligible Obligations, or both, in accordance with this Section, together with the documents required by clauses (x), (y) and (z) above, the Trustee shall, upon receipt of a Company Request, accompanied by an Officer's Certificate and an Opinion of Counsel in compliance with Section 102 of this Indenture, acknowledge in writing that the Security or Securities or portions thereof with respect to which such deposit was made are deemed to have been paid for all purposes of this Indenture and that the entire indebtedness of the Company in respect thereof has been satisfied and discharged as contemplated in this Section. In the event that all of the conditions set 36 forth in the preceding paragraph shall have been satisfied in respect of any Securities or portions thereof except that, for any reason, the Officer's Certificate and Opinion of Counsel specified in clause (z) shall not have been delivered, such Securities or portions thereof shall nevertheless be deemed to have been paid for all purposes of this Indenture, and the Holders of such Securities or portions thereof shall nevertheless be no longer entitled to the benefits of this Indenture or of any of the covenants of the Company under Article Six (except the covenants contained in Sections 602 and 603 and Article Eleven) or any other covenants made in respect of such Securities or portions thereof as contemplated by Section 301, but the indebtedness of the Company in respect of such Securities or portions thereof shall not be deemed to have been satisfied and discharged prior to Maturity for any other purpose, and the Holders of such Securities or portions thereof shall continue to be entitled to look to the Company for payment of the indebtedness represented thereby; and, upon Company Request, , accompanied by an Officer's Certificate and an Opinion of Counsel in compliance with Section 102 of this Indenture, the Trustee shall acknowledge in writing that such Securities or portions thereof are deemed to have been paid for all purposes of this Indenture. If payment at Stated Maturity of less than all of the Securities of any series, or any Tranche thereof, is to be provided for in the manner and with the effect provided in this Section, the Security Registrar shall select such Securities, or portions of principal amount thereof, in the manner specified by Section 403 for selection for redemption of less than all the Securities of a series or Tranche. In the event that Securities which shall be deemed to have been paid for purposes of this Indenture, and, if such is the case, in respect of which the Company's indebtedness shall have been satisfied and discharged, all as provided in this Section do not mature and are not to be redeemed within the 60 day period commencing with the date of the deposit of moneys or Eligible Obligations, as aforesaid, the Company shall, as promptly as practicable, give a notice, in the same manner as a notice of redemption with respect to such Securities, to the Holders of such Securities to the effect that such deposit has been made and the effect thereof. Notwithstanding that any Securities shall be deemed to have been paid for purposes of this Indenture, as aforesaid, the obligations of the Company and the Trustee in respect of such Securities under Sections 304, 305, 306, 404, 503 (as to notice of redemption), 602, 603, 907 and 915 and this Article Seven shall survive. The Company shall pay, and shall indemnify the Trustee or any Paying Agent with which Eligible Obligations shall have been deposited as provided in this Section against, any tax, fee or other charge imposed on or assessed against such Eligible Obligations or the principal or interest received in respect of such Eligible Obligations, including, but not limited to, any such tax payable by any entity deemed, for tax purposes, to have been created as a result of such deposit. Anything herein to the contrary notwithstanding, (a) if, at any time after a Security would be deemed to have been paid for purposes of this Indenture, and, if such is the case, the Company's indebtedness in respect thereof would be deemed to have been satisfied or discharged, pursuant to this Section (without regard to the provisions of this paragraph), the Trustee or any Paying Agent, as the case may be, shall be required to return the money or 37 Eligible Obligations, or combination thereof, deposited with it as aforesaid to the Company or its representative under any applicable Federal or State bankruptcy, insolvency or other similar law, such Security shall thereupon be deemed retroactively not to have been paid and any satisfaction and discharge of the Company's indebtedness in respect thereof shall retroactively be deemed not to have been effected, and such Security shall be deemed to remain Outstanding and (b) any satisfaction and discharge of the Company's indebtedness in respect of any Security shall be subject to the provisions of the last paragraph of Section 603. Section 702 Satisfaction and Discharge of Indenture. This Indenture ---------------------------------------- shall upon Company Request, accompanied by an Officer's Certificate and an Opinion of Counsel in compliance with Section 102 of this Indenture, cease to be of further effect (except as hereinafter expressly provided), and the Trustee, at the expense of the Company, shall execute proper instruments acknowledging satisfaction and discharge of this Indenture, when (a) no Securities remain Outstanding hereunder; and (b) the Company has paid or caused to be paid all other sums payable hereunder by the Company; provided, however, that if, in accordance with the last paragraph of Section - -------- ------- 701, any Security, previously deemed to have been paid for purposes of this Indenture, shall be deemed retroactively not to have been so paid, this Indenture shall thereupon be deemed retroactively not to have been satisfied and discharged, as aforesaid, and to remain in full force and effect, and the Company shall execute and deliver such instruments as the Trustee shall reasonably request to evidence and acknowledge the same. Notwithstanding the satisfaction and discharge of this Indenture as aforesaid, the obligations of the Company and the Trustee under Sections 304, 305, 306, 404, 503 (as to notice of redemption), 602, 603, 907 and 915 and this Article Seven shall survive. Upon satisfaction and discharge of this Indenture as provided in this Section, the Trustee shall assign, transfer and turn over to the Company, subject to the lien provided by Section 907, any and all money, securities and other property then held by the Trustee for the benefit of the Holders of the Securities other than money and Eligible Obligations held by the Trustee pursuant to Section 703. Section 703 Application of Trust Money. Neither the Eligible ------------------------------ Obligations nor the money deposited pursuant to Section 701, nor the principal or interest payments on any such Eligible Obligations, shall be withdrawn or used for any purpose other than, and shall be held in trust for, the payment of the principal of and premium, if any, and interest, if any, on the Securities or portions of principal amount thereof in respect of which such deposit was made, all subject, however, to the provisions of Section 603; provided, however, that, ----------------- so long as there shall not have occurred and be continuing an Event of Default, any cash received from such principal or interest payments on such Eligible Obligations, if not then needed for such purpose, shall, to the extent practicable and upon Company Request, be invested in Eligible Obligations of the type described in clause (b) in the first paragraph of Section 701 maturing at such times and in such amounts as shall be sufficient, together with any other moneys and the principal of and interest on any other Eligible Obligations then held by the Trustee, to pay when due the principal of and premium, if any, and interest, if any, due and to become due on such Securities or portions thereof 38 on and prior to the Maturity thereof, and interest earned from such reinvestment shall be paid over to the Company as received, free and clear of any trust, lien or pledge under this Indenture except the lien provided by Section 907; and provided, further, that, so long as there shall not have occurred and be - ------------------ continuing an Event of Default, any moneys held in accordance with this Section on the Maturity of all such Securities in excess of the amount required to pay the principal of and premium, if any, and interest, if any, then due on such Securities shall be paid over to the Company free and clear of any trust, lien or pledge under this Indenture except the lien provided by Section 907; and provided, further, that if an Event of Default shall have occurred and be - ------------------ continuing, moneys to be paid over to the Company pursuant to this Section shall be held until such Event of Default shall have been waived or cured. ARTICLE EIGHT EVENTS OF DEFAULT; REMEDIES --------------------------- Section 801 Events of Default. "Event of Default", wherever used herein ----------------- ---------------- with respect to Securities of anyseries, means any one of the following events: (a) failure to pay interest, if any, on any Security of such series within 30 days after the same becomes due and payable; provided, however, that a ----------------- valid extension of the interest payment period by the Company as contemplated in Section 312 of this Indenture shall not constitute a failure to pay interest for this purpose; or (b) failure to pay the principal of or premium, if any, on any Security of such series at its Maturity; or (c) 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 or which has expressly been included in this Indenture solely for the benefit of one or more series of Securities other than such series) for a period of 90 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 Holders of at least 33% in principal amount of the Outstanding Securities of such series, 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 Holders of a principal amount of Securities of such series not less than the principal amount of Securities the Holders 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 the Trustee, or the Trustee and the Holders of such - ------------------ principal amount of Securities of such series, 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 (d) the entry by a court having jurisdiction in the premises of (1) 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 (2) a decree or order adjudging the Company a bankrupt or insolvent, or approving as properly filed a petition by 39 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 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 90 consecutive days; or (e) 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 (f) any other Event of Default with respect to Securities of such series as shall have been specified in the terms thereof as contemplated by Section 301(o). Section 802 Acceleration of Maturity; Rescission and Annulment. If an -------------------------------------------------- Event of Default due to the default in payment of principal of, premium, if any, or interest on, any series of Securities or due to the default in the performance or breach of any other covenant or warranty of the Company applicable to the Securities of such series but not applicable to all Outstanding Securities shall have occurred and be continuing, either the Trustee or the Holders of not less than 33% in principal amount of the Securities of such series may then declare the principal amount (or, if any of the Securities of such series are Discount Securities, such portion of the principal amount as may be specified in the terms thereof as contemplated by Section 301) of all Securities of such series and interest accrued thereon to be due and payable immediately. If an Event of Default due to default in the performance of any other of the covenants or agreements herein applicable to all Outstanding Securities or an Event of Default specified in Section 801(d) or (e) shall have occurred and be continuing, either the Trustee or the Holders of not less than 33% in principal amount of all Securities then Outstanding (considered as one class), and not the Holders of the Securities of any one of such series, may declare the principal of all Securities and interest accrued thereon to be due and payable immediately. As a consequence of each such declaration (herein referred to as a declaration of acceleration) with respect to Securities of any series, the principal amount (or portion thereof in the case of Discount Securities) of such Securities and interest accrued thereon shall become due and payable immediately. At any time after such a declaration of acceleration with respect to Securities of any series shall have been made and before a judgment or decree for payment of the money due shall have been obtained by the Trustee as hereinafter in this Article provided, the Event or Events of Default giving rise 40 to such declaration of acceleration shall, without further act, be deemed to have been waived, and such declaration and its consequences shall, without further act, be deemed to have been rescinded and annulled, if (a) the Company shall have paid or deposited with the Trustee a sum sufficient to pay (1) all overdue interest on all Securities of such series; (2) the principal of and premium, if any, on any Securities of such series which have become due otherwise than by such declaration of acceleration and interest thereon at the rate or rates prescribed therefor in such Securities; (3) to the extent that payment of such interest is lawful, interest upon overdue interest, if any, at the rate or rates prescribed therefor in such Securities; (4) all amounts due to the Trustee under Section 907; and (b) any other Event or Events of Default with respect to Securities of such series, other than the nonpayment of the principal of Securities of such series which shall have become due solely by such declaration of acceleration, shall have been cured or waived as provided in Section 813. No such rescission shall affect any subsequent Event of Default or impair any right consequent thereon. Section 803 Collection of Indebtedness and Suits for Enforcement by ---------------------------------------------------------- Trustee. If an Event of Default described in clause (a) or (b) of Section 801 - ------- shall have occurred and be continuing, the Company shall, upon demand of the Trustee, pay to it, for the benefit of the Holders of the Securities of the series with respect to which such Event of Default shall have occurred, the whole amount then due and payable on such Securities for principal and premium, if any, and interest, if any, and, to the extent permitted by law, interest on any overdue principal and interest, at the rate or rates prescribed therefor in such Securities, and, in addition thereto, such further amount as shall be sufficient to cover any amounts due to the Trustee under Section 907. If the Company shall fail to pay such amounts forthwith upon such demand, the Trustee, in its own name and as trustee of an express trust, may institute a judicial proceeding for the collection of the sums so due and unpaid, may prosecute such proceeding to judgment or final decree and may enforce the same against the Company or any other obligor upon such Securities and collect the moneys adjudged or decreed to be payable in the manner provided by law out of the property of the Company or any other obligor upon such Securities, wherever situated. If an Event of Default with respect to Securities of any series shall have occurred and be continuing, the Trustee may in its discretion proceed to 41 protect and enforce its rights and the rights of the Holders of Securities of such series under the Indenture by such appropriate judicial proceedings as the Trustee shall deem most effectual to protect and enforce any such rights, whether for the specific enforcement of any covenant or agreement in this Indenture or in aid of the exercise of any power granted herein, or to enforce any other proper remedy. Section 804 Trustee May File Proofs of Claim. In case of the pendency -------------------------------- of any receivership, insolvency, liquidation, bankruptcy, reorganization, arrangement, adjustment, composition or other judicial proceeding relative to the Company or any other obligor upon the Securities or the property of the Company or of such other obligor or their creditors, the Trustee (irrespective of whether the principal of the Securities shall then be due and payable as therein expressed or by declaration or otherwise and irrespective of whether the Trustee shall have made any demand on the Company for the payment of overdue principal or interest) shall be entitled and empowered, by intervention in such proceeding or otherwise, (a) to file and prove a claim for the whole amount of principal, premium, if any, and interest, if any, owing and unpaid in respect of the Securities and to file such other papers or documents as may be necessary or advisable in order to have the claims of the Trustee (including any claim for amounts due to the Trustee under Section 907) and of the Holders allowed in such judicial proceeding, and (b) to collect and receive any moneys or other property payable or deliverable on any such claims and to distribute the same; and any custodian, receiver, assignee, trustee, liquidator, sequestrator or other similar official in any such judicial proceeding is hereby authorized by each Holder to make such payments to the Trustee and, in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amounts due it under Section 907. Nothing herein contained shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Holder any plan of reorganization, arrangement, adjustment or composition affecting the Securities or the rights of any Holder thereof or to authorize the Trustee to vote in respect of the claim of any Holder in any such proceeding. Section 805 Trustee May Enforce Claims Without Possession of ------------------------------------------------------- Securities. All rights of action and claims under this Indenture or the - ---------- Securities may be prosecuted and enforced by the Trustee without the possession of any of the Securities or the production thereof in any proceeding relating thereto, and any such proceeding instituted by the Trustee shall be brought in its own name as trustee of an express trust, and any recovery of judgment shall, after provision for the payment of the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, be for the ratable benefit of the Holders in respect of which such judgment has been recovered. Section 806 Application of Money Collected. Any money or other property ------------------------------ collected by the Trustee pursuant to this Article and any money or other property distributable in respect of the Company's obligations under this Indenture after an Event of Default shall be applied in the following order, at the date or dates fixed by the Trustee and, in case of the distribution of such 42 money on account of principal or premium, if any, or interest, if any, upon presentation of the Securities in respect of which or for the benefit of which such money shall have been collected and the notation thereon of the payment if only partially paid and upon surrender thereof if fully paid: (a) To the payment of all amounts due the Trustee (including any predecessor Trustee) under Section 907; (b) To the payment of the amounts then due and unpaid upon the Securities for principal of and premium, if any, and interest, if any, in respect of which or for the benefit of which such money has been collected, ratably, without preference or priority of any kind, according to the amounts due and payable on such Securities for principal, premium, if any, and interest, if any, respectively; and (c) To the payment of the remainder, if any, to the Company or to whomsoever may be lawfully entitled to receive the same or as a court of competent jurisdiction may direct. Section 807 Limitation on Suits. No Holder shall have any right to ------------------- institute any proceeding, judicial or otherwise, with respect to this Indenture, or for the appointment of a receiver or trustee, or for any other remedy hereunder, unless: (a) such Holder shall have previously given written notice to the Trustee of a continuing Event of Default with respect to the Securities of such series; (b) the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series in respect of which an Event of Default shall have occurred and be continuing, considered as one class, shall have made written request to the Trustee to institute proceedings in respect of such Event of Default in its own name as Trustee hereunder; (c) such Holder or Holders shall have offered to the Trustee reasonable indemnity against the costs, expenses and liabilities to be incurred in compliance with such request; (d) the Trustee for 60 days after its receipt of such notice, request and offer of indemnity shall have failed to institute any such proceeding; and (e) no direction inconsistent with such written request shall have been given to the Trustee during such 60-day period by the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series in respect of which an Event of Default shall have occurred and be continuing, considered as one class; it being understood and intended that no one or more of such Holders shall have any right in any manner whatever by virtue of, or by availing of, any provision of this Indenture to affect, disturb or prejudice the rights of any other of such Holders or to obtain or to seek to obtain priority or preference over any other of such Holders or to enforce any right under this Indenture, except in the manner herein provided and for the equal and ratable benefit of all of such Holders. Section 808 Unconditional Right of Holders to Receive Principal, ------------------------------------------------------- Premium and Interest. Notwithstanding any other provision in this Indenture, the - -------------------- 43 Holder of any Security shall have the right, which is absolute and unconditional, to receive payment of the principal of and premium, if any, and (subject to Sections 307 and 312) interest, if any, on such Security on the Stated Maturity or Maturities expressed in such Security (or, in the case of redemption, on the Redemption Date) and to institute suit for the enforcement of any such payment, and such rights shall not be impaired without the consent of such Holder. Section 809 Restoration of Rights and Remedies. If the Trustee or any ---------------------------------- any Holder has instituted any proceeding to enforce any right or remedy under this Indenture and such proceeding shall have been discontinued or abandoned for any reason, or shall have been determined adversely to the Trustee or to such Holder, then and in every such case, subject to any determination in such proceeding, the Company, and Trustee and such Holder shall be restored severally and respectively to their former positions hereunder and thereafter all rights and remedies of the Trustee and such Holder shall continue as though no such proceeding had been instituted. Section 810 Rights and Remedies Cumulative. Except as otherwise --------------------------------- provided in the last paragraph of Section 306, no right or remedy herein conferred upon or reserved to the Trustee or to the Holders is intended to be exclusive of any other right or remedy, and every right and remedy shall, to the extent permitted by law, be cumulative and in addition to every other right and remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion or employment of any right or remedy hereunder, or otherwise, shall not prevent the concurrent assertion or employment of any other appropriate right or remedy. Section 811 Delay or Omission Not Waiver. No delay or omission of the ---------------------------- Trustee or of any Holder to exercise any right or remedy accruing upon any Event of Default shall impair any such right or remedy or constitute a waiver of any such Event of Default or an acquiescence therein. Every right and remedy given by this Article or by law to the Trustee or to the Holders may be exercised from time to time, and as often as may be deemed expedient, by the Trustee or by the Holders, as the case may be. Section 812 Control by Holders of Securities. The Holders of a majority -------------------------------- in principal amount of the Outstanding Securities of any series shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred on the Trustee, with respect to the Securities of such series; provided, however, that if an Event of Default shall have occurred and be continuing with respect to more than one series of Securities, the Holders of a majority in aggregate principal amount of the Outstanding Securities of all such series, considered as one class, shall have the right to make such direction, and not the Holders of the Securities of any one of such series; and provided, further, that (a) such direction shall not be in conflict with any rule of law or with this Indenture, and could not involve the Trustee in personal liability in circumstances where indemnity would not, in the Trustee's sole discretion, be adequate, and (b) the Trustee may take any other action, deemed proper by the Trustee, which is not inconsistent with any such direction. Section 813 Waiver of Past Defaults. The Holders of not less than a ------------------------ majority in principal amount of the Outstanding Securities of any series may on 44 behalf of the Holders of all the Securities of such series waive any past default hereunder with respect to such series and its consequences, except a default (a) in the payment of the principal of or premium, if any, or interest, if any, on any Security of such series, or (b) in respect of a covenant or provision hereof which under Section 1202 cannot be modified or amended without the consent of the Holder of each Outstanding Security of such series affected. Upon any such waiver, such default shall cease to exist, and any and all Events of Default arising therefrom shall be deemed to have been cured, for every purpose of this Indenture; but no such waiver shall extend to any subsequent or other default or impair any right consequent thereon. Section 814 Undertaking for Costs. The Company and the Trustee agree, ---------------------- and each Holder by his acceptance thereof shall be deemed to have agreed, that any court may in its discretion require, in any suit for the enforcement of any right or remedy under this Indenture, or in any suit against the Trustee for any action taken, suffered or omitted by it as Trustee, the filing by any party litigant in such suit of an undertaking to pay the costs of such suit, and that such court may in its discretion assess reasonable costs, including reasonable attorneys' fees, against any party litigant in such suit, having due regard to the merits and good faith of the claims or defenses made by such party litigant; but the provisions of this Section shall not apply to any suit instituted by the Company, to any suit instituted by the Trustee, to any suit instituted by any Holder, or group of Holders, holding in the aggregate more than 10% in aggregate principal amount of the Outstanding Securities of all series in respect of which such suit may be brought, considered as one class, or to any suit instituted by any Holder for the enforcement of the payment of the principal of or premium, if any, or interest, if any, on any Security on or after the Stated Maturity or Maturities expressed in such Security (or, in the case of redemption, on or after the Redemption Date). Section 815 Waiver of Stay or Extension Laws. The Company covenants (to -------------------------------- the extent that it may lawfully do so) that it will not at any time insist upon, or plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay or extension law wherever enacted, now or at any time hereafter in force, which may affect the covenants or the performance of this Indenture; and the Company (to the extent that it may lawfully do so) hereby expressly waives all benefit or advantage of any such law and covenants that it will not hinder, delay or impede the execution of any power herein granted to the Trustee, but will suffer and permit the execution of every such power as though no such law had been enacted. ARTICLE NINE THE TRUSTEE ----------- Section 901 Certain Duties and Responsibilities. (a) Except during the ----------------------------------- continuance of an Event of Default, 45 (1) the Trustee undertakes to perform such duties and only such duties as are specifically set forth in this Indenture, and no implied covenants or obligations shall be read into this Indenture against the Trustee; and (2) in the absence of bad faith on its part, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon certificates or opinions furnished to the Trustee and conforming to the requirements of this Indenture; but in the case of any such certificates or opinions which by any provision hereof are specifically required to be furnished to the Trustee, the Trustee shall be under a duty to examine the same to determine whether or not they conform to the requirements of this Indenture (but need not confirm or investigate the accuracy of mathematical calculations or other facts stated therein). (b) In case an Event of Default has occurred and is continuing, the Trustee shall exercise such of the rights and powers vested in it by this Indenture, and use the same degree of care and skill in their exercise, as a prudent person would exercise or use under the circumstances in the conduct of his or her own affairs. (c) No provision of this Indenture shall be construed to relieve the Trustee from liability for its own negligent action, its own negligent failure to act, or its own willful misconduct, except that (1) this Subsection shall not be construed to limit the effect of Subsections (a) or (d) of this Section; (2) the Trustee shall not be liable for any error of judgment made in good faith by a Responsible Officer, unless it shall be proved that the Trustee was negligent in ascertaining the pertinent facts; and (3) the Trustee shall not be liable with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of the Holders of a majority in principal amount of the Outstanding Securities of any series, determined as provided in Sections 101 and 104, relating to the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred upon the Trustee, under this Indenture with respect to the Securities of such series. (d) No provision of this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder, or in the exercise of any of its rights or powers, if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. (e) Whether or not therein expressly so provided, every provision of this Indenture relating to the conduct or affecting the liability of or affording protection to the Trustee shall be subject to the provisions of this Section. 46 Section 902 Notice of Defaults. The Trustee shall give notice of any ------------------ default hereunder known to the Trustee with respect to the Securities of any series to the Holders of Securities of such series in the manner and to the extent required to do so by the Trust Indenture Act, unless such default shall have been cured or waived; provided, however, that in the case of any default of ----------------- the character specified in Section 801(c), no such notice to Holders shall be given until at least 45 days after the occurrence thereof. For the purpose of this Section and clause (h) of Section 903, the term "default" means any event which is, or after notice or lapse of time, or both, would become, an Event of Default. Section 903 Certain Rights of Trustee. Subject to the provisions of ------------------------- Section 901 and to the applicable provisions of the Trust Indenture Act: (a) the Trustee may conclusively rely and shall be fully protected in acting or refraining from acting upon any resolution, certificate, Officer's Certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, other evidence of indebtedness or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties; (b) any request or direction of the Company mentioned herein shall be sufficiently evidenced by a Company Request or Company Order, or as otherwise expressly provided herein, and any resolution of the Board of Directors may be sufficiently evidenced by a Board Resolution; (c) whenever in the administration of this Indenture the Trustee shall deem it desirable that a matter be proved or established prior to taking, suffering or omitting any action hereunder, the Trustee (unless other evidence be herein specifically prescribed) may, in the absence of bad faith on its part, conclusively rely upon an Officer's Certificate; (d) the Trustee may consult with counsel and the advice of such counsel or any Opinion of Counsel shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by it hereunder in good faith and in reliance thereon; (e) the Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture at the request or direction of any Holder pursuant to this Indenture, unless such Holder shall have offered to the Trustee reasonable security or indemnity against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction; (f) the Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, other evidence of indebtedness or other paper or document, but the Trustee, in its discretion, may make such further inquiry or investigation into such facts or matters as it may see fit, and, if the Trustee shall determine to make such further inquiry or investigation, it shall (subject to applicable legal requirements) be entitled to examine, during normal business hours, the books, records and premises of the Company, personally or by agent or attorney; 47 (g) the Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through agents or attorneys, and the Trustee shall not be responsible for any misconduct or negligence on the part of any agent or attorney appointed with due care by it hereunder; (h) the Trustee shall not be charged with knowledge of any default (as defined in Section 902) or Event of Default, as the case may be, with respect to the Securities of any series for which it is acting as Trustee unless either (1) a Responsible Officer of the Trustee shall have actual knowledge that such default or Event of Default, as the case may be, exists and constitutes a default or Event of Default under this Indenture or (2) written notice of such default or Event of Default, as the case may be, shall have been given in the manner provided in Section 105 hereof to the Trustee by the Company, any other obligor on such Securities or by any Holder of such Securities and such notice refers to such Securities and this Indenture; (i) the rights, privileges, protections, immunities and benefits given to the Trustee, including, without limitation, its right to be indemnified, are extended to, and shall be enforceable by, the Trustee in each of its capacities hereunder; and (j) the Trustee shall not be liable for any action it takes or omits to take in good faith which it reasonably believes to be authorized or within its rights or powers. Section 904 Not Responsible for Recitals or Issuance of Securities. The ------------------------------------------------------ recitals contained herein and in the Securities (except the Trustee's certificates of authentication) shall be taken as the statements of the Company, and neither the Trustee nor any Authenticating Agent assumes responsibility for their correctness. The Trustee makes no representations as to the validity or sufficiency of this Indenture or of the Securities. Neither the Trustee nor any Authenticating Agent shall be accountable for the use or application by the Company of Securities or the proceeds thereof. Section 905 May Hold Securities. Each of the Trustee, any ---------------------- Authenticating Agent, any Paying Agent, any Security Registrar or any other agent of the Company, in its individual or any other capacity, may become the owner or pledgee of Securities and, subject to Sections 908 and 913, may otherwise deal with the Company with the same rights it would have if it were not the Trustee, Authenticating Agent, Paying Agent, Security Registrar or such other agent. Section 906 Money Held in Trust. Money held by the Trustee in trust ------------------- hereunder need not be segregated from other funds, except to the extent required by law. The Trustee shall be under no liability for interest on any money received by it hereunder except as expressly provided herein or otherwise agreed with, and for the sole benefit of, the Company. Section 907 Compensation and Reimbursement. The Company shall ------------------------------ (a) pay to the Trustee from time to time such compensation for all services rendered by it hereunder (which compensation shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust) as the Company and the Trustee shall agree in writing; 48 (b) except as otherwise expressly provided herein, reimburse the Trustee upon its request for all reasonable expenses, disbursements and advances reasonably incurred or made by the Trustee in accordance with any provision of this Indenture (including the reasonable compensation and the expenses and disbursements of its agents and counsel), except to the extent that any such expense, disbursement or advance may be attributable to the Trustee's gross negligence or wilful misconduct; and (c) indemnify the Trustee for, and hold it harmless from and against, any loss, liability or expense reasonably incurred by it arising out of or in connection with the acceptance or administration of the trust or trusts hereunder or the performance of its duties hereunder, including the reasonable costs and expenses of defending itself against any claim or liability in connection with the exercise or performance of any of its powers or duties hereunder, except to the extent any such loss, liability or expense may be attributable to its gross negligence or wilful misconduct. As security for the performance of the obligations of the Company under this Section, the Trustee shall have a lien prior to the Securities upon all property and funds held or collected by the Trustee as such, other than property and funds held in trust under Section 703 (except as otherwise provided in Section 703). In addition to and without prejudice to the rights provided to the Trustee under any of the provisions of this Indenture or applicable law, when the Trustee incurs expenses or renders services in connection with an Event of Default specified in Section 801(d) or Section 801(e), the expenses (including the reasonable charges and expenses of its counsel) and the compensation for the services are intended to constitute expenses of administration under any applicable Federal or State bankruptcy, insolvency or other similar law. "Trustee" for purposes of this Section shall include any predecessor ------- Trustee; provided, however, that the negligence, wilful misconduct or bad faith ----------------- of any Trustee hereunder shall not affect the rights of any other Trustee hereunder. The provisions of this Section 907 shall survive the discharge of the Company's obligations in respect of any Securities, including under Article Seven, the termination of this Indenture for any reason and the resignation or removal of any Trustee. Section 908 Disqualification; Conflicting Interests. If the Trustee ----------------------------------------- shall have or acquire any conflicting interest within the meaning of the Trust Indenture Act, it shall either eliminate such conflicting interest or resign to the extent, in the manner and with the effect, and subject to the conditions, provided in the Trust Indenture Act and this Indenture. For purposes of Section 310(b)(1) of the Trust Indenture Act and to the fullest extent permitted thereby, the Trustee, in its capacity as trustee in respect of the Securities of any series, shall not be deemed to have a conflicting interest arising from its capacity as trustee in respect of the Securities of any other series. To the extent permitted by the Trust Indenture Act, the Indenture dated as of May 1, 1991 between the Company and the Trustee, the Indenture dated as of June 13, 1997 among the Company, Toledo Edison Company and the Trustee, and the Indenture dated as of October 24, 1997 between the Company and the Trustee shall be deemed to be specifically described for the purpose of the proviso to Section 310(b)(i)(1) of the Trust Indenture Act. Nothing herein shall prevent the 49 Trustee from filing with the Commission the application referred to in the second to last paragraph of Section 310(b) of the Trust Indenture Act. Section 909 Corporate Trustee Required; Eligibility. There shall at all --------------------------------------- times be a Trustee hereunder which shall be (a) a corporation organized and doing business under the laws of the United States, any State or Territory thereof or the District of Columbia, authorized under such laws to exercise corporate trust powers, having a combined capital and surplus of at least $50,000,000 and subject to supervision or examination by Federal or State authority, or (b) if and to the extent permitted by the Commission by rule, regulation or order upon application, a corporation or other Person organized and doing business under the laws of a foreign government, authorized under such laws to exercise corporate trust powers, having a combined capital and surplus of at least $50,000,000 or the Dollar equivalent of the applicable foreign currency and subject to supervision or examination by authority of such foreign government or a political subdivision thereof substantially equivalent to supervision or examination applicable to United States institutional trustees, and, in either case, qualified and eligible under this Article and the Trust Indenture Act. If such corporation publishes reports of condition at least annually, pursuant to law or to the requirements of such supervising or examining authority, then for the purposes of this Section, the combined capital and surplus of such corporation shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time the Trustee shall cease to be eligible in accordance with the provisions of this Section, it shall resign immediately in the manner and with the effect hereinafter specified in this Article. Section 910 Resignation and Removal; Appointment of Successor. (a) No -------------------------------------------------- resignation or removal of the Trustee and no appointment of a successor Trustee pursuant to this Article shall become effective until the acceptance of appointment by the successor Trustee in accordance with the applicable requirements of Section 911. (b) The Trustee may resign at any time with respect to the Securities of one or more series by giving written notice thereof to the Company. If the instrument of acceptance by a successor Trustee required by Section 911 shall not have been delivered to the Trustee within 30 days after the giving of such notice of resignation, the resigning Trustee may petition any court of competent jurisdiction for the appointment of a successor Trustee with respect to the Securities of such series. (c) The Trustee may be removed at any time with respect to the Securities of any series by Act of the Holders of a majority in principal amount of the Outstanding Securities of such series delivered to the Trustee and to the Company. (d) If at any time: (1) the Trustee shall fail to comply with Section 908 after written request therefor by the Company or by any Holder who has been a bona fide Holder for at least six months, or 50 (2) the Trustee shall cease to be eligible under Section 909 and shall fail to resign after written request therefor by the Company or by any such Holder, or (3) the Trustee shall become incapable of acting or shall be adjudged a bankrupt or insolvent or a receiver of the Trustee or of its property shall be appointed or any public officer shall take charge or control of the Trustee or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, then, in any such case, (x) the Company by a Board Resolution may remove the Trustee with respect to all Securities or (y) subject to Section 814, any Holder who has been a bona fide Holder for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the removal of the Trustee with respect to all Securities and the appointment of a successor Trustee or Trustees. (e) If the Trustee shall resign, be removed or become incapable of acting, or if a vacancy shall occur in the office of Trustee for any cause (other than as contemplated in clause (y) in Subsection (d) of this Section), with respect to the Securities of one or more series, the Company shall promptly appoint a successor Trustee or Trustees with respect to the Securities of that or those series (it being understood that any such successor Trustee may be appointed with respect to the Securities of one or more or all of such series and that at any time there shall be only one Trustee with respect to the Securities of any particular series) and shall comply with the applicable requirements of Section 911. If, within one year after such resignation, removal or incapability, or the occurrence of such vacancy, a successor Trustee with respect to the Securities of any series shall be appointed by Act of the Holders of a majority in principal amount of the Outstanding Securities of such series delivered to the Company and the retiring Trustee, the successor Trustee so appointed shall, forthwith upon its acceptance of such appointment in accordance with the applicable requirements of Section 911, become the successor Trustee with respect to the Securities of such series and to that extent supersede the successor Trustee appointed by the Company. If no successor Trustee with respect to the Securities of any series shall have been so appointed by the Company or the Holders and accepted appointment in the manner required by Section 911, any Holder who has been a bona fide Holder of a Security of such series for at least six months may, on behalf of itself and all others similarly situated, petition any court of competent jurisdiction for the appointment of a successor Trustee with respect to the Securities of such series. (f) So long as no event which is, or after notice or lapse of time, or both, would become, an Event of Default shall have occurred and be continuing, and except with respect to a Trustee appointed by Act of the Holders of a majority in principal amount of the Outstanding Securities pursuant to Subsection (e) of this Section, if the Company shall have delivered to the Trustee (i) a Board Resolution appointing a successor Trustee, effective as of a date specified therein, and (ii) an instrument of acceptance of such appointment, effective as of such date, by such successor Trustee in accordance with Section 911, the Trustee shall be deemed to have resigned as contemplated in Subsection (b) of this Section, the successor Trustee shall be deemed to have been appointed by the Company pursuant to Subsection (e) of this Section and such appointment shall be deemed to have been accepted as contemplated in 51 Section 911, all as of such date, and all other provisions of this Section and Section 911 shall be applicable to such resignation, appointment and acceptance except to the extent inconsistent with this Subsection (f). (g) The Company (or, should the Company fail so to act promptly, the successor trustee at the expense of the Company) shall give notice of each resignation and each removal of the Trustee with respect to the Securities of any series and each appointment of a successor Trustee with respect to the Securities of any series by mailing written notice of such event by first-class mail, postage prepaid, to all Holders of Securities of such series as their names and addresses appear in the Security Register. Each notice shall include the name of the successor Trustee with respect to the Securities of such series and the address of its corporate trust office. Section 911 Acceptance of Appointment by Successor. (a) In case of the -------------------------------------- appointment hereunder of a successor Trustee with respect to the Securities of all series, every such successor Trustee so appointed shall execute, acknowledge and deliver to the Company and to the retiring Trustee an instrument accepting such appointment, and thereupon the resignation or removal of the retiring Trustee shall become effective and such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee; but, on the request of the Company or the successor Trustee, such retiring Trustee shall, upon payment of all sums owed to it, execute and deliver an instrument transferring to such successor Trustee all the rights, powers and trusts of the retiring Trustee and shall duly assign, transfer and deliver to such successor Trustee all property and money held by such retiring Trustee hereunder, subject nevertheless to its lien provided for in Section 907. (b) In case of the appointment hereunder of a successor Trustee with respect to the Securities of one or more (but not all) series, the Company, the retiring Trustee and each successor Trustee with respect to the Securities of one or more series shall execute and deliver an indenture supplemental hereto wherein each successor Trustee shall accept such appointment and which (1) shall contain such provisions as shall be necessary or desirable to transfer and confirm to, and to vest in, each successor Trustee all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series to which the appointment of such successor Trustee relates, (2) if the retiring Trustee is not retiring with respect to all Securities, shall contain such provisions as shall be deemed necessary or desirable to confirm that all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series as to which the retiring Trustee is not retiring shall continue to be vested in the retiring Trustee and (3) shall add to or change any of the provisions of this Indenture as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one Trustee, it being understood that nothing herein or in such supplemental indenture shall constitute such Trustees co-trustees of the same trust and that each such Trustee shall be trustee of a trust or trusts hereunder separate and apart from any trust or trusts hereunder administered by any other such Trustee; and upon the execution and delivery of such supplemental indenture the resignation or removal of the retiring Trustee shall become effective to the extent provided therein and each such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee with respect to the Securities of that or those series to which the appointment of such successor Trustee relates; but, on request of the Company or any successor Trustee, such retiring Trustee, upon payment of all sums owed to it, shall duly assign, transfer and deliver to such successor Trustee all property and money held by 52 such retiring Trustee hereunder with respect to the Securities of that or those series to which the appointment of such successor Trustee relates, subject nevertheless to its lien provided for in Section 907. (c) Upon request of any such successor Trustee, the Company shall execute any instruments which fully vest in and confirm to such successor Trustee all such rights, powers and trusts referred to in Subsection (a) or (b) of this Section, as the case may be. (d) No successor Trustee shall accept its appointment unless at the time of such acceptance such successor Trustee shall be qualified and eligible under this Article. Section 912 Merger, Conversion, Consolidation or Succession to -------------------------------------------------------- Business. Any Person into which the Trustee may be merged or converted or with - -------- which it may be consolidated, or any Person resulting from any merger, conversion or consolidation to which the Trustee shall be a party, or any Person succeeding to all or substantially all the corporate trust business of the Trustee, shall be the successor of the Trustee hereunder, provided such Person shall be otherwise qualified and eligible under this Article, without the execution or filing of any paper or any further act on the part of any of the parties hereto. In case any Securities shall have been authenticated, but not delivered, by the Trustee then in office, any successor by merger, conversion or consolidation to such authenticating Trustee may adopt such authentication and deliver the Securities so authenticated with the same effect as if such successor Trustee had itself authenticated such Securities. Section 913 Preferential Collection of Claims Against Company. If the ------------------------------------------------- Trustee shall be or become a creditor of the Company or any other obligor upon the Securities (other than by reason of a relationship described in Section 311(b) of the Trust Indenture Act), the Trustee shall be subject to any and all applicable provisions of the Trust Indenture Act regarding the collection of claims against the Company or such other obligor. For purposes of Section 311(b) of the Trust Indenture Act: (a) the term "cash transaction" means any transaction in which full payment for goods or securities sold is made within seven days after delivery of the goods or securities in currency or in checks or other orders drawn upon banks or bankers and payable upon demand; (b) the term "self-liquidating paper" means any draft, bill of exchange, acceptance or obligation which is made, drawn, negotiated or incurred by the Company for the purpose of financing the purchase, processing, manufacturing, shipment, storage or sale of goods, wares or merchandise and which is secured by documents evidencing title to, possession of, or a lien upon, the goods, wares or merchandise or the receivables or proceeds arising from the sale of the goods, wares or merchandise previously constituting the security, provided the security is received by the Trustee simultaneously with the creation of the creditor relationship with the Company arising from the making, drawing, negotiating or incurring of the draft, bill of exchange, acceptance or obligation. Section 914 Co-trustees and Separate Trustees. At any time or times, ---------------------------------- for the purpose of meeting the legal requirements of any applicable jurisdiction, the Company and the Trustee shall have power to appoint, and, upon 53 the written request of the Trustee or of the Holders of at least 33% in principal amount of the Securities then Outstanding, the Company shall for such purpose join with the Trustee in the execution and delivery of all instruments and agreements necessary or proper to appoint, one or more Persons approved by the Trustee either to act as co-trustee, jointly with the Trustee, or to act as separate trustee, in either case with such powers as may be provided in the instrument of appointment, and to vest in such Person or Persons, in the capacity aforesaid, any property, title, right or power deemed necessary or desirable, subject to the other provisions of this Section. If the Company does not join in such appointment within 15 days after the receipt by it of a request so to do, or if an Event of Default shall have occurred and be continuing, the Trustee alone shall have power to make such appointment. Should any written instrument or instruments from the Company be required by any co-trustee or separate trustee so appointed to more fully confirm to such co-trustee or separate trustee such property, title, right or power, any and all such instruments shall, on request, be executed, acknowledged and delivered by the Company. Every co-trustee or separate trustee shall, to the extent permitted by law, but to such extent only, be appointed subject to the following conditions: (a) the Securities shall be authenticated and delivered, and all rights, powers, duties and obligations hereunder in respect of the custody of securities, cash and other personal property held by, or required to be deposited or pledged with, the Trustee hereunder, shall be exercised solely, by the Trustee; (b) the rights, powers, duties and obligations hereby conferred or imposed upon the Trustee in respect of any property covered by such appointment shall be conferred or imposed upon and exercised or performed either by the Trustee or by the Trustee and such co-trustee or separate trustee jointly, as shall be provided in the instrument appointing such co-trustee or separate trustee, except to the extent that under any law of any jurisdiction in which any particular act is to be performed, the Trustee shall be incompetent or unqualified to perform such act, in which event such rights, powers, duties and obligations shall be exercised and performed by such co-trustee or separate trustee; (c) the Trustee at any time, by an instrument in writing executed by it, with the concurrence of the Company, may accept the resignation of or remove any co-trustee or separate trustee appointed under this Section, and, if an Event of Default shall have occurred and be continuing, the Trustee shall have power to accept the resignation of, or remove, any such co-trustee or separate trustee without the concurrence of the Company. Upon the written request of the Trustee, the Company shall join with the Trustee in the execution and delivery of all instruments and agreements necessary or proper to effectuate such resignation or removal. A successor to any co-trustee or separate trustee so resigned or removed may be appointed in the manner provided in this Section; (d) no co-trustee or separate trustee hereunder shall be personally liable by reason of any act or omission of the Trustee, or any other such trustee hereunder; and the Trustee shall not be personally liable by reason of any act or omission of any other such trustee hereunder; and 54 (e) any Act of Holders delivered to the Trustee shall be deemed to have been delivered to each such co-trustee and separate trustee. Section 915 Appointment of Authenticating Agent. The Trustee may -------------------------------------- appoint an Authenticating Agent or Agents with respect to the Securities of one or more series, or Tranches thereof, which shall be authorized to act on behalf of the Trustee to authenticate Securities of such series or Tranche issued upon original issuance and upon exchange, registration of transfer or partial redemption thereof or pursuant to Section 306, and Securities so authenticated shall be entitled to the benefits of this Indenture and shall be valid and obligatory for all purposes as if authenticated by the Trustee hereunder. Wherever reference is made in this Indenture to the authentication and delivery of Securities by the Trustee or the Trustee's certificate of authentication, such reference shall be deemed to include authentication and delivery on behalf of the Trustee by an Authenticating Agent and a certificate of authentication executed on behalf of the Trustee by an Authenticating Agent. Each Authenticating Agent shall be acceptable to the Company and shall at all times be a corporation organized and doing business under the laws of the United States, any State or territory thereof or the District of Columbia, authorized under such laws to act as Authenticating Agent, having a combined capital and surplus of not less than $50,000,000 and subject to supervision or examination by Federal or State authority. If such Authenticating Agent publishes reports of condition at least annually, pursuant to law or to the requirements of said supervising or examining authority, then for the purposes of this Section, the combined capital and surplus of such Authenticating Agent shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time an Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, such Authenticating Agent shall resign immediately in the manner and with the effect specified in this Section. Any corporation into which an Authenticating Agent may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which such Authenticating Agent shall be a party, or any corporation succeeding to the corporate agency or corporate trust business of an Authenticating Agent, shall continue to be an Authenticating Agent, provided such corporation shall be otherwise eligible under this Section, without the execution or filing of any paper or any further act on the part of the Trustee or the Authenticating Agent. An Authenticating Agent may resign at any time by giving written notice thereof to the Trustee and to the Company. The Trustee may at any time terminate the agency of an Authenticating Agent by giving written notice thereof to such Authenticating Agent and to the Company. Upon receiving such a notice of resignation or upon such a termination, or in case at any time such Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, the Trustee may appoint a successor Authenticating Agent which shall be acceptable to the Company. Any successor Authenticating Agent upon acceptance of its appointment hereunder shall become vested with all the rights, powers and duties of its predecessor hereunder, with like effect as if originally named as an Authenticating Agent. No successor Authenticating Agent shall be appointed unless eligible under the provisions of this Section. 55 The Company agrees to pay to each Authenticating Agent from time to time reasonable compensation for its services under this Section. The provisions of Sections 308, 904 and 905 shall be applicable to each Authenticating Agent. If an appointment with respect to the Securities of one or more series shall be made pursuant to this Section, the Securities of such series may have endorsed thereon, in addition to the Trustee's certificate of authentication, an alternate certificate of authentication substantially in the following form: This is one of the Securities of the series designated therein referred to in the within-mentioned Indenture. Dated: JPMorgan Chase Bank As Trustee By ------------------------------ As Authenticating Agent By ------------------------------ Authorized Signatory If all of the Securities of a series may not be originally issued at one time, and if the Trustee does not have an office capable of authenticating Securities upon original issuance located in a Place of Payment where the Company wishes to have Securities of such series authenticated upon original issuance, the Trustee, if so requested by the Company in writing (which writing need not comply with Section 102 and need not be accompanied by an Opinion of Counsel), shall appoint, in accordance with this Section and in accordance with such procedures as shall be acceptable to the Trustee, an Authenticating Agent having an office in a Place of Payment designated by the Company with respect to such series of Securities. ARTICLE TEN HOLDERS' LISTS AND REPORTS BY TRUSTEE AND COMPANY ------------------------------------------------- Section 1001 Lists of Holders. Semiannually, not later than June 1 and ---------------- December 1 in each year, commencing June 1, 2004 and at such other times as the Trustee may request in writing, the Company shall furnish or cause to be furnished to the Trustee information as to the names and addresses of the Holders, and the Trustee shall preserve such information and similar information received by it in any other capacity and afford to the Holders access to information so preserved by it, all to such extent, if any, and in such manner as shall be required by the Trust Indenture Act; provided, however, that no such ----------------- list need be furnished so long as the Trustee shall be the Security Registrar. 56 Section 1002 Reports by Trustee and Company. Not later than July 15 in ------------------------------ each year, commencing with the year 2004, the Trustee shall transmit to the Holders, the Commission and each securities exchange upon which any Securities are listed, a report, dated as of the next preceding May 15, with respect to any events and other matters described in Section 313(a) of the Trust Indenture Act, in such manner and to the extent required by the Trust Indenture Act. The Trustee shall transmit to the Holders, the Commission and each securities exchange upon which any Securities are listed, and the Company shall file with the Trustee (within 30 days after filing with the Commission in the case of reports which pursuant to the Trust Indenture Act must be filed with the Commission and furnished to the Trustee) and transmit to the Holders, such other information, reports and other documents, if any, at such times and in such manner, as shall be required by the Trust Indenture Act. The Company shall notify the Trustee of the listing of any Securities on any securities exchange. Delivery of such reports, information and documents filed with the Commission pursuant to the Securities Exchange Act of 1934, as amended, to the Trustee is for informational purposes only, and the Trustee's receipt of such shall not constitute notice or constructive notice of any information contained therein or determinable from information contained therein, including the Company's compliance with any of its covenants hereunder (as to which the Trustee is entitled to rely exclusively on Officer's Certificates). ARTICLE ELEVEN CONSOLIDATION, MERGER, CONVEYANCE OR OTHER TRANSFER --------------------------------------------------- Section 1101 Company May Consolidate, etc. Only on Certain Terms. The ----------------------------------------------------- Company shall not consolidate with or merge into any other Person, or convey or otherwise transfer or lease its properties and assets substantially as an entirety to any Person, unless (a) the Person formed by such consolidation or into which the Company is merged or the Person which acquires by conveyance or transfer, or which leases, the properties and assets of the Company substantially as an entirety shall be a Person organized and validly existing under the laws of the United States, any State thereof or the District of Columbia, and shall expressly assume, by an indenture supplemental hereto, executed and delivered to the Trustee, in form satisfactory to the Trustee, the due and punctual payment of the principal of and premium, if any, and interest, if any, on all Outstanding Securities and the performance of every covenant of this Indenture on the part of the Company to be performed or observed; (b) immediately after giving effect to such transaction no Event of Default, and no event which, after notice or lapse of time or both, would become an Event of Default, shall have occurred and be continuing; and (c) the Company shall have delivered to the Trustee an Officer's Certificate and an Opinion of Counsel, each stating that such consolidation, merger, conveyance, or other transfer or lease and such supplemental indenture comply with this Article and that all conditions precedent herein provided for relating to such transactions have been complied with. Section 1102 Successor Person Substituted. Upon any consolidation by ----------------------------- the Company with or merger by the Company into any other Person or any conveyance, or other transfer or lease of the properties and assets of the 57 Company substantially as an entirety in accordance with Section 1101, the successor Person formed by such consolidation or into which the Company is merged or the Person to which such conveyance, transfer or lease is made shall succeed to, and be substituted for, and may exercise every right and power of, the Company under this Indenture with the same effect as if such successor Person had been named as the Company herein, and thereafter, except in the case of a lease, the predecessor Person shall be relieved of and released from all obligations and covenants under this Indenture and the Securities Outstanding hereunder. ARTICLE TWELVE SUPPLEMENTAL INDENTURES ----------------------- Section 1201 Supplemental Indentures Without Consent of Holders. ------------------------------------------------------- Without the consent of any Holders, the Company and the Trustee, at any time and from time to time, may enter into one or more indentures supplemental hereto, in form satisfactory to the Trustee, for any of the following purposes: (a) to evidence the succession of another Person to the Company and the assumption by any such successor of the covenants of the Company herein and in the Securities, all as provided in Article Eleven; or (b) to add one or more covenants of the Company or other provisions for the benefit of all Holders or for the benefit of the Holders of, or to remain in effect only so long as there shall be Outstanding, Securities of one or more specified series, or one or more specified Tranches thereof, or to surrender any right or power herein conferred upon the Company; or (c) to add any additional Events of Default with respect to all or any series of Securities Outstanding hereunder; or (d) to change or eliminate any provision of this Indenture or to add any new provision to this Indenture; provided, however, that if such change, ------------------ elimination or addition shall adversely affect the interests of the Holders of Securities of any series or Tranche Outstanding, other than any series the terms of which permit such change, elimination or addition, on the date of such indenture supplemental hereto in any material respect, such change, elimination or addition shall become effective with respect to such series or Tranche only pursuant to the provisions of Section 1202 hereof or when no Security of such series or Tranche remains Outstanding; or (e) to provide collateral security for all but not part of the Securities; or (f) to establish the form or terms of Securities of any series or Tranche as contemplated by Sections 201 and 301; or (g) to provide for the authentication and delivery of bearer securities and coupons appertaining thereto representing interest, if any, thereon and for the procedures for the registration, exchange and replacement thereof and for the giving of notice to, and the solicitation of the vote or 58 consent of, the holders thereof, and for any and all other matters incidental thereto; or (h) to evidence and provide for the acceptance of appointment hereunder by a separate or successor Trustee or co-trustee with respect to the Securities of one or more series and to add to or change any of the provisions of this Indenture as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one Trustee, pursuant to the requirements of Section 911(b); or (i) to provide for the procedures required to permit the Company to utilize, at its option, a noncertificated system of registration for all, or any series or Tranche of, the Securities; or (j) to change any place or places where (1) all or any series of Securities, or any Tranche thereof, may be surrendered for registration of transfer, (2) all or any series of Securities, or any Tranche thereof, may be surrendered for exchange and (3) notices and demands to or upon the Company in respect of all or any series of Securities, or any Tranche thereof, and this Indenture may be served; or (k) to cure any ambiguity, to correct or supplement any provision herein which may be defective or inconsistent with any other provision herein, or to make any other changes to the provisions hereof or to add other provisions with respect to matters or questions arising under this Indenture, provided that such other changes or additions shall not adversely affect the interests of the Holders of Securities of any series or Tranche in any material respect. Without limiting the generality of the foregoing, if the Trust Indenture Act as in effect at the date of the execution and delivery of this Indenture or at any time thereafter shall be amended and (x) if any such amendment shall require one or more changes to any provisions hereof or the inclusion herein of any additional provisions, or shall by operation of law be deemed to effect such changes or incorporate such provisions by reference or otherwise, this Indenture shall be deemed to have been amended so as to conform to such amendment to the Trust Indenture Act, and the Company and the Trustee may, without the consent of any Holders, enter into an indenture supplemental hereto to effect or evidence such changes or additional provisions; or (y) if any such amendment shall permit one or more changes to, or the elimination of, any provisions hereof which, at the date of the execution and delivery hereof or at any time thereafter, are required by the Trust Indenture Act to be contained herein, the Company and the Trustee may, without the consent of any Holders, enter into an indenture supplemental hereto to effect such change or elimination herein. Section 1202 Supplemental Indentures With Consent of Holders. With the ------------------------------------------------ consent of the Holders of a majority in aggregate principal amount of the Securities of all series then Outstanding under this Indenture, considered as one class, by Act of said Holders delivered to the Company and the Trustee, the Company, when authorized by a Board Resolution, and the Trustee may enter into 59 an indenture or indentures supplemental hereto for the purpose of adding any provisions to, or changing in any manner or eliminating any of the provisions of, this Indenture or modifying in any manner the rights of the Holders of Securities of such series under the Indenture; provided, however, that if there ----------------- shall be Securities of more than one series Outstanding hereunder and if a proposed supplemental indenture shall directly affect the rights of the Holders of Securities of one or more, but less than all, of such series, then the consent only of the Holders of a majority in aggregate principal amount of the Outstanding Securities of all series so directly affected, considered as one class, shall be required; and provided, further, that if the Securities of any ------------------ series shall have been issued in more than one Tranche and if the proposed supplemental indenture shall directly affect the rights of the Holders of Securities of one or more, but less than all, of such Tranches, then the consent only of the Holders of a majority in aggregate principal amount of the Outstanding Securities of all Tranches so directly affected, considered as one class, shall be required; and provided, further, that no such supplemental ------------------ indenture shall: (a) change the Stated Maturity of the principal of, or any installment of principal of or interest on, any Security, or reduce the principal amount thereof or the rate of interest thereon (or the amount of any installment of interest thereon) or change the method of calculating such rate or reduce any premium payable upon the redemption thereof, or reduce the amount of the principal of a Discount Security that would be due and payable upon a declaration of acceleration of the Maturity thereof pursuant to Section 802, or change any Place of Payment where or the coin or currency (or other property), in which any Security or any premium or the interest thereon is payable, or impair the right to institute suit for the enforcement of any such payment on or after the Stated Maturity of any Security (or, in the case of redemption, on or after the Redemption Date), without, in any such case, the consent of the Holder of such Security, or (b) reduce the percentage in principal amount of the Outstanding Securities of any series, or any Tranche thereof, the consent of the Holders of which is required for any such supplemental indenture, or the consent of the Holders of which is required for any waiver of compliance with any provision of this Indenture or of any default hereunder and its consequences, or reduce the requirements of Section 1304 for quorum or voting, without, in any such case, the consent of the Holders of each Outstanding Security of such series or Tranche, or (c) modify any of the provisions of this Section, Section 607 or Section 813 with respect to the Securities of any series, or any Tranche thereof, except to increase the percentages in principal amount referred to in this Section or such other Sections or to provide that other provisions of this Indenture cannot be modified or waived without the consent of the Holder of each Outstanding Security affected thereby; provided, however, that this clause shall ----------------- not be deemed to require the consent of any Holder with respect to changes in the references to "the Trustee" and concomitant changes in this Section, or the deletion of this proviso, in accordance with the requirements of Sections 911(b), 914 and 1201(h). A supplemental indenture which changes or eliminates any covenant or other provision of this Indenture which has expressly been included solely for the benefit of one or more particular series of Securities, or one or more Tranches thereof, or which modifies the rights of the Holders of Securities of such series with respect to such covenant or other provision, shall be deemed not to affect the rights under this Indenture of the Holders of Securities of any other series or Tranche. 60 It shall not be necessary for any Act of Holders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such Act shall approve the substance thereof. A waiver by a Holder of such Holder's right to consent under this Section shall be deemed to be a consent of such Holder. Section 1203 Execution of Supplemental Indentures. In executing, or ------------------------------------- accepting the additional trusts created by, any supplemental indenture permitted by this Article or the modifications thereby of the trusts created by this Indenture, the Trustee shall be entitled to receive, and (subject to Section 901) shall be fully protected in relying upon, an Opinion of Counsel stating that the execution of such supplemental indenture is authorized or permitted by this Indenture. The Trustee may, but shall not be obligated to, enter into any such supplemental indenture which affects the Trustee's own rights, duties, immunities or liabilities under this Indenture or otherwise. Section 1204 Effect of Supplemental Indentures. Upon the execution of --------------------------------- any supplemental indenture under this Article, this Indenture shall be modified in accordance therewith, and such supplemental indenture shall form a part of this Indenture for all purposes; and every Holder of Securities theretofore or thereafter authenticated and delivered hereunder shall be bound thereby. Any supplemental indenture permitted by this Article may restate this Indenture in its entirety, and, upon the execution and delivery thereof, any such restatement shall supersede this Indenture as theretofore in effect for all purposes. Section 1205 Conformity With Trust Indenture Act. Unless otherwise ------------------------------------ provided as contemplated by Section 301 with respect to any series of Securities, every supplemental indenture executed pursuant to this Article shall conform to the requirements of the Trust Indenture Act as then in effect. Section 1206 Reference in Securities to Supplemental Indentures. ------------------------------------------------------ Securities of any series, or any Tranche thereof, authenticated and delivered after the execution of any supplemental indenture pursuant to this Article may, and shall if required by the Trustee, bear a notation in form approved by the Trustee as to any matter provided for in such supplemental indenture. If the Company shall so determine, new Securities of any series, or any Tranche thereof, so modified as to conform, in the opinion of the Trustee and the Company, to any such supplemental indenture may be prepared and executed by the Company and authenticated and delivered by the Trustee in exchange for Outstanding Securities of such series or Tranche. Section 1207 Modification Without Supplemental Indenture. If the terms ------------------------------------------- of any particular series of Securities shall have been established in a Board Resolution or an Officer's Certificate as contemplated by Section 301, and not in an indenture supplemental hereto, additions to, changes in or the elimination of any of such terms may be effected by means of a supplemental Board Resolution or Officer's Certificate, as the case may be, delivered to, and accepted by, the Trustee; provided, however, that such supplemental Board Resolution or Officer's ----------------- Certificate shall not be accepted by the Trustee or otherwise be effective unless all conditions set forth in this Indenture which would be required to be satisfied if such additions, changes or elimination were contained in a supplemental indenture shall have been appropriately satisfied. Upon the acceptance thereof by the Trustee, any such supplemental Board Resolution or 61 Officer's Certificate shall be deemed to be a "supplemental indenture" for purposes of Sections 1204 and 1206. ARTICLE THIRTEEN MEETINGS OF HOLDERS; ACTION WITHOUT MEETING ------------------------------------------- Section 1301 Purposes for Which Meetings May Be Called. A meeting of ------------------------------------------ Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, may be called at any time and from time to time pursuant to this Article to make, give or take any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be made, given or taken by Holders of Securities of such series or Tranches. Section 1302 Call, Notice and Place of Meetings. (a) The Trustee may at ---------------------------------- any time call a meeting of Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, for any purpose specified in Section 1301, to be held at such time and at such place in the Borough of Manhattan, The City of New York, as the Trustee shall determine, or, with the approval of the Company, at any other place. Notice of every such meeting, setting forth the time and the place of such meeting and in general terms the action proposed to be taken at such meeting, shall be given, in the manner provided in Section 106, not less than 21 nor more than 180 days prior to the date fixed for the meeting. (b) If the Trustee shall have been requested to call a meeting of the Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, by the Company or by the Holders of 33% in aggregate principal amount of all of such series and Tranches, considered as one class, for any purpose specified in Section 1301, by written request setting forth in reasonable detail the action proposed to be taken at the meeting, and the Trustee shall not have given the notice of such meeting within 21 days after receipt of such request or shall not thereafter proceed to cause the meeting to be held as provided herein, then the Company or the Holders of Securities of such series and Tranches in the amount above specified, as the case may be, may determine the time and the place in the Borough of Manhattan, The City of New York, or in such other place as shall be determined or approved by the Company, for such meeting and may call such meeting for such purposes by giving notice thereof as provided in Subsection (a) of this Section. (c) Any meeting of Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, shall be valid without notice if the Holders of all Outstanding Securities of such series or Tranches are present in person or by proxy and if representatives of the Company and the Trustee are present, or if notice is waived in writing before or after the meeting by the Holders of all Outstanding Securities of such series, or any Tranche or Tranches thereof, or by such of them as are not present at the meeting in person or by proxy, and by the Company and the Trustee. Section 1303 Persons Entitled to Vote at Meetings. To be entitled to ------------------------------------- vote at any meeting of Holders of Securities of one or more, or all, series, or any Tranche or Tranches thereof, a Person shall be (a) a Holder of one or more Outstanding Securities of such series or Tranches, or (b) a Person appointed by an instrument in writing as proxy for a Holder or Holders of one or more Outstanding Securities of such series or Tranches by such Holder or Holders. The 62 only Persons who shall be entitled to attend any meeting of Holders of Securities of any series or Tranche shall be the Persons entitled to vote at such meeting and their counsel, any representatives of the Trustee and its counsel and any representatives of the Company and its counsel. Section 1304 Quorum; Action. The Persons entitled to vote a majority -------------- in aggregate principal amount of the Outstanding Securities of the series and Tranches with respect to which a meeting shall have been called as hereinbefore provided, considered as one class, shall constitute a quorum for a meeting of Holders of Securities of such series and Tranches; provided, however, that if any action is to be taken at such meeting which this Indenture expressly provides may be taken by the Holders of a specified percentage, which is less than a majority, in principal amount of the Outstanding Securities of such series and Tranches, considered as one class, the Persons entitled to vote such specified percentage in principal amount of the Outstanding Securities of such series and Tranches, considered as one class, shall constitute a quorum. In the absence of a quorum within one hour of the time appointed for any such meeting, the meeting shall, if convened at the request of Holders of Securities of such series and Tranches, be dissolved. In any other case the meeting may be adjourned for such period as may be determined by the chairman of the meeting prior to the adjournment of such meeting. In the absence of a quorum at any such adjourned meeting, such adjourned meeting may be further adjourned for such period as may be determined by the chairman of the meeting prior to the adjournment of such adjourned meeting. Except as provided by Section 1305(e), notice of the reconvening of any meeting adjourned for more than 30 days shall be given as provided in Section 1302(a) not less than 10 days prior to the date on which the meeting is scheduled to be reconvened. Notice of the reconvening of an adjourned meeting shall state expressly the percentage, as provided above, of the principal amount of the Outstanding Securities of such series and Tranches which shall constitute a quorum. Except as limited by Section 1202, any resolution presented to a meeting or adjourned meeting duly reconvened at which a quorum is present as aforesaid may be adopted only by the affirmative vote of the Holders of a majority in aggregate principal amount of the Outstanding Securities of the series and Tranches with respect to which such meeting shall have been called, considered as one class; provided, however, that, except as so limited, any ------------------ resolution with respect to any action which this Indenture expressly provides may be taken by the Holders of a specified percentage, which is less than a majority, in principal amount of the Outstanding Securities of such series and Tranches, considered as one class, may be adopted at a meeting or an adjourned meeting duly reconvened and at which a quorum is present as aforesaid by the affirmative vote of the Holders of such specified percentage in principal amount of the Outstanding Securities of such series and Tranches, considered as one class. Any resolution passed or decision taken at any meeting of Holders of Securities duly held in accordance with this Section shall be binding on all the Holders of Securities of the series and Tranches with respect to which such meeting shall have been held, whether or not present or represented at the meeting. Section 1305 Attendance at Meetings; Determination of Voting Rights; --------------------------------------------------------- Conduct and Adjournment of Meetings. (a) Attendance at meetings of Holders of - ------------------------------------- 63 Securities may be in person or by proxy; and, to the extent permitted by law, any such proxy shall remain in effect and be binding upon any future Holder of the Securities with respect to which it was given unless and until specifically revoked by the Holder or future Holder of such Securities before being voted. (b) Notwithstanding any other provisions of this Indenture, the Trustee may make such reasonable regulations as it may deem advisable for any meeting of Holders of Securities in regard to proof of the holding of such Securities and of the appointment of proxies and in regard to the appointment and duties of inspectors of votes, the submission and examination of proxies, certificates and other evidence of the right to vote, and such other matters concerning the conduct of the meeting as it shall deem appropriate. Except as otherwise permitted or required by any such regulations, the holding of Securities shall be proved in the manner specified in Section 104 and the appointment of any proxy shall be proved in the manner specified in Section 104. Such regulations may provide that written instruments appointing proxies, regular on their face, may be presumed valid and genuine without the proof specified in Section 104 or other proof. (c) The Trustee shall, by an instrument in writing, appoint a temporary chairman of the meeting, unless the meeting shall have been called by the Company or by Holders as provided in Section 1302(b), in which case the Company or the Holders of Securities of the series and Tranches calling the meeting, as the case may be, shall in like manner appoint a temporary chairman. A permanent chairman and a permanent secretary of the meeting shall be elected by vote of the Persons entitled to vote a majority in aggregate principal amount of the Outstanding Securities of all series and Tranches represented at the meeting, considered as one class. (d) At any meeting each Holder or proxy shall be entitled to one vote for each $1 principal amount of Securities held or represented by him; provided, however, that no vote shall be cast or counted at any meeting in respect of any Security challenged as not Outstanding and ruled by the chairman of the meeting to be not Outstanding. The chairman of the meeting shall have no right to vote, except as a Holder of a Security or proxy. (e) Any meeting duly called pursuant to Section 1302 at which a quorum is present may be adjourned from time to time by Persons entitled to vote a majority in aggregate principal amount of the Outstanding Securities of all series and Tranches represented at the meeting, considered as one class; and the meeting may be held as so adjourned without further notice. Section 1306 Counting Votes and Recording Action of Meetings. The vote ----------------------------------------------- upon any resolution submitted to any meeting of Holders shall be by written ballots on which shall be subscribed the signatures of the Holders or of their representatives by proxy and the principal amounts and serial numbers of the Outstanding Securities, of the series and Tranches with respect to which the meeting shall have been called, held or represented by them. The permanent chairman of the meeting shall appoint two inspectors of votes who shall count all votes cast at the meeting for or against any resolution and who shall make and file with the secretary of the meeting their verified written reports of all votes cast at the meeting. A record of the proceedings of each meeting of Holders shall be prepared by the secretary of the meeting and there shall be attached to said record the original reports of the inspectors of votes on any vote by ballot taken thereat and affidavits by one or more persons having 64 knowledge of the facts setting forth a copy of the notice of the meeting and showing that said notice was given as provided in Section 1302 and, if applicable, Section 1304. Each copy shall be signed and verified by the affidavits of the permanent chairman and secretary of the meeting and one such copy shall be delivered to the Company, and another to the Trustee to be preserved by the Trustee, the latter to have attached thereto the ballots voted at the meeting. Any record so signed and verified shall be conclusive evidence of the matters therein stated. Section 1307 Action Without Meeting. In lieu of a vote of Holders at a ---------------------- meeting as hereinbefore contemplated in this Article, any request, demand, authorization, direction, notice, consent, waiver or other action may be made, given or taken by Holders by written instruments as provided in Section 104. ARTICLE FOURTEEN IMMUNITY OF INCORPORATORS, SHAREHOLDERS, OFFICERS AND DIRECTORS --------------------------------------------------------------- Section 1401 Liability Solely Corporate. No recourse shall be had for --------------------------- the payment of the principal of or premium, if any, or interest, if any, on any Securities, or any part thereof, or for any claim based thereon or otherwise in respect thereof, or of the indebtedness represented thereby, or upon any obligation, covenant or agreement under this Indenture, against any incorporator, shareholder, officer or director, as such, past, present or future of the Company or of any predecessor or successor corporation (either directly or through the Company or a predecessor or successor corporation), whether by virtue of any constitutional provision, statute or rule of law, or by the enforcement of any assessment or penalty or otherwise; it being expressly agreed and understood that this Indenture and all the Securities are solely corporate obligations, and that no personal liability whatsoever shall attach to, or be incurred by, any incorporator, shareholder, officer or director, past, present or future, of the Company or of any predecessor or successor corporation, either directly or indirectly through the Company or any predecessor or successor corporation, because of the indebtedness hereby authorized or under or by reason of any of the obligations, covenants or agreements contained in this Indenture or in any of the Securities or to be implied herefrom or therefrom, and that any such personal liability is hereby expressly waived and released as a condition of, and as part of the consideration for, the execution of this Indenture and the issuance of the Securities. ------------------------- This instrument may be executed in any number of counterparts, each of which so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument. 65 IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be duly executed, all as of the day and year first above written. THE CLEVELAND ELECTRIC ILLUMINATING COMPANY By: ------------------------------------------------ Randy Scilla Assistant Treasurer JPMORGAN CHASE BANK, as Trustee By: ------------------------------------------------ James Freeman Vice President EX-12 23 cei_ex12-3.txt EX 12-3 CEI FIXED CHARGE RATIO EXHIBIT 12.3 Page 1 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, ------------------------------------------------------------- 1999 2000 2001 2002 2003 -------- -------- -------- -------- ------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items........................... $194,089 $210,424 $177,905 $136,952 $197,033 Interest and other charges, before reduction for amounts capitalized....................................... 211,960 201,739 192,102 189,502 164,132 Provision for income taxes.................................. 123,869 138,426 137,887 84,938 131,285 Interest element of rentals charged to income (a)........... 66,680 65,616 59,497 51,170 49,761 -------- -------- -------- -------- -------- Earnings as defined....................................... $596,598 $616,205 $567,391 $462,562 $542,211 ======== ======== ======== ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K: Interest expense............................................ $211,960 $201,739 $191,727 $180,602 $159,632 Subsidiary's preferred stock dividend requirements.......... -- -- 375 8,900 4,500 Interest element of rentals charged to income (a)........... 66,680 65,616 59,497 51,170 49,761 -------- -------- -------- -------- -------- Fixed charges as defined.................................. $278,640 $267,355 $251,599 $240,672 $213,893 ======== ======== ======== ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES................ 2.14 2.30 2.26 1.92 2.53 ==== ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 93
EXHIBIT 12.3 Page 2 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS) (Dollars in thousands)
Year Ended December 31, ------------------------------------------------------------- 1999 2000 2001 2002 2003 -------- -------- -------- -------- ------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items........................... $194,089 $210,424 $177,905 $136,952 $197,033 Interest and other charges, before reduction for amounts capitalized............................................... 211,960 201,739 192,102 189,502 164,132 Provision for income taxes.................................. 123,869 138,426 137,887 84,938 131,285 Interest element of rentals charged to income (a)........... 66,680 65,616 59,497 51,170 49,761 -------- -------- -------- -------- -------- Earnings as defined....................................... $596,598 $616,205 $567,391 $462,562 $542,211 ======== ======== ======== ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS): Interest expense............................................ $211,960 $201,739 $191,727 $180,602 $159,632 Preferred stock dividend requirements....................... 33,524 20,843 25,213 24,590 12,026 Adjustments to preferred stock dividends to state on a pre-income tax basis........................ 21,395 13,012 20,178 8,204 5,137 Interest element of rentals charged to income (a)........... 66,680 65,616 59,497 51,170 49,761 -------- -------- -------- -------- -------- Fixed charges as defined plus preferred stock dividend requirements (pre-income tax basis)............ $333,559 $301,210 $296,615 $264,566 $226,556 ======== ======== ======== ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)...................................... 1.79 2.05 1.91 1.75 2.39 ==== ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 94
EX-13 24 cei_ex13-2.txt EX 13-2 CEI ANNUAL REPORT THE CLEVELAND ELECTRIC ILLUMINATING COMPANY 2003 ANNUAL REPORT TO STOCKHOLDERS The Cleveland Electric Illuminating Company is a wholly owned electric utility operating subsidiary of FirstEnergy Corp. It engages in the generation, distribution and sale of electric energy in an area of approximately 1,700 square miles in northeastern Ohio. It also engages in the sale, purchase and interchange of electric energy with other electric companies. The area it serves has a population of approximately 1.9 million. Contents Page - -------- ---- Selected Financial Data...................................... 1 Management's Discussion and Analysis......................... 2-13 Consolidated Statements of Income............................ 14 Consolidated Balance Sheets.................................. 15 Consolidated Statements of Capitalization.................... 16-17 Consolidated Statements of Common Stockholder's Equity....... 18 Consolidated Statements of Preferred Stock................... 18 Consolidated Statements of Cash Flows........................ 19 Consolidated Statements of Taxes............................. 20 Notes to Consolidated Financial Statements................... 21-39 Report of Independent Auditors............................... 40
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY SELECTED FINANCIAL DATA 2003 2002 2001 2000 1999 - --------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) GENERAL FINANCIAL INFORMATION: Operating Revenues...................... $1,720,784 $1,843,671 $2,064,622 $1,890,339 $1,864,954 ========== ========== ========== ========== ========== Operating Income........................ $ 255,148 $ 306,152 $ 354,422 $ 397,568 $ 405,640 ========== ========== ========== ========== ========== Income Before Cumulative Effect of Accounting Change................. $ 197,033 $ 136,952 $ 177,905 $ 210,424 $ 204,963 ========== ========== ========== ========== ========== Net Income.............................. $ 239,411 $ 136,952 $ 177,905 $ 210,424 $ 204,963 ========== ========== ========== ========== ========== Earnings on Common Stock................ $ 231,885 $ 121,262 $ 153,067 $ 189,581 $ 171,439 ========== ========== ========== ========== ========== Total Assets............................ $6,773,448 $6,510,243 $6,526,596 $6,756,921 $6,189,261 ========== ========== ========== ========== ========== CAPITALIZATION AS OF DECEMBER 31: Common Stockholder's Equity............. $1,778,827 $1,200,001 $1,082,041 $1,095,874 $ 990,177 Preferred Stock- Not Subject to Mandatory Redemption.. 96,404 96,404 141,475 238,325 238,325 Subject to Mandatory Redemption...... -- 105,021 106,288 26,105 116,246 Long-Term Debt.......................... 1,884,643 1,975,001 2,156,322 2,634,692 2,682,795 ---------- ---------- ---------- ---------- ---------- Total Capitalization.................... $3,759,874 $3,376,427 $3,486,126 $3,994,996 $4,027,543 ========== ========== ========== ========== ========== CAPITALIZATION RATIOS: Common Stockholder's Equity............. 47.3% 35.5% 31.0% 27.4% 24.6% Preferred Stock- Not Subject to Mandatory Redemption.. 2.6 2.9 4.1 6.0 5.9 Subject to Mandatory Redemption...... -- 3.1 3.0 0.6 2.9 Long-Term Debt.......................... 50.1 58.5 61.9 66.0 66.6 ----- ----- ----- ----- ----- Total Capitalization.................... 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== ===== DISTRIBUTION KILOWATT-HOUR DELIVERIES (Millions): Residential............................. 5,216 5,370 5,061 5,061 5,278 Commercial.............................. 4,690 4,628 4,907 6,656 6,509 Industrial.............................. 8,908 8,921 9,593 8,320 8,069 Other................................... 169 167 166 167 166 ------ ------ ------ ------ ------ Total................................... 18,983 19,086 19,727 20,204 20,022 ====== ====== ====== ====== ====== CUSTOMERS SERVED: Residential............................. 669,337 677,095 673,852 667,115 667,954 Commercial.............................. 80,596 71,893 70,636 69,103 69,954 Industrial.............................. 2,318 4,725 4,783 4,851 5,090 Other................................... 286 289 292 307 223 ------- ------- ------- ------- ------- Total................................... 752,537 754,002 749,563 741,376 743,221 ======= ======= ======= ======= ======= Number of Employees..................... 949 974 1,025 1,046 1,694
1 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the continuing availability and o peration of generating units, the inability of the Davis-Besse Nuclear Power Station to restart (including because of an inability to obtain a favorable final determination from the Nuclear Regulatory Commission) in Spring 2004, inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage, a denial of or material change to the Company's Application related to its Rate Stabilization Plan, and other similar factors. Restatements - ------------ We restated our consolidated financial statements for the three years ended December 31, 2002 to reflect a change in the method of amortizing costs being recovered under the Ohio transition plan and to recognize above-market liabilities of certain leased generation facilities. Financial comparisons described below reflect the effect of these restatements and reclassifications on 2002 financial results. Results of Operations - --------------------- Earnings on common stock in 2003 increased 91.2% to $231.9 million from $121.3 million in 2002. The increase in earnings in 2003 was due primarily to a gain of $74.7 million, net of tax, representing net proceeds from the settlement of our claim against NRG Energy, Inc. relating to the terminated sale of three of our fossil power plants (see Note 6). Also contributing to the increase in earnings was a $42.4 million gain from the cumulative effect of adopting Statement of Financial Accounting Standards (SFAS) 143, "Accounting for Asset Retirement Obligations." Excluding these gains, earnings on common stock decreased $6.4 million or 5%, in 2003. The decrease resulted primarily from lower operating revenues, which were partially offset by lower operating expenses, net interest charges and preferred stock dividend requirements. Earnings on common stock in 2002 decreased 20.8% to $121.3 million in 2002 from $153.1 million in 2001. The earnings decrease in 2002 primarily resulted from lower operating revenues, which was partially offset by lower operating expenses, net interest charges and preferred stock dividend requirements. Operating revenues decreased $122.9 million or 6.7% in 2003 compared with 2002. The lower revenues were due to milder weather and increased sales by alternative suppliers. Kilowatt-hour sales to retail customers declined by 13.6% in 2003 from the prior year, with declines in all customer sectors (residential, commercial and industrial), resulting in a $56.0 million reduction in generation sales revenue. Kilowatt-hour sales of electricity by alternative suppliers in our franchise area increased by 9 percentage points in 2003 from last year. Further decreasing operating revenues were Ohio transition plan incentives, provided to customers to encourage switching to alternative energy providers - $30.1 million of additional credits were provided to customers in 2003 compared with 2002. These revenue reductions are deferred for future recovery under our transition plan and do not materially affect current period earnings. Sales revenues from wholesale customers (primarily FirstEnergy Solutions (FES), an affiliated company) decreased by $25.8 million in 2003 compared with 2002. The lower sales resulted from reductions in available nuclear generation of 17.2% in 2003 compared to 2002. Available generation decreased due to the extended outage of Davis-Besse and generating capacity removed from service due to additional nuclear refueling activities in 2003 compared to 2002. Operating revenues decreased $221.0 million or 10.7% in 2002 compared with 2001. The lower revenues reflected the effects of a sluggish national economy on our service area, shopping by Ohio customers for alternative energy providers and decreases in wholesale revenues. Retail kilowatt-hour sales declined by 23.9% in 2002 from the prior year, with declines in all customer sectors (residential, commercial and industrial), resulting in a $123.0 million reduction in generation sales revenue. Our lower generation kilowatt-hour sales resulted primarily from customer choice in Ohio. Sales of electric generation by alternative suppliers as a percent of total sales delivered in our franchise area 2 increased to 31.5% in 2002 from 12.9% in 2001, while our share of electric generation sales in our franchise areas decreased by 18.6% compared to the prior year. Distribution deliveries decreased 3.3% in 2002 compared with 2001, which decreased revenues from electricity throughput by $18.9 million in 2002 from the prior year. The lower distribution deliveries resulted from the effect that continued sluggishness in the economy had on demand by commercial and industrial customers which was offset in part by the additional residential demand due to warmer summer weather. Customer shopping incentives further reduced operating revenues $43.4 million in 2002 from the prior year. Sales revenues from wholesale customers decreased by $43.8 million in 2002 compared to 2001, due to lower kilowatt-hour sales. The reduced kilowatt-hour sales resulted from lower sales to FES, reflecting the extended outage at Davis-Besse. Changes in electric generation sales and distribution deliveries in 2003 and 2002, compared to the prior year, are summarized in the following table: Changes in KWH Sales 2003 2002 --------------------------------------------------------------------- Increase (Decrease) Electric Generation: Retail................................ (13.6)% (23.9)% Wholesale............................. (12.4)% (12.8)% - ---------------------------------------------------------------------- Total Electric Generation Sales......... (13.0)% (18.9)% ===================================================================== Distribution Deliveries: Residential........................... (2.9)% 6.1% Commercial and industrial............. 0.4% (6.6)% - ---------------------------------------------------------------------- Total Distribution Deliveries........... (0.5)% (3.3)% ===================================================================== Operating Expenses and Taxes Total operating expenses and taxes decreased by $71.9 million in 2003 and by $172.7 million in 2002 from 2001. The following table presents changes from the prior year by expense category. Operating Expenses and Taxes - Changes 2003 2002 --------------------------------------------------------------------- Increase (Decrease) (In millions) Fuel and purchased power..................... $ 8.2 $(181.2) Nuclear operating costs...................... 33.7 98.7 Other operating costs........................ (42.9) 16.5 -------------------------------------------------------------------- Total operation and maintenance expenses... (1.0) (66.0) Provision for depreciation and amortization.. (46.4) (59.7) General taxes................................ (11.4) 2.9 Income taxes................................. (13.1) (49.9) --------------------------------------------------------------------- Total operating expenses and taxes......... $(71.9) $(172.7) - ----------------------------------------------------------------------- Higher fuel and purchased power costs in 2003 resulted from an increase in purchased power costs partially offset by lower fuel costs from reduced nuclear generation. Higher purchased power costs primarily reflect increased unit costs partially offset by lower power purchases from FES in 2003 compared to 2002. Increased nuclear costs resulted from unplanned work performed during the Perry Plant's 56-day nuclear refueling outage (44.85% ownership) in the Spring of 2003, and the Beaver Valley Unit 2 28-day refueling outage (24.47% ownership) in the third quarter of 2003, compared with the 24-day refueling outage at Beaver Valley Unit 2 in the first quarter of 2002. Lower other operating costs in 2003 reflect lower employee costs -- specifically the absence of short-term incentive compensation and reduced health care costs. Lower fuel and purchased power costs in 2002 resulted from a $177.0 million reduction in power purchased from FES, reflecting lower kilowatt-hours purchased due to reduced kilowatt-hour sales and lower unit prices. Nuclear operating costs increased $98.7 million in 2002, primarily due to approximately $59.1 million of incremental Davis-Besse maintenance costs related to its extended outage (see Davis-Besse Restoration). The $16.5 million increase in other operating costs resulted principally from higher employee benefit costs. The decrease in depreciation and amortization charges in 2003 was primarily attributable to several factors - higher shopping incentive deferrals ($30.1 million), lower charges following the implementation of SFAS 143 ($17.5 million) and lower fossil plant depreciation ($13.6 million) - partially offset by higher transition plan amortization ($17.7 million). Charges for depreciation and amortization decreased by $59.7 million in 2002 from 2001 primarily due to higher shopping incentive deferrals and tax-related deferrals under our transition plan, and the cessation of goodwill amortization. 3 General taxes decreased $11.4 million in 2003 from 2002 principally due to settled property tax claims. Net Interest Charges Net interest charges continued to trend lower, decreasing by $29.3 million in 2003 and by $4.6 million in 2002 due to our debt paydown program. Our redemption and refinancing activities during 2003 totaled $416 million and $194 million, respectively, and are expected to result in annualized savings of approximately $39 million. Cumulative Effect of Accounting Changes Results for 2003 include an after-tax credit to net income of $42.4 million recorded upon adoption of SFAS 143 in January 2003. We identified applicable legal obligations as defined under the new accounting standard for nuclear power plant decommissioning, reclamation of a sludge disposal pond at the Bruce Mansfield Plant, and closure of two coal ash disposal sites. As a result of adopting SFAS 143, asset retirement costs of $49.9 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $6.8 million. The asset retirement obligation (ARO) liability at the date of adoption was $238.3 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, we had recorded decommissioning liabilities of $242.5 million. The cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $72.5 million increase to income, or $42.4 million net of income taxes. Preferred Stock Dividend Requirements Preferred stock dividend requirements were $8.2 million lower in 2003, compared to the prior year principally due to optional redemptions of preferred stock in 2002. The redemption resulted in a decrease of $9.1 million in 2002. Premiums related to the optional redemptions partially offset the lower dividend requirements. Capital Resources and Liquidity - ------------------------------- Through net debt and preferred stock redemptions, we continued to reduce the cost of debt and preferred stock, and improve our financial position in 2003. During 2003, we reduced our total outstanding debt by approximately $490 million, partially funded by a $300 million equity contribution from FirstEnergy. As a result, our common stockholder's equity as a percentage of total capitalization increased to 47% as of December 31, 2003 from 21% at the end of 1997. Over the last six years, we have reduced the average cost of outstanding debt from 8.15% in 1997 to 6.56% in 2003. Changes in Cash Position As of December 31, 2003, we had $24.8 million of cash and cash equivalents, compared with $30.4 million as of December 31, 2002. Cash and cash equivalents included $25 million received in December 2003 which was included in the NRG settlement claim sold in January 2004 (see Note 6) and $30 million used for the redemption of long-term debt in January 2003 as of December 31, 2003 and 2002, respectively. The major sources for changes in these balances are summarized below. Cash Flows from Operating Activities Our consolidated net cash from operating activities is provided by our regulated energy services. Net cash provided from operating activities was $364.8 million in 2003, $317.2 million in 2002 and $365.5 million in 2001. Cash flows provided from operating activities are as follows: Operating Cash Flows 2003 2002 2001 ------------------------------------------------------------------------ (In millions) Cash earnings (1)............. $309.4 $326.5 $ 467.6 Working capital and other..... 55.4 (9.3) (102.1) ------------------------------------------------------------------------ Total................... $364.8 $317.2 $365.5 ======================================================================== (1) Includes net income, depreciation and amortization, deferred operating lease costs, deferred income taxes, investment tax credits and major noncash charges. Net cash from operating activities increased $48 million in 2003 compared to 2002 as a result of a $65 million reduction in working capital and other requirements partially offset by a $17 million reduction in cash earnings. The largest factor contributing to the working capital and other decrease was an $80 million increase in accrued taxes. 4 Cash Flows from Financing Activities In 2003, the net cash used for financing activities of $197.9 million primarily reflects the redemptions of debt and preferred stock shown below. The following table provides details regarding new issues and redemptions during 2003 and 2002: Securities Issued or Redeemed 2003 2002 --------------------------------------------------------------------------- (In millions) New Issues ---------- Pollution Control Notes................... -- $107.0 Unsecured Notes........................... $296.9 -- ---------------------------------------------------------------------------- Short-term Borrowings, Net..................... $ -- $190.9 ============================================================================ Redemptions ----------- First Mortgage Bonds...................... 550.0 195.0 Pollution Control Notes................... 111.7 78.7 Secured Notes............................. 15.0 33.0 Preferred Stock........................... 1.1 164.7 Other..................................... 0.4 2.8 --------------------------------------------------------------------------- 678.2 474.2 Short-term Borrowings, Net..................... $109.2 $ -- =========================================================================== We had about $25.3 million of cash and temporary investments and approximately $188.2 million of short-term indebtedness at the end of 2003. We had the capability to issue approximately $1.1 billion of additional first mortgage bonds (FMB) on the basis of property additions and retired bonds, although unsecured senior note indentures entered into by the Company in 2003 limit our ability to issue secured debt, including FMBs, subject to certain exceptions. We have no restrictions on the issuance of preferred stock. At the end of 2003, our common equity as a percentage of capitalization, including debt relating to assets held for sale, stood at 47% compared to 36% at the end of 2002. We have the ability to borrow from our regulated affiliates and FirstEnergy to meet our short-term working capital requirements. FirstEnergy Service Company administers this money pool and tracks surplus funds of FirstEnergy and its regulated subsidiaries. Companies receiving a loan under the money pool agreements must repay the principal amount, together with accrued interest, within 364 days of borrowing the funds. The rate of interest is the same for each company receiving a loan from the pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47%. Our access to capital markets and costs of financing are dependent on the ratings of our securities and that of our holding company, FirstEnergy. The following table shows our securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. Ratings of Securities - ------------------------------------------------------------------------------ Securities S&P Moody's Fitch - ------------------------------------------------------------------------------ FirstEnergy Senior unsecured BB+ Baa3 BBB- CEI Senior secured BBB- Baa2 BBB- Senior unsecured BB+ Baa3 BB Preferred stock BB Ba2 BB- - ---------------------------------------------------------------------------- On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." Fitch also lowered the senior secured, senior unsecured, and preferred stock ratings of CEI. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy, and all of the securities of its electric utility operating companies. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." On December 23, 2003, Standard & Poor's (S&P) lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". CEI's ratings were lowered one notch as well. The ratings were removed from CreditWatch with negative implications, where 5 they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions of the ratings included uncertainty regarding the timing of the Ohio Rate Plan filing (see State Regulatory Matters), the pending final report on the August 14 blackout (see Power Outage), the outcome of the remedial phase of litigation relating to the Sammis plant, and the extended Davis-Besse outage and the related pending subpoena (see Davis-Besse Restoration). S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of the credit ratings in December 2003 triggered cash and letter-of-credit collateral calls of FirstEnergy in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2. Ratings of the Company were confirmed. Moody's said that FirstEnergy's lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows from Investing Activities Net cash used in investing activities totaled $172.5 million in 2003. The net cash used for investing resulted from property additions, which was offset in part by a reduction of the investment in collateralized lease bonds. Expenditures for property additions primarily include expenditures supporting our distribution of electricity and capital expenditures related to Davis-Besse (see Davis-Besse Restoration). Our cash requirements in 2004 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without increasing our net debt and preferred stock outstanding. Over the next three years, we expect to meet our contractual obligations with cash from operations. Thereafter, we expect to use a combination of cash from operations and funds from the capital markets. Contractual Obligations - ----------------------- Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows:
Contractual Obligations Total 2004 2005-2006 2007-2008 Thereafter - ----------------------------------------------------------------------------------------------------------------- (In millions) Long-term debt.................. $2,234 $288 $ 22 $269 $1,655 Short-term borrowings........... 188 188 -- -- -- Preferred stock (1)............. 5 1 2 2 -- Capital leases (2).............. 9 1 2 2 4 Operating leases (2)............ 202 27 33 21 121 Purchases (3) .................. 505 66 142 113 184 - -------------------------------------------------------------------------------------------------------------- Total...................... $3,143 $571 $201 $407 $1,964 ============================================================================================================== (1) Subject to mandatory redemption. (2) Operating lease payments are net of capital trust receipts of $574.6 million (see Note 2). (3) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing.
Our capital spending for the period 2004-2006 is expected to be about $275 million (excluding nuclear fuel) of which approximately $92 million applies to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $61 million, of which about $29 million relates to 2004. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $60 million and $30 million, respectively, as the nuclear fuel is consumed. Off-Balance Sheet Arrangements Obligations not included on our Consolidated Balance Sheet primarily consist of a sale and leaseback arrangement involving the Bruce Mansfield Plant, which is reflected in the operating lease payments disclosed above (see Note 2 - Leases). The present value of these sale and leaseback operating lease commitments, net of trust investments, was $134 million as of December 31, 2003. We sell substantially all of our retail customer receivables, which provided $112 million of off-balance sheet financing as of December 31, 2003. 6 Interest Rate Risk - ------------------ Our exposure to fluctuations in market interest rates is reduced since a significant portion of our debt has fixed interest rates, as noted in the following table. The table below presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio, debt obligations and preferred stock with mandatory redemption provisions.
Comparison of Carrying Value to Fair Value - ------------------------------------------------------------------------------------------------------------------- There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - ------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets Investments Other Than Cash and Cash Equivalents- Fixed Income............... $ 10 $44 $45 $ 36 $ 38 $ 665 $ 838 $ 952 Average interest rate...... 7.7% 7.9% 7.8% 7.7% 7.7% 7.1% 7.3% ____________________________________________________________________________________________________________________ Liabilities - -------------------------------------------------------------------------------------------------------------------- Long-term Debt and Other Long-Term Obligations: Fixed rate.................... $288 $10 $12 $129 $140 $1,437 $2,016 $2,226 Average interest rate ..... 7.7% 7.7% 7.7% 7.2% 6.9% 7.1% 7.2% Variable rate................. $ 218 $ 218 $ 218 Average interest rate...... 1.7% 1.8% Preferred Stock Subject to Mandatory Redemption....... $ 1 $ 1 $ 1 $ 1 $ 1 $ 5 $ 5 Average dividend rate...... 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% Short-term Borrowings......... $188 $ 188 $ 188 Average interest rate...... 2.2% 2.2% - -------------------------------------------------------------------------------------------------------------------
Equity Price Risk - ----------------- Included in our nuclear decommissioning trust investments are marketable equity securities carried at their market value of approximately $188 million and $120 million as of December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges would result in a $19 million reduction in fair value as of December 31, 2003 (see Note 1(K) -Cash and Financial Instruments) Outlook - ------- Beginning in 2001, our customers were able to select alternative energy suppliers. We continue to deliver power to residential homes and businesses through our existing distribution systems, which remain regulated. Customer rates have been restructured into separate components to support customer choice. We have a continuing responsibility to provide power to those customers not choosing to receive power from an alternative energy supplier subject to certain limits. Adopting new approaches to regulation and experiencing new forms of competition have created new uncertainties. Regulatory Matters In 2001, Ohio customer rates were restructured to establish separate charges for transmission, distribution, transition cost recovery and a generation-related component. When one of our customers elects to obtain power from an alternative supplier, we reduce the customer's bill with a "generation shopping credit," based on the regulated generation component (plus an incentive), and the customer receives a generation charge from the alternative supplier. We have continuing provider of last resort (PLR) responsibility to our franchise customers through December 31, 2005. Regulatory assets are costs which have been authorized by the PUCO and the Federal Energy Regulatory Commission for recovery from customers in future periods and, without such authorization, would have been charged to income when incurred. Our regulatory assets as of December 2003 and 2002 were $ 1.1 billion and $1.2 billion, respectively. All of our regulatory assets are expected to continue to be recovered under the provisions of the transition plan. As part of the Ohio transition plan we are obligated to supply electricity to customers who do not choose an alternative supplier. We are also required to provide 400 megawatts (MW) of low cost supply to unaffiliated alternative suppliers who serve customers within our service area. Our competitive retail sales affiliate, FES, acts as an alternate supplier for a portion of the load in our franchise area. 7 On October 21, 2003, FirstEnergy's regulated subsidiaries filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate generation supply at stable prices, and continuing our support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for our Ohio customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of our support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, we are requesting: o Extension of the transition cost amortization period from 2008 to July 2009; o Deferral of interest costs on the accumulated shopping incentives and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates under certain limited conditions. On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 23, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S.-Canada Power System Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. Davis-Besse Restoration On April 30, 2002, the Nuclear Regulatory Commission (NRC) initiated a formal inspection process at the Davis-Besse nuclear plant. This action was taken in response to corrosion found by FirstEnergy Nuclear Operating Company (FENOC) in the reactor vessel head near the nozzle penetration hole during a refueling outage in the first quarter of 2002. The purpose of the formal inspection process is to establish criteria for NRC oversight of the licensee's performance and to provide a record of the major regulatory and licensee actions taken, and technical issues resolved, leading to the NRC's approval of restart of the plant. Restart activities include both hardware and management issues. In addition to refurbishment and installation work at the plant, we made significant management and human performance changes with the intent of re-establishing the proper safety culture throughout the workforce. Work was completed on the reactor head during 2002 and efforts continued in 2003 to focus on design enhancements to the unit's reliability and performance. We also accelerated maintenance work that had been planned for future refueling and maintenance outages. We installed a state-of-the-art leak-detection system around the reactor, as well as modified high-pressure injection pumps. Testing of the bottom of the reactor for leaks was completed in October 2003 and no indication of leakage was discovered. The focus of activities now involves management and human performance issues. As a result, incremental maintenance and capital expenditures declined in 2003 as emphasis shifted to performance issues; replacement power costs were higher in 2003. We anticipate that Davis-Besse will be ready for restart in the first quarter of 2004. The NRC must authorize restart of the plant following its formal inspection process before the unit can be returned to service. Delays in Davis-Besse's return to 8 service contributed to S&P's reduction in our credit rating in the fourth quarter of 2003 (see Cash Flows from Financing Activities). Incremental costs associated with the extended Davis-Besse outage (CEI's share - 51.38%) for 2003 and 2002 were as follows: Costs of Davis-Besse Increase Extended Outage 2003 2002 (Decrease) - ----------------------------------------------------------------------------- (In millions) Incremental Expense Replacement power.............. $196 $120 $ 76 Maintenance.................... 93 115 (22) - ---------------------------------------------------------------------------- Total...................... $289 $235 $ 54 ============================================================================ Incremental Net of Tax Expense... $170 $138 $32 ============================================================================ Capital Expenditures............. $ 21 $ 63 $(42) ============================================================================ FirstEnergy anticipates spending $10 million in 2004 for remaining non-capital restart activities, expected NRC inspection activities after Davis-Besse's return to service and other related activities. No additional capital expenditures related to the restoration are expected. Replacement power costs are expected to be $15-20 million per month during the remaining period of the outage. FirstEnergy has hedged the on-peak replacement energy supply for Davis-Besse for the expected length of the outage. If there are significant delays in the NRC approval process, replacement power costs will continue to be incurred, adversely affecting our cash flows and results of operations. Environmental Matters We believe we are in material compliance with current sulfur dioxide (SO2) and nitrogen oxide (NOx) reduction requirements under the Clean Air Act Amendments of 1990. In 1998, the Environmental Protection Agency (EPA) finalized regulations requiring additional NOx reductions from the Company's Ohio and Pennsylvania facilities. Various regulatory and judicial actions have since sought to further define NOx reduction requirements. We continue to evaluate our compliance plans and other compliance options. Violations of federally approved SO2 regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. We cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. We have been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, our proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. We have accrued liabilities aggregating approximately $2 million as of December 31, 2003. We do not believe environmental remediation costs will have a material adverse effect on our financial condition, cash flows or results of operations. In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. We cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions 9 per kilowatt-hour of electricity generated by the Company is lower than many regional competitors due to the Company's diversified generation sources which include non-CO2 emitting nuclear generators. Power Outage On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which are described above. Critical Accounting Policies - ---------------------------- We prepare our consolidated financial statements in accordance with accounting principles that are generally accepted in the United States (GAAP). Application of these principles often requires a high degree of judgment, estimates and assumptions that affect financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting these specific factors. Our more significant accounting policies are described below. Regulatory Accounting We are subject to regulation that sets the prices (rates) we are permitted to charge our customers based on the costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. As a result of the changing regulatory framework in Ohio, a significant amount of regulatory assets have been recorded - $1.1 billion as of December 31, 2003. We regularly review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for kilowatt-hours that have been delivered but not yet billed through the end of the accounting period. The determination of unbilled revenues requires management to make various estimates including: o Net energy generated or purchased for retail load o Losses of energy over distribution lines o Allocations to distribution companies within the FirstEnergy system o Mix of kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers 10 Pension and Other Postretirement Benefits Accounting FirstEnergy's reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions (OPEB) are dependent upon numerous factors resulting from actual plan experience and certain assumptions. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions FirstEnergy makes to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, FirstEnergy reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. FirstEnergy's assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by their pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. FirstEnergy's pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and their pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, our accrued pension costs as of June 30, 2003 decreased by $17 million. The corresponding adjustment related to this change increased other comprehensive income and deferred income taxes and decreased the payable to associated companies. Due to the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $12 million, recording a decrease of $4 million in an intangible asset and crediting OCI by $5 million (offsetting previously recorded deferred tax benefits by $3 million). The remaining balance in OCI of $25 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $33 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, FirstEnergy will not be required to fund their pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. FirstEnergy's pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 1(I)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining their trend rate assumptions, FirstEnergy included the specific provisions of their health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in their health care plans, and projections of future medical trend rates. The effect on FirstEnergy's pension and OPEB costs and liabilities from changes in key assumptions are as follows: 11 Increase in Costs from Adverse Changes in Key Assumptions - ------------------------------------------------------------------------------ Assumption Adverse Change Pension OPEB Total - ------------------------------------------------------------------------------ (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 5 $ 15 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% na $26 $ 26 Increase in Minimum Liability - ----------------------------- Discount rate................ Decrease by 0.25% $104 na $104 - ------------------------------------------------------------------------------- Ohio Transition Cost Amortization In connection with our Ohio transition plan, the PUCO determined allowable transition costs based on amounts recorded on our regulatory books. These costs exceeded those deferred or capitalized on our balance sheet prepared under GAAP since they included certain costs which have not yet been incurred or that were recognized on the regulatory financial statements (fair value purchase accounting adjustments). We use an effective interest method for amortizing transition costs, often referred to as a "mortgage-style" amortization. The interest rate under this method is equal to the rate of return authorized by the PUCO in the transition plan. In computing the transition cost amortization, we include only the portion of the transition revenues associated with transition costs included on the balance sheet prepared under GAAP. Revenues collected for the off balance sheet costs and the return associated with these costs are recognized as income when received. Long-Lived Assets In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. Goodwill In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Based on the guidance provided by SFAS 142, we evaluate our goodwill for impairment at least annually and would make such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. If impairment were indicated, we would recognize a loss - calculated as the difference between the implied fair value of our goodwill and the carrying value of the goodwill. Our annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in our evaluation of goodwill reflect operations consistent with our general business assumptions. Unanticipated changes in those assumptions could have a significant effect on our future evaluations of goodwill. As of December 31, 2003, we had approximately $1.7 billion of goodwill. Nuclear Decommissioning In accordance with SFAS No. 143, we recognize an ARO for the future decommissioning of our nuclear power plants. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. The scenarios consider settlement of the ARO at the expiration of the nuclear power plants' current license and settlement based on an extended license term. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS ADOPTED FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to 12 as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, we adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. We will adopt FIN 46R for all other types of entities effective March 31, 2004. We currently have transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. In 1997, the Company and The Toledo Edison Company (TE), an affiliated company, established the Shippingport Capital Trust (Shippingport) to purchase all of the lease obligation bonds issued by the owner trusts in the Bruce Mansfield Plant sale and leaseback transactions. Prior to the adoption of FIN 46R, the assets and liabilities of the trust were included on a proportionate basis in the financial statements of the Company and TE. Upon adoption of FIN 46R, we were determined to be the primary beneficiary of Shippingport, and therefore consolidated the entire trust as of December 31, 2003. As a result, Shippingport's note payable to TE of approximately $208 million ($9 million current) is recognized as long-term debt on our Consolidated Balance Sheets. In reviewing the sale and leaseback arrangements, the Company also evaluated its interest in the owner trusts that acquired interests in the Bruce Mansfield Plant. The Company was determined not to be the primary beneficiary of any of these owner trusts and was therefore not required to consolidate these entities. The leases are accounted for as operating leases in accordance with GAAP and their related obligations are disclosed in Note 2. As described in Note 3(F), we created a statutory business trust to issue trust preferred securities in the amount of $100 million. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. Therefore, we have deconsolidated the trust and recognized an equity investment in the trust of $3 million and subordinated debentures to the trust of $103 million as of December 31, 2003. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, certain financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, we reclassified as debt the preferred stock subject to mandatory redemption with a carrying value of approximately $5 million as of December 31, 2003. Dividends on preferred stock subject to mandatory redemption on our Consolidated Statements of Income, which were not included in net interest charges prior to the adoption of SFAS 150, are now included in net interest charges for the six months ended December 31, 2003. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, we implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(F) and 1(M) for further discussions of SFAS 143. EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" In November 2003, the EITF reached consensus that certain quantitative and qualitative disclosures are required for debt and equity securities classified as available-for-sale or held-to-maturity. The guidance requires the disclosure of the aggregate amount of unrealized losses and the aggregate related fair value for investments with unrealized losses that have not been recognized as other-than-temporary impairments. We adopted the disclosure requirements of EITF Issue No. 03-1 as of December 31, 2003 (See Note 1(K)). 13
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------- (In thousands) OPERATING REVENUES (Note 1(J)).............................. $1,720,784 $1,843,671 $2,064,622 ---------- ---------- ---------- OPERATING EXPENSES AND TAXES: Fuel and purchased power (Note 1(J))..................... 595,279 587,108 768,306 Nuclear operating costs (Note 1(J))...................... 240,971 207,313 108,587 Other operating costs (Note 1(J))........................ 236,408 279,242 262,745 ---------- ---------- ---------- Total operation and maintenance expenses............... 1,072,658 1,073,663 1,139,638 Provision for depreciation and amortization.............. 198,307 244,727 304,417 General taxes............................................ 136,434 147,804 144,948 Income taxes............................................. 58,237 71,325 121,197 ---------- ---------- ---------- Total operating expenses and taxes..................... 1,465,636 1,537,519 1,710,200 ---------- ---------- ---------- OPERATING INCOME............................................ 255,148 306,152 354,422 OTHER INCOME (Note 6)....................................... 97,785 15,971 13,292 ---------- ---------- ---------- INCOME BEFORE NET INTEREST CHARGES.......................... 352,933 322,123 367,714 ---------- ---------- ---------- NET INTEREST CHARGES: Interest on long-term debt............................... 157,967 179,140 191,695 Allowance for borrowed funds used during construction........................................... (8,232) (4,331) (2,293) Other interest expense................................... 1,665 1,462 32 Subsidiary's preferred stock dividend requirements....... 4,500 8,900 375 ---------- ---------- ---------- Net interest charges..................................... 155,900 185,171 189,809 ---------- ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE..................................... 197,033 136,952 177,905 Cumulative effect of accounting change (net of income taxes of $30,168,000) (Note 1(M))........................ 42,378 -- -- ---------- ---------- ---------- NET INCOME.................................................. 239,411 136,952 177,905 PREFERRED STOCK DIVIDEND REQUIREMENTS............................................. 7,526 15,690 24,838 ---------- ---------- ---------- EARNINGS ON COMMON STOCK.................................... $ 231,885 $ 121,262 $ 153,067 ========== ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED BALANCE SHEETS As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------ (In thousands) ASSETS UTILITY PLANT: In service..................................................................... $4,232,335 $4,045,465 Less-Accumulated provision for depreciation.................................... 1,857,588 1,778,085 ---------- ---------- 2,374,747 2,267,380 ---------- ---------- Construction work in progress- Electric plant............................................................... 159,897 153,104 Nuclear fuel................................................................. 21,338 45,354 ---------- ---------- 181,235 198,458 ---------- ---------- 2,555,982 2,465,838 ---------- ---------- OTHER PROPERTY AND INVESTMENTS: Investment in lessor notes (Note 2)............................................ 605,915 435,907 Nuclear plant decommissioning trusts........................................... 313,621 230,527 Long-term notes receivable from associated companies........................... 107,946 102,978 Other.......................................................................... 23,636 21,004 ---------- ---------- 1,051,118 790,416 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents...................................................... 24,782 30,382 Receivables- Customers.................................................................... 10,313 11,317 Associated companies......................................................... 40,541 74,002 Other (less accumulated provisions of $1,765,000 and $1,015,000, respectively, for uncollectible accounts).................................. 185,179 134,375 Notes receivable from associated companies..................................... 482 447 Materials and supplies, at average cost- Owned........................................................................ 50,616 18,293 Under consignment............................................................ -- 38,094 Prepayments and other.......................................................... 4,511 4,217 ---------- ---------- 316,424 311,127 ---------- ---------- DEFERRED CHARGES: Regulatory assets.............................................................. 1,056,050 1,145,005 Goodwill....................................................................... 1,693,629 1,693,629 Property taxes................................................................. 77,122 79,430 Other.......................................................................... 23,123 24,798 ---------- ---------- 2,849,924 2,942,862 ---------- ---------- $6,773,448 $6,510,243 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholder's equity.................................................... $1,778,827 $1,200,001 Preferred stock- Not subject to mandatory redemption.......................................... 96,404 96,404 Subject to mandatory redemption (Note 3(E)).................................. -- 5,021 Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely Company subordinated debentures (Note 7)..... -- 100,000 Long-term debt and other long-term obligations- Preferred stock subject to mandatory redemption (Note 3(E)).................. 4,014 -- Subordinated debentures to affiliated trusts................................. 103,093 -- Notes payable to associated companies........................................ 198,843 -- Other........................................................................ 1,578,693 1,975,001 ---------- ---------- 3,759,874 3,376,427 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt and preferred stock........................... 387,414 388,190 Accounts payable- Associated companies......................................................... 245,815 267,664 Other........................................................................ 7,342 14,583 Notes payable to associated companies.......................................... 188,156 288,583 Accrued taxes................................................................. 202,522 126,261 Accrued interest............................................................... 37,872 51,767 Lease market valuation liability............................................... 60,200 60,200 Other.......................................................................... 76,722 64,624 ---------- ---------- 1,206,043 1,261,872 ---------- ---------- NONCURRENT LIABILITIES: Accumulated deferred income taxes.............................................. 486,048 407,297 Accumulated deferred investment tax credits.................................... 65,996 70,803 Nuclear plant decommissioning costs............................................ -- 242,511 Asset retirement obligation.................................................... 254,834 -- Retirement benefits............................................................ 105,101 171,968 Lease market valuation liability............................................... 728,400 788,600 Other.......................................................................... 167,152 190,765 ---------- ---------- 1,807,531 1,871,944 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Notes 2 and 5)................................................................ ---------- ---------- $6,773,448 $6,510,243 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
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THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION As of December 31, 2003 2002 - --------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDER'S EQUITY: Common stock, without par value, authorized 105,000,000 shares 79,590,689 shares outstanding.................................................... $1,281,962 $ 981,962 Accumulated other comprehensive income (loss) (Note 3(G)).......................... 2,653 (44,284) Retained earnings (Note 3(A))...................................................... 494,212 262,323 ---------- ---------- Total common stockholder's equity................................................ 1,778,827 1,200,001 ---------- ---------- Number of Shares Optional Outstanding Redemption Price ---------------- --------------------- 2003 2002 Per Share Aggregate ---- ---- --------- --------- PREFERRED STOCK (NOTE 3(C)): Cumulative, without par value- Authorized 4,000,000 shares Not Subject to Mandatory Redemption: $ 7.40 Series A................... 500,000 500,000 $101.00 $50,500 50,000 50,000 Adjustable Series L................ 474,000 474,000 100.00 47,400 46,404 46,404 --------- --------- ------- ---------- ---------- Total Not Subject to Mandatory Redemption......................... 974,000 974,000 $97,900 96,404 96,404 ========= ========= ======= ---------- ---------- Subject to Mandatory Redemption (Note 3(E)): $ 7.35 Series C**................. -- 60,000 -- 6,021 Redemption Within One Year**......... -- (1,000) --------- --------- ---------- ---------- Total Subject to Mandatory Redemption -- 60,000 -- 5,021 ========= ========= ---------- ---------- COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES (Note 3(F)): Cumulative, $25 stated value- Authorized 4,000,000 shares Subject to Mandatory Redemption: 9.00%.............................. -- 4,000,000 -- $ -- -- 100,000 ========= ========= ======= ---------- ---------- LONG-TERM DEBT (Note 3(D)): First mortgage bonds: 7.375% due 2003................................................................... -- 100,000 9.500% due 2005................................................................... -- 300,000 6.860% due 2008................................................................... 125,000 125,000 9.000% due 2023................................................................... -- 150,000 ---------- ---------- Total first mortgage bonds...................................................... 125,000 675,000 ---------- ---------- Unsecured notes: 6.000% due 2013................................................................... 78,700 78,700 5.650% due 2013................................................................... 300,000 -- 9.000% due 2031................................................................... 103,093 -- * 5.580% due 2033................................................................... 27,700 27,700 ---------- ---------- 509,493 106,400 7.682% due to associated companies 2005-2016 (Note 7)............................. 198,843 -- ---------- ---------- Total unsecured notes........................................................... 708,336 106,400 ---------- ----------
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THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont'd) As of December 31, 2003 2002 - --------------------------------------------------------------------------------------------------------------------- (In thousands) LONG-TERM DEBT (Cont'd): Secured notes: 7.000% due 2004-2009............................................................. 1,730 1,760 7.750% due 2003.................................................................. -- 15,000 7.670% due 2004.................................................................. 280,000 280,000 7.130% due 2007.................................................................. 120,000 120,000 7.430% due 2009.................................................................. 150,000 150,000 * 1.120% due 2015.................................................................. 39,835 39,835 7.880% due 2017.................................................................. 300,000 300,000 * 1.120% due 2018.................................................................. 72,795 72,795 * 1.150% due 2020.................................................................. 47,500 47,500 6.000% due 2020.................................................................. 62,560 62,560 6.100% due 2020.................................................................. 70,500 70,500 9.520% due 2021.................................................................. 7,500 7,500 6.850% due 2023.................................................................. -- 30,000 8.000% due 2023.................................................................. 46,100 46,100 7.625% due 2025.................................................................. 53,900 53,900 7.700% due 2025.................................................................. 43,800 43,800 7.750% due 2025.................................................................. 45,150 45,150 5.375% due 2028.................................................................. 5,993 5,993 3.400% due 2030.................................................................. 23,255 23,255 4.600% due 2030.................................................................. -- 81,640 * 1.150% due 2033.................................................................. 30,000 30,000 ---------- ---------- Total secured notes............................................................ 1,400,618 1,527,288 ---------- ---------- Preferred stock subject to mandatory redemption**.................................. 5,014 -- ---------- ---------- Capital lease obligations (Note 2)................................................. 5,924 6,351 ---------- ---------- Net unamortized premium on debt.................................................... 27,165 47,152 ---------- ---------- Long-term debt due within one year**............................................... (387,414) (387,190) ---------- ---------- Total long-term debt and long-term obligations**............................... 1,884,643 1,975,001 ---------- ---------- TOTAL CAPITALIZATION.................................................................. $3,759,874 $3,376,427 ========== ========== * Denotes variable rate issue with December 31, 2003 interest rate shown. ** The December 31, 2003 balances for Preferred Stock subject to Mandatory Redemption is classified as debt under SFAS 150. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY Accumulated Other Comprehensive Number Carrying Comprehensive Retained Income of Shares Value Income (Loss) Earnings ------------- --------- -------- ------------- -------- (Dollars in thousands) Balance, January 1, 2001....................... 79,590,689 $ 931,962 $ -- $ 163,912 Net income.................................. $177,905 177,905 Unrealized gain on instruments, net of $5,900,000 of income taxes................ 9,000 9,000 -------- Comprehensive income........................ $186,905 ======== Cash dividends on preferred stock........... (24,838) Cash dividends on common stock.............. (175,900) - ------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2001..................... 79,590,689 931,962 9,000 141,079 Net income.................................. $136,952 136,952 Unrealized loss on investments, net of $(6,058,000) of income taxes.............. (9,233) (9,233) Minimum liability for unfunded retirement benefits, net of $(31,359,000) of income taxes...... (44,051) (44,051) -------- Comprehensive income........................ $ 83,668 ======== Equity contribution from parent............. 50,000 Cash dividends on preferred stock........... (10,965) Preferred stock redemption premiums......... (4,743) - ------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2002..................... 79,590,689 981,962 (44,284) 262,323 Net income.................................. $239,411 239,411 Unrealized gain on investments, net of $19,598,000 of income taxes............... 28,255 28,255 Minimum liability for unfunded retirement benefits, net of $13,760,000 of income taxes..................................... 18,682 18,682 -------- Comprehensive income........................ $286,348 ======== Equity contribution from parent............. 300,000 Cash dividends on preferred stock........... (7,429) Preferred stock redemption premiums......... (93) - ------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2003..................... 79,590,689 $1,281,962 $ 2,653 $ 494,212 ========================================================================================================================
CONSOLIDATED STATEMENTS OF PREFERRED STOCK Not Subject to Subject to Mandatory Redemption Mandatory Redemption ---------------------- ----------------------- Number Carrying Number Carrying of Shares Value of Shares Value --------- -------- ---------- -------- (Dollars in thousands) Balance, January 1, 2001............ 1,624,000 $238,325 177,216 $ 106,571 Issues 9.00%........................... 4,000,000 100,000 Redemptions- $ 7.35 Series C (10,000) (1,000) $88.00 Series R................. (50,000) (50,000) $91.50 Series Q................. (10,716) (10,716) $90.00 Series S................. (18,750) (18,750) Amortization of fair market value adjustments- $ 7.35 Series C ................ (11) $88.00 Series R................. (1,128) $90.00 Series S................. (668) ------------------------------------------------------------------------------------------- Balance, December 31, 2001.......... 1,624,000 238,325 4,087,750 124,298 Redemptions- $7.56 Series B................. (450,000) (45,071) $42.40 Series T................. (200,000) (96,850) $7.35 Series C................. (10,000) (1,000) $90.00 Series S................. (17,750) (17,010) Amortization of fair market value adjustments- $7.35 Series C................. (9) $90.00 Series S................. (258) ------------------------------------------------------------------------------------------- Balance, December 31, 2002.......... 974,000 96,404 4,060,000 106,021 Redemptions- $7.35 Series C................. (10,000) (1,000) FIN 46 Deconsolidation- 9.00% Series................... (4,000,000) (100,000) Amortization of fair market value adjustments- $7.35 Series C................. (7) ------------------------------------------------------------------------------------------- Balance, December 31, 2003.......... 974,000 $ 96,404 50,000 $ 5,014* =========================================================================================== * December 31, 2003 balance for preferred stock subject to mandatory redemption is classified as debt under SFAS 150 (see note 7). The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------ (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income........................................................... $ 239,411 $ 136,952 $ 177,905 Adjustments to reconcile net income to net cash from operating activities: Provision for depreciation and amortization..................... 198,307 244,727 304,417 Nuclear fuel and capital lease amortization..................... 17,466 21,044 30,539 Other amortization.............................................. (16,278) (15,008) (14,071) Deferred operating lease costs, net............................. (78,214) (60,200) (60,200) Deferred income taxes, net...................................... 27,139 3,637 32,741 Amortization of investment tax credits.......................... (4,807) (4,632) (3,770) Accrued retirement benefit obligations.......................... 7,630 (103,448) 3,837 Accrued compensation, net....................................... (8,743) 6,372 (13,886) Cumulative effect of accounting change (Note 1(M)).............. (72,546) -- -- Receivables..................................................... (16,339) (27,159) 42,542 Materials and supplies.......................................... 5,771 (7,624) 15,949 Accounts payable................................................ (54,858) 47,147 (52,068) Accrued taxes................................................... 76,261 (3,568) (48,877) Accrued interest................................................ (13,895) (5,334) 959 Prepayments and other current assets............................ (294) 27,418 27,743 Other........................................................... 58,824 56,831 (78,265) --------- --------- --------- Net cash provided from operating activities................... 364,835 317,155 365,495 --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Long-term debt.................................................. 296,905 106,981 -- Preferred stock................................................. -- -- 96,739 Short-term borrowings, net...................................... -- 190,879 69,118 Equity contributions from parent................................ 300,000 50,000 -- Redemptions and Repayments- Preferred stock................................................. (1,093) (164,674) (80,466) Long-term debt.................................................. (677,097) (309,480) (74,230) Short-term borrowings, net...................................... (109,212) -- -- Dividend Payments- Common stock.................................................... -- -- (175,900) Preferred stock................................................. (7,451) (13,782) (27,645) --------- --------- --------- Net cash used for financing activities........................ (197,948) (140,076) (192,384) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Property additions................................................... (134,899) (163,199) (154,927) Loan payments from (to) associated companies, net.................... (5,003) 415 (10,734) Investment in lessor notes (Note 2).................................. 44,732 39,636 16,287 Sale of assets to associated companies............................... -- -- 11,117 Contributions to nuclear decommissioning trusts...................... (29,024) (29,024) (30,468) Other................................................................ (48,293) 5,179 (6,945) --------- --------- --------- Net cash used for investing activities........................ (172,487) (146,993) (175,670) --------- --------- --------- Net increase (decrease) in cash and cash equivalents................. (5,600) 30,086 (2,559) Cash and cash equivalents at beginning of year....................... 30,382 296 2,855 --------- --------- --------- Cash and cash equivalents at end of year............................. $ 24,782 $ 30,382 $ 296 ========= ========= ========= SUPPLEMENTAL CASH FLOWS INFORMATION: Cash Paid During the Year- Interest (net of amounts capitalized)........................... $ 174,375 $ 186,040 $ 196,001 ========= ========= ========= Income taxes.................................................... $ 24,796 $ 121,668 $ 131,801 ========= ========= ========= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF TAXES For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: Real and personal property......................................... $ 63,448 $ 77,516 $ 72,665 State gross receipts*.............................................. -- -- 27,169 Ohio kilowatt-hour excise*......................................... 68,459 66,775 42,608 Social security and unemployment................................... 4,331 3,478 2,752 Other.............................................................. 196 35 (246) --------- --------- --------- Total general taxes......................................... $ 136,434 $ 147,804 $ 144,948 ========= ========= ========= PROVISION FOR INCOME TAXES: Currently payable- Federal......................................................... $ 109,775 $ 76,364 $ 92,739 State........................................................... 29,346 14,721 16,177 --------- --------- --------- 139,121 91,085 108,916 --------- --------- --------- Deferred, net- Federal......................................................... 21,382 (3,661) 32,368 State........................................................... 5,757 2,146 1,125 --------- --------- --------- 27,139 (1,515) 33,493 --------- --------- --------- Investment tax credit amortization................................. (4,807) (4,632) (4,522) --------- --------- --------- Total provision for income taxes............................ $ 161,453 $ 84,938 $ 137,887 ========= ========= ========= INCOME STATEMENT CLASSIFICATION OF PROVISION FOR INCOME TAXES: Operating income................................................... $ 58,237 $ 71,325 $ 121,197 Other income....................................................... 73,048 13,613 16,690 Cumulative effect of accounting change............................. 30,168 -- -- --------- --------- --------- Total provision for income taxes............................ $ 161,453 $ 84,938 $ 137,887 ========= ========= ========= RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes...................... $ 400,864 $ 221,890 $ 315,792 ========= ========= ========= Federal income tax expense at statutory rate....................... $ 140,302 $ 77,662 $ 110,527 Increases (reductions) in taxes resulting from- State income taxes, net of federal income tax benefit........... 22,817 10,964 11,246 Amortization of investment tax credits.......................... (4,807) (4,632) (4,522) Amortization of tax regulatory assets........................... 1,087 999 1,012 Amortization of goodwill........................................ -- -- 16,530 Other, net...................................................... 2,054 (55) 3,094 --------- --------- --------- Total provision for income taxes............................ $ 161,453 $ 84,938 $ 137,887 ========= ========= ========= ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: Property basis differences......................................... $ 477,358 $ 473,506 $ 463,344 Regulatory transition charge....................................... 302,270 371,486 424,484 Unamortized investment tax credits................................. (25,311) (27,839) (29,528) Deferred gain for asset sale to affiliated company................. 38,394 43,193 49,735 Other comprehensive income......................................... 1,841 (31,517) 5,900 Above market leases................................................ (324,843) (350,299) (375,333) Retirement Benefits................................................ (32,023) (42,079) (73,483) All other.......................................................... 48,362 (29,154) (51,481) --------- --------- --------- Net deferred income tax liability........................... $ 486,048 $ 407,297 $ 413,638 ========= ========= ========= * Collected from customers through regulated rates and included in revenue in the Consolidated Statements of Income. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include The Cleveland Electric Illuminating Company (Company) and its wholly owned subsidiaries, Centerior Funding Corporation (CFC), Centerior Financing Trust (CFT) and Shippingport Capital Trust (see Note 7). The Company is a wholly owned subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the issued and outstanding common shares of its other principal electric utility operating subsidiaries, including Ohio Edison Company (OE), The Toledo Edison Company (TE), American Transmission Systems, Inc. (ATSI), Jersey Central Power & Light Company (JCP&L), Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec). The Company follows the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the Public Utilities Commission of Ohio (PUCO) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. The Company's consolidated financial statements for the three years ended December 31, 2002 were restated to reflect a change in the method of amortizing costs being recovered under the Ohio transition plan, recognition of above-market liabilities of certain leased generation facilities, regulatory assets and goodwill. Certain prior year amounts have been reclassified to conform with the current year presentation, as described further in Note 1(F). (A) CONSOLIDATION- The Company consolidates all majority-owned subsidiaries over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) over which the Company has the ability to exercise significant influence, but not control, are accounted for on the equity basis. (B) REVENUES- The Company's principal business is providing electric service to customers in northeastern Ohio. The Company's retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. Receivables from customers include sales to residential, commercial and industrial customers located in the Company's service area and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of the Company's customers. Total customer receivables were $10 million (billed - $6 million and unbilled - $4 million) and $11 million (billed - $8 million and unbilled - $3 million) as of December 31, 2003 and 2002, respectively. The Company and TE sell substantially all of their retail customers' receivables to CFC. CFC subsequently transfers the receivables to a trust (a Statement of Financial Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," - - "qualified special purpose entity") under an asset-backed securitization agreement. Transfers are made in return for an interest in the trust (19% as of December 31, 2003), which is stated at fair value, reflecting adjustments for anticipated credit losses. The average collection period for billed receivables is 28 days. Given the short collection period after billing, the fair value of CFC's interest in the trust approximates the stated value of its retained interest in underlying receivables after adjusting for anticipated credit losses. Accordingly, subsequent measurements of the retained interest under SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities", (as an available-for-sale financial instrument) result in no material change in value. Sensitivity analyses reflecting 10% and 20% increases in the rate of anticipated credit losses would not have significantly affected FirstEnergy's retained interest in the pool of receivables through the trust. Of the $250 million sold to the trust and outstanding as of December 31, 2003, FirstEnergy had a retained interest in $48 million of the receivables included as other receivables on the Consolidated Balance Sheets. Accordingly, receivables recorded on FirstEnergy's Consolidated Balance Sheets were reduced by approximately $202 million due to these sales. Collections of receivables previously transferred to the trust and used for the purchase of new receivables from CFC during 2003, totaled approximately $2.4 billion. The Company and TE processed receivables for the trust and received servicing fees of approximately $3.6 million ($2.4 million CEI and $1.2 million TE) in 2003. Expenses associated with the factoring discount related to the sale of receivables were $3.5 million, $4.7 million and $12.0 million in 2003, 2002 and 2001. 21 (C) REGULATORY MATTERS- In July 1999, Ohio's electric utility restructuring legislation, which allowed Ohio electric customers to select their generation suppliers beginning January 1, 2001, was signed into law. Among other things, the legislation provided for a 5% reduction on the generation portion of residential customers' bills and the opportunity to recover transition costs, including regulatory assets, from January 1, 2001 through December 31, 2005 (market development period). The period for the recovery of regulatory assets only can be extended up to December 31, 2010. The PUCO was authorized to determine the level of transition cost recovery, as well as the recovery period for the regulatory assets portion of those costs, in considering each Ohio electric utility's transition plan application. In July 2000, the PUCO approved FirstEnergy's transition plan for the Company, OE and TE (Ohio Companies) as modified by a settlement agreement with major parties to the transition plan. The application of SFAS 71, "Accounting for the Effects of Certain Types of Regulation" to the Company's nonnuclear generation business was discontinued with the issuance of the PUCO transition plan order, as described further below. Major provisions of the settlement agreement consisted of approval of recovery of generation-related transition costs as filed of $1.6 billion net of deferred income taxes and transition costs related to regulatory assets as filed of $1.4 billion net of deferred income taxes, with recovery through no later than 2008 for the Company, except where a longer period of recovery is provided for in the settlement agreement. The generation-related transition costs include $0.2 billion, net of deferred income taxes, of impaired generating assets recognized as regulatory assets as described further below, $0.4 billion, net of deferred income taxes of above market operating lease costs and $0.5 billion, net of deferred income taxes, of additional plant costs that were reflected on the Company's regulatory financial statements. Also as part of the settlement agreement, FirstEnergy is giving preferred access over its subsidiaries to nonaffiliated marketers, brokers and aggregators to 400 megawatts (MW) of generation capacity through 2005 at established prices for sales to the Company's retail customers. Customer prices are frozen through the five-year market development period, which runs through the end of 2005, except for certain limited statutory exceptions, including the 5% reduction referred to above. In February 2003, the Company was authorized increases in annual revenues aggregating approximately $4 million to recover its higher tax costs resulting from the Ohio deregulation legislation. The Company's customers choosing alternative suppliers receive an additional incentive applied to the shopping credit (generation component) of 45% for residential customers, 30% for commercial customers and 15% for industrial customers. The amount of the incentive is deferred for future recovery from customers. Subject to approval by the PUCO, recovery will be accomplished by extending the transition cost recovery period. On October 21, 2003, the Ohio Companies filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate supply and continuing FirstEnergy's support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for the Ohio Companies' customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of the Company's support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, CEI is requesting: o Extension of the transition cost amortization period from 2008 to July 2009; o Deferral of interest costs on the accumulated shopping incentive and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates only under certain limited conditions. 22 On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 23, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S.-Canada Power System Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. Transition Cost Amortization - The Company amortizes transition costs (see Regulatory Matters) using the effective interest method. Under the current Ohio transition plan, total transition cost amortization is expected to approximate the following for 2004 through 2009. (In millions) -------------------------------- 2004.................. $192 2005.................. 219 2006.................. 129 2007.................. 145 2008.................. 164 2009.................. 46 ------------------------------- Regulatory Assets- The Company recognizes, as regulatory assets, costs which the FERC and the PUCO have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are expected to continue to be recovered from customers under the Company's transition plan. Based on that plan, the Company continues to bill and collect cost-based rates for its transmission and distribution services, which will remain regulated; accordingly, it is appropriate that the Company continues the application of SFAS 71 to those operations. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2003 2002 - --------------------------------------------------------------------------- (In millions) Regulatory transition charge.................... $ 900 $1,066 Customer shopping incentives.................... 179 85 Customer receivables for future income taxes.... 7 8 Loss on reacquired debt......................... 14 16 Employee postretirement benefit costs........... 15 17 Component removal costs......................... (60) (47) Other........................................... 1 -- - ------------------------------------------------------------------------- Total...................................... $1,056 $1,145 ========================================================================= Regulatory Accounting Generation Operations- The application of SFAS 71 has been discontinued with respect to the Company's generation operations. The SEC issued interpretive guidance regarding asset impairment measurement providing that any supplemental regulated cash flows such as a competitive transition charge should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. Consistent with the SEC guidance $304 million of impaired plant investments were recognized by the Company as regulatory assets recoverable as transition costs through future regulatory cash flows. Net assets included in utility plant relating to the operations for which the application of SFAS 71 was discontinued were $1.4 billion as of December 31, 2003. (D) UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction (except for the Company's nuclear generating units which were adjusted to fair value), including payroll and related costs such as taxes, employee benefits, administrative and 23 general costs, and interest costs incurred to place the assets in service. The Company's accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. The Company provides for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The annualized composite rate was approximately 3.0% in 2003, 3.4% in 2002 and 3.2% in 2001. Nuclear Fuel- Nuclear fuel is recorded at original cost, which includes material, enrichment, fabrication and interest costs incurred prior to reactor load. The Company amortizes the cost of nuclear fuel based on the rate of consumption. (E) COMMON OWNERSHIP OF GENERATING FACILITIES- The Company, together with TE, OE and OE's wholly owned subsidiary, Pennsylvania Power Company (Penn), own and/or lease, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Company's portion of operating expenses associated with jointly owned facilities is included in the corresponding operating expenses on the Consolidated Statements of Income. The amounts reflected on the Consolidated Balance Sheet under utility plant as of December 31, 2003 include the following:
Utility Accumulated Construction Ownership/ Plant Provision for Work in Leasehold Generating Units in Service Depreciation Progress Interest - ------------------------------------------------------------------------------------------ (In millions) W. H. Sammis Unit 7........... $ 180 $123 $ -- 31.20% Bruce Mansfield Units 1, 2 and 3....................... 127 43 25 20.42% Beaver Valley Unit 2.......... 13 1 14 24.47% Davis-Besse................... 248 56 84 51.38% Perry......................... 655 161 9 44.85% - ------------------------------------------------------------------------------------------ Total...................... $1,223 $384 $132 . ==========================================================================================
The Bruce Mansfield Plant is being leased through a sale and leaseback transaction (see Note 2) and the above-related amounts represent construction expenditures subsequent to the transaction. (F) ASSET RETIREMENT OBLIGATION- In January 2003, the Company implemented SFAS 143, "Accounting for Asset Retirement Obligations", which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. The Company identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning, reclamation of a sludge disposal pond related to the Bruce Mansfield Plant, and closure of two coal ash disposal sites. The ARO liability as of the date of adoption of SFAS 143 was $238.3 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. Accretion during 2003 was $16.5 million, bringing the ARO liability as of December 31, 2003 to $254.8 million. The ARO includes the Company's obligation for nuclear decommissioning of the Beaver Valley Unit 2, Davis-Besse, and Perry generating facilities. The Company's share of the obligation to decommission these units was developed based on site specific studies performed by an independent engineer. The Company utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Company maintains nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $313.6 million. In accordance with SFAS 143, the Company ceased the accounting practice of depreciating non-regulated generation assets using a cost of removal component in the depreciation rates. That practice recognized accumulated depreciation in excess of the historical cost of an asset because the removal cost would exceed the estimated salvage value. Beginning in 2003, the cost of removal related to non-regulated generation assets is charged to expense rather than 24 to the accumulated provision for depreciation. In accordance with SFAS 71, the cost of removal on regulated plant assets continues to be accounted for as a component of depreciation rates and is recognized as a regulatory liability. The following table provides the effect on income as if SFAS 143 had been applied during 2002 and 2001. Effect of the Change in Accounting Principle Applied Retroactively 2002 2001 ----------------------------------------------------------------------------- (In millions) Reported net income........................................ $137 $178 Increase (Decrease): Elimination of decommissioning expense..................... 29 29 Depreciation of asset retirement cost...................... (1) (1) Accretion of ARO liability................................. (15) (14) Non-regulated generation cost of removal component, net.... 9 6 Income tax effect.......................................... (9) (8) ------------------------------------------------------------------------------ Net earnings increase...................................... 13 12 ----------------------------------------------------------------------------- Net income adjusted........................................ $150 $190 ============================================================================= The following table provides the year-end balance of the ARO for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 -------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002 $223.1 Accretion in 2002 15.2 ------------------------------------------------------ Ending balance as of December 31, 2002 $238.3 ------------------------------------------------------ (G) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 3B). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date resulting in substantially no intrinsic value. If FirstEnergy had accounted for employee stock options under the fair value method of SFAS 123, "Accounting for Stock Compensation," a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 - ---------------------------------------------------------------------------- Valuation assumptions: Expected option term (years). 7.9 8.1 8.3 Expected volatility.......... 26.91% 23.31% 23.45% Expected dividend yield...... 5.09% 4.36% 5.0% Risk-free interest rate...... 3.67% 4.60% 4.6% Fair value per option.......... $5.09 $6.45 $4.97 - ---------------------------------------------------------------------------- The effects of applying fair value accounting to FirstEnergy's stock options would not materially affect the Company's net income. (H) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. The Company is included in FirstEnergy's consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with each Company recognizing any tax losses or credits the Company contributes to the consolidated return. 25 (I) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS- FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of the Company's employees. The trusteed plans provide defined benefits based on years of service and compensation levels. FirstEnergy's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company recognizes the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. The following sets forth the funded status of the plans and amounts recognized on FirstEnergy's Consolidated Balance Sheets as of December 31:
Obligations and Funded Status Pension Benefits Other Benefits ---------------- -------------- As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $ 1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition.......................... -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------- Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $ 2,077 ====== ====== ======= ======= Change in fair value of plan assets Fair value of plan assets at beginning of year................................ $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------- Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ======= Funded status............................ $ (847) $ (977) $(1,831) (1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit).............................. 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ -------- ------- Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= =======
Amounts Recognized in the Consolidated Balance Sheets As of December 31 ----------------------------------------- Accrued benefit cost..................... $ (438) $ (548) $ (975) $ (867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ------ ------ ------- ------- Net amount recognized.................... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Company's share of net amount recognized. $ 22 $ 39 $ (71) $ (117) ====== ====== ======= ======= Increase in minimum liability included in other comprehensive income (net of tax) $ (145) $ 444 $ -- $ -- Weighted-Average Assumptions Used to Determine Benefit Obligations As of December 31 ----------------------------------------- Discount rate........................... 6.25% 6.75% 6.25% 6.75% Rate of compensation increase........... 3.50% 3.50% Allocation of Plan Assets As of December 31 ----------------------------------------- Asset Category Equity securities..................... 70% 61% 71% 58% Debt securities....................... 27 35 22 29 Real estate........................... 2 2 -- -- Other................................. 1 2 7 13 --- --- --- --- Total................................. 100% 100% 100% 100% === === === === Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 ----------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889
FirstEnergy's net pension and other postretirement benefit costs for the three years ended December 31, 2003 were computed as follows:
Pension Benefits Other Benefits ---------------------- ------------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 ------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset)................................ -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ----- ----- ----- ---- ---- ---- Net periodic cost (income).............. $ 142 $ (29) $ (24) $177 $114 $ 92 ===== ===== ===== ==== ==== ==== Company's share of net benefit costs (income).............................. $ 10 $ 1 $ (2) $ 15 $ 10 $ 13 ===== ===== ===== ==== ==== ==== Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31 Discount rate.......................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets............................... 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase.......... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy. 27 Assumed health care cost trend rates As of December 31 2003 2002 - ------------------------------------------------------------------------------ Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2008-2010 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Increase Point Decrease - ------------------------------------------------------------------------------- (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, the accrued pension costs for the Company as of June 30, 2003 decreased by $17 million. The corresponding adjustment related to this change increased other comprehensive income and deferred income taxes and decreased the payable to associated companies. Due to the increased market value of its pension plan assets, the Company reduced its minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $12 million, recording a decrease of $4 million in an intangible asset and crediting OCI by $5 million (offsetting previously recorded deferred tax benefits by $3 million). The remaining balance in OCI of $25 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $33 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. (J) TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and other income include transactions with affiliated companies, primarily ATSI, FirstEnergy Solutions Corp. (FES) and FirstEnergy Service Company (FESC). The Ohio transition plan, as discussed in the "Regulatory Matters" section, resulted in the corporate separation of FirstEnergy's regulated and unregulated operations in 2001. FES operates the generation businesses of the Company, TE, OE and Penn. As a result, the Company entered into power supply agreements (PSA) whereby FES purchases all of the Company's nuclear generation and the generation from leased fossil generating facilities and the Company purchases its power from FES to meet its "provider of last resort" obligations. CFC serves as the transferor in connection with the accounts receivable securitization for the Company and TE. The primary affiliated companies transactions are as follows: 28 2003 2002 2001 - ------------------------------------------------------------------------------ (In millions) Operating Revenues: PSA revenues from FES............ $260 $284 $334 Generating units rent from FES... 59 60 59 Ground lease with ATSI........... 7 7 7 Operating Expenses: Purchased power under PSA........ 423 420 597 Purchased power from TE.......... 109 104 97 Transmission expenses............ 32 41 29 FESC support services............ 63 52 50 Other Income: Interest income from ATSI........ 7 7 7 Interest income from FES......... 1 1 1 - --------------------------------------------------------------------------- The Company is buying 150 MW of TE's Beaver Valley Unit 2 leased capacity entitlement. Purchased power expenses for this transaction were $109 million, $104 million and $97 million in 2003, 2002 and 2001, respectively. This purchase is expected to continue through the end of the lease period (see Note 2). FirstEnergy does not bill directly or allocate any of its costs to any subsidiary company. Costs are allocated to the Company from FESC, a subsidiary of FirstEnergy and a "mutual service company" as defined in Rule 93 of the Public Utility Holding Company Act of 1935 (PUHCA). The majority of costs are directly billed or assigned at no more than cost as determined by PUHCA Rule 91. The remaining costs are for services that are provided on behalf of more than one company, or costs that cannot be precisely identified and are allocated using formulas that are filed annually with the SEC on Form U-13-60. The current allocation or assignment formulas used and their bases include multiple factor formulas; each company's proportionate amount of FirstEnergy's aggregate direct payroll, number of employees, asset balances, revenues, number of customers, other factors and specific departmental charge ratios. Management believes that these allocation methods are reasonable. Intercompany transactions with FirstEnergy and its other subsidiaries are generally settled under commercial terms within thirty days, except for $145 million payable to affiliates for pension and OPEB obligations. (K) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Consolidated Balance Sheets at cost, which approximates their fair market value. Cash and cash equivalents included $25 million received in December 2003 which was included in the NRG settlement claim sold in January 2004 (see Note 6) and $30 million used for the redemption of long-term debt in January 2003 as of December 31, 2003 and 2002, respectively. Noncash financing and investing activities included capital lease transactions amounting to $2.1 million in 2001. There were no capital lease transactions in 2003 or 2002. "Other amortization" on the Consolidated Statement of Cash Flows under Cash Flows from Operating Activities consists of amounts from the reduction of an electric service obligation under the Company's electric service prepayment program. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Consolidated Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31:
2003 2002 - ---------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value - ---------------------------------------------------------------------------------------------------------- (In millions) Long-term debt................................... $2,234 $2,444 $2,309 $2,493 Preferred stock*................................. $ 5 $ 5 $ 106 $ 113 Investments other than cash and cash equivalents: Debt securities - Maturity (5-10 years)....................... $ 11 $ 11 $ 11 $ 11 - Maturity (more than 10 years)............... 698 812 528 576 All other..................................... 318 318 232 232 - ---------------------------------------------------------------------------------------------------------- $1,027 $1,141 $ 771 $ 819 ========================================================================================================== * The December 31, 2003 amount is classified as debt under SFAS 150.
The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Company's ratings. 29 The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. The Company has no securities held for trading purposes. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "All other" in the table above) consist of equity securities ($188 million) and fixed income securities ($124 million) as of December 31, 2003. Unrealized gains and losses applicable to the Company's decommissioning trusts are recognized in the trust investment with a corresponding offset to OCI, as fluctuations in the fair value of the trusts will eventually affect earnings. Realized gains (losses) are recognized as additions (reductions) to trust asset balances with an offset to earnings. For 2003 and 2002, net realized losses were approximately $0.8 million and $6.9 million, respectively, and interest and dividend income totaled approximately $8.5 million and $7.3 million, respectively. Investments other than cash and cash equivalents in the table above include available-for-sale securities, at fair value, with the following net results: 2003* 2002* - ---------------------------------------------------------------- (In millions) Unrealized gains (losses)........... $ 48.1 $(15.3) Proceeds from sales................. 226.0 197.8 Realized gains (losses)............. (0.8) (6.9) - ---------------------------------------------------------------- * Includes the available-for-sale securities of the Company's decommissioning trusts. As of December 31, 2003 accumulated other comprehensive income (loss) for available-for-sale securities consisted of investments with net unrealized gains of $59.8 million and net unrealized losses of $12.1 million. The following table provides details for the available-for-sale securities with net unrealized losses as of December 31, 2003.
Less Than 12 Months 12 Months or More Total -------------------- -------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Security Type Value Losses Value Losses Value Losses - ------------------------------------------------------------------------------------------------------- (In millions) Equity Securities....... $ 7.8 $2.3 $11.2 $9.6 $19.0 $11.9 Debt Securities......... 10.2 0.2 -- -- 10.2 0.2 - ----------------------------------------------------------------------------------------------------- Total............... $18.0 $2.5 $11.2 $9.6 $29.2 $12.1 - -------------------------------------------------------------------------------------------------------
All of the aggregate unrealized losses related to available-for-sale securities in the table above are considered to be temporary in nature. These securities are primarily held by the Company's nuclear decommissioning trusts. The Company has the ability and intent to hold these securities for the period necessary to fund their cost. (L) GOODWILL- In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Under SFAS 142, "Goodwill and Other Intangible Assets," amortization of existing goodwill ceased January 1, 2002. Instead, the Company evaluates its goodwill for impairment at least annually and makes such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. When impairment is indicated, the Company would recognize a loss - calculated as the difference between the implied fair value of its goodwill and the carrying value of the goodwill. The Company's annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in the Company's evaluation of goodwill reflect operations consistent with its general business assumptions. Unanticipated changes in those assumptions could have a significant effect on its future evaluations of goodwill. As of December 31, 2003, the Company had approximately $1.7 billion of goodwill. The impairment analysis includes a significant source of cash representing the Company's recovery of transition costs as described above under "Regulatory Matters." The Company does not believe that completion of transition cost recovery will result in an impairment of goodwill. 30 The following table shows what net income would have been if goodwill amortization had been excluded from prior periods: 2003 2002 2001 ---- ---- ---- (In thousands) Reported net income................ $239,411 $136,952 $177,905 Add back goodwill amortization..... -- -- 47,230 -------- -------- -------- Adjusted net income................ $239,411 $136,952 $225,135 ======== ======== ======== (M) CUMULATIVE EFFECT OF ACCOUNTING CHANGE- Results for 2003 include an after-tax credit to net income of $42.4 million recorded by the Company upon adoption of SFAS 143 in January of 2003. The Company identified applicable legal obligations as defined under the new accounting standard for nuclear power plant decommissioning, reclamation of a sludge disposal pond at the Bruce Mansfield Plant, and closure of two coal ash disposal sites. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $49.9 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $6.8 million. The asset retirement obligation liability at the date of adoption was $238.3 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, the Company had recorded decommissioning liabilities of $242.5 million. The cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $72.5 million increase to income, or $42.4 million net of income taxes. 2. LEASES: The Company leases certain generating facilities, office space and other property and equipment under cancelable and noncancelable leases. The Company and TE sold their ownership interests in Bruce Mansfield Units 1, 2 and 3 and TE sold a portion of its ownership interest in Beaver Valley Unit 2. In connection with these sales, which were completed in 1987, the Company and TE entered into operating leases for lease terms of approximately 30 years as co-lessees. During the terms of the leases, the Company and TE continue to be responsible, to the extent of their combined ownership and leasehold interest, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. The Company and TE have the right, at the end of the respective basic lease terms, to renew the leases. The Company and TE also have the right to purchase the facilities at the expiration of the basic lease term or any renewal term at a price equal to the fair market value of the facilities. As co-lessee with TE, the Company is also obligated for TE's lease payments. If TE is unable to make its payments under the Beaver Valley Unit 2 and Bruce Mansfield Plant leases, the Company would be obligated to make such payments. No such payments have been made on behalf of TE. (TE's future minimum lease payments as of December 31, 2003 were approximately $1.0 billion, net of trust cash receipts.) Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 2003 are summarized as follows: 2003 2002 2001 - ------------------------------------------------------------------ (In millions) Operating leases Interest element...... $31.6 $33.6 $35.3 Other................. 45.9 42.8 36.4 Capital leases Interest element...... 0.6 0.6 3.6 Other................. 0.4 0.4 19.4 - ------------------------------------------------------------------ Total rentals......... $78.5 $77.4 $94.7 ================================================================== 31 The future minimum lease payments as of December 31, 2003 are:
Operating Leases ------------------------------------ Capital Lease Capital Leases Payments Trust Net --------------------------------------------------------------------------------------------- (In millions) 2004.................................. $ 1.0 $ 55.7 $ 28.6 $ 27.1 2005.................................. 1.0 66.7 48.3 18.4 2006.................................. 1.0 71.3 56.2 15.1 2007.................................. 1.0 57.8 48.2 9.6 2008.................................. 1.0 54.2 42.9 11.3 Years thereafter...................... 3.7 470.5 350.4 120.1 ---------------------------------------------------------------------------------------------- Total minimum lease payments.......... 8.7 $776.2 $574.6 $201.6 ====== ====== ====== Interest portion...................... 2.8 ------------------------------------------------- Present value of net minimum lease payments...................... 5.9 Less current portion.................. 0.4 ------------------------------------------------- Noncurrent portion.................... $ 5.5 =================================================
The Company has recorded above-market lease liabilities for Beaver Valley Unit 2 and the Bruce Mansfield Plant associated with the 1997 merger creating FirstEnergy. The total above-market lease obligation of $611 million associated with Beaver Valley Unit 2 is being amortized on a straight-line basis through the end of the lease term in 2017 (approximately $31 million per year). The total above-market lease obligation of $457 million associated with the Bruce Mansfield Plant is being amortized on a straight-line basis through the end of 2016 (approximately $29 million per year). As of December 31, 2003 the above-market lease liabilities for Beaver Valley Unit 2 and the Bruce Mansfield Plant totaled approximately $789 million, of which $60 million is current. The Company and TE refinanced high-cost fixed obligations related to their 1987 sale and leaseback transaction for the Bruce Mansfield Plant through a lower cost transaction in June and July 1997. In a June 1997 offering (Offering), the two companies pledged $720 million aggregate principal amount ($575 million for the Company and $145 million for TE) of first mortgage bonds due through 2007 to a trust as security for the issuance of a like principal amount of secured notes due through 2007. The obligations of the two companies under these secured notes are joint and several. Using available cash, short-term borrowings and the net proceeds from the Offering, the two companies invested $906.5 million ($569.4 million for the Company and $337.1 million for TE) in a business trust, in June 1997. The trust used these funds in July 1997 to purchase lease notes and redeem all $873.2 million aggregate principal amount of 10-1/4% and 11-1/8% secured lease obligation bonds (SLOBs) due 2003 and 2016. The SLOBs were issued by a special-purpose-funding corporation in 1988 on behalf of lessors in the two companies' 1987 sale and leaseback transaction. The Shippingport arrangement effectively reduces lease costs related to that transaction (see Note 7 for FIN 46R discussion). 3. CAPITALIZATION: (A) RETAINED EARNINGS- There are no restrictions on retained earnings for payment of cash dividends on the Company's common stock. (B) STOCK COMPENSATION PLANS- FirstEnergy administers the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Several other stock compensation plans have been acquired through the mergers with GPU and Centerior - GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan), 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan) and Centerior Equity Plan. No further stock-based compensation can be awarded under these plans. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 32 2003 2002 2001 - --------------------------------------------------------------------------- Restricted common shares granted...... -- 36,922 133,162 Weighted average market price ........ n/a (1) $36.04 $35.68 Weighted average vesting period (years)............................. n/a (1) 3.2 3.7 Dividends restricted.................. n/a (1) Yes -- (2) - --------------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares; MYR Plan dividends are paid as unrestricted cash on 128,662 shares Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price - ----------------------------------------------------------------------------- Balance, January 1, 2001.............. 5,021,862 24.09 (473,314 options exercisable)......... 24.11 Options granted..................... 4,240,273 28.11 Options exercised................... 694,403 24.24 Options forfeited................... 120,044 28.07 Balance, December 31, 2001............ 8,447,688 26.04 (1,828,341 options exercisable)....... 24.83 Options granted..................... 3,399,579 34.48 Options exercised................... 1,018,852 23.56 Options forfeited................... 392,929 28.19 Balance, December 31, 2002............ 10,435,486 28.95 (1,400,206 options exercisable)....... 26.07 Options granted..................... 3,981,100 29.71 Options exercised................... 455,986 25.94 Options forfeited................... 311,731 29.09 Balance, December 31, 2003............ 13,648,869 29.27 (1,919,662 options exercisable)....... 29.67 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. Options outstanding by plan and range of exercise price as of December 31, 2003 were as follows: Range of Options FirstEnergy Program Exercise Prices Outstanding - ----------------------------------------------------------------------- FE plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU plan $23.75 - $35.92 501,734 Other plans 27,673 - ---------------------------------------------------------------------- Total 13,648,869 ====================================================================== No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 1G - "Stock-Based Compensation." 33 (C) PREFERRED AND PREFERENCE STOCK- The Company's preferred stock may be redeemed in whole, or in part, with 30-90 days' notice. The preferred dividend rate on the Company's Series L fluctuates based on prevailing interest rates and market conditions. The dividend rate for this issue was 7% in 2003. The Company has three million authorized and unissued shares of preference stock having no par value. (D) LONG-TERM DEBT- The Company has a first mortgage indenture under which it issues first mortgage bonds secured by a direct first mortgage lien on substantially all of its property and franchises, other than specifically excepted property. The Company has various debt covenants under its financing arrangements. The most restrictive of the debt covenants relate to the nonpayment of interest and/or principal on debt which could trigger a default and the maintenance of minimum fixed charge ratios and debt to capitalization ratios covenants. There also exists cross-default provisions among financing agreements of FirstEnergy and the Company. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) - ---------------------------------------------- 2004................................ $386 2005................................ 10 2006................................ 12 2007................................ 129 2008................................ 140 - --------------------------------------------- Included in the table above are amounts for various variable interest rate long-term debt which have provisions by which individual debt holders have the option to "put back" or require the respective debt issuer to redeem their debt at those times when the interest rate may change prior to its maturity date. The amount is $98.5 million in 2004, which represents the next time debt holders may exercise this provision. The Company's obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds. Certain pollution control revenue bonds are entitled to the benefit of an irrevocable bank letter of credit of $48.1 million and a noncancelable municipal bond insurance policy of $30.0 million to pay principal of, or interest on, the pollution control revenue bonds. To the extent that drawings are made under the letter of credit or policies, the Company is entitled to a credit against its obligation to repay that bond. The Company pays an annual fee of 1.125% of the amount of the letter of credit to the issuing bank and is obligated to reimburse the bank for any drawings thereunder. The Company and TE have unsecured letters of credit of approximately $215.9 million in connection with the sale and leaseback of Beaver Valley Unit 2 that expire in April 2005. The Company and TE are jointly and severally liable for the letters of credit (see Note 2). (E) LONG-TERM DEBT: PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- Effective July 1, 2003, upon adoption of SFAS 150 (see Note 7), the Company reclassified as debt its preferred stock subject to mandatory redemption. Prior year amounts were not reclassified. The Company's $7.35 C series has an annual sinking fund requirement for 10,000 shares with annual sinking fund requirements for the next five years of $1.0 million in each year 2004-2008. (F) LONG-TERM DEBT: SUBORDINATED DEBENTURES TO AFFILIATED TRUSTS- The Company formed a wholly owned statutory business trust to sell preferred securities and invest the gross proceeds in the 9.00% subordinated debentures of the Company. The sole assets of the trust are the applicable subordinated debentures. Interest payment provisions of the subordinated debentures match the distribution payment provisions of the trust's preferred securities. In addition, upon redemption or payment at maturity of subordinated debentures, the trust's preferred securities will be redeemed on a pro rata basis at their liquidation value. Under certain circumstances, the applicable subordinated debentures could be distributed to the holders of the outstanding preferred securities of the trust in the event that the trust is liquidated. The Company has effectively provided a full and unconditional guarantee of payments due on the trust's preferred securities. The trust's preferred securities are redeemable at 100% of their principal amount at the Company's option beginning in December 2006. 34 Interest on the subordinated debentures (and therefore distributions on the trust's preferred securities) may be deferred for up to 60 months, but the Company may not pay dividends on, or redeem or acquire, any of its cumulative preferred or common stock until deferred payments on its subordinated debentures are paid in full. Upon adoption of FIN 46R, the statutory business trust discussed above is not consolidated on the Company's financial statements as of December 31, 2003 (see Note 7). (G) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholder's equity except those resulting from transactions with FirstEnergy. As of December 31, 2003, accumulated other comprehensive loss consisted of a minimum liability for unfunded retirement benefits of $(25.4) million and unrealized gains on investments in securities available for sale of $28.0 million. 4. SHORT-TERM BORROWINGS: The Company may borrow from its affiliates on a short-term basis. As of December 31, 2003, the Company had total short-term borrowings of $188.2 million from its affiliates. The weighted average interest rates on short-term borrowings outstanding as of December 31, 2003 and 2002, were 2.2% and 1.8%, respectively. 5. COMMITMENTS AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $275 million for property additions and improvements from 2004-2006, of which approximately $92 million is applicable to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $61 million, of which approximately $29 million applies to 2004. During the same periods, the Company's nuclear fuel investments are expected to be reduced by approximately $60 million and $30 million, respectively, as the nuclear fuel is consumed. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its ownership and leasehold interests in Beaver Valley Unit 2, the Davis-Besse Station and the Perry Plant, the Company's maximum potential assessment under the industry retrospective rating plan (assuming the other affiliate co-owners contribute their proportionate shares of any assessments under the retrospective rating plan) would be $121.4 million per incident but not more than $12.1 million in any one year for each incident. The Company is also insured as to its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Company has also obtained approximately $382 million of insurance coverage for replacement power costs for its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry. Under these policies, the Company can be assessed a maximum of approximately $20.5 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Company's plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. (C) ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Company with regard to air and water quality and other environmental matters. The effects of compliance on the Company with regard to environmental matters could have a material adverse effect on the Company's earnings and competitive position. These environmental regulations affect the Company's earnings and competitive position to the extent that it competes with companies that are not subject to such regulations and therefore do not bear the risk of costs associated with compliance, or failure to comply, with such regulations. Overall, the Company believes it is in material compliance with existing regulations but are unable to predict future change in regulatory policies and what, if any, the effects of such change would be. In accordance with the Ohio 35 transition plan discussed in "Regulatory Matters" in Note 1(C), generation operations and any related additional capital expenditures for environmental compliance are the responsibility of FirstEnergy's competitive services business unit. Clean Air Act Compliance The Company is required to meet federally approved sulfur dioxide (SO2) regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The Environmental Protection Agency (EPA) has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Company cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. The Company is complying with SO2 reduction requirements under the Clean Air Act Amendments of 1990 by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or using emission allowances. NOx reductions required by the 1990 Amendments are being achieved through combustion controls and the generation of more electricity at lower-emitting plants. In September 1998, the EPA finalized regulations requiring additional NOx reductions from the Company's Ohio and Pennsylvania facilities. The EPA's NOx Transport Rule imposes uniform reductions of NOx emissions (an approximate 85% reduction in utility plant NOx emissions from projected 2007 emissions) across a region of nineteen states (including Ohio and Pennsylvania) and the District of Columbia based on a conclusion that such NOx emissions are contributing significantly to ozone pollution in the eastern United States. State Implementation Plans (SIP) must comply by May 31, 2004 with individual state NOx budgets established by the EPA. Pennsylvania submitted a SIP that required compliance with the NOx budgets at the Company's Pennsylvania facilities by May 1, 2003 and Ohio submitted a SIP that requires compliance with the NOx budgets at the Company's Ohio facilities by May 31, 2004. The Company's Pennsylvania facilities complied with the NOx budgets in 2003 and all facilities will comply with the NOx budgets in 2004 and thereafter. National Ambient Air Quality Standards In July 1997, the EPA promulgated changes in the National Ambient Air Quality Standard (NAAQS) for ozone and proposed a new NAAQS for fine particulate matter. On December 17, 2003, the EPA proposed the "Interstate Air Quality Rule" covering a total of 29 states (including Ohio and Pennsylvania) and the District of Columbia based on proposed findings that air pollution emissions from 29 eastern states and the District of Columbia significantly contribute to nonattainment of the NAAQS for fine particles and/or the "8-hour" ozone NAAQS in other states. The EPA has proposed the Interstate Air Quality Rule to "cap-and-trade" NOx and SO2 emissions in two phases (Phase I in 2010 and Phase II in 2015). According to the EPA, SO2 emissions would be reduced by approximately 3.6 million tons in 2010, across states covered by the rule, with reductions ultimately reaching more than 5.5 million tons annually. NOx emission reductions would measure about 1.5 million tons in 2010 and 1.8 million tons in 2015. The future cost of compliance with these proposed regulations may be substantial and will depend if and how they are ultimately implemented by the states in which the Company operates affected facilities. Mercury Emissions In December 2000, the EPA announced it would proceed with the development of regulations regarding hazardous air pollutants from electric power plants, identifying mercury as the hazardous air pollutant of greatest concern. On December 15, 2003, the EPA proposed two different approaches to reduce mercury emissions from coal-fired power plants. The first approach would require plants to install controls known as "maximum achievable control technologies" (MACT) based on the type of coal burned. According to the EPA, if implemented, the MACT proposal would reduce nationwide mercury emissions from coal-fired power plants by fourteen tons to approximately thirty-four tons per year. The second approach proposes a cap-and-trade program that would reduce mercury emissions in two distinct phases. Initially, mercury emissions would be reduced by 2010 as a "co-benefit" from implementation of SO2 and NOx emission caps under the EPA's proposed Interstate Air Quality Rule. Phase II of the mercury cap-and-trade program would be implemented in 2018 to cap nationwide mercury emissions from coal-fired power plants at fifteen tons per year. The EPA has agreed to choose between these two options and issue a final rule by December 15, 2004. The future cost of compliance with these regulations may be substantial. Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. 36 The Company has been named as "potentially responsible parties" (PRPs) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Company's proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. The Company has total accrued liabilities aggregating approximately $2 million as of December 31, 2003. The Company accrues environmental liabilities only when it can conclude that it is probable that it has an obligation for such costs and can reasonably determine the amount of such costs. Unasserted claims are reflected in the Company's determination of environmental liabilities and are accrued in the period that they are both probable and reasonably estimable. Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but it failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. The Company cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Company is lower than many regional competitors due to the Company's diversified generation sources which includes low or non-CO2 emitting gas-fired and nuclear generators. Clean Water Act Various water quality regulations, the majority of which are the result of the federal Clean Water Act and its amendments, apply to the Company's plants. In addition, Ohio and Pennsylvania have water quality standards applicable to the Company's operations. As provided in the Clean Water Act, authority to grant federal National Pollutant Discharge Elimination System water discharge permits can be assumed by a state. Ohio and Pennsylvania have assumed such authority. (D) LEGAL MATTERS AND OTHER CONTINGENCIES Various lawsuits, claims and proceedings related to the Company's normal business operations are pending against FirstEnergy and its subsidiaries. On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. 37 6. SALE OF GENERATING ASSETS: In November 2001, FirstEnergy reached an agreement to sell four coal-fired power plants totaling 2,535 MW to NRG Energy Inc. The proposed sale had included the 376 MW Ashtabula, 1,262 MW Eastlake and 249 MW Lakeshore plants owned by the Company. On August 8, 2002, FirstEnergy notified NRG that it was canceling the agreement because NRG stated that it could not complete the transaction under the original terms of the agreement. NRG filed voluntary bankruptcy petitions in May 2003; subsequently, FirstEnergy reached an agreement for settlement of its claim against NRG. FirstEnergy sold its entire claim for $170 million (Company's share - $131 million) in January 2004. In December 2002, FirstEnergy decided to retain ownership of these plants after reviewing other bids it subsequently received from other parties who had expressed interest in purchasing the plants. Since FirstEnergy did not execute a sales agreement by year-end, the Company reflected approximately $45 million ($26 million net of tax) of previously unrecognized depreciation and other transaction costs in the fourth quarter of 2002 related to these plants from November 2001 through December 2002 on its Consolidated Statement of Income. 7. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS: FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, the Company adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. the Company will adopt FIN 46R for all other types of entities effective March 31, 2004. The Company currently has transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. In 1997, the Company and TE established Shippingport to purchase all of the lease obligation bonds issued by the owner trusts in the Bruce Mansfield Plant sale and leaseback transactions. Prior to the adoption of FIN 46R, the assets and liabilities of the trust were included on a proportionate basis in the financial statements of the Company and TE. Upon adoption of FIN 46R, the Company was determined to be the primary beneficiary of Shippingport, and therefore consolidated the entire trust as of December 31, 2003. As a result, Shippingport's note payable to TE of approximately $208 million ($9 million current) is recognized as long-term debt on the Consolidated Balances Sheets. In reviewing the sale and leaseback arrangements, the Company also evaluated its interest in the owner trusts that acquired interests in the Bruce Mansfield Plant. The Company was determined not to be the primary beneficiary of any of these owner trusts and was therefore not required to consolidate these entities. The leases are accounted for as operating leases in accordance with GAAP and their related obligations are disclosed in Note 2. As described in Note 3(F), the Company created a statutory business trust to issue trust preferred securities in the amount of $100 million. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. Therefore, the Company has deconsolidated the trust and recognized an equity investment in the trust of $3 million and subordinated debentures to the trust of $103 million as of December 31, 2003. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, the Company reclassified as debt the preferred stock subject to mandatory redemption with a carrying value of approximately $5 million as of December 31, 2003. Dividends on preferred stock subject to mandatory redemption on the Company's Consolidated Statements of Income, which were not included in net interest charges prior to the adoption of SFAS 150, are now included in net interest charges for the six months ended December 31, 2003. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, the Company implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(F) and 1(M) for further discussions of SFAS 143. 38 EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" In November 2003, the EITF reached consensus that certain quantitative and qualitative disclosures are required for debt and equity securities classified as available-for-sale or held-to-maturity. The guidance requires the disclosure of the aggregate amount of unrealized losses and the aggregate related fair value for investments with unrealized losses that have not been recognized as other-than-temporary impairments. The Company adopted the disclosure requirements of EITF Issue No. 03-1 as of December 31, 2003 (See Note 1(K)). 8. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 2003 and 2002.
March 31, June 30, September 30, December 31, Three Months Ended 2003 2003 2003 2003 (a) - ------------------------------------------------------------------------------------------------------------------ (In millions) Operating Revenues.......................... $419.8 $412.1 $496.7 $392.2 Operating Expenses and Taxes................ 365.8 367.6 396.7 335.6 - ------------------------------------------------------------------------------------------------------------------- Operating Income ........................... 54.0 44.5 100.0 56.6 Other Income................................ 4.7 4.7 6.5 81.9 Net Interest Charges........................ 43.5 39.9 38.6 33.9 - ------------------------------------------------------------------------------------------------------------------- Income Before Cumulative Effect of Accounting Change........................ 15.2 9.3 67.9 104.6 Cumulative Effect of Accounting Change (Net of Income Taxes).................... 42.4 -- -- -- Net Income.................................. $ 57.6 $ 9.3 $ 67.9 $104.6 =================================================================================================================== Earnings Applicable to Common Stock $ 58.4 $ 7.5 $ 66.0 $100.0 =================================================================================================================== March 31, June 30, September 30, December 31, Three Months Ended 2002 2002 2002 2002 - ------------------------------------------------------------------------------------------------------------------ (In millions) Operating Revenues.......................... $433.3 $462.9 $538.9 $408.6 Operating Expenses and Taxes................ 375.8 355.8 419.0 387.0 - ------------------------------------------------------------------------------------------------------------------- Operating Income ........................... 57.5 107.1 119.9 21.6 Other Income................................ 5.2 3.4 5.6 1.8 Net Interest Charges........................ 47.8 46.8 47.3 43.3 Net Income (Loss)........................... $ 14.9 $ 63.7 $ 78.2 $(19.8) =================================================================================================================== Earnings (Loss) Applicable to Common Stock $ 8.3 $ 60.6 $ 75.1 $(22.8) =================================================================================================================== (a) Net income for the three months ended December 31, 2003, was increased by $3.2 million due to adjustments that were subsequently capitalized to construction projects in the fourth quarter. The adjustments included $0.3 million, $1.2 million and $1.7 million of costs charged to expense in the first, second and third quarters, respectively. Management concluded that the adjustments were not material to the consolidated financial statements for any quarter of 2003.
39 Report of Independent Auditors To the Stockholders and Board of Directors of The Cleveland Electric Illuminating Company: In our opinion, the accompanying consolidated balance sheets and consolidated statements of capitalization and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of The Cleveland Electric Illuminating Company (a wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three yeas in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. As discussed in Note 1(L) to the consolidated financial statements, the Company changed its method of accounting for goodwill as of January 1, 2002. As discussed in Note 1(F) to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003. As discussed in Note 7 to the consolidated financial statements, the Company changed its method of accounting for the consolidation of variable interest entities as of December 31, 2003. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 40 EX-21 25 cei_ex21-2.txt 21-2 CEI LIST OF SUB EXHIBIT 21.2 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 2003 Centerior Funding Corporation - Incorporated in Delaware Cleveland Electric Financing Trust I - Incorporated in Delaware Statement of Differences ------------------------ Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 2003, is not included in the printed document. EX-4 26 te_ex4-9.txt EX4-9 53RD SI ================================================================================ THE TOLEDO EDISON COMPANY TO JPMORGAN CHASE BANK (FORMERLY KNOWN AS THE CHASE MANHATTAN BANK) Trustee. ---------------------- Fifty-third Supplemental Indenture Dated as of April 1, 2003 ---------------------- (Supplemental to Indenture of Mortgage and Deed of Trust dated as of April 1, 1947) ---------------------- First Mortgage Bonds, Pledge Series A of 2003 due 2024 First Mortgage Bonds, Pledge Series B of 2003 due 2024 ================================================================================ FIFTY-THIRD SUPPLEMENTAL INDENTURE, dated as of April 1, 2003, between THE TOLEDO EDISON COMPANY, a corporation organized and existing under the laws of the State of Ohio (hereinafter called the "Company"), and JPMORGAN CHASE BANK (formerly known as THE CHASE MANHATTAN BANK), a corporation existing under the laws of the State of New York (hereinafter called the "Trustee"), as Trustee. RECITALS The Company has heretofore executed and delivered an Indenture of Mortgage and Deed of Trust dated as of April 1, 1947 (hereinafter referred to as the "Original Indenture") to The Chase National Bank of the City of New York, predecessor Trustee, to secure an issue of First Mortgage Bonds of the Company, issuable in series, and created thereunder an initial series of bonds designated as First Mortgage Bonds, 2?% Series due 1977; and The Company has heretofore executed and delivered to The Chase National Bank of the City of New York, predecessor Trustee, four Supplemental Indentures supplementing the Original Indenture dated, respectively, September 1, 1948, April 1, 1949, December 1, 1950 and March 1, 1954 and has heretofore executed and delivered to The Chase Manhattan Bank, which on March 31, 1955, became the Trustee under the Original Indenture by virtue of the merger of The Chase National Bank of the City of New York into President and Directors of The Manhattan Company under the name of The Chase Manhattan Bank, the Fifth and the Sixth Supplemental Indentures dated, respectively, February 1, 1956, and May 1, 1958, supplementing the Original Indenture; and The Chase Manhattan Bank was converted into a national banking association under the name The Chase Manhattan Bank (National Association), effective September 23, 1965; and by virtue of said conversion the continuity of the business of The Chase Manhattan Bank, including its business of acting as corporate trustee, and its corporate existence, was not affected, so that The Chase Manhattan Bank (National Association) was vested with all the trusts, powers, discretion, immunities, privileges and all other matters as were vested in said The Chase Manhattan Bank under the Indenture (hereinafter defined), with like effect as if originally named as Trustee therein; and The Company has heretofore executed and delivered to The Chase Manhattan Bank (National Association) forty-one Supplemental Indentures dated, respectively, as follows: Seventh, August 1, 1967, Eighth, November 1, 1970, Ninth, August 1, 1972, Tenth, November 1, 1973, Eleventh, July 1, 1974, Twelfth, October 1, 1975, Thirteenth, June 1, 1976, Fourteenth, October 1, 1978, Fifteenth, September 1, 1979, Sixteenth, September 1, 1980, Seventeenth, October 1, 1980, Eighteenth, April 1, 1981, Nineteenth, November 1, 1981, Twentieth, June 1, 1982, Twenty-first, September 1, 1982, Twenty-second, April 1, 1983, Twenty-third, December 1, 1983, Twenty-fourth, April 1, 1984, Twenty-fifth, October 15, 1984, Twenty-sixth, October 15, 1984, Twenty-seventh, August 1, 1985, Twenty-eighth, August 1, 1985, Twenty-ninth, December 1, 1985, Thirtieth, March 1, 1986, Thirty-first, October 15, 1987, Thirty-second, September 15, 1988, Thirty-third, June 15, 1989, Thirty-fourth, October 15, 1989, Thirty-fifth, May 15, 1990, Thirty-sixth, March 1, 1991, Thirty-seventh, May 1, 1992, Thirty-eighth, August 1, 1992, Thirty-ninth, October 1, 1992, Fortieth, January 1, 1993, Forty-first, September 15, 1994, Forty-second, May 1, 1995, Forty-third, June 1, 1995, Forty-fourth, July 14, 1995, Forty-fifth, July 15, 1995, Forty-sixth, June 15, 1997 and Forty-seventh, August 1, 1997 supplementing the Original Indenture; and The Chase Manhattan Bank (National Association), Successor Trustee, was merged on July 1, 1996, with and into Chemical Bank, a New York banking corporation, which changed its name to The Chase Manhattan Bank, and which became the Trustee under the Original Indenture by virtue of such merger; and The Company has heretofore executed and delivered to The Chase Manhattan Bank four Supplemental Indentures dated as follows: Forty-eighth, June 1, 1998, Forty-ninth, January 15, 2000, Fiftieth, May 1, 2000 and Fifty-first, September 1, 2000 supplementary to the Original Indenture; and The Chase Manhattan Bank changed its name to JPMorgan Chase Bank on November 10, 2001; and The Company has heretofore executed and delivered to JPMorgan Chase Bank the Fifty-second Supplemental Indenture dated as of October 1, 2002 supplementary to the Original Indenture (the Original Indenture, all the aforementioned Supplemental Indentures, this Fifty-third Supplemental Indenture and any other indentures supplemental to the Original Indenture are herein collectively called the "Indenture" and this Fifty-third Supplemental Indenture is hereinafter called this "Supplemental Indenture"); and The Company covenanted in and by the Original Indenture to execute and deliver such further instruments and do such further acts as may be necessary or proper to carry out more effectually the purposes of the Original Indenture and to make subject to the lien thereof property acquired after the execution and delivery of the Original Indenture; and Under Article 3 of the Original Indenture, the Company is authorized to issue additional bonds upon the terms and conditions expressed in the Original Indenture; and The Company proposes to create two new series of First Mortgage Bonds to be designated as First Mortgage Bonds, Pledge Series A of 2003 due 2024 (hereinafter called the "Bonds of 2003 Pledge Series A") and First Mortgage Bonds, Pledge Series B of 2003 due 2024 (hereinafter called the "Bonds of 2003 Pledge Series B," and together with the Bonds of 2003 Pledge Series A, the "Bonds of 2003 Pledge Series") with the respective denominations, rates of interest, dates of maturity, redemption provisions and other provisions and agreements in respect thereof as in this Supplemental Indenture set forth; and The Bonds of 2003 Pledge Series are to be issued by the Company and delivered to Fifth Third Bank, as trustee for $33,200,000 aggregate principal amount of the State of Ohio Pollution Control Revenue Refunding Bonds, Series 2000-A (The Toledo Edison Company Project) (the "Water Bonds") previously issued by the Ohio Water Development Authority (the "Water Authority") and as trustee for $34,100,000 aggregate principal amount of the State of Ohio Pollution Control Revenue Refunding Bonds, Series 2000-A (The Toledo Edison Company Project) (the "Air Bonds," and together with the Water Bonds, the "Authority 2 Bonds") previously issued by the Ohio Air Quality Development Authority (the "Air Authority"), in each case, to secure the payment of principal of and interest on the corresponding note of the Company held by that trustee with respect to, and for the benefit of the holders of, the corresponding series of Authority Bonds; and The Company, by appropriate corporate action, has duly resolved and determined to execute this Supplemental Indenture for the purpose of providing for the creation of the Bonds of 2003 Pledge Series and of specifying the respective forms, provisions and particulars thereof as in said Original Indenture, as amended, provided or permitted, including the issuance only of fully registered bonds, and of giving to the Bonds of 2003 Pledge Series the protection and security of the Indenture; and The text of the Bonds of 2003 Pledge Series is to be substantially in the following forms: [FORM OF FULLY REGISTERED BOND OF 2003 PLEDGE SERIES A] - -------------------------------------------------------------------------------- THIS BOND IS NOT TRANSFERABLE EXCEPT TO A SUCCESSOR TRUSTEE UNDER THE TRUST INDENTURE, DATED AS OF APRIL 1, 2000, BETWEEN THE OHIO WATER DEVELOPMENT AUTHORITY AND FIFTH THIRD BANK, AS TRUSTEE, OR IN CONNECTION WITH THE EXERCISE OF THE RIGHTS AND REMEDIES OF THE HOLDER HEREOF CONSEQUENT UPON A "DEFAULT" AS DEFINED IN THE INDENTURE REFERRED TO HEREIN. - -------------------------------------------------------------------------------- THE TOLEDO EDISON COMPANY FIRST MORTGAGE BOND, PLEDGE SERIES A OF 2003 DUE 2024 No. $__________ THE TOLEDO EDISON COMPANY, an Ohio corporation (hereinafter called the Company), for value received, hereby promises to pay to ________________________ _________________________________, or registered assigns, the principal sum of _______________________ dollars ($_________) or the aggregate unpaid principal amount hereof, whichever is less, on April 1, 2024, in any coin or currency of the United States of America which at the time of such payment shall be legal tender for the payment of public and private debts, and to pay interest on the unpaid principal amount hereof in like coin or currency to the registered owner hereof from the Initial Interest Accrual Date (hereinafter defined) at the Authority Bond Interest Rate (hereinafter defined) per annum payable on the same date immediately succeeding the Initial Interest Accrual Date as interest is payable on the Authority Bonds (hereinafter defined) whether at maturity or upon acceleration of such Authority Bonds (each such date herein referred to as an "interest payment date") on and until maturity, or, in the case of any Bonds of this Series duly called for redemption, on and until the redemption date, or in the case of any default by the Company in the payment of the principal due on any Bonds of this Series, until the Company's obligation with respect to the payment of the principal shall be discharged as provided in the Indenture (hereinafter defined). Payments of principal of and interest on this Bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. The amount of interest 4 payable on each interest payment date shall be computed on the same basis as the corresponding amount is computed on the Authority Bonds, provided, however, that the aggregate amount of interest payable on any interest payment date shall not exceed an amount which results in an interest rate of more than 10% per annum on the aggregate principal amount of the Bonds of this Series outstanding from time to time. This Bond is one of the Bonds of the Company, known as its First Mortgage Bonds, issued and to be issued in one or more series under and equally and ratably secured (except as any sinking, amortization, improvement or other fund, established in accordance with the provisions of said Indenture, may afford additional security for the Bonds of any particular series) by a certain Indenture of Mortgage and Deed of Trust, dated as of April 1, 1947 (hereinafter called the "Original Indenture"), made by the Company to The Chase National Bank of the City of New York (JPMorgan Chase Bank (formerly known as The Chase Manhattan Bank), successor), as Trustee (hereinafter called the "Trustee"), and by certain indentures supplemental thereto, including the Fifty-third Supplemental Indenture dated as of April 1, 2003 (the Original Indenture and said indentures supplemental thereto herein collectively called the "Indenture" and said Fifty-third Supplemental Indenture hereinafter called the "Supplemental Indenture"), to which Indenture reference is hereby made for a description of the property mortgaged, the nature and extent of the security, the rights and limitations of rights of the Company, the Trustee and the holders of said Bonds and of the coupons appurtenant to coupon Bonds under the Indenture and the terms and conditions upon which said Bonds are and are to be issued and secured, to all of the provisions of which Indenture and of all such supplemental indentures in respect of such security, including the provisions of the Indenture permitting the issue of Bonds of any series for property which, under the restrictions and limitations therein specified, may be subject to liens prior to the lien of the Indenture, the holder, by accepting this Bond, assents. To the extent permitted by and as provided in the Indenture, the rights and obligations of the Company and of the holders of said Bonds and coupons (including those pertaining to any sinking or other fund) may be changed and modified, with the consent of the Company, by the holders of at least 75% in aggregate principal amount of the Bonds then outstanding, such percentage being determined as provided in the Indenture; provided, however, that in case such changes and modifications affect one or more but less than all series of Bonds then outstanding, they shall be required to be adopted only by the affirmative vote of the holders of at least 75% in aggregate principal amount of outstanding Bonds of such one or more series so affected; and further provided, that without the consent of the holder hereof no such change or modification shall be made which will extend the time of payment of the principal of, or of the interest or premium, if any, on this Bond or reduce the principal amount hereof or the rate of interest or the premium, if any, hereon, or affect any other modification of the terms of payment of such principal or interest or premium, if any, or will permit the creation of any lien ranking prior to or on a parity with the lien of the Indenture on any of the mortgaged property, or will deprive the holder hereof of the benefit of a lien upon the mortgaged property for the security of this Bond, or will reduce the percentage of Bonds required for the adoption of changes or modifications as aforesaid. This Bond is one of a series of Bonds designated as the First Mortgage Bonds, Pledge Series A of 2003 due 2024, of the Company (herein called the 4 "Bonds of this Series") limited, except as otherwise provided in the Indenture, in aggregate principal amount to $33,200,000, and is issued under and secured by the Supplemental Indenture. The Bonds of this Series have been issued by the Company to Fifth Third Bank, as trustee (such trustee and any successor trustee being hereinafter referred to as the "Authority Bond Trustee") for $33,200,000 aggregate principal amount of the State of Ohio Pollution Control Revenue Refunding Bonds, Series 2000-A (The Toledo Edison Company Project) (the "Authority Bonds") issued on behalf of the Company by the Ohio Water Development Authority (the "Authority") and under the Trust Indenture, dated as of April 1, 2000 (the "Authority Bond Indenture"), between the Authority and the Authority Bond Trustee to secure the payment of the principal of and interest on the note of the Company held by the Authority Bond Trustee with respect to, and for the benefit of the holders of, the Authority Bonds. The Bonds of this Series shall be redeemed in whole, by payment of the principal amount thereof plus accrued interest thereon, if any, to the date fixed for redemption, upon receipt by the Trustee of a written advice from the Authority Bond Trustee stating that the principal amount of all the Authority Bonds then outstanding under the Authority Bond Indenture has been declared due and payable pursuant to the provisions of Section 11.02 of the Authority Bond Indenture, specifying the date of the accelerated maturity of such Authority Bonds and the date from which interest on the Authority Bonds issued under the Authority Bond Indenture has then accrued and is unpaid (specifying the rate or rates of such accrual and the principal amount of the particular Authority Bonds to which such rates apply), stating such declaration of maturity has not been annulled and demanding payment of the principal amount hereof plus accrued interest hereon to the date fixed for such redemption. The date fixed for such redemption shall not be earlier than the date specified in the aforesaid written advice as the date of the accelerated maturity of the Authority Bonds then outstanding under the Authority Bond Indenture and not later than the 45th day after receipt by the Trustee of such advice, unless such 45th day is earlier than such date of accelerated maturity. The date fixed for such redemption shall be specified in a notice of redemption to be given not less than 30 days prior to the date so fixed for such redemption. Upon mailing of such notice of redemption, the date from which unpaid interest on the Authority Bonds has then accrued (as specified by the Authority Bond Trustee) shall become the initial interest accrual date (the "Initial Interest Accrual Date") with respect to the Bonds of this Series; provided, however, on any demand for payment of the principal amount hereof at maturity as a result of the principal of the Authority Bonds becoming due and payable on the maturity date of the Bonds of this Series, the earliest date from which unpaid interest on the Authority Bonds has then accrued shall become the Initial Interest Accrual Date with respect to the Bonds of this Series, which date, together with each other different date from which unpaid interest on the Authority Bonds has then accrued, shall be specified in a written notice from the Authority Bond Trustee to the Trustee, in which notice shall also be specified for each such date the rate or rates of such accrual and the principal amount of the particular Authority Bonds to which such rate or rates apply. The aforementioned notice of redemption shall become null and void for all purposes under the Indenture, (including the fixing of the Initial Interest Accrual Date with respect to the Bonds of this Series) upon receipt by the Trustee of written notice from the Authority Bond Trustee of the annulment of the acceleration of the maturity of the Authority Bonds then outstanding under the Authority Bond Indenture and the rescission of the aforesaid written advice prior to the redemption date specified in such notice of redemption, and thereupon no redemption of the Bonds of this Series and no 5 payment in respect thereof as specified in such notice of redemption shall be effected or required. But no such rescission shall extend to any subsequent written advice from the Authority Bond Trustee or impair any right consequent on such subsequent written advice. Bonds of this Series are not otherwise redeemable prior to their maturity. The "Authority Bond Interest Rate" shall be the rate of interest that results in the total amount of interest payable on an interest payment date, a redemption date or at maturity, as the case may be, or at any other time interest on this Bond is due and payable, to be equal to the total amount of unpaid interest that has accrued on all then outstanding Authority Bonds. The Bonds of this Series are not transferable except (i) to a successor trustee under the Authority Bond Indenture or (ii) in connection with the exercise of the rights and remedies of the holder hereof consequent upon a default, as defined in the Indenture. Upon payment of the principal of and interest due on the Authority Bonds, whether at maturity or prior to maturity by acceleration, redemption or otherwise, or upon provision for the payment thereof having been made in accordance with the Authority Bond Indenture, the Bonds of this Series in a principal amount equal to the principal amount of Authority Bonds so paid or for which such provision for payment has been made shall be deemed fully paid, satisfied and discharged and the obligations of the Company thereunder shall be terminated and such Bonds of this Series shall be surrendered to and canceled by the Trustee. The Trustee may rely on a certificate of the Company to this effect. The principal of this Bond may be declared or may become due before the maturity hereof, on the conditions, in the manner and at the times set forth in the Indenture, upon the happening of a default as therein defined. No recourse under or upon any covenant or obligation of the Indenture, or of any indenture supplemental thereto, or of this Bond, for the payment of the principal of or the interest on this Bond, or for any claim based thereon, or otherwise in any manner in respect thereof, shall be had against any incorporator, subscriber to the capital stock, stockholder, officer or director, as such, of the Company, whether former, present or future, either directly or indirectly through the Company or any predecessor or successor corporation or the Trustee, by the enforcement of any subscription to capital stock, assessment or otherwise, or by any legal or equitable proceeding by virtue of any constitution, statute, or otherwise (including, without limiting the generality of the foregoing, any proceeding to enforce any claimed liability of stockholders of the Company based upon any theory of disregarding the corporate entity of the Company or upon any theory that the Company was acting as the agent or instrumentality of the stockholders), any and all such liability of incorporators, stockholders, subscribers, officers and directors, as such, being released by the holder hereof, by the acceptance of this Bond, and being likewise waived and released by the terms of the Indenture. 6 This Bond shall not be valid or become obligatory for any purpose until the certificate of authentication endorsed hereon shall have been signed by JPMorgan Chase Bank or its successor, as Trustee under the Indenture. IN WITNESS WHEREOF, THE TOLEDO EDISON COMPANY has caused this Bond to be signed in its name by its President or a Vice-President and its corporate seal to be impressed or imprinted hereon and attested by its Corporate Secretary or an Assistant Corporate Secretary. Dated THE TOLEDO EDISON COMPANY By ----------------------------------- Vice President Attest: - ------------------------------------- Corporate Secretary [FORM OF TRUSTEE'S CERTIFICATE OF AUTHENTICATION] This Bond is one of the Bonds of the series designated herein, described in the within-mentioned Indenture. JPMORGAN CHASE BANK, AS TRUSTEE By ----------------------------------- Authorized Officer [END OF FORM OF BOND OF 2003 PLEDGE SERIES A] 7 [FORM OF FULLY REGISTERED BOND OF 2003 PLEDGE SERIES B] - -------------------------------------------------------------------------------- THIS BOND IS NOT TRANSFERABLE EXCEPT TO A SUCCESSOR TRUSTEE UNDER THE TRUST INDENTURE, DATED AS OF APRIL 1, 2000, BETWEEN THE OHIO AIR QUALITY DEVELOPMENT AUTHORITY AND FIFTH THIRD BANK, AS TRUSTEE, OR IN CONNECTION WITH THE EXERCISE OF THE RIGHTS AND REMEDIES OF THE HOLDER HEREOF CONSEQUENT UPON A "DEFAULT" AS DEFINED IN THE INDENTURE REFERRED TO HEREIN. - -------------------------------------------------------------------------------- THE TOLEDO EDISON COMPANY FIRST MORTGAGE BOND, PLEDGE SERIES B OF 2003 DUE 2024 No. $__________ THE TOLEDO EDISON COMPANY, an Ohio corporation (hereinafter called the Company), for value received, hereby promises to pay to ________________________ _________________________________, or registered assigns, the principal sum of _______________________ dollars ($_________) or the aggregate unpaid principal amount hereof, whichever is less, on April 1, 2024, in any coin or currency of the United States of America which at the time of such payment shall be legal tender for the payment of public and private debts, and to pay interest on the unpaid principal amount hereof in like coin or currency to the registered owner hereof from the Initial Interest Accrual Date (hereinafter defined) at the Authority Bond Interest Rate (hereinafter defined) per annum payable on the same date immediately succeeding the Initial Interest Accrual Date as interest is payable on the Authority Bonds (hereinafter defined) whether at maturity or upon acceleration of such Authority Bonds (each such date herein referred to as an "interest payment date") on and until maturity, or, in the case of any Bonds of this Series duly called for redemption, on and until the redemption date, or in the case of any default by the Company in the payment of the principal due on any Bonds of this Series, until the Company's obligation with respect to the payment of the principal shall be discharged as provided in the Indenture (hereinafter defined). Payments of principal of and interest on this Bond shall be made at an office or agency of the Company in the Borough of Manhattan, The City of New York, N.Y. or in the City of Akron, Ohio. The amount of interest payable on each interest payment date shall be computed on the same basis as the corresponding amount is computed on the Authority Bonds, provided, however, that the aggregate amount of interest payable on any interest payment date shall not exceed an amount which results in an interest rate of more than 10% per annum on the aggregate principal amount of the Bonds of this Series outstanding from time to time. This Bond is one of the Bonds of the Company, known as its First Mortgage Bonds, issued and to be issued in one or more series under and equally and ratably secured (except as any sinking, amortization, improvement or other fund, established in accordance with the provisions of said Indenture, may afford additional security for the Bonds of any particular series) by a certain Indenture of Mortgage and Deed of Trust, dated as of April 1, 1947 (hereinafter called the "Original Indenture"), made by the Company to The Chase National Bank of the City of New York (JPMorgan Chase Bank (formerly known as The Chase 8 Manhattan Bank), successor), as Trustee (hereinafter called the "Trustee"), and by certain indentures supplemental thereto, including the Fifty-third Supplemental Indenture dated as of April 1, 2003 (the Original Indenture and said indentures supplemental thereto herein collectively called the "Indenture" and said Fifty-third Supplemental Indenture hereinafter called the "Supplemental Indenture"), to which Indenture reference is hereby made for a description of the property mortgaged, the nature and extent of the security, the rights and limitations of rights of the Company, the Trustee and the holders of said Bonds and of the coupons appurtenant to coupon Bonds under the Indenture and the terms and conditions upon which said Bonds are and are to be issued and secured, to all of the provisions of which Indenture and of all such supplemental indentures in respect of such security, including the provisions of the Indenture permitting the issue of Bonds of any series for property which, under the restrictions and limitations therein specified, may be subject to liens prior to the lien of the Indenture, the holder, by accepting this Bond, assents. To the extent permitted by and as provided in the Indenture, the rights and obligations of the Company and of the holders of said Bonds and coupons (including those pertaining to any sinking or other fund) may be changed and modified, with the consent of the Company, by the holders of at least 75% in aggregate principal amount of the Bonds then outstanding, such percentage being determined as provided in the Indenture; provided, however, that in case such changes and modifications affect one or more but less than all series of Bonds then outstanding, they shall be required to be adopted only by the affirmative vote of the holders of at least 75% in aggregate principal amount of outstanding Bonds of such one or more series so affected; and further provided, that without the consent of the holder hereof no such change or modification shall be made which will extend the time of payment of the principal of, or of the interest or premium, if any, on this Bond or reduce the principal amount hereof or the rate of interest or the premium, if any, hereon, or affect any other modification of the terms of payment of such principal or interest or premium, if any, or will permit the creation of any lien ranking prior to or on a parity with the lien of the Indenture on any of the mortgaged property, or will deprive the holder hereof of the benefit of a lien upon the mortgaged property for the security of this Bond, or will reduce the percentage of Bonds required for the adoption of changes or modifications as aforesaid. This Bond is one of a series of Bonds designated as the First Mortgage Bonds, Pledge Series B of 2003 due 2024, of the Company (herein called the "Bonds of this Series") limited, except as otherwise provided in the Indenture, in aggregate principal amount to $34,100,000, and is issued under and secured by the Supplemental Indenture. The Bonds of this Series have been issued by the Company to Fifth Third Bank, as trustee (such trustee and any successor trustee being hereinafter referred to as the "Authority Bond Trustee") for $34,100,000 aggregate principal amount of the State of Ohio Pollution Control Revenue Refunding Bonds, Series 2000-A (The Toledo Edison Company Project) (the "Authority Bonds") issued on behalf of the Company by the Ohio Air Quality Development Authority (the "Authority") and under the Trust Indenture, dated as of April 1, 2000 (the "Authority Bond Indenture"), between the Authority and the Authority Bond Trustee to secure the payment of the principal of and interest on the note of the Company held by the Authority Bond Trustee with respect to, and for the benefit of the holders of, the Authority Bonds. The Bonds of this Series shall be redeemed in whole, by payment of the principal amount thereof plus accrued interest thereon, if any, to the date 9 fixed for redemption, upon receipt by the Trustee of a written advice from the Authority Bond Trustee stating that the principal amount of all the Authority Bonds then outstanding under the Authority Bond Indenture has been declared due and payable pursuant to the provisions of Section 11.02 of the Authority Bond Indenture, specifying the date of the accelerated maturity of such Authority Bonds and the date from which interest on the Authority Bonds issued under the Authority Bond Indenture has then accrued and is unpaid (specifying the rate or rates of such accrual and the principal amount of the particular Authority Bonds to which such rates apply), stating such declaration of maturity has not been annulled and demanding payment of the principal amount hereof plus accrued interest hereon to the date fixed for such redemption. The date fixed for such redemption shall not be earlier than the date specified in the aforesaid written advice as the date of the accelerated maturity of the Authority Bonds then outstanding under the Authority Bond Indenture and not later than the 45th day after receipt by the Trustee of such advice, unless such 45th day is earlier than such date of accelerated maturity. The date fixed for such redemption shall be specified in a notice of redemption to be given not less than 30 days prior to the date so fixed for such redemption. Upon mailing of such notice of redemption, the date from which unpaid interest on the Authority Bonds has then accrued (as specified by the Authority Bond Trustee) shall become the initial interest accrual date (the "Initial Interest Accrual Date") with respect to the Bonds of this Series; provided, however, on any demand for payment of the principal amount hereof at maturity as a result of the principal of the Authority Bonds becoming due and payable on the maturity date of the Bonds of this Series, the earliest date from which unpaid interest on the Authority Bonds has then accrued shall become the Initial Interest Accrual Date with respect to the Bonds of this Series, which date, together with each other different date from which unpaid interest on the Authority Bonds has then accrued, shall be specified in a written notice from the Authority Bond Trustee to the Trustee, in which notice shall also be specified for each such date the rate or rates of such accrual and the principal amount of the particular Authority Bonds to which such rate or rates apply. The aforementioned notice of redemption shall become null and void for all purposes under the Indenture, (including the fixing of the Initial Interest Accrual Date with respect to the Bonds of this Series) upon receipt by the Trustee of written notice from the Authority Bond Trustee of the annulment of the acceleration of the maturity of the Authority Bonds then outstanding under the Authority Bond Indenture and the rescission of the aforesaid written advice prior to the redemption date specified in such notice of redemption, and thereupon no redemption of the Bonds of this Series and no payment in respect thereof as specified in such notice of redemption shall be effected or required. But no such rescission shall extend to any subsequent written advice from the Authority Bond Trustee or impair any right consequent on such subsequent written advice. Bonds of this Series are not otherwise redeemable prior to their maturity. The "Authority Bond Interest Rate" shall be the rate of interest that results in the total amount of interest payable on an interest payment date, a redemption date or at maturity, as the case may be, or at any other time interest on this Bond is due and payable, to be equal to the total amount of unpaid interest that has accrued on all then outstanding Authority Bonds. The Bonds of this Series are not transferable except (i) to a successor trustee under the Authority Bond Indenture or (ii) in connection with the exercise of the rights and remedies of the holder hereof consequent upon a default, as defined in the Indenture. 10 Upon payment of the principal of and interest due on the Authority Bonds, whether at maturity or prior to maturity by acceleration, redemption or otherwise, or upon provision for the payment thereof having been made in accordance with the Authority Bond Indenture, the Bonds of this Series in a principal amount equal to the principal amount of Authority Bonds so paid or for which such provision for payment has been made shall be deemed fully paid, satisfied and discharged and the obligations of the Company thereunder shall be terminated and such Bonds of this Series shall be surrendered to and canceled by the Trustee. The Trustee may rely on a certificate of the Company to this effect. The principal of this Bond may be declared or may become due before the maturity hereof, on the conditions, in the manner and at the times set forth in the Indenture, upon the happening of a default as therein defined. No recourse under or upon any covenant or obligation of the Indenture, or of any indenture supplemental thereto, or of this Bond, for the payment of the principal of or the interest on this Bond, or for any claim based thereon, or otherwise in any manner in respect thereof, shall be had against any incorporator, subscriber to the capital stock, stockholder, officer or director, as such, of the Company, whether former, present or future, either directly or indirectly through the Company or any predecessor or successor corporation or the Trustee, by the enforcement of any subscription to capital stock, assessment or otherwise, or by any legal or equitable proceeding by virtue of any constitution, statute, or otherwise (including, without limiting the generality of the foregoing, any proceeding to enforce any claimed liability of stockholders of the Company based upon any theory of disregarding the corporate entity of the Company or upon any theory that the Company was acting as the agent or instrumentality of the stockholders), any and all such liability of incorporators, stockholders, subscribers, officers and directors, as such, being released by the holder hereof, by the acceptance of this Bond, and being likewise waived and released by the terms of the Indenture. This Bond shall not be valid or become obligatory for any purpose until the certificate of authentication endorsed hereon shall have been signed by JPMorgan Chase Bank or its successor, as Trustee under the Indenture. 11 IN WITNESS WHEREOF, THE TOLEDO EDISON COMPANY has caused this Bond to be signed in its name by its President or a Vice-President and its corporate seal to be impressed or imprinted hereon and attested by its Corporate Secretary or an Assistant Corporate Secretary. Dated THE TOLEDO EDISON COMPANY By ---------------------------------- Vice President Attest: - ------------------------------- Corporate Secretary [FORM OF TRUSTEE'S CERTIFICATE OF AUTHENTICATION] This Bond is one of the Bonds of the series designated herein, described in the within-mentioned Indenture. JPMORGAN CHASE BANK, AS TRUSTEE By ---------------------------------- Authorized Officer [END OF FORM OF BOND OF 2003 PLEDGE SERIES B] All conditions and requirements necessary to make this Supplemental Indenture a valid, legal and binding instrument in accordance with its terms and to make the Bonds of 2003 Pledge Series, when duly executed by the Company and authenticated and delivered by the Trustee, and duly issued, the valid, binding and legal obligations of the Company, have been done and performed, and the execution and delivery of this Supplemental Indenture have been in all respects duly authorized. NOW, THEREFORE, THIS SUPPLEMENTAL INDENTURE WITNESSETH: That The Toledo Edison Company, the Company herein named, in consideration of the premises and of One Dollar ($1.00) to it duly paid by the Trustee at or before the ensealing and delivery of these presents, the receipt whereof is hereby acknowledged, does hereby covenant and agree to and with the Trustee and its successors in the 12 trust under the Indenture, for the benefit of those who shall hold the bonds to be issued hereunder and thereunder, as hereinafter provided, as follows: Article I CREATION AND DESCRIPTION OF BONDS OF 2003 PLEDGE SERIES A SECTION 1. A new series of bonds to be issued under and secured by the Indenture is hereby created, to be designated as "First Mortgage Bonds, Pledge Series A of 2003 due 2024" (such bonds herein referred to as the "Bonds of 2003 Pledge Series A"). The Bonds of 2003 Pledge Series A shall be limited to an aggregate principal amount of $33,200,000. The Bonds of 2003 Pledge Series A shall be substantially in the form hereinbefore recited. SECTION 2. The principal of all Bonds of 2003 Pledge Series A shall be payable on April 1, 2024, unless earlier redeemed, and shall bear interest from the Initial Interest Accrual Date as provided in the form of the bond of the 2003 Pledge Series A hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. The interest rate and maturity date of the Bonds of 2003 Pledge Series A shall be as set forth in the form of bond of the 2003 Pledge Series A hereinabove set forth. The amount of interest payable on each interest payment date shall be computed on the same basis as the corresponding amount is computed on the Water Bonds, provided, however, that the aggregate amount of interest payable on any interest payment date shall not exceed an amount which results in an interest rate of more than 10% per annum on the aggregate principal amount of the Bonds of 2003 Pledge Series A outstanding from time to time. SECTION 3. The Bonds of 2003 Pledge Series A shall be payable as to principal and interest at the office or agency of the Company in the Borough of Manhattan, The City of New York or in the City of Akron, Ohio; and principal and interest shall be payable in any coin or currency of the United States of America which at the time of payment shall be legal tender for the payment of public and private debts. SECTION 4. The Bonds of 2003 Pledge Series A shall be issued only as fully registered Bonds in the denominations of $1,000 or any higher multiple of $1.00. SECTION 5. Except as may be necessary to comply with a final order of a court of competent jurisdiction in connection with any bankruptcy or reorganization proceeding of the Company, the Bonds of 2003 Pledge Series A shall be transferable only to a successor to the Fifth Third Bank, as trustee for the Water Bonds in the manner and upon the terms set forth in ss. 2.05 of the Original Indenture, but notwithstanding the provisions of ss. 2.08 of the Original Indenture, no charge shall be made upon any transfer or exchange of Bonds of 2003 Pledge Series A other than for any tax or taxes or other governmental charge required to be paid by the Company. SECTION 6. The Company's obligation to pay the principal of or interest on the Bonds of 2003 Pledge Series A, shall be fully or partially satisfied as stated in the form of the Bonds of the 2003 Pledge Series A hereinbefore recited. 13 SECTION 7. The Bonds of 2003 Pledge Series A may be executed by the Company and delivered to the Trustee and, upon compliance with all applicable provisions and requirements of the Original Indenture in respect thereof, shall be authenticated by the Trustee and delivered (without awaiting the filing or recording of this Supplemental Indenture) in accordance with the written order or orders of the Company. SECTION 8. The Bonds of 2003 Pledge Series A shall be redeemed by the Company in whole or in part at any time prior to maturity at a redemption price of 100% of the principal amount to be redeemed, plus any accrued and unpaid interest to the redemption date as stated in the form of the Bonds of the 2003 Pledge Series A hereinbefore recited. Article II CREATION AND DESCRIPTION OF BONDS OF 2003 PLEDGE SERIES B SECTION 1. A new series of bonds to be issued under and secured by the Indenture is hereby created, to be designated as "First Mortgage Bonds, Pledge Series B of 2003 due 2024" (such bonds herein referred to as the "Bonds of 2003 Pledge Series B"). The Bonds of 2003 Pledge Series B shall be limited to an aggregate principal amount of $34,100,000. The Bonds of 2003 Pledge Series B shall be substantially in the form hereinbefore recited. SECTION 2. The principal of all Bonds of 2003 Pledge Series B shall be payable on April 1, 2024, unless earlier redeemed, and shall bear interest from the Initial Interest Accrual Date as provided in the form of the bond of the 2003 Pledge Series B hereinabove set forth, and such provisions are incorporated at this place as though set forth in their entirety. The interest rate and maturity date of the Bonds of 2003 Pledge Series B shall be as set forth in the form of bond of the 2003 Pledge Series B hereinabove set forth. The amount of interest payable on each interest payment date shall be computed on the same basis as the corresponding amount is computed on the Air Bonds, provided, however, that the aggregate amount of interest payable on any interest payment date shall not exceed an amount which results in an interest rate of more than 10% per annum on the aggregate principal amount of the Bonds of 2003 Pledge Series B outstanding from time to time. SECTION 3. The Bonds of 2003 Pledge Series B shall be payable as to principal and interest at the office or agency of the Company in the Borough of Manhattan, The City of New York or in the City of Akron, Ohio; and principal and interest shall be payable in any coin or currency of the United States of America which at the time of payment shall be legal tender for the payment of public and private debts. SECTION 4. The Bonds of 2003 Pledge Series B shall be issued only as fully registered Bonds in the denominations of $1,000 or any higher multiple of $1.00. SECTION 5. Except as may be necessary to comply with a final order of a court of competent jurisdiction in connection with any bankruptcy or reorganization proceeding of the Company, the Bonds of 2003 Pledge Series B 14 shall be transferable only to a successor to the Fifth Third Bank, as trustee for the Air Bonds in the manner and upon the terms set forth in ss. 2.05 of the Original Indenture, but notwithstanding the provisions of ss. 2.08 of the Original Indenture, no charge shall be made upon any transfer or exchange of Bonds of 2003 Pledge Series B other than for any tax or taxes or other governmental charge required to be paid by the Company. SECTION 6. The Company's obligation to pay the principal of or interest on the Bonds of 2003 Pledge Series B, shall be fully or partially satisfied as stated in the form of the Bonds of the 2003 Pledge Series B hereinbefore recited. SECTION 7. The Bonds of 2003 Pledge Series B may be executed by the Company and delivered to the Trustee and, upon compliance with all applicable provisions and requirements of the Original Indenture in respect thereof, shall be authenticated by the Trustee and delivered (without awaiting the filing or recording of this Supplemental Indenture) in accordance with the written order or orders of the Company. SECTION 8. The Bonds of 2003 Pledge Series B shall be redeemed by the Company in whole or in part at any time prior to maturity at a redemption price of 100% of the principal amount to be redeemed, plus any accrued and unpaid interest to the redemption date as stated in the form of the Bonds of the 2003 Pledge Series B hereinbefore recited. Article III THE TRUSTEE The Trustee accepts the trusts created by this Supplemental Indenture upon the terms and conditions in the Original Indenture and in this Supplemental Indenture set forth. The recitals in this Supplemental Indenture are made by the Company only and not by the Trustee. Each and every term and condition contained in Article 13 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. For purposes of this Supplemental Indenture (a) the Trustee may conclusively rely and shall be protected in acting upon a written certificate of the Authority Bond Trustee as to the interest rate of, interest payment dates of and basis on which interest is computed for, the respective Authority Bonds and with respect to payments under the respective Authority Bonds, or any officer's certificate or opinion of counsel, as to the truth of the statements and the correctness of the opinions expressed therein, without independent investigation or verification thereof, subject to Article 13 of the Indenture and (b) a written certificate of the Authority Bond Trustee shall mean a written certificate executed by the president, any vice president or any authorized officer of such Authority Bond Trustee. 15 Article IV MISCELLANEOUS PROVISIONS SECTION 1. The Original Indenture, as heretofore supplemented, is in all respects ratified and confirmed, and the Original Indenture, this Supplemental Indenture and all other indentures supplemental to the Original Indenture shall be read, taken and construed as one and the same instrument. Neither the execution of this Supplemental Indenture nor anything herein contained shall be construed to impair the lien of the Indenture on any of the property subject thereto, and such lien shall remain in full force and effect as security for all bonds now outstanding or hereafter issued under the Indenture. All covenants and provisions of the Original Indenture, except as modified by this Supplemental Indenture and all other indentures supplemental to the Original Indenture, shall continue in full force and effect for the respective periods of time therein specified, and this Supplemental Indenture shall form part of the Indenture. All terms defined in Article 1 of the Original Indenture shall, for all purposes of this Supplemental Indenture, have the meanings in said Article 1 specified, except as modified by this Supplemental Indenture and all other indentures supplemental to the Original Indenture and unless the context otherwise requires. SECTION 2. This Supplemental Indenture may be simultaneously executed in any number of counterparts, and all said counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. IN WITNESS WHEREOF, The Toledo Edison Company has caused its corporate name to be hereunto affixed and this instrument to be signed by its President or a Vice President and its corporate seal to be hereunto affixed and attested by its Corporate Secretary or an Assistant Corporate Secretary for and in its behalf and JPMorgan Chase Bank, as Trustee, in evidence of its acceptance of the trust hereby created, has caused its corporate name to be hereunto affixed, this instrument to be signed by its President or a Vice President and its corporate seal to be hereunto affixed and attested by its Secretary or an Assistant Secretary or any other authorized officer for and on its behalf, all as of the day and year first above written. 16 THE TOLEDO EDISON COMPANY By ----------------------------------------- Richard H. Marsh, Senior Vice President and Chief Financial Officer [SEAL] Attest: ---------------------------------------- David W. Whitehead, Corporate Secretary Signed, sealed and acknowledged on behalf of THE TOLEDO EDISON COMPANY in the presence of ------------------------------------------------ Julie A. Phillips ------------------------------------------------ Amit D. Patel As witnesses JPMORGAN CHASE BANK, AS TRUSTEE By ----------------------------------- Carol Ng, Vice President Attest: ----------------------------------- ____________________, Trust Officer Signed, sealed and acknowledged on behalf of JPMORGAN CHASE BANK in the presence of -------------------------------------------- [SEAL] Print Name: -------------------------------------------- Print Name: As witnesses STATE OF OHIO ) ) ss.: COUNTY OF SUMMIT ) On this 17th day of April, 2003, before me personally appeared Richard H. Marsh and David W. Whitehead to me personally known, who being by me severally duly sworn, did say that they are a Senior Vice President and Chief Financial Officer and the Corporate Secretary, respectively, of The Toledo Edison Company, that the seal affixed to the foregoing instrument is the corporate seal of said corporation and that said instrument was signed and sealed in behalf of said corporation by authority of its Board of Directors; and said officers severally acknowledged said instrument to be the free act and deed of said corporation. ___________________________________[Seal) Susie M. Hoisten, Notary Public Residence - Summit County State Wide Jurisdiction, Ohio My Commission Expires December 9, 2006 STATE OF NEW YORK ) ) ss.: COUNTY OF NEW YORK ) On this 17th day of April, 2003, before me personally appeared Carol Ng and _____________ to me personally known, who being by me severally duly sworn, did say that they are a Vice President and a Trust Officer, respectively, of JPMorgan Chase Bank, that the seal affixed to the foregoing instrument is the corporate seal of said Corporation and that said instrument was signed and sealed in behalf of said a Corporation by authority of its Board of Directors; and said officers severally acknowledged said instrument to be the free act and deed of said Corporation. [SEAL] __________________________ [Seal] Notary ublic This instrument was prepared by: FirstEnergy Corp. 76 South Main Street Akron, Ohio 44308 EX-12 27 te_ex12-4.txt EX 12-4 TE FIXED CHARGE RATIO EXHIBIT 12.4 Page 1 THE TOLEDO EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, 1999 2000 2001 2002 2003 --------- ---------- --------- --------- -------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items.............................. $101,982 $138,144 $ 42,691 $ (5,142) $ 19,930 Interest and other charges, before reduction for amounts capitalized.......................................... 78,496 71,373 62,773 57,672 42,126 Provision for income taxes..................................... 58,884 78,780 26,362 (9,844) 5,394 Interest element of rentals charged to income (a).............. 98,445 96,358 92,108 87,174 84,894 -------- -------- --------- -------- -------- Earnings as defined.......................................... $337,807 $384,655 $ 223,934 $129,860 $152,344 ======== ======== ========= ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K: Interest expense............................................... $ 78,496 $ 71,373 $ 62,773 $ 57,672 $ 42,126 Interest element of rentals charged to income (a).............. 98,445 96,358 92,108 87,174 84,894 --------- -------- --------- -------- -------- Fixed charges as defined..................................... $176,941 $167,731 $ 154,881 $144,846 $127,020 ======== ======== ========= ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES........................................................ 1.91 2.29 1.45 0.90 1.20 ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 95
EXHIBIT 12.4 Page 2 THE TOLEDO EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, 1999 2000 2001 2002 2003 -------- -------- --------- -------- -------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items.......................... $101,982 $138,144 $ 42,691 $ (5,142) $ 19,930 Interest and other charges, before reduction for amounts capitalized...................................... 78,496 71,373 62,773 57,672 42,126 Provision for income taxes................................. 58,884 78,780 26,362 (9,844) 5,394 Interest element of rentals charged to income (a).......... 98,445 96,358 92,108 87,174 84,894 -------- -------- -------- -------- -------- Earnings as defined...................................... $337,807 $384,655 $223,934 $129,860 $152,344 ======== ======== ======== ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS): Interest expense........................................... $ 78,496 $ 71,373 $ 62,773 $ 57,672 $ 42,126 Preferred stock dividend requirements...................... 16,238 16,247 16,135 10,756 8,838 Adjustments to preferred stock dividends to state on a pre-income tax basis....................... 10,363 10,143 10,167 4,146 2,158 Interest element of rentals charged to income (a).......... 98,445 96,358 92,108 87,174 84,894 -------- -------- -------- -------- -------- Fixed charges as defined plus preferred stock dividend requirements (pre-income tax basis)........... $203,542 $194,121 $181,183 $159,748 $138,016 ======== ======== ======== ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)..................................... 1.66 1.98 1.24 0.81 1.10 ==== ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 o rental expense where no readily defined interest element can be determined. 96
EX-13 28 te_ex13-3.txt EX 13-3 TE ANNUAL REPORT THE TOLEDO EDISON COMPANY 2003 ANNUAL REPORT TO STOCKHOLDERS The Toledo Edison Company (TE) is a wholly owned electric utility operating subsidiary of FirstEnergy Corp. It engages in the generation, distribution and sale of electric energy in an area of approximately 2,500 square miles in northwestern Ohio. The area it serves has a population of approximately 0.8 million. Contents Page - -------- ---- Selected Financial Data........................................... 1 Management's Discussion and Analysis.............................. 2-13 Consolidated Statements of Income................................. 14 Consolidated Balance Sheets....................................... 15 Consolidated Statements of Capitalization......................... 16-17 Consolidated Statements of Common Stockholder's Equity............ 18 Consolidated Statements of Preferred Stock........................ 18 Consolidated Statements of Cash Flows............................. 19 Consolidated Statements of Taxes.................................. 20 Notes to Consolidated Financial Statements........................ 21-38 Report of Independent Auditors.................................... 39
THE TOLEDO EDISON COMPANY SELECTED FINANCIAL DATA 2003 2002 2001 2000 1999 - --------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) GENERAL FINANCIAL INFORMATION: Operating Revenues........................ $ 932,847 $ 996,045 $1,086,503 $ 954,947 $ 921,159 ========== ========== ========== ========== ========== Operating Income.......................... $ 34,023 $ 36,699 $ 85,964 $ 194,325 $ 165,809 ========== ========== ========== ========== ========== Income (Loss) Before Cumulative Effect of Accounting Change............. $ 19,930 $ (5,142) $ 42,691 $ 138,144 $ 101,982 ========== ========== ========== ========== ========== Net Income (Loss)......................... $ 45,480 $ (5,142) $ 42,691 $ 138,144 $ 101,982 ========== ========== ========== ========== ========== Earnings (Loss) on Common Stock........... $ 36,642 $ (15,898) $ 26,556 $ 121,897 $ 85,744 ========== ========== ========== ========== ========== Total Assets.............................. $2,855,398 $2,861,614 $2,875,908 $3,010,657 $2,663,428 ========== ========== ========== ========== ========== CAPITALIZATION AS OF DECEMBER 31: Common Stockholder's Equity............... $ 749,521 $ 681,195 $ 629,805 $ 610,847 $ 557,853 Preferred Stock Not Subject to Mandatory Redemption............................. 126,000 126,000 126,000 210,000 210,000 Long-Term Debt............................ 270,072 557,265 646,174 944,193 981,029 ---------- ---------- ---------- ---------- ---------- Total Capitalization...................... $1,145,593 $1,364,460 $1,401,979 $1,765,040 $1,748,882 ========== ========== ========== ========== ========== CAPITALIZATION RATIOS AS OF DECEMBER 31: Common Stockholder's Equity............... 65.4% 49.9% 44.6% 34.6% 31.8% Preferred Stock Not Subject to Mandatory Redemption............................. 11.0 9.2 9.0 11.9 12.0 Long-Term Debt............................ 23.6 40.9 46.4 53.5 56.2 ----- ----- ----- ----- ----- Total Capitalization...................... 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== ===== DISTRIBUTION KILOWATT-HOUR DELIVERIES (Millions): Residential............................... 2,312 2,427 2,258 2,183 2,127 Commercial................................ 2,771 2,702 2,667 2,380 2,236 Industrial................................ 5,097 5,280 5,397 5,595 5,449 Other..................................... 69 57 61 49 54 ------ ------ ------ ------- ----- Total..................................... 10,249 10,466 10,383 10,207 9,866 ====== ====== ====== ====== ===== CUSTOMERS SERVED: Residential............................... 270,258 272,474 270,589 269,071 266,900 Commercial................................ 36,969 32,037 31,680 31,413 32,481 Industrial................................ 215 1,883 1,898 1,917 1,937 Other..................................... 451 468 443 598 398 ------- ------- ------- ------- ------- Total..................................... 307,893 306,862 304,610 302,999 301,716 ======= ======= ======= ======= ======= Number of Employees ...................... 446 508 507 539 977
1 THE TOLEDO EDISON COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the continuing availability and operation of generating units, the inability of the Davis-Besse Nuclear Power Station to restart (including because of an inability to obtain a favorable final determination from the Nuclear Regulatory Commission) in early 2004, inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage, a denial of or material change to the Company's Application related to its Rate Stabilization Plan, and other similar factors. Restatements - ------------ We restated our consolidated financial statements for the three years ended December 31, 2002, to reflect a change in the method of amortizing costs associated with the Ohio transition plan and to recognize above-market liabilities of certain leased generation facilities. Financial comparisons described below reflect the effect of these restatements on 2002 financial results. Results of Operations - --------------------- Earnings on common stock increased to $36.6 million in 2003 from a loss of $15.9 million in 2002 and earnings of $26.6 million in 2001. Earnings on common stock in 2003 included an after-tax credit of $25.6 million from the cumulative effect of an accounting change due to the adoption of SFAS 143, "Accounting for Asset Retirement Obligations." Income before the cumulative effect was $19.9 million in 2003, compared to a loss of $5.1 million for the same period of 2002. The increase in 2003 reflected lower fuel and purchased power costs, other operating costs, depreciation and amortization and financing costs and net proceeds of $12 million (pre-tax) from the settlement of our claim against NRG Energy, Inc. (see Note 6), partially offset by lower operating revenues and higher nuclear operating costs. Operating revenues decreased by $63.2 million or 6.3% in 2003 from 2002. Reduced revenues resulted from lower kilowatt-hour sales due to milder weather in the second and third quarters, continued sluggishness in the regional economy and increased sales by alternative suppliers. The decline in revenues primarily resulted from lower generation sales revenues from all retail customer sectors. Kilowatt-hour sales to retail customers declined by 9.0% in 2003 from 2002, which reduced generation retail sales revenues by $49.8 million. Electric generation services provided to retail customers by alternative suppliers as a percent of total sales delivered in our service area increased 5.9 percentage points in 2003. Sales revenues from wholesale customers decreased by $19.1 million in 2003 compared to 2002. Kilowatt-hour sales to the wholesale market declined in 2003 due to reduced nuclear generation available for sale to FirstEnergy Solutions (FES), an affiliated company. Distribution deliveries decreased 2.1% in 2003 from 2002. However, higher unit prices resulted in overall revenue increases from electricity throughput of $17.2 million when compared to 2002. Transition plan incentives provided to customers to encourage switching to alternative energy providers, reduced revenues by $7.3 million in 2003, compared to last year. These revenue reductions are deferred for future recovery under our transition plan and do not materially affect current period earnings. Operating revenues decreased by $90.5 million or 8.3% in 2002, compared with 2001. The lower revenues reflect the effects of a sluggish national economy on our service area, shopping by Ohio customers for alternative energy providers and decreases in wholesale revenues. Retail kilowatt-hour sales declined by 11.4% in 2002 from the prior year, with declines in all customer sectors (residential, commercial and industrial), resulting in a $34.4 million reduction in generation sales revenue. Our lower generation kilowatt-hour sales resulted primarily from customer choice in Ohio. Sales of electric generation by alternative suppliers as a percent of total sales delivered in our franchise area increased to 17.0% in 2002 from 5.6% in 2001. Distribution deliveries increased 0.8% in 2002, compared with 2001, but revenues from electricity throughput decreased by $11.1 million in 2002 from the prior year due to lower unit prices. The higher distribution deliveries resulted from additional residential and commercial demand due to warmer summer weather that was more than offset by the effect that the weakened economy had on demand by the industrial customers. Customer 2 shopping incentives further reduced operating revenues by $15.0 million in 2002 from the prior year. Sales revenues from wholesale customers decreased by $45.1 million in 2002 compared to 2001, due to lower kilowatt-hour sales and a decline in market prices. Reduced wholesale kilowatt-hour sales resulted principally from lower sales to FES reflecting the extended outage at Davis-Besse (see Davis-Besse Restoration). Changes in electric generation sales and distribution deliveries for 2003 and 2002 are summarized in the following table: Changes in Kilowatt-Hour Sales 2003 2002 - -------------------------------------------------------------------- Increase (Decrease) Electric Generation: Retail................................ (9.0)% (11.4)% Wholesale............................. (15.4)% (27.6)% - ------------------------------------------------------------------- Total Electric Generation Sales......... (11.8)% (19.2)% ==================================================================== Distribution Deliveries: Residential........................... (4.8)% 7.5% Commercial and industrial ............ (1.4)% (1.0)% - ------------------------------------------------------------------- Total Distribution Deliveries........... (2.1)% 0.8% ==================================================================== Operating Expenses and Taxes Total operating expenses and taxes decreased by $60.5 million in 2003 and by $41.2 million in 2002. The following table presents changes from the prior year by expense category. Operating Expenses and Taxes - Changes 2003 2002 - -------------------------------------------------------------------------- Increase (Decrease) (In millions) Fuel and purchased power........................... $(32.5) $(90.5) Nuclear operating costs............................ 2.3 96.8 Other operating costs.............................. (14.8) 7.2 - -------------------------------------------------------------------------- Total operation and maintenance expenses........ (45.0) 13.5 Provision for depreciation and amortization........ (21.4) (14.7) General taxes...................................... (2.5) (4.6) Income taxes....................................... 8.4 (35.4) - --------------------------------------------------------------------------- Total operating expenses and taxes............. $(60.5) $(41.2) =========================================================================== Lower fuel and purchased power costs in 2003, compared with 2002, resulted from reduced nuclear generation -down 19.9% - and reduced kilowatt-hours required for customer needs which more than offset an increase in unit costs. Increased nuclear costs resulted from incremental costs associated with the extended Davis-Besse outage, unplanned work performed during the Perry Plant's 56-day nuclear refueling outage (19.91% interest) in the Spring of 2003, and the 28-day refueling outage at Beaver Valley Unit 2 (19.91% interest) in the third quarter of 2003, compared with a 24-day refueling outage at Beaver Valley Unit 2, in the first quarter of 2002. Lower other operating costs in 2003 reflect lower employee costs - specifically the absence of short-term incentive compensation and reduced health care costs. Lower fuel and purchased power costs in 2002, compared to 2001, resulted from a $69.0 million reduction in purchased power from FES, reflecting lower kilowatt-hours purchased due to reduced kilowatt-hour sales and lower unit prices. Nuclear operating costs increased by $96.8 million in 2002, primarily due to approximately $55.9 million of incremental Davis-Besse maintenance costs related to the extended outage (see Davis-Besse Restoration). During 2002, costs also included amounts incurred for refueling outages at two nuclear plants (Beaver Valley Unit 2 and Davis-Besse), compared to only one outage (Perry) in 2001. The $7.2 million increase in other operating costs in 2002 resulted principally from higher employee benefit costs, employee severance costs and uncollectible accounts expense. Charges for depreciation and amortization decreased by $ 21.4 million in 2003, compared with 2002 primarily from five factors - higher shopping incentive deferrals ($7.3 million), lower charges resulting from the implementation of SFAS 143 ($14.8 million), revised service life assumptions for generating plants ($11.0 million), a slight decline in amortization of regulatory assets being recovered under our transition plan ($4.3 million) and reduced regulatory asset deferrals ($4.4 million). Charges for depreciation and amortization decreased by $14.7 million in 2002 from 2001. This decrease reflects higher shopping incentive deferrals and tax-related deferrals under the Ohio transition plan and the cessation of goodwill amortization. General taxes decreased in 2003 due to settled property tax claims and in 2002 due to state tax changes in connection with the Ohio electric industry restructuring. 3 Net Interest Charges Net interest charges continued to trend lower, decreasing by $18.9 million in 2003 and $3.8 million in 2002, compared to the prior years, due to our debt paydown program. Cumulative Effect of Accounting Change Upon adoption of SFAS 143 in the first quarter of 2003, we recorded an after-tax credit to net income of $25.6 million. We identified applicable legal obligations as defined under the new accounting standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond at the Bruce Mansfield Plant. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $41.1 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $5.5 million. The asset retirement obligation liability at the date of adoption was $172 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, we had recorded decommissioning liabilities of $179.6 million. The cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, resulted in a $43.8 million increase to income, or $25.6 million net of income taxes. Capital Resources and Liquidity - ------------------------------- Our cash requirements in 2004 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without significantly increasing our net debt and preferred stock outstanding. Available borrowing capacity under short-term credit facilities will be used to manage working capital requirements. Over the next three years, we expect to meet our contractual obligations with cash from operations. Thereafter, we expect to use a combination of cash from operations and funds from the capital markets. Changes in Cash Position As of December 31, 2003, we had $ 2.2 million of cash and cash equivalents, compared with $20.7 million as of December 31, 2002. Cash and cash equivalents included $2 million received in December 2003 which was included in the NRG settlement claim sold in January 2004 (see Note 6) and $20 million used for the redemption of long-term debt in January 2003 as of December 31, 2003 and 2002, respectively. The major sources for changes in these balances are summarized below. Cash Flows From Operating Activities Cash provided by operating activities in 2003, 2002 and 2001 were as follows: Operating Cash Flows 2003 2002 2001 ----------------------------------------------------------------------- (in millions) Cash earnings (1).................... $119 $142 $236 Working capital and other............ (21) 14 (46) ------------------------------------------------------------------------ Total................................ $ 98 $156 $190 ======================================================================= (1) Includes net income, depreciation and amortization, deferred operating lease costs, deferred income taxes, investment tax credits and major noncash charges. Net cash provided from operating activities decreased to $98 million in 2003 compared to $156 million in 2002. The 2003 decrease in funds from operating activities resulted from a decrease of $35 million from higher working capital and other requirements (primarily due to a change in payables) and a $23 million decrease in cash earnings. Cash Flows From Financing Activities In 2003, the net cash provided from financing activities of $6.7 million primarily reflects short-term borrowings partially offset by long-term debt redemptions. 4 The following table provides details regarding new issues and redemptions during 2003 and 2002: Securities Issued or Redeemed 2003 2002 ------------------------------------------------------------------------ (in millions) New Issues ---------- Pollution Control Notes..................... $ -- $ 20 Redemptions ----------- Unsecured Notes............................. 7 135 Secured Notes............................... 183 44 Preferred Stock............................. -- 85 Other, principally redemption premiums...... 1 2 ------------------------------------------------------------------------ 191 266 Short-term Borrowings, Net....................... $206 $132 ------------------------------------------------------------------------ We had approximately $21.6 million of cash and temporary investments and approximately $356 million of short-term indebtedness as of December 31, 2003. We are currently precluded from issuing first mortgage bonds or preferred stock based upon applicable earnings coverage tests. We have the ability to borrow from our regulated affiliates and FirstEnergy to meet our short-term working capital requirements. FirstEnergy Service Company administers this money pool and tracks surplus funds of FirstEnergy and its regulated subsidiaries. Companies receiving a loan under the money pool agreements must repay the principal, together with accrued interest, within 364 days of borrowing the funds. The rate of interest is the same for each company receiving a loan from the pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47%. Our access to capital markets and costs of financing are dependent on the ratings of our securities and that of our holding company, FirstEnergy. The following table shows our securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. Ratings of Securities - ------------------------------------------------------------------------------- Securities S&P Moody's Fitch - ------------------------------------------------------------------------------- FirstEnergy Senior unsecured BB+ Baa3 BBB- Toledo Edison Senior secured BBB- Baa2 BBB- Senior unsecured BB+ Baa3 BB Preferred stock BB Ba2 BB- - ------------------------------------------------------------------------------ On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." Fitch also lowered the senior secured, senior unsecured, and preferred stock ratings of TE. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy, and all of the securities of its electric utility operating companies. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." On December 23, 2003, Standard & Poor's (S&P) lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". TE's ratings were lowered one notch as well (see table above). The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions of the ratings included uncertainty regarding the timing of the Ohio Rate Plan filing (see State Regulatory Matters), the pending final report on the August 14 blackout (see Power Outage), the outcome of the remedial phase of litigation relating to the Sammis plant, and the extended Davis-Besse outage and the related pending subpoena (see Davis-Besse Restoration). S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of the credit ratings in December 2003 triggered cash and letter-of-credit collateral calls of FirstEnergy in addition to higher interest rates for some outstanding borrowings. 5 On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2. The ratings of TE were confirmed. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows From Investing Activities Net cash used for investing activities increased to $123 million in 2003 from $106 million in 2002. This change reflects an increase in loans to associated companies partially offset by lower property additions. Contractual Obligations Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows:
2005- 2007- Contractual Obligations Total 2004 2006 2008 Thereafter - ----------------------------------------------------------------------------------------------------------------- (in millions) Long-term debt................... $ 540 $230 $ -- $ 30 $ 280 Short-term borrowings............ 356 356 -- -- -- Operating leases (1)............. 991 73 161 146 611 Purchases (2).................... 328 36 94 74 124 - -------------------------------------------------------------------------------------------------------------- Total....................... $2,215 $695 $255 $250 $1,015 - -------------------------------------------------------------------------------------------------------------- (1) Operating lease payments are net of capital trust receipts of $326.8 million (see Note 2). (2) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing.
Our capital spending for the period 2004-2006 is expected to be about $141 million (excluding nuclear fuel) of which $50 million applies to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $42 million, of which about $13 million relates to 2004. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $42 million and $21 million, respectively, as the nuclear fuel is consumed. Off-Balance Sheet Arrangements - ------------------------------ Obligations not included on our Consolidated Balance Sheet primarily consist of sale and leaseback arrangements involving the Bruce Mansfield Plant and Beaver Valley Unit 2, which are reflected in the operating lease payments above (see Note 2 - Leases). The present value as of December 31, 2003, of these sale and leaseback operating lease commitments, net of trust investments, total $592 million. We sell substantially all of our retail customer receivables, which provided $90 million of off-balance sheet financing as of December 31, 2003. Interest Rate Risk - ------------------ Our exposure to fluctuations in market interest rates is reduced since a significant portion of our debt has fixed interest rates, as noted in the table below which presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio and debt obligations.
Comparison of Carrying Value to Fair Value - ------------------------------------------------------------------------------------------------------------------- There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - ------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets - ------------------------------------------------------------------------------------------------------------------- Investments Other Than Cash and Cash Equivalents- Fixed Income............... $ 9 $134 $12 $ 9 $15 $287 $466 $509 Average interest rate...... 7.7% 7.8% 7.7% 7.7% 7.7% 6.7% 7.1% ___________________________________________________________________________________________________________________ Liabilities Long-term Debt and Other Long-Term Obligations: Fixed rate.................... $230 $30 $143 $403 $427 Average interest rate ..... 7.9% 7.1% 7.6% 7.7% Variable rate................. $137 $137 $137 Average interest rate...... 3.5% 3.5% Short-term Borrowings......... $356 $356 $356 Average interest rate...... 1.8% 1.8% - -------------------------------------------------------------------------------------------------------------------
6 Equity Price Risk - ----------------- Included in our nuclear decommissioning trust investments are marketable equity securities carried at their market value of approximately $145 million and $90 million as of December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges would result in a $15 million reduction in fair value as of December 31, 2003 (see Note 1(K) - Cash and Financial Instruments). Outlook - ------- Beginning in 2001, our customers were able to select alternative energy suppliers. We continue to deliver power to residential homes and businesses through our existing distribution systems, which remain regulated. Customer rates have been restructured into separate components to support customer choice. We have a continuing responsibility to provide power to those customers not choosing to receive power from an alternative energy supplier subject to certain limits. Adopting new approaches to regulation and experiencing new forms of competition have created new uncertainties. Regulatory Matters In 2001, Ohio customer rates were restructured to establish separate charges for transmission, distribution, transition cost recovery and a generation-related component. When one of our customers elects to obtain power from an alternative supplier, we reduce the customer's bill with a "generation shopping credit," based on the regulated generation component (plus an incentive), and the customer receives a generation charge from the alternative supplier. We have continuing provider of last resort (PLR) responsibility to our franchise customers through December 31, 2005. Regulatory assets are costs which have been authorized by the PUCO and the Federal Energy Regulatory Commission for recovery from customers in future periods and, without such authorization, would have been charged to income when incurred. Our regulatory assets as of December 2003 and 2002 are $459 million and $545 million, respectively. All of our regulatory assets are expected to continue to be recovered under the provisions of the transition plan. As part of the Ohio transition plan we are obligated to supply electricity to customers who do not choose an alternative supplier. We are also required to provide 160 megawatts (MW) of low cost supply to unaffiliated alternative suppliers who serve customers within our service area. Our competitive retail sales affiliate, FES, acts as an alternate supplier for a portion of the load in our franchise area. On October 21, 2003, FirstEnergy's regulated subsidiaries filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate generation supply at stable prices, and continuing our support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for our Ohio customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of our support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, we are requesting: o Extension of the transition cost amortization period from 2007 to 2008; o Deferral of interest costs on the accumulated shopping incentives and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates under certain limited conditions. 7 On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 23, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S.-Canada Power System Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. Davis-Besse Restoration On April 30, 2002, the Nuclear Regulatory Commission (NRC) initiated a formal inspection process at the Davis-Besse nuclear plant. This action was taken in response to corrosion found by FirstEnergy Nuclear Operating Company (FENOC) in the reactor vessel head near the nozzle penetration hole during a refueling outage in the first quarter of 2002. The purpose of the formal inspection process is to establish criteria for NRC oversight of the licensee's performance and to provide a record of the major regulatory and licensee actions taken, and technical issues resolved, leading to the NRC's approval of restart of the plant. Restart activities include both hardware and management issues. In addition to refurbishment and installation work at the plant, we made significant management and human performance changes with the intent of re-establishing the proper safety culture throughout the workforce. Work was completed on the reactor head during 2002 and efforts continued in 2003 to focus on design enhancements to the unit's reliability and performance. We also accelerated maintenance work that had been planned for future refueling and maintenance outages. We installed a state-of-the-art leak-detection system around the reactor, as well as modified high-pressure injection pumps. Testing of the bottom of the reactor for leaks was completed in October 2003 and no indication of leakage was discovered. The focus of activities now involves management and human performance issues. As a result, incremental maintenance and capital expenditures declined in 2003 as emphasis shifted to performance issues; replacement power costs were higher in 2003. We anticipate that Davis-Besse will be ready for restart in the first quarter of 2004. The NRC must authorize restart of the plant following its formal inspection process before the unit can be returned to service. Delays in Davis-Besse's return to service contributed to S&P's reduction in our credit rating in the fourth quarter of 2003 (see Cash Flows from Financing Activities below). Incremental costs associated with the extended Davis-Besse outage (the Company's share - 48.62%) for 2003 and 2002 were as follows: Costs of Davis-Besse Increase Extended Outage 2003 2002 (Decrease) - ---------------------------------------------------------------------------- (In millions) Incremental Expense Replacement power................. $196 $120 $ 76 Maintenance....................... 93 115 (22) - --------------------------------------------------------------------------- Total......................... $289 $235 $ 54 =========================================================================== Incremental Net of Tax Expense...... $170 $138 $ 32 =========================================================================== Capital Expenditures................ $ 21 $ 63 $(42) =========================================================================== FirstEnergy anticipates spending $10 million in 2004 for remaining non-capital restart activities, expected NRC inspection activities after Davis-Besse's return to service and other related activities. No additional capital expenditures related to the restoration are expected. Replacement power costs are expected to be $15-20 million per month during the remaining period of the outage. FirstEnergy has hedged the on-peak replacement energy supply for Davis-Besse for the expected length of the outage. If there are significant delays in the NRC approval process, replacement power costs will continue to be incurred, adversely affecting our cash flows and results of operations. Environmental Matters We believe we are in material compliance with current sulfur dioxide (SO2) and nitrogen oxide (NOx) reduction requirements under the Clean Air Act Amendments of 1990. In 1998, the Environmental Protection Agency (EPA) finalized regulations requiring additional NOx reductions from the Companies' Ohio and Pennsylvania facilities. Various regulatory 8 and judicial actions have since sought to further define NOx reduction requirements. We continue to evaluate our compliance plans and other compliance options. Violations of federally approved SO2 regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. We cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. We have been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, our proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. We have accrued liabilities aggregating approximately $0.2 million as of December 31, 2003. We do not believe environmental remediation costs will have a material adverse effect on our financial condition, cash flows or results of operations. In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. We cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Company is lower than many regional competitors due to the Company's diversified generation sources which includes the low or non-CO2 emitting gas-fired and nuclear generators. Power Outage On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposed to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. 9 Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which are described above. Critical Accounting Policies - ---------------------------- We prepare our consolidated financial statements in accordance with accounting principles that are generally accepted in the United States (GAAP). Application of these principles often requires a high degree of judgment, estimates and assumptions that affect financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting these specific factors. Our more significant accounting policies are described below. Regulatory Accounting We are subject to regulation that sets the prices (rates) we are permitted to charge our customers based on the costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. As a result of the changing regulatory framework in Ohio, a significant amount of regulatory assets have been recorded - $459 million as of December 31, 2003. We regularly review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for kilowatt-hours that have been delivered but not yet billed through the end of the accounting period. The determination of unbilled revenues requires management to make various estimates including: o Net energy generated or purchased for retail load o Losses of energy over distribution lines o Allocations to distribution companies within the FirstEnergy system o Mix of kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers Pension and Other Postretirement Benefits Accounting FirstEnergy's reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions (OPEB) are dependent upon numerous factors resulting from actual plan experience and certain assumptions. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions FirstEnergy makes to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. 10 In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, FirstEnergy reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. FirstEnergy's assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by their pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. FirstEnergy's pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and their pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, our accrued pension costs as of June 30, 2003 decreased by $3 million. The corresponding adjustment related to this change increased other comprehensive income and deferred income taxes and decreased the payable to associated companies. Due to the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $13 million, recording a decrease of $3 million in an intangible asset and crediting OCI by $6 million (offsetting previously recorded deferred tax benefits by $4 million). The remaining balance in OCI of $9 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $13 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, FirstEnergy will not be required to fund their pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. FirstEnergy's pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 1(I)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining their trend rate assumptions, FirstEnergy included the specific provisions of their health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in their health care plans, and projections of future medical trend rates. The effect on FirstEnergy's pension and OPEB costs and liabilities from changes in key assumptions are as follows:
Increase in Costs from Adverse Changes in Key Assumptions - --------------------------------------------------------------------------------------------- Assumption Adverse Change Pension OPEB Total - --------------------------------------------------------------------------------------------- (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 6 $ 16 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% na $26 $ 26 Increase in Minimum Liability - ----------------------------- Discount rate................ Decrease by 0.25% $104 na $104 - ----------------------------------------------------------------------------------------------
Ohio Transition Cost Amortization In connection with our Ohio transition plan, the PUCO determined allowable transition costs based on amounts recorded on our regulatory books. These costs exceeded those deferred or capitalized on our balance sheet prepared under GAAP since they included certain costs which have not yet been incurred or that were recognized on the regulatory financial statements (fair value purchase accounting adjustments). We use an effective interest method for amortizing transition costs, often referred to as a "mortgage-style" amortization. The interest rate under this method is equal to the rate of return authorized by the PUCO in the transition plan. In computing the transition cost amortization, we include only the portion of the transition revenues associated with transition costs included on the balance sheet prepared under GAAP. Revenues collected for the off balance sheet costs and the return associated with these costs are recognized as income when received. Long-Lived Assets In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be 11 recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. Goodwill In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Based on the guidance provided by SFAS 142, we evaluate our goodwill for impairment at least annually and would make such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. If impairment were indicated, we would recognize a loss - calculated as the difference between the implied fair value of our goodwill and the carrying value of the goodwill. Our annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in our evaluation of goodwill reflect operations consistent with our general business assumptions. Unanticipated changes in those assumptions could have a significant effect on our future evaluations of goodwill. As of December 31, 2003, we had approximately $505 million of goodwill. Nuclear Decommissioning In accordance with SFAS No. 143, we recognize an asset retirement obligation (ARO) for the future decommissioning of our nuclear power plants. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. The scenarios consider settlement of the ARO at the expiration of the nuclear power plants' current license and settlement based on an extended license term. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS ADOPTED FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, we adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. We will adopt FIN 46R for all other types of entities effective March 31, 2004. We currently have transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. In 1997, we and The Cleveland Electric Illuminating Company (CEI), an affiliated company, established the Shippingport Capital Trust (Shippingport) to purchase all of the lease obligation bonds issued by the owner trusts in the Bruce Mansfield Plant sale and leaseback transactions. Prior to the adoption of FIN 46R, the assets and liabilities of the trust were included on a proportionate basis in the financial statements of TE and CEI. Upon adoption of FIN 46R, CEI was determined to be the primary beneficiary of Shippingport, and therefore consolidated the entire trust as of December 31, 2003. This changed our Shippingport investment of $220 million to an investment in collateralized lease bonds of $210 million ($9 million current). The $10 million difference represents the minority interest included on the financial statements of CEI. In reviewing the sale and leaseback arrangements, the Company also evaluated its interest in the owner trusts that acquired interests in the Bruce Mansfield Plant. The Company was determined not to be the primary beneficiary of any of these owner trusts and was therefore not required to consolidate these entities. The leases are accounted for as operating leases in accordance with GAAP and their related obligations are disclosed in Note 2. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, we implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(F) and 1(M) for further discussions of SFAS 143. 12 EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" In November 2003, the EITF reached consensus that certain quantitative and qualitative disclosures are required for debt and equity securities classified as available-for-sale or held-to-maturity. The guidance requires the disclosure of the aggregate amount of unrealized losses and the aggregate related fair value for investments with unrealized losses that have not been recognized as other-than-temporary impairments. We adopted the disclosure requirements of EITF Issue No. 03-1 as of December 31, 2003 (See Note 1(K)). 13
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------ (In thousands) OPERATING REVENUES (a) (Note 1(J))............................... $932,847 $996,045 $1,086,503 -------- -------- ---------- OPERATING EXPENSES AND TAXES: Fuel and purchased power (Note 1(J)).......................... 334,409 366,932 457,444 Nuclear operating costs....................................... 254,986 252,608 155,832 Other operating costs (Note 1(J))............................. 127,148 141,997 134,744 -------- -------- ---------- Total operation and maintenance expenses.................... 716,543 761,537 748,020 Provision for depreciation and amortization................... 140,613 162,082 176,796 General taxes................................................. 50,742 53,223 57,810 Income taxes (benefit)........................................ (9,074) (17,496) 17,913 -------- -------- ---------- Total operating expenses and taxes.......................... 898,824 959,346 1,000,539 -------- -------- ---------- OPERATING INCOME................................................. 34,023 36,699 85,964 OTHER INCOME (Notes 1(J) and 6).................................. 22,195 13,329 15,652 -------- -------- ---------- INCOME BEFORE NET INTEREST CHARGES............................... 56,218 50,028 101,616 -------- -------- ---------- NET INTEREST CHARGES: Interest on long-term debt.................................... 38,874 58,120 66,463 Allowance for borrowed funds used during construction................................................ (5,838) (2,502) (3,848) Other interest expense (credit)............................... 3,252 (448) (3,690) -------- -------- ---------- Net interest charges........................................ 36,288 55,170 58,925 -------- -------- ---------- INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE............................................. 19,930 (5,142) 42,691 Cumulative effect of accounting change (net of income taxes of $18,201,000) (Note (1M))................................... 25,550 -- -- -------- -------- ---------- NET INCOME (LOSS)................................................ 45,480 (5,142) 42,691 PREFERRED STOCK DIVIDEND REQUIREMENTS.................................................. 8,838 10,756 16,135 -------- -------- ---------- EARNINGS (LOSS) ON COMMON STOCK.................................. $ 36,642 $(15,898) $ 26,556 ======== ======== ========== (a) Includes electric sales to associated companies of $212 million, $232 million and $278 million in 2003, 2002 and 2001, respectively. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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THE TOLEDO EDISON COMPANY CONSOLIDATED BALANCE SHEETS As of December 31, 2003 2002 - -------------------------------------------------------------------------------------------------------------------- (In thousands) ASSETS UTILITY PLANT: In service.................................................................... $1,714,870 $1,600,860 Less-Accumulated provision for depreciation................................... 721,754 673,367 ---------- ---------- 993,116 927,493 ---------- ---------- Construction work in progress- Electric plant.............................................................. 125,051 104,091 Nuclear fuel................................................................ 20,189 33,650 ---------- ---------- 145,240 137,741 ---------- ---------- 1,138,356 1,065,234 ---------- ---------- OTHER PROPERTY AND INVESTMENTS: Investment in lessor notes (Note 2)........................................... 200,938 240,963 Nuclear plant decommissioning trusts.......................................... 240,634 174,514 Long-term notes receivable from associated companies.......................... 163,626 162,159 Other......................................................................... 2,119 2,236 ---------- ---------- 607,317 579,872 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents..................................................... 2,237 20,688 Receivables- Customers................................................................... 4,083 4,711 Associated companies........................................................ 29,158 55,245 Other....................................................................... 14,386 6,778 Notes receivable from associated companies.................................... 19,316 1,957 Materials and supplies, at average cost- Owned....................................................................... 35,147 13,631 Under consignment........................................................... -- 22,997 Prepayments and other......................................................... 6,704 3,455 ---------- ---------- 111,031 129,462 ---------- ---------- DEFERRED CHARGES: Regulatory assets............................................................. 459,040 544,838 Goodwill...................................................................... 504,522 504,522 Property taxes................................................................ 24,443 23,429 Other......................................................................... 10,689 14,257 ---------- ---------- 998,694 1,087,046 ---------- ---------- $2,855,398 $2,861,614 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholder's equity................................................... $ 749,521 $ 681,195 Preferred stock not subject to mandatory redemption........................... 126,000 126,000 Long-term debt................................................................ 270,072 557,265 ---------- ---------- 1,145,593 1,364,460 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt.............................................. 283,650 189,355 Short-term borrowings......................................................... 70,000 -- Accounts payable- Associated companies........................................................ 132,876 171,862 Other....................................................................... 2,816 9,338 Notes payable to associated companies......................................... 285,953 149,653 Accrued taxes................................................................ 55,604 34,676 Accrued interest.............................................................. 12,412 16,377 Lease market valuation liability.............................................. 24,600 24,600 Other......................................................................... 37,299 57,462 ---------- ---------- 905,210 653,323 ---------- ---------- NONCURRENT LIABILITIES: Accumulated deferred income taxes............................................. 201,954 158,279 Accumulated deferred investment tax credits................................... 27,200 29,255 Retirement benefits........................................................... 47,006 82,553 Asset retirement obligation................................................... 181,839 -- Nuclear plant decommissioning costs........................................... -- 179,587 Lease market valuation liability.............................................. 292,600 317,200 Other......................................................................... 53,996 76,957 ---------- ---------- 804,595 843,831 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Notes 2 and 5)............................................................... ---------- ---------- $2,855,398 $2,861,614 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
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THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION As of December 31, 2003 2002 - --------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDER'S EQUITY: Common stock, $5 par value, authorized 60,000,000 shares 39,133,887 shares outstanding.................................................. $ 195,670 $ 195,670 Other paid-in capital............................................................ 428,559 428,559 Accumulated other comprehensive income (loss) (Note 3(E))........................ 11,672 (20,012) Retained earnings (Note 3(A)).................................................... 113,620 76,978 ---------- ---------- Total common stockholder's equity.............................................. 749,521 681,195 ---------- ---------- Number of Shares Optional Outstanding Redemption Price --------------------- ---------------------- 2003 2002 Per Share Aggregate ---- ---- --------- --------- PREFERRED STOCK (Note 3(C)): Cumulative, $100 par value- Authorized 3,000,000 shares Not Subject to Mandatory Redemption: $4.25............................. 160,000 160,000 $104.63 $ 16,740 16,000 16,000 $4.56............................. 50,000 50,000 101.00 5,050 5,000 5,000 $4.25............................. 100,000 100,000 102.00 10,200 10,000 10,000 --------- --------- -------- ---------- ---------- 310,000 310,000 31,990 31,000 31,000 --------- --------- -------- ---------- ---------- Cumulative, $25 par value- Authorized 12,000,000 shares Not Subject to Mandatory Redemption: $2.365............................ 1,400,000 1,400,000 27.75 38,850 35,000 35,000 Adjustable Series A............... 1,200,000 1,200,000 25.00 30,000 30,000 30,000 Adjustable Series B............... 1,200,000 1,200,000 25.00 30,000 30,000 30,000 --------- --------- -------- ---------- ---------- 3,800,000 3,800,000 98,850 95,000 95,000 --------- --------- -------- ---------- ---------- Total Not Subject to Mandatory Redemption.................... 4,110,000 4,110,000 $130,840 126,000 126,000 ========= ========= ======== ---------- ---------- LONG-TERM DEBT (Note 3(D)): First mortgage bonds: 8.000% due 2003................................................................ -- 33,725 7.875% due 2004................................................................ 145,000 145,000 ---------- ---------- Total first mortgage bonds..................................................... 145,000 178,725 ---------- ---------- Unsecured notes and debentures: 10.000% due 2004-2010............................................................ -- 910 * 4.850% due 2030................................................................ 34,850 34,850 4.000% due 2033................................................................ -- 5,700 * 4.500% due 2033................................................................ 31,600 31,600 * 5.580% due 2033................................................................ 18,800 18,800 ---------- ---------- Total unsecured notes and debentures........................................... 85,250 91,860 ---------- ----------
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THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont'd) As of December 31, 2003 2002 - -------------------------------------------------------------------------------------------------------------------- (In thousands) LONG-TERM DEBT (Cont'd): Secured notes: 7.760% due 2003.................................................................. -- 5,000 7.780% due 2003.................................................................. -- 1,000 7.820% due 2003.................................................................. -- 38,400 7.850% due 2003.................................................................. -- 15,000 7.910% due 2003.................................................................. -- 3,000 7.670% due 2004.................................................................. 70,000 70,000 7.130% due 2007.................................................................. 30,000 30,000 7.625% due 2020.................................................................. 45,000 45,000 7.750% due 2020.................................................................. 54,000 54,000 9.220% due 2021.................................................................. 15,000 15,000 6.875% due 2023.................................................................. -- 20,200 8.000% due 2023.................................................................. 30,500 30,500 1.700% due 2024.................................................................. -- 67,300 6.100% due 2027.................................................................. 10,100 10,100 5.375% due 2028.................................................................. 3,751 3,751 * 1.150% due 2033.................................................................. 30,900 30,900 * 1.100% due 2033.................................................................. 20,200 20,200 ---------- ---------- Total secured notes............................................................ 309,451 459,351 ---------- ---------- Net unamortized premium on debt....................................................... 14,021 16,684 ---------- ---------- Long-term debt due within one year.................................................... (283,650) (189,355) ---------- ---------- Total long-term debt........................................................... 270,072 557,265 ---------- ---------- TOTAL CAPITALIZATION.................................................................. $1,145,593 $1,364,460 ========== ========== * Denotes variable rate issue with December 31, 2003 interest rate shown. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY Accumulated Other Other Comprehensive Number Par Paid-In Comprehensive Retained Income (Loss) of Shares Value Capital Income (Loss) Earnings ------------- --------- ----- ------- ------------- -------- (Dollars in thousands) Balance, January 1, 2001............... 39,133,887 $195,670 $328,559 $ -- $ 86,618 Net income.......................... $ 42,691 42,691 Unrealized gain on investments, net of $4,800,000 of income taxes..... 7,100 7,100 -------- Comprehensive income................ $ 49,791 ======== Cash dividends on preferred stock... (16,133) Cash dividends on common stock...... (14,700) - ----------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001............. 39,133,887 195,670 328,559 7,100 98,476 Net loss............................ $ (5,142) (5,142) Unrealized loss on investments, net of $(4,034,000) of income taxes... (5,997) (5,997) Minimum liability for unfunded retirement benefits, net of $(15,042,000) of income taxes..... (21,115) (21,115) -------- Comprehensive loss.................. $(32,254) Equity contribution from parent..... 100,000 Cash dividends on preferred stock... (9,457) Cash dividends on common stock...... (5,600) Preferred stock redemption premiums. (1,299) - ----------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002............. 39,133,887 195,670 428,559 (20,012) 76,978 Net income.......................... $ 45,480 45,480 Unrealized gain on investments, net of $13,908,000 of income taxes.... 19,988 19,988 Minimum liability for unfunded retirement benefits, net of $8,489,000 of income taxes........ 11,696 11,696 -------- Comprehensive income................ $ 77,164 Cash dividends on preferred stock... (8,838) - ----------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003............. 39,133,887 $195,670 $428,559 $ 11,672 $113,620 =======================================================================================================================
CONSOLIDATED STATEMENTS OF PREFERRED STOCK Not Subject to Mandatory Redemption -------------------- Number of Shares Value --------- ----- (Dollars in thousands) Balance, January 1, 2001....... 5,700,000 $210,000 --------------------------------------------------------- Balance, December 31, 2001..... 5,700,000 210,000 --------------------------------------------------------- Redemptions $8.32 Series.............. (100,000) (10,000) $7.76 Series.............. (150,000) (15,000) $7.80 Series.............. (150,000) (15,000) $10.00 Series ............. (190,000) (19,000) $2.21 Series.............. (1,000,000) (25,000) --------------------------------------------------------- Balance, December 31, 2002..... 4,110,000 126,000 --------------------------------------------------------- Balance, December 31, 2003..... 4,110,000 $126,000 ========================================================= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
18
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------ (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income (Loss).................................................. $ 45,480 $ (5,142) $ 42,691 Adjustments to reconcile net income (loss) to net cash from operating activities: Provision for depreciation and amortization................... 140,613 162,082 176,796 Nuclear fuel and capital lease amortization................... 9,289 11,866 22,222 Deferred operating lease costs, net........................... (37,001) (24,600) (24,600) Deferred income taxes, net.................................... 5,619 (24,821) (1,383) Amortization of investment tax credits........................ (2,056) (1,851) (3,832) Accrued retirement benefit obligation......................... 6,205 (59,123) 1,234 Accrued compensation, net..................................... (5,365) 2,614 (8,178) Cumulative effect of accounting change (Note 1(M))............ (43,751) -- -- Receivables................................................... 19,107 5,164 (1,437) Materials and supplies........................................ 1,481 (5,582) 8,336 Accounts payable.............................................. (53,765) 40,801 22,144 Accrued taxes................................................. 20,928 (4,881) (17,671) Accrued interest.............................................. (3,965) (3,541) (28) Prepayments and other current assets.......................... (3,249) 11,125 12,571 Other......................................................... (1,398) 51,427 (39,009) --------- --------- --------- Net cash provided from operating activities................. 98,172 155,538 189,856 --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Long-term debt................................................ -- 19,580 -- Short-term borrowings, net.................................... 206,300 132,445 -- Equity contributions from parent.............................. -- 100,000 -- Redemptions and Repayments- Preferred stock............................................... -- (85,299) -- Long-term debt................................................ (190,794) (180,368) (42,265) Short-term borrowings, net.................................... -- -- (24,728) Dividend Payments- Common stock.................................................. -- (5,600) (14,700) Preferred stock............................................... (8,844) (10,057) (16,135) --------- --------- --------- Net cash provided from (used for) financing activities...... 6,662 (29,299) (97,828) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Property additions................................................. (84,924) (105,510) (112,451) Loan payments from (to) associated companies, net.................. (18,826) 5,838 25,185 Investment in lessor notes......................................... 40,025 21,168 17,705 Contributions to nuclear decommissioning trust..................... (28,541) (28,541) (28,541) Other.............................................................. (31,019) 1,192 4,991 --------- --------- --------- Net cash used for investing activities...................... (123,285) (105,853) (93,111) --------- --------- --------- Net increase (decrease) in cash and cash equivalents............... (18,451) 20,386 (1,083) Cash and cash equivalents at beginning of period................... 20,688 302 1,385 --------- --------- --------- Cash and cash equivalents at end of period......................... $ 2,237 $ 20,688 $ 302 ========= ========= ========= SUPPLEMENTAL CASH FLOWS INFORMATION: Cash Paid During the Year- Interest (net of amounts capitalized)........................... $ 38,576 $ 61,498 $ 63,159 ========= ========= ========= Income taxes (refund)........................................... $ (9,257) $ 3,561 $ 33,210 ========= ========= ========= The preceding Notes to Consolidated Financial Statements as they relate to The Toledo Edison Company are an integral part of these statements.
19
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF TAXES For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: Real and personal property......................................... $ 18,488 $ 22,737 $ 23,624 Ohio kilowatt-hour excise*......................................... 29,793 28,046 19,576 State gross receipts*.............................................. -- -- 12,789 Social security and unemployment................................... 1,861 1,684 1,128 Other.............................................................. 600 756 693 --------- --------- --------- Total general taxes......................................... $ 50,742 $ 53,223 $ 57,810 ========= ========= ========= PROVISION FOR INCOME TAXES: Currently payable- Federal......................................................... $ 15,495 $ 12,845 $ 22,244 State........................................................... 4,537 3,983 4,840 --------- --------- --------- 20,032 16,828 27,084 --------- --------- --------- Deferred, net- Federal......................................................... 4,414 (19,091) 4,725 State........................................................... 1,205 (5,570) (1,539) --------- --------- --------- 5,619 (24,661) 3,186 --------- --------- --------- Investment tax credit amortization................................. (2,056) (2,011) (3,908) --------- --------- --------- Total provision for income taxes............................ $ 23,595 $ (9,844) $ 26,362 ========= ========= ========= INCOME STATEMENT CLASSIFICATION OF PROVISION FOR INCOME TAXES: Operating income................................................... $ (9,074) $ (17,496) $ 17,913 Other income....................................................... 14,468 7,652 8,449 Cumulative effect of accounting change............................. 18,201 -- -- --------- --------- --------- Total provision for income taxes............................ $ 23,595 $ (9,844) $ 26,362 ========= ========= ========= RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes...................... $ 69,075 $ (14,986) $ 69,053 ========= ========= ========= Federal income tax expense at statutory rate....................... $ 24,176 $ (5,245) $ 24,169 Increases (reductions) in taxes resulting from- State income taxes, net of federal income tax benefit........... 3,732 (1,031) 2,146 Amortization of investment tax credits.......................... (2,056) (2,011) (3,908) Amortization of tax regulatory assets........................... (2,397) (2,362) (2,563) Amortization of goodwill........................................ -- -- 4,911 Other, net...................................................... 140 805 1,607 --------- --------- --------- Total provision for (benefit from) income taxes............. $ 23,595 $ (9,844) $ 26,362 ========= ========= ========= ACCUMULATED DEFERRED INCOME TAXES AS OF DECEMBER 31: Property basis differences......................................... $ 193,409 $ 177,262 $ 171,976 Regulatory transition charge....................................... 151,129 196,812 239,088 Unamortized investment tax credits................................. (10,472) (11,414) (12,184) Deferred gain for asset sale to affiliated company................. 12,618 14,186 16,305 Other comprehensive income......................................... 8,121 (14,276) 4,800 Above market leases................................................ (130,231) (140,399) (150,634) Retirement benefits................................................ (4,568) (9,768) (35,126) Other.............................................................. (18,052) (54,124) (63,861) --------- --------- --------- Net deferred income tax liability............................... $ 201,954 $ 158,279 $ 170,364 ========= ========= ========= * Collected from customers through regulated rates and included in revenue on the Consolidated Statements of Income. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include The Toledo Edison Company (Company) and its 90% owned subsidiary, The Toledo Edison Capital Corporation (TECC). The subsidiary was formed in 1997 to make equity investments in a business trust in connection with financing related to the Bruce Mansfield Plant sale and leaseback transactions (see Note 2). The Cleveland Electric Illuminating Company (CEI), an affiliate, has a 10% interest in TECC. The Company is a wholly owned subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the issued and outstanding common shares of its other principal electric utility operating subsidiaries, including CEI, Ohio Edison Company (OE), American Transmission Systems, Inc. (ATSI), Jersey Central Power & Light Company (JCP&L), Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec). The Company follows the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the Public Utilities Commission of Ohio (PUCO) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. The Company's consolidated financial statements for the years ended December 31, 2002 and 2001 were restated to reflect a change in the method of amortizing costs being recovered under the Ohio transition plan, recognition of above-market liabilities of certain leased generation facilities, Ohio transition plan regulatory assets and goodwill. Certain prior year amounts have been reclassified to conform with the current year presentation, as described further in Notes 1(F). (A) CONSOLIDATION- The Company consolidates all majority-owned subsidiaries, over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) over which the Company has the ability to exercise significant influence, but not control, are accounted for on the equity basis. (B) REVENUES- The Company's principal business is providing electric service to customers in northwestern Ohio. The Company's retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. Receivables from customers include sales to residential, commercial and industrial customers located in the Company's service area and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of the Company's customers. Total customer receivables were $4.0 million (billed - $2 million and unbilled - $2 million) and $5 million (billed - $3 million and unbilled - $2 million) as of December 31, 2003 and 2002, respectively. The Company and CEI sell substantially all of their retail customers' receivables to Centerior Funding Corporation (CFC), a wholly owned subsidiary of CEI. CFC subsequently transfers the receivables to a trust ("a qualified special purpose entity") under Statement of Financial Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," under an asset-backed securitization agreement. Transfers are made in return for an interest in the trust (19% as of December 31, 2003), which is stated at fair value, reflecting adjustments for anticipated credit losses. The average collection period for billed receivables is 28 days. Given the short collection period after billing, the fair value of CFC's interest in the trust approximates the stated value of its retained interest in underlying receivables after adjusting for anticipated credit losses. Accordingly, subsequent measurements of the retained interest under SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities", (as an available-for-sale financial instrument) result in no material change in value. Sensitivity analyses reflecting 10% and 20% increases in the rate of anticipated credit losses would not have significantly affected FirstEnergy's retained interest in the pool of receivables through the trust. Of the $250 million sold to the trust and outstanding as of December 31, 2003, FirstEnergy had a retained interest in $48 million of the receivables included as other receivables on the Consolidated Balance Sheets. Accordingly, receivables recorded on FirstEnergy's Consolidated Balance Sheets were reduced by approximately $202 million due to these sales. Collections of receivables previously transferred to the trust and used for the purchase of new receivables from CFC during 2003, totaled approximately $2.4 billion. The Company and CEI processed receivables for the trust and received servicing fees of approximately $3.6 million ($1.2 million TE and $2.4 million CEI) in 2003. Expenses associated with the factoring discount related to the sale of receivables were $3.5 million, $4.7 million and $12.0 million in 2003, 2002 and 2001, respectively. 21 (C) REGULATORY MATTERS- In July 1999, Ohio's electric utility restructuring legislation, which allowed Ohio electric customers to select their generation suppliers beginning January 1, 2001, was signed into law. Among other things, the legislation provided for a 5% reduction on the generation portion of residential customers' bills and the opportunity to recover transition costs, including regulatory assets, from January 1, 2001 through December 31, 2005 (market development period). The period for the recovery of regulatory assets only can be extended up to December 31, 2010. The PUCO was authorized to determine the level of transition cost recovery, as well as the recovery period for the regulatory assets portion of those costs, in considering each Ohio electric utility's transition plan application. In July 2000, the PUCO approved FirstEnergy's transition plan for the Company, OE and CEI (Ohio Companies) as modified by a settlement agreement with major parties to the transition plan. The application of SFAS 71, "Accounting for the Effects of Certain Types of Regulation" to the Company's nonnuclear generation business was discontinued with the issuance of the PUCO transition plan order, as described further below. Major provisions of the settlement agreement consisted of approval of recovery of generation-related transition costs as filed of $0.8 billion net of deferred income taxes and transition costs related to regulatory assets as filed of $0.5 billion net of deferred income taxes, with recovery through no later than mid-2007 for the Company, except where a longer period of recovery is provided for in the settlement agreement. The generation-related transition costs include $0.3 billion of impaired generating assets recognized as regulatory assets as described further below, $1.0 billion, net of deferred income taxes, of above-market operating lease costs and $0.3 billion, net of deferred income taxes, of additional plant costs that were reflected on the Company's regulatory financial statements. Also as part of the settlement agreement, FirstEnergy is giving preferred access over its subsidiaries to nonaffiliated marketers, brokers and aggregators to 160 megawatts (MW) of generation capacity through 2005 at established prices for sales to the Company's retail customers. Customer prices are frozen through the five-year market development period, which runs through the end of 2005, except for certain limited statutory exceptions, including the 5% reduction referred to above. In February 2003, the Company was authorized increases in annual revenues aggregating approximately $5 million to recover its higher tax costs resulting from the Ohio deregulation legislation. The Company's customers choosing alternative suppliers receive an additional incentive applied to the shopping credit (generation component) of 45% for residential customers, 30% for commercial customers and 15% for industrial customers. The amount of the incentive is deferred for future recovery from customers. Subject to approval by the PUCO, recovery will be accomplished by extending the transition cost recovery period. On October 21, 2003, the Ohio Companies filed an application with the PUCO to establish generation service rates beginning January 1, 2006, in response to expressed concerns by the PUCO about price and supply uncertainty following the end of the market development period. The filing included two options: o A competitive auction, which would establish a price for generation that customers would be charged during the period covered by the auction, or o A Rate Stabilization Plan, which would extend current generation prices through 2008, ensuring adequate supply and continuing FirstEnergy's support of energy efficiency and economic development efforts. Under the first option, an auction would be conducted to secure generation service for the Ohio Companies' customers. Beginning in 2006, customers would pay market prices for generation as determined by the auction. Under the Rate Stabilization Plan option, customers would have price and supply stability through 2008 - three years beyond the end of the market development period - as well as the benefits of a competitive market. Customer benefits would include: customer savings by extending the current five percent discount on generation costs and other customer credits; maintaining current distribution base rates through 2007; market-based auctions that may be conducted annually to ensure that customers pay the lowest available prices; extension of the Company's support of energy-efficiency programs and the potential for continuing the program to give preferred access to nonaffiliated entities to generation capacity if shopping drops below 20%. Under the proposed plan, TE is requesting: o Extension of the transition cost amortization period from mid-2007 to mid-2008; o Deferral of interest costs on the accumulated shopping incentive and other cost deferrals as new regulatory assets; and o Ability to initiate a request to increase generation rates only under certain limited conditions. 22 On January 7, 2004, the PUCO staff filed testimony on the proposed rate plan generally supporting the Rate Stabilization Plan as opposed to the competitive auction proposal. Hearings began on February 11, 2004. On February 23, 2004, after consideration of PUCO Staff comments and testimony as well as those provided by some of the intervening parties, FirstEnergy made certain modifications to the Rate Stabilization Plan. A decision is expected from the PUCO in the Spring of 2004. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will address certain problems identified by the U.S.-Canada Power System Outage Task Force (in connection with the August 14, 2003 regional power outage) and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software, improve its control room training procedures and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. Transition Cost Amortization- The Company amortizes transition costs (see Regulatory Matters) using the effective interest method. Under the current Ohio transition plan, total transition cost amortization is expected to approximate the following for 2004 through 2007. (In millions) - --------------------------------- 2004.................. $130 2005.................. 150 2006.................. 96 2007.................. 63 - -------------------------------- Regulatory Assets- The Company recognizes, as regulatory assets, costs which the FERC and the PUCO have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets will continue to be recovered from customers under the Company's transition plan. Based on that plan, the Company continues to bill and collect cost-based rates for its transmission and distribution services, which remain regulated; accordingly, it is appropriate that the Company continues the application of SFAS 71 to those operations. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2003 2002 - ----------------------------------------------------------------------- (In millions) Regulatory transition costs...................... $447 $558 Customer shopping incentives..................... 52 24 Customer receivables for future income taxes..... (13) (16) Loss on reacquired debt.......................... 3 3 Employee postretirement benefit costs............ 8 9 Component removal costs and all other............ (38) (33) - ------------------------------------------------------------------------ Total..................................... $459 $545 ======================================================================= Regulatory Accounting for Generation Operations- The application of SFAS 71 has been discontinued with respect to the Company's generation operations. The SEC issued interpretive guidance regarding asset impairment measurement providing that any supplemental regulated cash flows such as a competitive transition charge should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. Consistent with the SEC guidance $53 million of impaired plant investments were recognized by the Company as regulatory assets recoverable as transition costs through future regulatory cash flows. Net assets included in utility plant relating to the operations for which the application of SFAS 71 was discontinued, were $561 million as of December 31, 2003. (D) UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction (except for the Company's nuclear generating units which were adjusted to fair value in connection with the purchase accounting and impairment tests prepared in connection with the transition plan), including payroll and related costs such as taxes, employee benefits, administrative and general costs, and interest costs incurred to place the assets in service. The Company's accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. 23 The Company provides for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The annualized composite rate was approximately 3.0% in 2003, 3.9% in 2002 and 3.5% in 2001. Nuclear Fuel- Nuclear fuel is recorded at original cost, which includes material, enrichment, fabrication and interest costs incurred prior to reactor load. The Company amortizes the cost of nuclear fuel based on the rate of consumption. (E) COMMON OWNERSHIP OF GENERATING FACILITIES- The Company, together with CEI, OE and OE's wholly owned subsidiary, Pennsylvania Power Company (Penn), own and/or lease, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Company's portion of operating expenses associated with jointly owned facilities is included in the corresponding operating expenses on the Consolidated Statements of Income. The amounts reflected on the Consolidated Balance Sheet under utility plant as of December 31, 2003 include the following:
Utility Accumulated Construction Ownership/ Plant Provision for Work in Leasehold Generating Units in Service Depreciation Progress Interest - -------------------------------------------------------------------------------------------------- (In millions) Bruce Mansfield Units 2 and 3............... $ 65 $ 20 $ 18 18.61% Beaver Valley Unit 2.......... 10 1 11 19.91% Davis-Besse................... 249 58 79 48.62% Perry......................... 354 68 4 19.91% - --------------------------------------------------------------------------------------------------- Total....................... $678 $147 $112 ===================================================================================================
The Bruce Mansfield Plant and Beaver Valley Unit 2 are being leased through sale and leaseback transactions (see Note 2) and the above-related amounts represent construction expenditures subsequent to the transaction. (F) ASSET RETIREMENT OBLIGATION- In January 2003, the Company implemented SFAS 143, "Accounting for Asset Retirement Obligations," which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. The Company identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond related to the Bruce Mansfield Plant. The ARO liability as of the date of adoption of SFAS 143 was $172 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. Accretion during 2003 was $9.8 million, bringing the ARO liability as of December 31, 2003 to $181.8 million. The ARO includes the Company's obligation for nuclear decommissioning of the Beaver Valley Unit 2, Davis-Besse, and Perry nuclear generating facilities. The Company's share of the obligation to decommission these units was developed based on site-specific studies performed by an independent engineer. The Company utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Company maintains nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $240.6 million. In accordance with SFAS 143, the Company ceased the accounting practice of depreciating non-regulated generation assets using a cost of removal component in the depreciation rates. That practice recognized accumulated depreciation in excess of the historical cost of an asset because the removal cost would exceed the estimated salvage value. Beginning in 2003, the cost of removal related to non-regulated generation assets is charged to expense rather than to the accumulated provision for depreciation. In accordance with SFAS 71, the cost of removal on regulated plant assets continues to be accounted for as a component of depreciation rates and is recognized as a regulatory liability. 24 The following table provides the effect on income as if SFAS 143 had been applied during 2002 and 2001. Effect of the Change in Accounting Principle Applied Retroactively 2002 2001 - ----------------------------------------------------------------------------- (In millions) Reported net income (loss)................................ $(5) $ 43 Increase (Decrease): Elimination of decommissioning expense.................... 29 28 Depreciation of asset retirement cost..................... (1) (1) Accretion of ARO liability................................ (11) (10) Non-regulated generation cost of removal component, net... 1 1 Income tax effect......................................... (7) (7) - ----------------------------------------------------------------------------- Net earnings increase..................................... 11 11 - ----------------------------------------------------------------------------- Net income adjusted....................................... $ 6 $ 54 ============================================================================= The following table provides the year-end balance of the ARO for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 - -------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002 $161.1 Accretion in 2002 10.9 - ------------------------------------------------------ Ending balance as of December 31, 2002 $172.0 - ------------------------------------------------------ (G) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 3(B)). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date, resulting in substantially no intrinsic value. If FirstEnergy had accounted for employee stock options under the fair value method of SFAS 123, "Accounting for Stock Compensation," a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 - --------------------------------------------------------------------------- Valuation assumptions: Expected option term (years)... 7.9 8.1 8.3 Expected volatility............ 26.91% 23.31% 23.45% Expected dividend yield........ 5.09% 4.36% 5.00% Risk-free interest rate........ 3.67% 4.60% 4.67% Fair value per option............ $5.09 $6.45 $4.97 - --------------------------------------------------------------------------- The effects of applying fair value accounting to FirstEnergy's stock options would not materially affect the Company's net income. (H) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. The Company is included in FirstEnergy's consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with the Company recognizing any tax losses or credits it contributed to the consolidated return. (I) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of the Company's employees. The trusteed plans provide defined benefits based on years of service and compensation levels. FirstEnergy's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. 25 FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company recognizes the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. The following sets forth the funded status of the plans and amounts recognized on FirstEnergy's Consolidated Balance Sheets as of December 31:
Obligations and Funded Status Pension Benefits Other Benefits ---------------- -------------- As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $ 1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition.......................... -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------- Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $ 2,077 ====== ====== ======= ======= Change in fair value of plan assets Fair value of plan assets at beginning of year................................ $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------- Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ======= Funded status............................ $ (847) $ (977) $(1,831) (1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit).............................. 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ ------- ------- Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Amounts Recognized in the Consolidated Balance Sheets As of December 31 Accrued benefit cost..................... $ (438) $ (548) $(975) $(867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ------ ------ ----- ----- Net amount recognized.................... $ 144 $ 287 $(975) $(867) ====== ====== ===== ===== Company's share of net amount recognized. $ 7 $ 19 $ (33) $ (56) ====== ====== ===== =====
26
Increase (decrease) in minimum liability included in other comprehensive income (net of tax).......................... $(145) $ 444 $ -- $ -- Weighted-Average Assumptions Used to Determine Benefit Obligations As of December 31 ---------------------------------------- Discount rate........................... 6.25% 6.75% 6.25% 6.75% Rate of compensation increase........... 3.50% 3.50% Allocation of Plan Assets As of December 31 ----------------------------------------- Asset Category Equity securities....................... 70% 61% 71% 58% Debt securities....................... 27 35 22 29 Real estate........................... 2 2 -- -- Other................................. 1 2 7 13 --- --- --- --- Total................................. 100% 100% 100% 100% === === === === Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 ----------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889
FirstEnergy's net pension and other postretirement benefit costs for the three years ended December 31, 2003 were computed as follows:
Pension Benefits Other Benefits ---------------------- --------------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 --------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset)................................ -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ----- ----- ----- ----- ---- ---- Net periodic cost (income).............. $ 142 $ (29) $ (24) $ 177 $114 $ 92 ===== ===== ===== ===== ==== ==== Company's share of net periodic cost (income).............................. $ 5 $ 1 $ (1) $ 6 $ 4 $ 4 ===== ===== ===== ===== ==== ==== Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31 Discount rate.......................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase.......... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy. Assumed health care cost trend rates As of December 31 2003 2002 - ------------------------------------------------------------------------------ Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2008-2010 27 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Increase Point Decrease - ------------------------------------------------------------------------------- (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, the accrued pension costs for the Company as of June 30, 2003 decreased by $3 million. The corresponding adjustment related to this change increased other comprehensive income and deferred income taxes and decreased the payable to associated companies. Due to the increased market value of its pension plan assets, the Company reduced its minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $13 million, recording a decrease of $3 million in an intangible asset and crediting OCI by $6 million (offsetting previously recorded deferred tax benefits by $4 million). The remaining balance in OCI of $9 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $13 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. (J) TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and other income include transactions with affiliated companies, primarily ATSI, FirstEnergy Solutions Corp. (FES) and FirstEnergy Service Company (FESC). The Ohio transition plan, as discussed in the "Regulatory Matters" section, resulted in the corporate separation of FirstEnergy's regulated and unregulated operations in 2001. FES operates the generation businesses of the Company, CEI, OE and Penn. As a result, the Company entered into power supply agreements (PSA) whereby FES purchases all of the Company's nuclear generation and the generation from leased fossil generating facilities and the Company purchases its power from FES to meet its "provider of last resort" obligations. CFC serves as the transferor in connection with the accounts receivable securitization for the Company and CEI. The primary affiliated companies transactions are as follows: 2003 2002 2001 - ------------------------------------------------------------------------- (In millions) Operating Revenues: PSA revenues from FES............... $103 $128 $181 Generating units rent from FES...... 15 14 14 Electric sales to CEI............... 109 104 97 Ground lease with ATSI.............. 2 2 2 Operating Expenses: Purchased power under PSA........... 298 319 388 Transmission expenses............... 19 23 17 FESC support services............... 35 26 24 Other Income: Interest income from ATSI........... 3 3 3 Interest income from FES............ 10 10 10 - ------------------------------------------------------------------------- 28 FirstEnergy does not bill directly or allocate any of its costs to any subsidiary company. Costs are allocated to the Company from FESC, a subsidiary of FirstEnergy Corp. and a "mutual service company" as defined in Rule 93 of the Public Utility Holding Company Act of 1935 (PUHCA). The majority of costs are directly billed or assigned at no more than cost as determined by PUHCA Rule 91. The remaining costs are for services that are provided on behalf of more than one company, or costs that cannot be precisely identified and are allocated using formulas that are filed annually with the SEC on Form U-13-60. The current allocation or assignment formulas used and their bases include multiple factor formulas; each company's proportionate amount of FirstEnergy's aggregate direct payroll, number of employees, asset balances, revenues, number of customers, other factors and specific departmental charge ratios. Management believes that these allocation methods are reasonable. Intercompany transactions with FirstEnergy and its other subsidiaries are generally settled under commercial terms within thirty days, except for $65 million payable to affiliates for pension and OPEB obligations. The Company is selling 150 megawatts of its Beaver Valley Unit 2 leased capacity entitlement to CEI. Operating revenues for this transaction were $109 million, $104 million and $97 million in 2003, 2002 and 2001, respectively. This sale is expected to continue through the end of the lease period. (See Note 2.) (K) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Consolidated Balance Sheets at cost, which approximates their fair market value. Cash and cash equivalents included $2 million received in December 2003 which was included in the NRG settlement claim sold in January 2004 (see Note 6) and $20 million used for the redemption of long-term debt in January 2003 as of December 31, 2003 and 2002, respectively. Noncash financing and investing activities included capital lease transactions amounting to $1.0 million in 2001. There were no capital lease transactions in 2003 and 2002. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Consolidated Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt and investments other than cash and cash equivalents as of December 31:
2003 2002 - ---------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value - ---------------------------------------------------------------------------------------------------------- (In millions) Long-term debt....................................... $540 $564 $730 $772 Investments other than cash and cash equivalents: Debt securities - Maturity (5-10 years)........................... $124 $127 $123 $127 - Maturity (more than 10 years)................... 246 286 278 303 Equity securities................................. 2 2 2 2 All other......................................... 241 241 175 175 - ---------------------------------------------------------------------------------------------------------- $613 $656 $578 $607 ==========================================================================================================
The fair value of long-term debt reflects the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Company's ratings. The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. The Company has no securities held for trading purposes. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "All other" in the table above) consist of equity securities ($145 million) and fixed income securities ($96 million) as of December 31, 2003. Unrealized gains and losses applicable to the Company's decommissioning trusts are recognized in the trust investment with a corresponding offset to OCI, as fluctuations in the fair value of the trusts will eventually affect earnings. Realized gains (losses) are recognized as additions (reductions) to trust asset balances with an offset to earnings. For 2003 and 2002, net realized losses were approximately $0.5 million, respectively, and $5.0 million and interest and dividend income totaled approximately $6.7 million and $5.9 million, respectively. Investments other than cash and cash equivalents in the table above include available-for-sale securities, at fair value, with the following net results: 29 2003* 2002* - --------------------------------------------------------------- (In millions) Unrealized gains (losses)........... $ 32.8 $(10.0) Proceeds from sales................. 147.2 143.5 Realized gains (losses)............. (0.5) (5.0) - --------------------------------------------------------------- * Includes the available-for-sale securities of the Company's decommissioning trusts. As of December 31, 2003 accumulated other comprehensive income (loss) for available-for-sale securities consisted of investments with net unrealized gains of $43.4 million and net unrealized losses of $8.7 million. The following table provides details for the available-for-sale securities with net unrealized losses as of December 31, 2003.
Less Than 12 Months 12 Months or More Total -------------------- -------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Security Type Value Losses Value Losses Value Losses - ------------------------------------------------------------------------------------------------------- (In millions) Equity Securities....... 5.7 1.7 8.1 6.9 13.8 8.6 Debt Securities......... 7.4 0.1 -- -- 7.4 0.1 - ---------------------------------------------------------------------------------------------------- Total............... 13.1 1.8 8.1 6.9 21.2 8.7 - ------------------------------------------------------------------------------------------------------
All of the aggregate unrealized losses related to available-for-sale securities in the table above are considered to be temporary in nature. These securities are primarily held by the Company's nuclear decommissioning trusts. The Company has the ability and intent to hold these securities for the period necessary to fund their cost. (L) GOODWILL- In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Under SFAS 142, "Goodwill and Other Intangible Assets," amortization of existing goodwill ceased January 1, 2002. Instead, the Company evaluates its goodwill for impairment at least annually and makes such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. When impairment is indicated, the Company would recognize a loss - calculated as the difference between the implied fair value of its goodwill and the carrying value of the goodwill. The Company's annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in the Company's evaluation of goodwill reflect operations consistent with its general business assumptions. Unanticipated changes in those assumptions could have a significant effect on its future evaluations of goodwill. As of December 31, 2003, the Company had approximately $505 million of goodwill. The impairment analysis includes a significant source of cash representing the Company's recovery of transition costs as described above under "Regulatory Matters." The Company does not believe that completion of transition cost recovery will result in an impairment of goodwill. The following table shows what net income would have been if goodwill amortization had been excluded from prior periods: 2003 2002 2001 ---- ---- ---- (In thousands) Reported net income (loss)......... $45,480 $(5,142) $42,691 Add back goodwill amortization..... -- -- 14,032 ------- ------- ------- Adjusted net income (loss)......... $45,480 $(5,142) $56,723 ======= ======= ======= (M) CUMULATIVE EFFECT OF ACCOUNTING CHANGE- Results for 2003 include an after-tax credit to net income of $25.6 million recorded by the Company upon adoption of SFAS 143 in January 2003. The Company identified applicable legal obligations as defined under the new accounting standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond at the Bruce Mansfield Plant. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $41.1 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $5.5 million. The asset retirement obligation liability at the date of adoption was $172 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, the Company had recorded decommissioning liabilities of $179.6 million. The cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $43.8 million increase to income, or $25.6 million net of income taxes. 30 2. LEASES: The Company leases certain generating facilities, office space and other property and equipment under cancelable and noncancelable leases. The Company and CEI sold their ownership interests in Bruce Mansfield Units 1, 2 and 3 and the Company sold a portion of its ownership interest in Beaver Valley Unit 2. In connection with these sales, which were completed in 1987, the Company and CEI entered into operating leases for lease terms of approximately 30 years as co-lessees. During the terms of the leases, the Company and CEI continue to be responsible, to the extent of their combined ownership and leasehold interest, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. The Company and CEI have the right, at the end of the respective basic lease terms, to renew the leases. The Company and CEI also have the right to purchase the facilities at the expiration of the basic lease term or any renewal term at a price equal to the fair market value of the facilities. As co-lessee with CEI, the Company is also obligated for CEI's lease payments. If CEI is unable to make its payments under the Bruce Mansfield Plant lease, the Company would be obligated to make such payments. No such payments have been made on behalf of CEI. (CEI's future minimum lease payments as of December 31, 2003 were approximately $0.2 billion, net of trust cash receipts.) Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 2003 are summarized as follows: 2003 2002 2001 - --------------------------------------------------------------------------- (In millions) Operating leases Interest element............... $ 49.4 $ 52.6 $ 55.7 Other.......................... 62.4 58.6 52.4 Capital leases Interest element............... -- -- 2.5 Other.......................... -- 0.3 14.1 - ------------------------------------------------------------------------- Total rentals.................. $111.8 $111.5 $124.7 ========================================================================= The future minimum lease payments as of December 31, 2003 are: Operating Leases ------------------------------------ Lease Capital Payments Trust Net - ---------------------------------------------------------------------------- (In millions) 2004................................ $ 97.9 $ 24.6 $ 73.3 2005................................ 104.8 25.3 79.5 2006................................ 107.8 26.0 81.8 2007................................ 99.2 22.6 76.6 2008................................ 96.9 27.2 69.7 Years thereafter.................... 811.7 201.1 610.6 - ---------------------------------------------------------------------------- Total minimum lease payments........ $1,318.3 $326.8 $991.5 ======== ====== ====== The Company has recorded above-market lease liabilities for Beaver Valley Unit 2 and the Bruce Mansfield Plant associated with the 1997 merger creating FirstEnergy. The total above-market lease obligation of $111 million associated with Beaver Valley Unit 2 is being amortized on a straight-line basis through the end of the lease term in 2017 (approximately $6 million per year). The total above-market lease obligation of $298 million associated with the Bruce Mansfield Plant is being amortized on a straight-line basis through the end of 2016 (approximately $19 million per year). As of December 31, 2003 the above-market lease liabilities for Beaver Valley Unit 2 and the Bruce Mansfield Plant totaled approximately $317 million, of which $25 million is current. The Company and CEI refinanced high-cost fixed obligations related to their 1987 sale and leaseback transaction for the Bruce Mansfield Plant through a lower cost transaction in June and July 1997. In a June 1997 offering (Offering), the two companies pledged $720 million aggregate principal amount ($145 million for the Company and $575 million for CEI) of first mortgage bonds due through 2007 to a trust as security for the issuance of a like principal amount of secured notes due through 2007. The obligations of the two companies under these secured notes are joint and several. Using available cash, short-term borrowings and the net proceeds from the Offering, the two companies invested $906.5 million ($337.1 million for the Company and $569.4 million for CEI) in a business trust, in June 1997. The trust used these funds in July 1997 to purchase lease notes and redeem all $873.2 million aggregate principal amount of 10-1/4% and 11-1/8% secured lease obligations bonds (SLOBs) due 2003 and 2016. The SLOBs were 31 issued by a special-purpose funding corporation in 1988 on behalf of lessors in the two companies' 1987 sale and leaseback transaction. The Shippingport Capital Trust (Shippingport) arrangement effectively reduces lease costs related to that transaction. 3. CAPITALIZATION: (A) RETAINED EARNINGS- There are no restrictions on retained earnings for payment of cash dividends on the Company's common stock. (B) STOCK COMPENSATION PLANS- FirstEnergy administers the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Several other stock compensation plans have been acquired through the mergers with GPU and Centerior - GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan), 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan) and Centerior Equity Plan. No further stock-based compensation can be awarded under these plans. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 2003 2002 2001 - ---------------------------------------------------------------------------- Restricted common shares granted...... -- 36,922 133,162 Weighted average market price ........ n/a (1) $36.04 $35.68 Weighted average vesting period (years)............................. n/a (1) 3.2 3.7 Dividends restricted.................. n/a (1) Yes -- (2) --------------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares; MYR Plan dividends are paid as unrestricted cash on 128,662 shares Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price - ------------------------------------------------------------------------------ Balance, January 1, 2001............... 5,021,862 $24.09 (473,314 options exercisable).......... 24.11 Options granted...................... 4,240,273 28.11 Options exercised.................... 694,403 24.24 Options forfeited.................... 120,044 28.07 Balance, December 31, 2001............. 8,447,688 26.04 (1,828,341 options exercisable)........ 24.83 Options granted...................... 3,399,579 34.48 Options exercised.................... 1,018,852 23.56 Options forfeited.................... 392,929 28.19 Balance, December 31, 2002............. 10,435,486 28.95 (1,400,206 options exercisable)........ 26.07 Options granted...................... 3,981,100 29.71 Options exercised.................... 455,986 25.94 Options forfeited.................... 311,731 29.09 Balance, December 31, 2003............. 13,648,869 29.27 (1,919,662 options exercisable)........ 29.67 32 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. Options outstanding by plan and range of exercise price as of December 31, 2003 were as follows: Range of Options FirstEnergy Program Exercise Prices Outstanding - ----------------------------------------------------------------------- FE plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU plan $23.75 - $35.92 501,734 Other plans 27,673 - ---------------------------------------------------------------------- Total 13,648,869 ====================================================================== No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 1(G) - "Stock-Based Compensation." (C) PREFERRED AND PREFERENCE STOCK- Preferred stock may be redeemed by the Company in whole, or in part, with 30-90 days' notice. The preferred dividend rates on the Company's Series A and Series B shares fluctuate based on prevailing interest rates and market conditions. The dividend rates for both issues averaged 7% in 2003. The Company has five million authorized and unissued shares of $25 par value preference stock. (D) LONG-TERM DEBT- The Company has a first mortgage indenture under which it issues first mortgage bonds, secured by a direct first mortgage lien on substantially all of its property and franchises, other than specifically excepted property. The Company has various debt covenants under its financing arrangements. The most restrictive of the debt covenants relate to the nonpayment of interest and/or principal on debt which could trigger a default and the maintenance of minimum fixed charge ratios and debt to capitalization ratios. There also exists cross-default provisions among financing arrangements of FirstEnergy and the Company. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) - --------------------------------------------- 2004................................. $284 2005................................. 32 2006................................. -- 2007................................. 30 2008................................. -- - --------------------------------------------- Included in the table above are amounts for various variable interest rate long-term debt which have provisions by which individual debt holders have the option to "put back" or require the respective debt issuer to redeem their debt at those times when the interest rate may change prior to its maturity date. These amounts are $54 million and $32 million in 2004 and 2005, respectively, which represents the next date at which the debt holders may exercise this provision. The Company's obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds. Certain pollution control revenue bonds are entitled to the benefit of noncancelable municipal bond insurance policies of $51 million to pay principal of, or interest on, the pollution control revenue bonds. The Company and CEI have unsecured letters of credit of approximately $216 million in connection with the sale and leaseback of Beaver Valley Unit 2 that expire in April 2005. The Company and CEI are jointly and severally liable for the letters of credit (see Note 2). 33 (E) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholder's equity except those resulting from transactions with FirstEnergy. As of December 31, 2003, accumulated other comprehensive income consisted of a minimum liability for unfunded retirement benefits of $(9.4) million and unrealized gains on investments in securities available for sale of $21.1 million. 4. SHORT-TERM -BORROWINGS: Short-term borrowings outstanding as of December 31, 2003, consisted of $70 million of bank borrowings and $286 million from affiliates. The average interest rate on short-term borrowings outstanding as of December 31, 2003 and 2002, were 1.8%. 5. COMMITMENTS AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $141 million for property additions and improvements from 2004-2006, of which approximately $50 million is applicable to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $42 million, of which approximately $13 million applies to 2004. During the same periods, the Company's nuclear fuel investments are expected to be reduced by approximately $42 million and $21 million, respectively, as the nuclear fuel is consumed. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its ownership and leasehold interests in Beaver Valley Unit 2, the Davis Besse Station and the Perry Plant, the Company's maximum potential assessment under the industry retrospective rating plan (assuming the other affiliate co-owners contribute their proportionate shares of any assessments under the retrospective rating plan) would be $89.0 million per incident but not more than $8.8 million in any one year for each incident. The Company is also insured as to its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Company has also obtained approximately $263.4 million of insurance coverage for replacement power costs for its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry. Under these policies, the Company can be assessed a maximum of approximately $13.9 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Company's plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. (C) ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Company with regard to air and water quality and other environmental matters. The effects of compliance on the Company with regard to environmental matters could have a material adverse effect on the Company's earnings and competitive position. These environmental regulations affect the Company's earnings and competitive position to the extent that it competes with companies that are not subject to such regulations and therefore do not bear the risk of costs associated with compliance, or failure to comply, with such regulations. Overall, the Company believes it is in material compliance with existing regulations but are unable to predict future change in regulatory policies and what, if any, the effects of such change would be. In accordance with the Ohio transition plan discussed in "Regulatory Matters" in Note 1(C), generation operations and any related additional capital expenditures for environmental compliance are the responsibility of FirstEnergy's competitive services business unit. Clean Air Act Compliance The Company is required to meet federally approved sulfur dioxide (SO2) regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for 34 each day the unit is in violation. The Environmental Protection Agency (EPA) has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Company cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. The Company is complying with SO2 reduction requirements under the Clean Air Act Amendments of 1990 by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or using emission allowances. NOx reductions required by the 1990 Amendments are being achieved through combustion controls and the generation of more electricity at lower-emitting plants. In September 1998, the EPA finalized regulations requiring additional NOx reductions from the Company's Ohio and Pennsylvania facilities. The EPA's NOx Transport Rule imposes uniform reductions of NOx emissions (an approximate 85% reduction in utility plant NOx emissions from projected 2007 emissions) across a region of nineteen states (including Ohio and Pennsylvania) and the District of Columbia based on a conclusion that such NOx emissions are contributing significantly to ozone pollution in the eastern United States. State Implementation Plans (SIP) must comply by May 31, 2004 with individual state NOx budgets established by the EPA. Pennsylvania submitted a SIP that required compliance with the NOx budgets at the Company's Pennsylvania facilities by May 1, 2003 and Ohio submitted a SIP that requires compliance with the NOx budgets at the Company's Ohio facilities by May 31, 2004. The Company's Pennsylvania facilities complied with the NOx budgets in 2003 and all facilities will comply with the NOx budgets in 2004 and thereafter. National Ambient Air Quality Standards In July 1997, the EPA promulgated changes in the National Ambient Air Quality Standard (NAAQS) for ozone and proposed a new NAAQS for fine particulate matter. On December 17, 2003, the EPA proposed the "Interstate Air Quality Rule" covering a total of 29 states (including Ohio and Pennsylvania) and the District of Columbia based on proposed findings that air pollution emissions from 29 eastern states and the District of Columbia significantly contribute to nonattainment of the NAAQS for fine particles and/or the "8-hour" ozone NAAQS in other states. The EPA has proposed the Interstate Air Quality Rule to "cap-and-trade" NOx and SO2 emissions in two phases (Phase I in 2010 and Phase II in 2015). According to the EPA, SO2 emissions would be reduced by approximately 3.6 million tons in 2010, across states covered by the rule, with reductions ultimately reaching more than 5.5 million tons annually. NOx emission reductions would measure about 1.5 million tons in 2010 and 1.8 million tons in 2015. The future cost of compliance with these proposed regulations may be substantial and will depend if and how they are ultimately implemented by the states in which the Company operates affected facilities. Mercury Emissions In December 2000, the EPA announced it would proceed with the development of regulations regarding hazardous air pollutants from electric power plants, identifying mercury as the hazardous air pollutant of greatest concern. On December 15, 2003, the EPA proposed two different approaches to reduce mercury emissions from coal-fired power plants. The first approach would require plants to install controls known as "maximum achievable control technologies" (MACT) based on the type of coal burned. According to the EPA, if implemented, the MACT proposal would reduce nationwide mercury emissions from coal-fired power plants by fourteen tons to approximately thirty-four tons per year. The second approach proposes a cap-and-trade program that would reduce mercury emissions in two distinct phases. Initially, mercury emissions would be reduced by 2010 as a "co-benefits" from implementation of SO2 and NOx emission caps under the EPA's proposed Interstate Air Quality Rule. Phase II of the mercury cap-and-trade program would be implemented in 2018 to cap nationwide mercury emissions from coal-fired power plants at fifteen tons per year. The EPA has agreed to choose between these two options and issue a final rule by December 15, 2004. The future cost of compliance with these regulations may be substantial. Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. The Company has been named as "potentially responsible parties" (PRPs) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Company's proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. The Company has total accrued liabilities aggregating approximately $0.2 million as of December 31, 2003. The Company accrues 35 environmental liabilities only when it can conclude that it is probable that it has an obligation for such costs and can reasonably determine the amount of such costs. Unasserted claims are reflected in the Company's determination of environmental liabilities and are accrued in the period that they are both probable and reasonably estimable. Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but it failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. The Company cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Company is lower than many regional competitors due to the Company's diversified generation sources which includes low or non-CO2 emitting gas-fired and nuclear generators. Clean Water Act Various water quality regulations, the majority of which are the result of the federal Clean Water Act and its amendments, apply to the Companies' plants. In addition, Ohio and Pennsylvania have water quality standards applicable to the Companies' operations. As provided in the Clean Water Act, authority to grant federal National Pollutant Discharge Elimination System water discharge permits can be assumed by a state. Ohio and Pennsylvania have assumed such authority. (D) OTHER LEGAL PROCEEDINGS- Various lawsuits, claims and proceedings related to the Company's normal business operations are pending against FirstEnergy and its subsidiaries. On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. 6. SALE OF GENERATING ASSETS: In November 2001, FirstEnergy reached an agreement to sell four coal-fired power plants totaling 2,535 MW to NRG Energy Inc. The proposed sale had included the 648 MW Bay Shore Plant owned by the Company. On August 8, 2002, FirstEnergy notified NRG that it was canceling the agreement because NRG stated that it could not complete the transaction under the original terms of the agreement. NRG filed voluntary bankruptcy petitions in May 2003; subsequently, FirstEnergy reached an agreement for settlement of its claim against NRG. FirstEnergy sold its entire claim for $170 million (Company's share - $12 million) in January 2004. 36 In December 2002, FirstEnergy decided to retain ownership of these plants after reviewing other bids it subsequently received from other parties who had expressed interest in purchasing the plants. Since FirstEnergy did not execute a sales agreement by year-end, the Company reflected approximately $13 million ($8 million net of tax) of previously unrecognized depreciation and other transaction costs in the fourth quarter of 2002 related to these plants from November 2001 through December 2002 on its Consolidated Statement of Income. 7. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS: FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, the Company adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. The Company will adopt FIN 46R for all other types of entities effective March 31, 2004. The Company currently has transactions with entities in connection with sale and leaseback arrangements which fall within the scope of this interpretation and which meet the definition of a VIE in accordance with FIN 46R. In 1997, the Company and CEI, an affiliated company, established Shippingport to purchase all of the lease obligation bonds issued by the owner trusts in the Bruce Mansfield Plant sale and leaseback transactions. Prior to the adoption of FIN 46R, the assets and liabilities of the trust were included on a proportionate basis in the financial statements of the Company and CEI. Upon adoption of FIN 46R, CEI was determined to be the primary beneficiary of Shippingport, and therefore consolidated the entire trust as of December 31, 2003. This changed our Shippingport investment of $220 million to an investment in collateralized lease bonds of $210 million ($9 million current). The $10 million difference represents the minority interest included on the financial statements of CEI. In reviewing the sale and leaseback arrangements, the Company also evaluated its interest in the owner trusts that acquired interests in the Bruce Mansfield Plant. The Company was determined not to be the primary beneficiary of any of these owner trusts and was therefore not required to consolidate these entities. The leases are accounted for as operating leases in accordance with GAAP and their related obligations are disclosed in Note 2. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, the company implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(F) and 1(M) for further discussions of SFAS 143. EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" In November 2003, the EITF reached consensus that certain quantitative and qualitative disclosures are required for debt and equity securities classified as available-for-sale or held-to-maturity. The guidance requires the disclosure of the aggregate amount of unrealized losses and the aggregate related fair value for investments with unrealized losses that have not been recognized as other-than-temporary impairments. The Company has adopted the disclosure requirements of EITF Issue No. 03-1 as of December 31, 2003 (See Note 1(K)). 8. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The quarterly financial information for the first three quarters of 2003 have been restated to correct the amounts reported for operating expense and interest charges. Costs that should have been capitalized to construction projects were improperly recorded as operating expenses of $0.2 million, $0.3 million and $0.7 million in the first, second and third quarters, respectively. In addition, interest expense was overstated by $0.6 million in the first quarter and $0.2 million in each of the second and third quarters. These corrections have resulted in restated earnings increases of $0.8 million, $0.5 million and $0.9 million during the quarters ended March 31, 2003, June 30, 2003 and September 30, 2003, respectively.The impact of these adjustments was not material to the Company's consolidated balance sheets or consolidated statements of cash flows for any quarter of 2003. The following summarizes certain consolidated operating results by quarter for 2003 and 2002. 37
Three Months Ended March 31, 2003 June 30, 2003 September 30, 2003 December 31, 2003 - ---------------------------------------------------------------------------------------------------------------------- As Previously As As Previously As As Previously As Reported Restated Reported Restated Reported Restated -------- -------- -------- -------- -------- -------- (In millions) Operating Revenues............. $231.8 $231.8 $216.0 $216.0 $260.2 $260.2 $224.8 Operating Expenses and Taxes... 226.3 226.7 218.1 217.9 242.0 241.5 212.7 - ----------------------------------------------------------------------------------------------------------------- Operating Income (Loss)........ 5.5 5.1 (2.1) (1.9) 18.2 18.7 12.1 Other Income .................. 3.1 3.3 3.8 3.8 5.8 5.8 9.3 Net Interest Charges........... 10.0 9.1 11.4 11.1 8.2 7.9 8.2 - ---------------------------------------------------------------------------------------------------------------- Income (Loss) Before Cumulative Effect of Accounting Change.. (1.4) (0.7) (9.7) (9.2) 15.8 16.6 13.2 Cumulative Effect of Accounting Change (Net of Income Taxes). 25.6 25.6 -- -- -- -- -- - ---------------------------------------------------------------------------------------------------------------- Net Income (Loss).............. $ 24.2 $ 24.9 $ (9.7) $ (9.2) $ 15.8 $ 16.6 $ 13.2 ================================================================================================================= Earnings (Loss) Applicable To Common Stock............. $ 21.9 $ 22.7 $(11.9) $(11.4) $ 13.5 $ 14.4 $ 11.0 ================================================================================================================= March 31, June 30, September 30, December 31, Three Months Ended 2002 2002 2002 2002 - ---------------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues.......................... $252.6 $250.3 $269.9 $223.3 Operating Expenses and Taxes................ 241.9 222.7 251.7 243.1 - ---------------------------------------------------------------------------------------------------------------- Operating Income (Loss)..................... 10.7 27.6 18.2 (19.8) Other Income ............................... 4.3 3.7 4.0 1.2 Net Interest Charges........................ 14.7 14.9 14.5 11.1 - ---------------------------------------------------------------------------------------------------------------- Net Income (Loss)........................... $ 0.3 $ 16.4 $ 7.7 $(29.7) ================================================================================================================ Earnings (Loss) Applicable to Common Stock............................. $ (4.4) $ 14.3 $ 5.5 $(31.4) ================================================================================================================
38 Report of Independent Auditors To the Stockholders and Board of Directors of The Toledo Edison Company: In our opinion, the accompanying consolidated balance sheets and consolidated statements of capitalization and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of The Toledo Edison Company (a wholly owned subsidiary of FirstEnergy Corp.) and subsidiary as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three yeas in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. As discussed in Note 1(L) to the consolidated financial statements, the Company changed its method of accounting for goodwill as of January 1, 2002. As discussed in Note 1(F) to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as January 1, 2003. As discussed in Note 7 to the consolidated financial statements, the Company changed its method of accounting for the consolidation of variable interest entities as of December 31, 2003. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 39 EX-21 29 te_ex21-3.txt EX 21-3 TE LIST OF SUBS EXHIBIT 21.3 THE TOLEDO EDISON COMPANY LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 2003 The Toledo Edison Capital Corporation - Incorporated in Delaware Statement of Differences ------------------------ Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 2003, is not included in the printed document. EX-12 30 pp_ex12-5.txt EX 12-5 PENN FIXED CHARGE RATIO EXHIBIT 12.5 Page 1 PENNSYLVANIA POWER COMPANY RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, 1999 2000 2001 2002 2003 ------- -------- -------- -------- -------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items.......................... $12,648 $22,847 $ 41,041 $ 47,717 $ 37,833 Interest before reduction for amounts capitalized.......... 21,317 20,437 18,172 16,674 15,526 Provision for income taxes................................. 18,834 26,121 39,921 43,044 35,959 Interest element of rentals charged to income (a).......... 1,887 2,791 1,316 326 167 ------- ------- --------- -------- -------- Earnings as defined...................................... $54,686 $72,196 $ 100,450 $107,761 $ 89,485 ======= ======= ========= ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K: Interest on long-term debt................................. $19,268 $18,651 $ 16,971 $ 15,521 $ 14,228 Interest on nuclear fuel obligations....................... 90 364 141 8 -- Other interest expense..................................... 1,959 1,422 1,060 1,145 1,298 Interest element of rentals charged to income (a).......... 1,887 2,791 1,316 326 167 -------- ------- --------- -------- -------- Fixed charges as defined................................. $23,204 $23,228 $ 19,488 $ 17,000 $ 15,693 ======= ======= ========= ======== ======== RATIO OF EARNINGS TO FIXED CHARGES ........................... 2.36 3.11 5.15 6.34 5.70 ==== ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 97
EXHIBIT 12.5 Page 2 PENNSYLVANIA POWER COMPANY RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, 1999 2000 2001 2002 2003 ------- -------- -------- -------- -------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items......................... $12,648 $22,847 $ 41,041 $ 47,717 $37,833 Interest before reduction for amounts capitalized......... 21,317 20,437 18,172 16,674 15,526 Provision for income taxes................................ 18,834 26,121 39,921 43,044 35,959 Interest element of rentals charged to income (a)......... 1,887 2,791 1,316 326 167 ------- ------- -------- -------- ------- Earnings as defined..................................... $54,686 $72,196 $100,450 $107,761 $89,485 ======= ======= ======== ======== ======= FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS): Interest on long-term debt................................ $19,268 $18,651 $ 16,971 $ 15,521 $14,228 Interest on nuclear fuel obligations...................... 90 364 141 8 -- Other interest expense.................................... 1,959 1,422 1,060 1,145 1,298 Preferred stock dividend requirements..................... 4,370 3,704 3,703 3,699 3,731 Adjustment to preferred stock dividends to state on a pre-income tax basis .............................. 6,403 4,018 3,534 3,274 3,469 Interest element of rentals charged to income (a)......... 1,887 2,791 1,316 326 167 ------- ------- -------- -------- ------- Fixed charges as defined plus preferred stock dividend requirements (pre-income tax basis).......... $33,977 $30,950 $ 26,725 $ 23,973 $22,893 ======= ======= ======== ======== ======= RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)........ 1.61 2.33 3.76 4.50 3.91 ==== ==== ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 98
EX-13 31 pp_ex13-4.txt EX 13-4 PENN ANNUAL REPORT PENNSYLVANIA POWER COMPANY 2003 ANNUAL REPORT TO STOCKHOLDERS Pennsylvania Power Company, an electric utility operating company of FirstEnergy Corp. and a wholly owned subsidiary of Ohio Edison Company, provides electric service to approximately 156,000 customers in western Pennsylvania. Contents Page - -------- ---- Selected Financial Data........................................... 1 Management's Discussion and Analysis.............................. 2-10 Statements of Income.............................................. 11 Balance Sheets.................................................... 12 Statements of Capitalization...................................... 13 Statements of Common Stockholder's Equity......................... 14 Statements of Preferred Stock..................................... 14 Statements of Cash Flows.......................................... 15 Statements of Taxes............................................... 16 Notes to Financial Statements..................................... 17-30 Reports of Independent Auditors................................... 31-32
PENNSYLVANIA POWER COMPANY SELECTED FINANCIAL DATA 2003 2002 2001 2000 1999 - --------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Operating Revenues...................... $526,867 $506,407 $498,401 $383,112 $ 329,234 ======== ======== ======== ======== ========== Operating Income........................ $ 47,320 $ 60,922 $ 55,178 $ 39,979 $ 32,063 ======== ======== ======== ======== ========== Income Before Cumulative Effect of Accounting Change................. $ 37,833 $ 47,717 $ 41,041 $ 22,847 $ 12,648 ======== ======== ======== ======== ========== Net Income.............................. $ 48,451 $ 47,717 $ 41,041 $ 22,847 $ 12,648 ======== ======== ======== ======== ========== Earnings on Common Stock................ $ 45,263 $ 44,018 $ 37,338 $ 19,143 $ 8,278 ======== ======== ======== ======== ========== Total Assets............................ $879,379 $907,748 $960,097 $988,909 $1,015,616 ======== ======== ======== ======== ========== CAPITALIZATION AS OF DECEMBER 31: Common Stockholder's Equity............. $230,786 $229,374 $223,788 $213,851 $ 199,608 Preferred Stock- Not Subject to Mandatory Redemption.. 39,105 39,105 39,105 39,105 39,105 Subject to Mandatory Redemption...... -- 13,500 14,250 15,000 15,000 Long-Term Debt.......................... 130,358 185,499 262,047 270,368 274,821 -------- -------- -------- -------- ---------- Total Capitalization.................... $400,249 $467,478 $539,190 $538,324 $ 528,534 ======== ======== ======== ======== ========== CAPITALIZATION RATIOS: Common Stockholder's Equity............. 57.7% 49.1% 41.5% 39.7% 37.8% Preferred Stock- Not Subject to Mandatory Redemption.. 9.8 8.3 7.3 7.3 7.4 Subject to Mandatory Redemption...... -- 2.9 2.6 2.8 2.8 Long-Term Debt.......................... 32.5 39.7 48.6 50.2 52.0 ----- ----- ------ ----- ----- Total Capitalization.................... 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ====== ===== ===== DISTRIBUTION KILOWATT-HOUR DELIVERIES (Millions): Residential............................. 1,506 1,533 1,391 1,387 1,325 Commercial.............................. 1,283 1,268 1,220 1,198 1,105 Industrial.............................. 1,464 1,505 1,540 1,665 1,495 Other................................... 6 6 6 6 6 ----- ----- ----- ----- ----- Total................................... 4,259 4,312 4,157 4,256 3,931 ===== ===== ===== ===== ===== CUSTOMERS SERVED: Residential............................. 137,170 136,410 134,956 121,066 117,440 Commercial.............................. 18,455 18,397 18,153 16,634 16,307 Industrial.............................. 219 220 224 177 175 Other................................... 85 85 87 87 87 ------- ------- ------- ------- ------- Total................................... 155,929 155,112 153,420 137,964 134,009 ======= ======= ======= ======= ======= NUMBER OF EMPLOYEES..................... 201 201 256 275 895
PENNSYLVANIA POWER COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the continuing availability and operation of generating units, the inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage, a denial of or material change to the Company's Application related to its Rate Stabilization Plan, and other similar factors. Results of Operations - --------------------- Earnings on common stock in 2003 increased 2.8% to $45.3 million from $44.0 million in 2002. Earnings in 2003 included an after-tax credit of $10.6 million from the cumulative effect of an accounting change due to the adoption of SFAS 143, "Accounting for Asset Retirement Obligations," (see Note 1(H)). Income before the cumulative effect in 2003 decreased 20.7% to $37.8 million from $47.7 million in 2002. The lower results for 2003 were primarily due to higher nuclear operating costs and purchased power costs. These increased costs were partially offset by higher operating revenues, lower fuel costs and reduced financing costs. Earnings on common stock in 2002 increased 17.9% to $44.0 million from $37.3 million in 2001. The earnings increase in 2002 primarily resulted from increased operating revenues and lower financing costs, which were partially offset by higher operating expenses and taxes and reduced other income. Operating revenues increased by $20.5 million, or 4%, in 2003 as compared to 2002. The higher revenues primarily resulted from increased wholesale revenues of $24.6 million in 2003, along with higher retail generation sales revenues of $2.5 million due to higher unit prices -- partially offset by a 1% decrease in retail kilowatt-hour sales. These electric generation revenue increases were partially offset by $5.1 million of lower revenues from distribution deliveries. Wholesale revenue increases from sales to FirstEnergy Solutions Corp. (FES) reflected higher unit prices, which were partially offset by lower kilowatt-hour sales due to reduced nuclear generation available for sale to FES. Operating revenues increased by $8.0 million, or 1.6%, in 2002 as compared to 2001. The return of customers previously served by alternative generation suppliers contributed to the revenue increase. Retail kilowatt-hour sales increased by 7.8% in 2002 from the prior year, with increases in the residential and commercial sectors contributing to a $15.8 million increase in generation sales revenue. Sales of electric generation by alternative suppliers as a percent of total sales delivered in our franchise area decreased to 0.4% in 2002 from 4.1% in 2001. Distribution deliveries increased 3.7% in 2002 as compared to 2001, which increased revenues from electricity throughput by $3.9 million in 2002 from the prior year. The higher distribution deliveries resulted from additional residential and commercial demand due to warmer summer weather that was offset in part by the effect of continued sluggishness in the economy on demand by industrial customers. Sales revenues from wholesale customers decreased by $14.3 million in 2002 compared to 2001, due to a decline in market prices. Changes in KWH Sales 2003 2002 ------------------------------------------------------------------- Increase (Decrease) Electric Generation: Retail................................ (1.0)% 7.8% Wholesale............................. (11.6)% 12.0% ------------------------------------------------------------------- Total Electric Generation Sales......... (7.4)% 10.3% ================================================================== Distribution Deliveries: Residential........................... (1.8)% 10.2% Commercial and industrial............. (1.0)% 0.5% ------------------------------------------------------------------- Total Distribution Deliveries........... (1.3)% 3.7% ================================================================== 2 Operating Expenses and Taxes Total operating expenses and taxes increased by $34.1 million in 2003 and $2.3 million in 2002 from the prior year. The following table presents changes from the prior year by expense category. Operating Expenses and Taxes - Changes 2003 2002 --------------------------------------------------------------------- Increase (Decrease) (In millions) Fuel.......................................... $(3.7) $ 1.6 Purchased power costs......................... 8.8 5.1 Nuclear operating costs....................... 38.9 (24.6) Other operating costs......................... 2.6 5.4 -------------------------------------------------------------------- Total operation and maintenance expenses.... 46.6 (12.5) Provision for depreciation and amortization... (2.9) (0.3) General taxes................................. (2.0) 10.3 Income taxes.................................. (7.6) 4.8 -------------------------------------------------------------------- Total operating expenses and taxes.......... $34.1 $ 2.3 ===================================================================== Lower fuel costs in 2003, compared with 2002, resulted from reduced nuclear generation. The increased purchased power costs in 2003 reflected higher unit costs and increased kilowatt-hour purchases. Higher nuclear operating costs occurred, in large part, due to the refueling outages at Beaver Valley Unit 1 (65.00% ownership); Perry (5.24% ownership) and Beaver Valley Unit 2 (13.74% ownership) in 2003, compared with one refueling outage at Beaver Valley Unit 2 in 2002. Charges for depreciation and amortization decreased by $2.9 million in 2003 compared to 2002, primarily from lower charges resulting from the implementation of SFAS 143, "Accounting for Asset Retirement Obligations," ($1.4 million for 2003) and revised service life assumptions for nuclear generating plants ($1.2 million for 2003). Higher fuel and purchased power costs in 2002 compared with 2001, resulted from a $4.2 million increase in power purchased from FES, reflecting higher kilowatt-hours purchased due to increased kilowatt-hour sales and lower unit prices. Nuclear operating costs decreased $24.6 million, primarily due to one less refueling outage in 2002 compared to 2001. The $5.4 million increase in other operating costs resulted principally from higher employee benefit costs. General taxes decreased $2 million in 2003 from 2002 principally due to settled property tax claims. General taxes increased by $10.3 million in 2002 from 2001 as a result of additional property taxes and gross receipt taxes. Net Interest Charges Net interest charges continued to trend lower, decreasing by $2.8 million in 2003 and by $2.2 million in 2002, compared to the prior year. We continued to redeem and refinance outstanding debt, with 2003 redemptions totaling $41.7 million (including mandatorily redeemable preferred stock). These redemptions will result in annualized savings of approximately $3.2 million. Cumulative Effect of Accounting Change Results for 2003 include an after-tax credit to net income of $10.6 million recorded upon the adoption of SFAS 143 in January 2003. We identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond at the Bruce Mansfield Plant. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $78 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $9 million. The ARO liability at the date of adoption was $121 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, we had recorded decommissioning liabilities of $120 million. We expect substantially all of its nuclear decommissioning costs to be recoverable in rates over time. Therefore, it recognized a regulatory liability of $69 million upon adoption of SFAS 143 for the transition amounts related to establishing the ARO for nuclear decommissioning. The remaining cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was an $18.2 million increase to income, or $10.6 million net of income taxes. Capital Resources and Liquidity - ------------------------------- Through net debt and preferred stock redemptions, we continue to reduce the cost of debt and preferred stock, and improve our financial position in 2003. During 2003, we reduced our total outstanding debt by approximately $30.5 million. Preferred stock subject to mandatory redemption is now classified as debt under SFAS 150. 3 Changes in Cash Position As of December 31, 2003, we had $40,000 of cash and cash equivalents, compared with $1.2 million as of December 31, 2002. The major sources for changes in these balances are summarized below. Cash Flows From Operating Activities Our net cash from operating activities is provided by our regulated energy services. Net cash provided from operating activities was $129 million in 2003, $106 million in 2002 and $93 million in 2001. Cash provided from 2003, 2002 and 2001 operating activities are as follows: Operating Cash Flows 2003 2002 2001 ------------------------------------------------------------- (In millions) Cash earnings (1)............. $ 98.8 $115.8 $101.6 Working capital and other..... 29.7 (10.0) (8.3) ------------------------------------------------------------- Total......................... $128.5 $105.8 $ 93.3 ============================================================= (1) Includes net income, depreciation and amortization, deferred income taxes, investment tax credits and major noncash charges. Net cash from operating activities increased to $129 million in 2003 compared with $106 million in 2002 due to a $40 million reduction in working capital and other requirements partially offset by a $17 million decrease in cash earnings. Cash Flows From Financing Activities In 2003 and 2002, the net cash used for financing activities of $76 million and $75 million, respectively, primarily reflects the redemptions of debt and preferred stock shown below and dividend payments. The following table provides details regarding new issues and redemptions during 2003 and 2002: Securities Issued or Redeemed 2003 2002 ------------------------------------------------------------- (In millions) New Issues ---------- Pollution Control Notes.............. $ -- $14.5 Short-Term Borrowings, Net........... 11.3 -- Redemptions ----------- First Mortgage Bonds................. 41.0 1.0 Pollution Control Notes.............. -- 14.5 Capital Fuel Leases.................. -- 40.7 Preferred Stock...................... 0.8 0.8 Other, principally redemption premiums........................... 0.1 0.6 -------------------------------------------------------------- $41.9 $57.6 In 2001, net cash flow used for financing activities totaled $51 million, primarily due to long-term debt redemptions and $31 million of dividend payments. We had about $0.4 million of cash and temporary investments and short-term indebtedness of $11.3 million as of December 31, 2003. At the end of 2003, we had the capability to issue $451 million of additional first mortgage bonds on the basis of property additions and retired bonds. Based upon applicable earnings in 2003 under the earnings coverage test contained in our charter, we could issue $244 million of preferred stock (assuming no additional debt was issued). We have the ability to borrow from our regulated affiliates and FirstEnergy to meet our short-term working capital requirements. FirstEnergy Service Company administers this money pool and tracks surplus funds of FirstEnergy and the respective regulated subsidiaries. Companies receiving a loan under the money pool agreements must repay the principal, together with accrued interest, within 364 days of borrowing the funds. The rate of interest is the same for each company receiving a loan from the pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47%. Our access to capital markets and costs of financing are dependent on the ratings of our securities, OE and FirstEnergy. The following table shows securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. 4 Ratings of Securities - ----------------------------------------------------------------------------- Securities S&P Moody's Fitch - ----------------------------------------------------------------------------- FirstEnergy Senior unsecured BB+ Baa3 BBB- OE Senior secured BBB Baa1 BBB+ Senior unsecured BB+ Baa2 BBB Preferred stock BB Ba1 BBB- Penn Senior secured BBB- Baa1 BBB+ Senior unsecured (1) BB+ Baa2 BBB Preferred stock BB Ba1 BBB- - ------------------------------------------------------------------------------ (1) Penn's only senior unsecured debt obligations are pollution control revenue refunding bonds issued in the name of the Ohio Air Quality Development Authority to which this rating applies. On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." In addition, Fitch affirmed the ratings of OE and the Company. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy, and all of the securities of its electric utility operating companies. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." On December 23, 2003, Standard & Poor's (S&P) lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". Except for OE's senior secured issue rating, which was left unchanged, all other subsidiary ratings were lowered one notch as well. The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of FirstEnergy's consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions in FirstEnergy's ratings included uncertainty regarding the timing of the Ohio Rate Plan filing, the pending final report on the August 14 regional outage (see Power Outage), the outcome of the remedial phase of litigation relating to the Sammis plant (see Environmental Matters), and the extended Davis-Besse outage and the related pending subpoena. S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of FirstEnergy's credit ratings in December 2003 triggered cash and letter-of-credit collateral calls in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2. The ratings of OE and the Company were confirmed. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows From Investing Activities Net cash used in investing activities totaled $53.9 million in 2003. The net cash used for investing resulted from increased property additions and nuclear plant decommissioning trust investments partially offset by loan payments from the Company's parent company, OE. Expenditures for property additions include expenditures supporting our distribution of electricity. Net cash used in investing activities totaled $29.3 million in 2002. The net cash used for investing resulted from increased property additions, which were offset in part by loan payments from associated companies. In 2001, net cash used in investing activities totaled $45.9 million, principally due to property additions and loans to associated companies, which were offset in part by sales of assets to associated companies. Our cash requirements in 2004 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without increasing our net debt and preferred stock outstanding. Our capital spending for the period 2004-2006 is expected to be about $143 million (excluding nuclear fuel) of which approximately $64 million applies to 2004. Investments for additional nuclear fuel during the 2004-2006 period are 5 estimated to be approximately $34 million, of which about $20 million relates to 2004. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $35 million and $17 million, respectively, as the nuclear fuel is consumed. We had no other material obligations as of December 31, 2003 that have not been recognized on our Balance Sheet. Contractual Obligations - ----------------------- Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows:
Contractual Obligations Total 2004 2005-2006 2007-2008 Thereafter - ----------------------------------------------------------------------------------------------------------------- (In millions) Long-term debt.................. $211 $63 $ 2 $ 2 $144 Preferred stock (1)............. 14 1 2 11 -- Short-term borrowings........... 11 11 -- -- -- Purchases (2)................... 121 20 30 28 43 - ---------------------------------------------------------------------------------------------------------------- Total........................ $357 $95 $34 $41 $187 ================================================================================================================ (1) Subject to mandatory redemption. (2) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing.
Interest Rate Risk - ------------------ Our exposure to fluctuations in market interest rates is reduced since a significant portion of our debt has fixed interest rates, as noted in the following table. The table below presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio, debt obligations and preferred stock with mandatory redemption provisions.
Comparison of Carrying Value to Fair Value - ------------------------------------------------------------------------------------------------------------------ There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - ------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets Investments Other Than Cash and Cash Equivalents- Fixed Income............... $6 $ 1 $1 $116 $124 $130 Average interest rate...... 7.8% 7.8% 7.8% 5.5% 5.6% __________________________________________________________________________________________________________________ Liabilities - ------------------------------------------------------------------------------------------------------------------ Long-term Debt and Other Long-Term Obligations: Fixed rate.................... $63 $1 $1 $ 1 $1 $ 82 $149 $166 Average interest rate ..... 7.4% 9.7% 9.7% 9.7% 9.7% 6.5% 7.0% Variable rate................. $ 62 $ 62 $ 62 Average interest rate...... 1.8% 1.8% Preferred Stock Subject to Mandatory Redemption....... $ 1 $1 $1 $11 $ 14 $ 14 Average dividend rate...... 7.6% 7.6% 7.6% 7.6% 7.6% Short-term Borrowings......... $11 $ 11 $ 11 Average interest rate...... 1.7% 1.7% - -------------------------------------------------------------------------------------------------------------------
Equity Price Risk - ----------------- Included in our nuclear decommissioning trust investments are marketable equity securities carried at their market value of approximately $50 million and $38 million as of December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges would result in a $5 million reduction in fair value as of December 31, 2003 (see Note 1(K) - Cash and Financial Instruments). Outlook - ------- We have a continuing responsibility to provide power to those customers not choosing to receive power from an alternative energy supplier subject to certain limits. Adopting new approaches to regulation and experiencing new forms of competition have created new uncertainties. We continue to deliver power to homes and businesses through our existing distribution system, which remains regulated. 6 Regulatory Matters- In late 2003, the Pennsylvania Public Utility Commission (PPUC) issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. We are currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of our levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August 2004 in this investigation and the Administrative Law Judge has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. We are unable to predict the outcome of the investigation or the impact of the PPUC Order. Environmental Matters We believe we are in compliance with the current sulfur dioxide (SO2) and nitrogen oxide (NOx) reduction requirements under the Clean Air Act Amendments of 1990. In 1998, the Environmental Protection Agency (EPA) finalized regulations requiring additional NOx reductions in the future from our Ohio and Pennsylvania facilities. Various regulatory and judicial actions have since sought to further define NOx reduction requirements (see Note 5(C) - Environmental Matters). We continue to evaluate our compliance plans and other compliance options. Clean Air Act Compliance Violations of federally approved SO2 regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. We cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. W. H. Sammis Plant In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a Compliance Order to nine utilities covering 44 power plants, including the W. H. Sammis Plant. In addition, the U.S. Department of Justice filed eight civil complaints against various investor-owned utilities, which included a complaint against OE and Penn in the U.S. District Court for the Southern District of Ohio. The NOV and complaint allege violations of the Clean Air Act based on operation and maintenance of the W. H. Sammis Plant dating back to 1984. The complaint requests permanent injunctive relief to require the installation of "best available control technology" and civil penalties of up to $27,500 per day of violation. On August 7, 2003, the United States District Court for the Southern District of Ohio ruled that 11 projects undertaken at the W. H. Sammis Plant between 1984 and 1998 required pre-construction permits under the Clean Air Act. The ruling concludes the liability phase of the case, which deals with applicability of Prevention of Significant Deterioration provisions of the Clean Air Act. The remedy phase, which is currently scheduled to be ready for trial beginning July 19, 2004, will address civil penalties and what, if any, actions should be taken to further reduce emissions at the plant. In the ruling, the Court indicated that the remedies it "may consider and impose involved a much broader, equitable analysis, requiring the Court to consider air quality, public health, economic impact, and employment consequences. The Court may also consider the less than consistent efforts of the EPA to apply and further enforce the Clean Air Act." The potential penalties that may be imposed, as well as the capital expenditures necessary to comply with substantive remedial measures that may be required, could have a material adverse impact on the Company's financial condition and results of operations. Management is unable to predict the ultimate outcome of this matter and no liability has been accrued as of December 31, 2003. Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. 7 Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. We cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Company is lower than many regional competitors due to the Company's diversified generation sources which includes the low or non-CO2 emitting gas-fired and nuclear generators. Power Outage On August 14, 2003, various states in the northeast United States and part of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest ISO and PJM Interconnection) to provide effective diagnostic support. We believe that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which are described above. Critical Accounting Policies - ---------------------------- We prepare our financial statements in accordance with accounting principles that are generally accepted in the United States. Application of these principles often requires a high degree of judgment, estimates and assumptions that affect our financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting those specific factors. Our more significant accounting policies are described below. Regulatory Accounting We are subject to regulation that sets the prices (rates) we are permitted to charge our customers based on our costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. We continually review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for kilowatt-hours that have been delivered but not yet been billed through the end of the year. The determination of unbilled revenues requires management to make various estimates including: 8 o Net energy generated or purchased for retail load o Losses of energy over distribution lines o Allocations to distribution companies within the FirstEnergy system o Mix of Kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers Pension and Other Postretirement Benefits Accounting FirstEnergy's reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions are dependent upon numerous factors resulting from actual plan experience and certain assumptions. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions we make to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, reduced FirstEnergy's obligation by $123 million and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, FirstEnergy reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. FirstEnergy's assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by our pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. FirstEnergy's pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and FirstEnergy's pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, our accrued pension costs as of June 30, 2003 increased by $16 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $16 million, recording an increase of $2 million in an intangible asset and crediting OCI by $11 million (offsetting previously recorded deferred tax benefits by $7 million). The remaining balance in OCI of $12 million will reverse in future periods to the extent the accumulated benefit obligation exceeds the fair value of trust assets. The accrued pension cost was reduced to $15 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, FirstEnergy will not be required to fund its pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. FirstEnergy's pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President 9 Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 1(I)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining FirstEnergy's trend rate assumptions, FirstEnergy included the specific provisions of its health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in its health care plans, and projections of future medical trend rates. The effect on FirstEnergy's pension and OPEB costs and liabilities from changes in key assumptions are as follows:
Increase in Costs from Adverse Changes in Key Assumptions - ----------------------------------------------------------------------------------------------- Assumption Adverse Change Pension OPEB Total - ----------------------------------------------------------------------------------------------- (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 5 $ 15 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% na $26 $ 26 Increase in Minimum Liability - ----------------------------- Discount rate................ Decrease by 0.25% $104 na $104 - ----------------------------------------------------------------------------------------------
Long-Lived Assets In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. Nuclear Decommissioning In accordance with SFAS 143, we recognize an ARO for the future decommissioning of our nuclear power plants. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. The scenarios consider settlement of the ARO at the expiration of the nuclear power plants' current license and settlement based on an extended license term. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS ADOPTED SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, Penn implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(E) and 1(H) for further discussions of SFAS 143. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, certain financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, we reclassified as debt our preferred stock subject to mandatory redemption with a carrying value of approximately $14 million as of December 31, 2003. Dividends on preferred stock subject to mandatory redemption on our Statements of Income, which were not included in net interest charges prior to the adoption of SFAS 150, are now included in net interest charges for the six months ended December 31, 2003. 10
PENNSYLVANIA POWER COMPANY STATEMENTS OF INCOME For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------- (In thousands) OPERATING REVENUES (Note 1(J))............................................ $526,867 $506,407 $498,401 -------- -------- -------- OPERATING EXPENSES AND TAXES: Fuel and purchased power (Note 1(J))................................... 187,086 181,968 175,257 Nuclear operating costs................................................ 128,896 90,024 114,623 Other operating costs (Note 1(J))...................................... 53,137 50,523 45,133 -------- -------- -------- Total operation and maintenance expenses............................. 369,119 322,515 335,013 Provision for depreciation and amortization............................ 53,806 56,763 57,087 General taxes.......................................................... 22,458 24,474 14,214 Income taxes........................................................... 34,164 41,733 36,909 -------- -------- -------- Total operating expenses and taxes................................... 479,547 445,485 443,223 -------- -------- -------- OPERATING INCOME.......................................................... 47,320 60,922 55,178 OTHER INCOME (Note 1(J)).................................................. 2,850 1,960 3,185 -------- -------- -------- INCOME BEFORE NET INTEREST CHARGES........................................ 50,170 62,882 58,363 -------- -------- -------- NET INTEREST CHARGES: Interest on long-term debt............................................. 14,228 15,521 16,971 Allowance for borrowed funds used during construction.................. (3,189) (1,509) (850) Other interest expense................................................. 1,298 1,153 1,201 -------- -------- -------- Net interest charges................................................. 12,337 15,165 17,322 -------- -------- -------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE...................... 37,833 47,717 41,041 Cumulative effect of accounting change (net of income taxes of $7,532,000) (Note 1(H))............................................................ 10,618 -- -- -------- -------- -------- NET INCOME................................................................ 48,451 47,717 41,041 PREFERRED STOCK DIVIDEND REQUIREMENTS..................................... 3,188 3,699 3,703 -------- -------- -------- EARNINGS ON COMMON STOCK.................................................. $ 45,263 $ 44,018 $ 37,338 ======== ======== ======== The accompanying Notes to Financial Statements are an integral part of these statements.
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PENNSYLVANIA POWER COMPANY BALANCE SHEETS As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------- (In thousands) ASSETS UTILITY PLANT: In service...................................................................... $808,637 $680,729 Less-Accumulated provision for depreciation..................................... 324,710 310,423 -------- -------- 483,927 370,306 -------- -------- Construction work in progress- Electric plant............................................................... 68,091 44,696 Nuclear fuel................................................................. 360 8,812 -------- -------- 68,451 53,508 -------- -------- 552,378 423,814 -------- -------- OTHER PROPERTY AND INVESTMENTS: Nuclear plant decommissioning trusts (Note 1(K))................................ 133,867 119,401 Long-term notes receivable from associated companies............................ 39,179 38,921 Other........................................................................... 2,195 2,569 -------- -------- 175,241 160,891 -------- -------- CURRENT ASSETS: Cash and cash equivalents....................................................... 40 1,222 Notes receivable from associated companies...................................... 399 35,317 Receivables- Customers (less accumulated provisions of $769,000 and $702,000, respectively, for uncollectible accounts).................................. 44,861 44,341 Associated companies......................................................... 24,965 42,652 Other........................................................................ 1,047 5,262 Materials and supplies, at average cost......................................... 33,918 30,309 Prepayments..................................................................... 9,383 5,346 -------- -------- 114,613 164,449 -------- -------- NONCURRENT LIABILITIES: Regulatory assets............................................................... 27,513 150,902 Other........................................................................... 9,634 7,692 -------- -------- 37,147 158,594 -------- -------- $879,379 $907,748 ======== ======== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Statements of Capitalization): Common stockholder's equity..................................................... $230,786 $229,374 Preferred stock- Not subject to mandatory redemption........................................ 39,105 39,105 Subject to mandatory redemption (Note 3(E))................................ -- 13,500 Long-term debt and other long-term obligations- Preferred stock subject to mandatory redemption (Note 3(E))................ 12,750 -- Other...................................................................... 117,608 185,499 -------- -------- 400,249 467,478 -------- -------- CURRENT LIABILITIES: Currently payable long-term debt and preferred stock............................ 93,474 66,556 Accounts payable- Associated companies......................................................... 40,172 52,653 Other........................................................................ 1,294 5,730 Notes payable to associated companies........................................... 11,334 -- Accrued taxes................................................................... 27,091 12,507 Accrued interest................................................................ 4,396 5,558 Other........................................................................... 8,444 10,479 -------- -------- 186,205 153,483 -------- -------- NONCURRENT LIABILITIES: Accumulated deferred income taxes............................................... 97,871 117,385 Accumulated deferred investment tax credits..................................... 3,516 3,810 Asset retirement obligation..................................................... 129,546 -- Nuclear plant decommissioning costs............................................. -- 119,863 Retirement benefits............................................................. 54,057 38,198 Other........................................................................... 7,935 7,531 -------- -------- 292,925 286,787 -------- -------- COMMITMENTS AND CONTINGENCIES (Notes 2 and 5)....................... -------- -------- $879,379 $907,748 ======== ======== The accompanying Notes to Financial Statements are an integral part of these balance sheets.
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PENNSYLVANIA POWER COMPANY STATEMENTS OF CAPITALIZATION As of December 31, 2003 2002 - ----------------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDER'S EQUITY: Common stock, $30 par value, 6,500,000 shares authorized, 6,290,000 shares outstanding $188,700 $188,700 Other paid-in capital................................................................ (310) (310) Accumulated other comprehensive loss (Note 3(F))..................................... (11,783) (9,932) Retained earnings (Note 3(A))........................................................ 54,179 50,916 -------- -------- Total common stockholder's equity.................................................. 230,786 229,374 -------- -------- Number of Shares Optional Outstanding Redemption Price ---------------- ---------------- 2003 2002 Per Share Aggregate ---- ---- --------- --------- PREFERRED STOCK (Note 3(C)): Cumulative, $100 par value- Authorized 1,200,000 shares Not Subject to Mandatory Redemption: 4.24%................................ 40,000 40,000 $103.13 $ 4,125 4,000 4,000 4.25%................................ 41,049 41,049 105.00 4,310 4,105 4,105 4.64%................................ 60,000 60,000 102.98 6,179 6,000 6,000 7.75%................................ 250,000 250,000 100.00 25,000 25,000 25,000 ------- ------- ------- -------- -------- Total not subject to mandatory redemption....................... 391,049 391,049 $39,614 39,105 39,105 ======= ======= ======= -------- -------- Subject to Mandatory Redemption (Note 3(E)): 7.625%**............................. -- 142,500 -- 14,250 Redemption Within One Year**........... -- -- (750) ------- ------- -------- -------- Total subject to mandatory redemption -- 142,500 -- 13,500 ======= ======= -------- -------- LONG-TERM DEBT (Note 3(D)): First mortgage bonds- 9.740% due 2004-2019..................................................................... 15,617 16,591 7.500% due 2003.......................................................................... -- 40,000 6.375% due 2004.......................................................................... 20,500 20,500 6.625% due 2004.......................................................................... 14,000 14,000 8.500% due 2022.......................................................................... 27,250 27,250 7.625% due 2023.......................................................................... 6,500 6,500 -------- -------- Total first mortgage bonds............................................................. 83,867 124,841 -------- -------- Secured notes- 5.400% due 2013.......................................................................... 1,000 1,000 5.400% due 2017.......................................................................... 10,600 10,600 *1.100% due 2017.......................................................................... 17,925 17,925 5.900% due 2018.......................................................................... 16,800 16,800 *1.100% due 2021.......................................................................... 14,482 14,482 6.150% due 2023.......................................................................... 12,700 12,700 *1.200% due 2027.......................................................................... 10,300 10,300 5.375% due 2028.......................................................................... 1,734 1,734 5.450% due 2028.......................................................................... 6,950 6,950 6.000% due 2028.......................................................................... 14,250 14,250 5.950% due 2029.......................................................................... 238 238 -------- -------- Total secured notes.................................................................... 106,979 106,979 -------- -------- Unsecured notes- *2.500% due 2029.......................................................................... 14,500 14,500 *5.900% due 2033.......................................................................... 5,200 5,200 -------- -------- Total unsecured notes.................................................................. 19,700 19,700 -------- -------- Preferred stock subject to mandatory redemption**.......................................... 13,500 -- -------- -------- Capital leases obligations (Note 2)........................................................ -- 32 -------- -------- Net unamortized discount on debt........................................................... (214) (247) -------- -------- Long-term debt due within one year**....................................................... (93,474) (65,806) -------- -------- Total long-term debt**................................................................. 130,358 185,499 -------- -------- TOTAL CAPITALIZATION.......................................................................... $400,249 $467,478 ======== ======== * Denotes variable rate issue with December 31, 2003 interest rate shown. ** The December 31, 2003 balance for preferred stock subject to mandatory redemption is classified as debt under SFAS 150. The accompanying Notes to Financial Statements are an integral part of these statements.
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PENNSYLVANIA POWER COMPANY STATEMENTS OF COMMON STOCKHOLDER'S EQUITY Accumulated Other Other Comprehensive Number Par Paid-In Comprehensive Retained Income of Shares Value Capital Income (Loss) Earnings ------------- --------- ----- ------- ------------- -------- (Dollars in thousands) Balance, January 1, 2001............. 6,290,000 $188,700 $(310) $ -- $ 25,461 Net income........................ $41,041 41,041 ======= Cash dividends on common stock.... (27,400) Cash dividends on preferred stock. (3,704) - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001........... 6,290,000 188,700 (310) -- 35,398 Net income........................ $47,717 47,717 Minimum liability for unfunded retirement benefits, net of $(7,045,000) of income taxes.... (9,932) (9,932) ------- Comprehensive income.............. $37,785 ======= Cash dividends on preferred stock. (3,699) Cash dividends on common stock.... (28,500) - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002........... 6,290,000 188,700 (310) (9,932) 50,916 Net income........................ $48,451 48,451 Minimum liability for unfunded retirement benefits, net of $(1,290,000) of income taxes.... (1,851) (1,851) ------- Comprehensive income.............. $46,600 ======= Cash dividends on preferred stock. (3,188) Cash dividends on common stock.... (42,000) - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003........... 6,290,000 $188,700 $(310) $(11,783) $ 54,179 =====================================================================================================================
STATEMENTS OF PREFERRED STOCK Not Subject to Subject to Mandatory Redemption Mandatory Redemption -------------------- -------------------- Number Par Number Par of Shares Value of Shares Value --------- ----- --------- ----- (Dollars in thousands) Balance, January 1, 2001.......... 391,049 $39,105 150,000 $15,000 ------------------------------------------------------------------------------------------ Balance, December 31, 2001........ 391,049 39,105 150,000 15,000 Redemptions- 7.625% Series.................. (7,500) (750) ------------------------------------------------------------------------------------------ Balance, December 31, 2002........ 391,049 39,105 142,500 14,250 Redemptions- 7.625% Series.................. (7,500) (750) ------------------------------------------------------------------------------------------ Balance, December 31, 2003........ 391,049 $39,105 135,000 $13,500* ========================================================================================== * December 31, 2003 balance for preferred stock subject to mandatory redemption is classified as debt under SFAS 150 (see Note 6). The accompanying Notes to Financial Statements are an integral part of these statements.
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PENNSYLVANIA POWER COMPANY STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................................ $ 48,451 $ 47,717 $ 41,041 Adjustments to reconcile net income to net cash from operating activities: Provision for depreciation and amortization........................ 53,806 56,763 57,087 Nuclear fuel and lease amortization................................ 15,947 19,204 17,323 Deferred income taxes, net......................................... (2,816) (5,337) (11,055) Amortization of investment tax credits............................. (2,412) (2,595) (2,775) Cumulative effect of accounting change (Note 1(H))................. (18,150) -- -- Receivables........................................................ 16,276 (8,434) 8,345 Materials and supplies............................................. (3,609) (4,711) 3,997 Accounts payable................................................... (11,163) 6,338 (11,413) Accrued taxes...................................................... 14,584 (6,346) (397) Accrued interest................................................... (1,162) 294 (708) Prepayments and other current assets............................... (4,037) 336 (3,638) Asset retirement obligation, net................................... 16,983 -- -- Other.............................................................. 5,814 2,533 (4,522) -------- -------- -------- Net cash provided from operating activities...................... 128,512 105,762 93,285 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Long-term debt..................................................... -- 14,500 31,626 Short-term borrowings, net......................................... 11,334 -- -- Redemptions and Repayments- Preferred stock.................................................... (750) (750) -- Long-term debt..................................................... (41,155) (56,837) (51,351) Dividend Payments- Common stock....................................................... (42,000) (28,500) (27,400) Preferred stock.................................................... (3,188) (3,699) (3,704) -------- -------- -------- Net cash used for financing activities........................... (75,759) (75,286) (50,829) -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Property additions.................................................... (70,864) (46,060) (40,529) Contributions to nuclear decommissioning trusts....................... (1,594) (1,594) (1,595) Loans from (to) associated companies, net............................. 34,660 19,463 (18,856) Sale of assets to associated companies................................ -- -- 6,053 Other................................................................. (16,137) (1,130) 9,063 -------- -------- -------- Net cash used for investing activities........................... (53,935) (29,321) (45,864) -------- -------- -------- Net increase (decrease) in cash and cash equivalents.................. (1,182) 1,155 (3,408) Cash and cash equivalents at beginning of year........................ 1,222 67 3,475 -------- -------- -------- Cash and cash equivalents at end of year............................. $ 40 $ 1,222 $ 67 ======== ======== ======== SUPPLEMENTAL CASH FLOWS INFORMATION: Cash paid during the year- Interest (net of amounts capitalized).............................. $ 12,449 $ 13,771 $ 19,286 ======== ======== ======== Income taxes....................................................... $ 33,502 $ 60,078 $ 53,527 ======== ======== ======== The accompanying Notes to Financial Statements are an integral part of these statements.
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PENNSYLVANIA POWER COMPANY STATEMENTS OF TAXES For the Years Ended December 31, 2003 2002 2001 - ------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: State gross receipts*................................................ $ 18,028 $ 18,516 $ 12,776 Real and personal property........................................... 2,262 3,729 59 State capital stock.................................................. 952 1,357 1,081 Social security and unemployment..................................... 878 750 201 Other................................................................ 338 122 97 -------- -------- -------- Total general taxes............................................. $ 22,458 $ 24,474 $ 14,214 ======== ======== ======== PROVISION FOR INCOME TAXES: Currently payable- Federal........................................................... $ 37,351 $ 38,972 $ 40,948 State............................................................. 11,368 12,004 12,803 -------- -------- -------- 48,719 50,976 53,751 -------- -------- -------- Deferred, net- Federal........................................................... (2,424) (4,144) (8,304) State............................................................. (392) (1,193) (2,751) -------- -------- -------- (2,816) (5,337) (11,055) -------- -------- -------- Investment tax credit amortization................................... (2,412) (2,595) (2,775) -------- -------- -------- Total provision for income taxes................................ $ 43,491 $ 43,044 $ 39,921 ======== ======== ======== INCOME STATEMENT CLASSIFICATION OF PROVISION FOR INCOME TAXES: Operating expenses................................................... $ 34,164 $ 41,733 $ 36,909 Other income......................................................... 1,795 1,311 3,012 Cumulative effect of accounting change............................... 7,532 -- -- -------- -------- -------- Total provision for income taxes................................ $ 43,491 $ 43,044 $ 39,921 ======== ======== ======== RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes........................ $ 91,942 $ 90,761 $ 80,962 ======== ======== ======== Federal income tax expense at statutory rate......................... $ 32,180 $ 31,766 $ 28,337 Increases (reductions) in taxes resulting from: State income taxes, net of federal income tax benefit............. 7,134 7,027 6,534 Amortization of investment tax credits............................ (2,412) (2,595) (2,775) Amortization of tax regulatory assets............................. 5,616 5,967 6,315 Other, net........................................................ 973 879 1,510 -------- -------- -------- Total provision for income taxes................................ $ 43,491 $ 43,044 $ 39,921 ======== ======== ======== ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: Competitive transition charge........................................ $ 37,280 $ 56,172 $ 75,686 Property basis differences........................................... 77,147 72,488 65,534 Allowance for equity funds used during construction.................. -- 1,045 2,608 Customer receivables for future income taxes......................... 2,860 4,249 5,640 Unamortized investment tax credits................................... (1,457) (1,578) (1,702) Deferred gain for asset sale to affiliated company................... 8,106 8,810 9,943 Other comprehensive income........................................... (8,335) (7,045) -- Other................................................................ (17,730) (16,756) (20,901) -------- -------- -------- Net deferred income tax liability............................... $ 97,871 $117,385 $136,808 ======== ======== ======== * Collected from customers through regulated rates and included in revenue on the Statements of Income. The accompanying Notes to Financial Statements are an integral part of these statements.
16 NOTES TO FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Pennsylvania Power Company (Company), a wholly owned subsidiary of Ohio Edison Company (OE), follows the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy Regulatory Commission (FERC). OE is a wholly owned subsidiary of FirstEnergy Corp. The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. Certain prior year amounts have been reclassified to conform with the current year presentation, as described further in Note 1(E). (A) REVENUES- The Company's principal business is providing electric service to customers in western Pennsylvania. The Company's retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. Receivables from customers include sales to residential, commercial and industrial customers located in the Company's service area and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of the Company's customers. Total customer receivables were $45 million (billed - $29 million and unbilled - $16 million) and $44 million (billed - $25 million and unbilled - $19 million) as of December 31, 2003 and 2002, respectively. (B) REGULATORY MATTERS- Pennsylvania enacted its electric utility competition law in 1996 with the phase in of customer choice for electric generation suppliers completed as of January 1, 2001. The Company continues to deliver power to homes and businesses through its distribution system, which remains regulated by the PPUC. The Company's rates have been restructured to itemize (unbundle) the current price of electricity into its component elements - including generation, transmission, distribution and stranded cost recovery. In the event customers obtain power from an alternative source, the generation portion of the Company's rates is excluded from their bill and the customers receive a generation charge from the alternative supplier. The stranded cost recovery portion of rates provides for recovery of certain amounts not otherwise considered recoverable in a competitive generation market, including regulatory assets. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. The Company is currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of the Company's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the Administrative Law Judge has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. The Company is unable to predict the outcome of the investigation or the impact of the PPUC Order. Regulatory Assets- The Company recognizes, as regulatory assets, costs which the FERC and PPUC have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are expected to continue to be recovered from customers under the Company's rate restructuring plan. Based on the rate restructuring plan, the Company continues to bill and collect cost-based rates relating to the Company's nongeneration operations and continues the application of Statement of Financial Accounting Standards No. (SFAS) 71, "Accounting for the Effects of Certain Types of Regulation" to these operations. 17 Net regulatory assets on the Balance Sheets are comprised of the following: 2003 2002 - ----------------------------------------------------------------------------- (In millions) Competitive transition charge.................. $ 90 $136 Customer receivables for future income taxes... 7 10 Loss on reacquired debt........................ 6 7 Employee postretirement benefit costs.......... 2 3 Nuclear decommissioning costs.................. (72) -- Component removal costs........................ (6) (6) Other.......................................... 1 1 - --------------------------------------------------------------------------- Total..................................... $ 28 $151 =========================================================================== Regulatory Accounting Generation Operations- In 1998, the PPUC authorized the Company's rate restructuring plan, which essentially resulted in the deregulation of the Company's generation business. The Company was required to remove from its balance sheet all regulatory assets and liabilities related to its generation business and assess all other assets for impairment. The SEC issued interpretive guidance regarding asset impairment measurement providing that any supplemental regulated cash flows such as a competitive transition charge (CTC) should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. Consistent with the SEC guidance, the Company reduced its nuclear generating unit investments by approximately $305 million, of which approximately $227 million was recognized as a regulatory asset to be recovered through the CTC over a seven-year transition period; the remaining net amount of $78 million was written off. The Company is entitled to recover $236 million of stranded costs through the CTC that began in 1999 and ends in 2006. The Company's net assets included in utility plant relating to the operations for which the application of SFAS 71 was discontinued were $92 million as of December 31, 2003. (C) UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction (except for nuclear generating units which were adjusted to fair value), including payroll and related costs such as taxes, employee benefits, administrative and general costs, and interest costs incurred to place the assets in service. The Company's accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. The Company provides for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The annual composite rate for electric plant was approximately 2.6% in 2003 and 2.9% in 2002 and 2001. Nuclear Fuel- Nuclear fuel is recorded at original cost, which includes material, enrichment, fabrication and interest costs incurred prior to reactor load. The Company amortizes the cost of nuclear fuel based on the rate of consumption. (D) COMMON OWNERSHIP OF GENERATING FACILITIES- The Company, together with OE and other affiliated companies, The Cleveland Electric Illuminating Company (CEI) and The Toledo Edison Company (TE), own, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Company's portion of operating expenses associated with jointly owned facilities is included in the corresponding operating expenses on the Statements of Income. The amounts reflected on the Balance Sheet under utility plant as of December 31, 2003 include the following:
Utility Accumulated Construction Company's Plant in Provision for Work in Ownership Generating Units Service Depreciation Progress Interest ------------------------------------------------------------------------------------------------------- (In millions) W. H. Sammis #7....................... $ 64 $ 22 $-- 20.80% Bruce Mansfield #1, #2 and #3....................... 187 100 -- 16.38% Beaver Valley #1 and #2............... 139 24 59 39.37% Perry #1.............................. 8 2 1 5.24% ------------------------------------------------------------------------------------------------------- Total............................. $398 $148 $60 =======================================================================================================
18 (E) ASSET RETIREMENT OBLIGATION- In January 2003, the Company implemented SFAS 143, "Accounting for Asset Retirement Obligations," which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. The Company identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond related to the Bruce Mansfield Plant. The ARO liability as of the date of adoption of SFAS 143 was $121.3 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. Accretion during 2003 was $8.2 million, bringing the ARO liability as of December 31, 2003 to $129.5 million. The ARO includes the Company's obligation for nuclear decommissioning of the Beaver Valley and Perry generating facilities. The Company's share of the obligation to decommission these units was developed based on site-specific studies performed by an independent engineer. The Company utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Company maintains nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $133.9 million. In accordance with SFAS 143, the Company ceased the accounting practice of depreciating non-regulated generation assets using a cost of removal component in the depreciation rates. That practice recognized accumulated depreciation in excess of the historical cost of an asset because the removal cost would exceed the estimated salvage value. Beginning in 2003, the cost of removal related to non-regulated generation assets is charged to expense rather than to the accumulated provision for depreciation. In accordance with SFAS 71, the cost of removal on regulated plant assets continues to be accounted for as a component of depreciation rates and is recognized as a regulatory liability. The following table provides the year-end balance of the ARO for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 - ------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002 $113.7 Accretion in 2002 7.6 - ------------------------------------------------------ Ending balance as of December 31, 2002 $121.3 - ------------------------------------------------------ (F) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 3(B)). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date resulting in substantially no intrinsic value. If FirstEnergy had accounted for employee stock options under the fair value method of SFAS 123, "Accounting for Stock Compensation," a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 - ---------------------------------------------------------------------------- Valuation assumptions: Expected option term (years). 7.9 8.1 8.3 Expected volatility.......... 26.91% 23.31% 23.45% Expected dividend yield...... 5.09% 4.36% 5.00% Risk-free interest rate...... 3.67% 4.60% 4.67% Fair value per option.......... $5.09 $6.45 $4.97 - ---------------------------------------------------------------------------- The effects of applying fair value accounting to FirstEnergy's stock options would not materially affect the Company's net income. 19 (G) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. The Company is included in FirstEnergy's consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with the Company recognizing any tax losses or credits it contributed to the consolidated return. (H) CUMULATIVE EFFECT OF ACCOUNTING CHANGE Results for 2003 include an after-tax credit to net income of $10.6 million recorded upon the adoption of SFAS 143 in January 2003. The Company identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning and reclamation of a sludge disposal pond at the Bruce Mansfield Plant. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $78 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $9 million. The ARO liability at the date of adoption was $121 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, the Company had recorded decommissioning liabilities of $120 million. The Company expects substantially all of its nuclear decommissioning costs to be recoverable in rates over time. Therefore, it recognized a regulatory liability of $69 million upon adoption of SFAS 143 for the transition amounts related to establishing the ARO for nuclear decommissioning. The remaining cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was an $18.2 million increase to income, or $10.6 million net of income taxes. If SFAS 143 had been applied during 2002 and 2001, the impact would not have been material to the Company's Statements of Income. (I) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of the Company's employees. The trusteed plans provide defined benefits based on years of service and compensation levels. FirstEnergy's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company recognizes the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 million and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. 20 The following sets forth the funded status of the plans and amounts recognized on FirstEnergy's Consolidated Balance Sheets as of December 31:
Obligations and Funded Status Pension Benefits Other Benefits ------------------- ------------------ As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $ 1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition.......................... -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------- Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $ 2,077 ====== ====== ======= ======= Change in fair value of plan assets Fair value of plan assets at beginning of year...................... $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------- Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ======= Funded status............................ $ (847) $ (977) $(1,831) $(1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit)............................... 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ ------- ------- Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Amounts Recognized in the Consolidated Balance Sheets Pension Benefits Other Benefits ----------------- ------------------ As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ Accrued benefit cost..................... $ (438) $ (548) $ (975) $ (867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ------ ------ ------- ------- Net amount recognized.................... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Company's share of net amount recognized. $ 10 $ 9 $ (39) $ (26) ====== ====== ======= ======= Increase (decrease) in minimum liability included in other comprehensive income (net of tax)........................... $ (145) $ 444 $ -- $ -- Weighted-Average Assumptions Used to Determine Benefit Obligations As of December 31 ---------------------------------------- Discount rate........................... 6.25% 6.75% 6.25% 6.75% Rate of compensation increase........... 3.50% 3.50% Allocation of Plan Assets As of December 31 ------------------------- Asset Category Equity securities..................... 70% 61% 71% 58% Debt securities....................... 27 35 22 29 Real estate........................... 2 2 -- -- Other................................. 1 2 7 13 --- ---- --- --- Total................................. 100% 100% 100% 100% === === === === Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 ----------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889
FirstEnergy's net pension and other postretirement benefit costs for the three years ended December 31, 2003 were computed as follows: 21
Pension Benefits Other Benefits ---------------------- -------------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 --------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset)................................ -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ----- ----- ----- ---- ---- ---- Net periodic cost (income).............. $ 142 $ (29) $ (24) $177 $114 $ 92 ===== ===== ===== ==== ==== ==== Company's share of net benefit costs.... $ 4 $ 1 $ (1) $ 7 $ 2 $ 4 ===== ===== ===== ==== ==== ==== Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31 --------------------------------------- Discount rate.......................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets............................... 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase.......... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy. Assumed health care cost trend rates As of December 31 2003 2002 - ------------------------------------------------------------------------------- Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2008-2010 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Increase Point Decrease - ------------------------------------------------------------------------------- (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, the accrued pension costs for the Company as of June 30, 2003 increased by $16 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of its pension plan assets, the Company reduced its minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $16 million, recording an increase of $2 million in an intangible 22 asset and crediting OCI by $11 million (offsetting previously recorded deferred tax benefits by $7 million). The remaining balance in OCI of $12 million will reverse in future periods to the extent the accumulated benefit obligation exceeds the fair value of trust assets. The accrued pension cost was reduced to $15 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. (J) TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and other income include transactions with affiliated companies, primarily American Transmission Systems, Inc. (ATSI), FirstEnergy Solutions Corp. (FES) and FirstEnergy Service Company (FESC). The Ohio transition plan resulted in the corporate separation of FirstEnergy's regulated and unregulated operations in 2001. FES operates the generation businesses of the Company, OE, CEI and TE. As a result, the Company entered into power supply agreements (PSA) whereby FES purchases all of the Company's nuclear generation and the Company purchases its power from FES to meet its "provider of last resort" obligations. In 2002, the Company terminated its nuclear fuel leasing arrangement with OES Fuel and now owns its nuclear fuel. The primary affiliated companies transactions are as follows: 2003 2002 2001 - ----------------------------------------------------------------------------- (In millions) Operating Revenues: PSA revenues from FES............... $162 $138 $152 Generating units rent from FES...... 20 20 20 Ground lease with ATSI.............. 1 1 1 Operating Expenses: Nuclear fuel leased from OES Fuel... -- 5 19 Purchased power under PSA........... 166 157 153 Transmission facilities rentals..... 10 13 10 FESC support services............... 13 9 10 Other Income: Interest income from ATSI........... 3 3 3 Interest income from FES............ 1 1 1 - ------------------------------------------------------------------------------ FirstEnergy does not bill directly or allocate any of its costs to any subsidiary company. Costs are allocated to the Company from FESC, a subsidiary of FirstEnergy Corp. and a "mutual service company" as defined in Rule 93 of the Public Utility Holding Company Act of 1935 (PUHCA). The majority of costs are directly billed or assigned at no more than cost as determined by PUHCA Rule 91. The remaining costs are for services that are provided on behalf of more than one company, or costs that cannot be precisely identified and are allocated using formulas that are filed annually with the SEC on Form U-13-60. The current allocation or assignment formulas used and their bases include multiple factor formulas; each company's proportionate amount of FirstEnergy's aggregate direct payroll, number of employees, asset balances, revenues, number of customers, other factors and specific departmental charge ratios. Management believes that these allocation methods are reasonable. Intercompany transactions with OE, FirstEnergy and its other subsidiaries are generally settled under commercial terms within thirty days, except for a net $2.3 million receivable from affiliates for pension and OPEB obligations. (K) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Balance Sheets at cost, which approximates their fair market value. Noncash financing and investing activities included capital lease transactions amounting to $1.5 million and $21.6 million for the years 2002 and 2001, respectively. There were no capital lease transactions in 2003. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31: 23
2003 2002 - ------------------------------------------------------------------------------------------------------ Carrying Fair Carrying Fair Value Value Value Value - ------------------------------------------------------------------------------------------------------ (In millions) Long-term debt...................................... $211 $228 $252 $260 Preferred stock*.................................... 14 14 14 14 Investments other than cash and cash equivalents.... 175 180 161 165 - ----------------------------------------------------------------------------------------------------- * The December 31, 2003 amount is classified as debt under SFAS 150.
The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by corporations with credit ratings similar to the Company's ratings. The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents consist primarily of decommissioning trust investments. The Company has no securities held for trading purposes. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "Investments other than cash and cash equivalents" in the table above) consist of equity securities ($50 million) and fixed income securities ($84 million) as of December 31, 2003. Realized and unrealized gains and losses applicable to the decommissioning trusts have been recognized in the trust investment with a corresponding change to regulatory assets. For 2003 and 2002, net realized gains (losses) were approximately $1.2 million and $(0.3) million and interest and dividend income totaled approximately $4.8 million and $5.2 million, respectively. 2. LEASES The Company leases office space and other property and equipment under cancelable and noncancelable leases. Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Statements of Income. Such costs for the three years ended December 31, 2003, are summarized as follows: 2003 2002 2001 - ---------------------------------------------------------------------------- (In millions) Operating leases Interest element................... $0.2 $0.1 $ -- Other.............................. 0.3 0.2 0.1 Capital leases Interest element................... -- -- -- Other.............................. -- 0.1 0.1 - ---------------------------------------------------------------------------- Total rentals......................... $0.5 $0.4 $0.2 ============================================================================ The future minimum lease payments as of December 31, 2003, are: Operating Leases --------------------------------------------------------------------- (In millions) 2004................................................... $0.1 2005................................................... 0.1 2006................................................... 0.1 2007................................................... 0.1 2008................................................... 0.1 Years thereafter....................................... 0.6 ---------------------------------------------------------------- Total minimum lease payments........................... $1.1 ================================================================ 24 3. CAPITALIZATION (A) RETAINED EARNINGS- Under the Company's Charter, the Company's retained earnings unrestricted for payment of cash dividends on the Company's common stock were $44.4 million as of December 31, 2003. (B) STOCK COMPENSATION PLANS- FirstEnergy administers the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Several other stock compensation plans have been acquired through the mergers with GPU and Centerior - GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan), 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan) and Centerior Equity Plan. No further stock-based compensation can be awarded under these plans. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 2003 2002 2001 - --------------------------------------------------------------------------- Restricted common shares granted...... -- 36,922 133,162 Weighted average market price ........ n/a (1) $36.04 $35.68 Weighted average vesting period (years)............................. n/a (1) 3.2 3.7 Dividends restricted.................. n/a (1) Yes -- (2) - --------------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares; MYR Plan dividends are paid as unrestricted cash on 128,662 shares Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price - -------------------------------------------------------------------- Balance, January 1, 2001....... 5,021,862 24.09 (473,314 options exercisable).. 24.11 Options granted.............. 4,240,273 28.11 Options exercised............ 694,403 24.24 Options forfeited............ 120,044 28.07 Balance, December 31, 2001..... 8,447,688 26.04 (1,828,341 options exercisable) 24.83 Options granted.............. 3,399,579 34.48 Options exercised............ 1,018,852 23.56 Options forfeited............ 392,929 28.19 Balance, December 31, 2002..... 10,435,486 28.95 (1,400,206 options exercisable) 26.07 Options granted.............. 3,981,100 29.71 Options exercised............ 455,986 25.94 Options forfeited............ 311,731 29.09 Balance, December 31, 2003..... 13,648,869 29.27 (1,919,662 options exercisable) 29.67 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. 25 Options outstanding by plan and range of exercise price as of December 31, 2003 were as follows: Range of Options FirstEnergy Program Exercise Prices Outstanding - --------------------------------------------------------------------- FE Plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU Plan $23.75 - $35.92 501,734 Other plans 27,673 - -------------------------------------------------------------------- Total 13,648,869 ==================================================================== No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 1(F) - "Stock-Based Compensation." (C) PREFERRED STOCK- All preferred stock may be redeemed by the Company in whole, or in part, with 30-60 days' notice. (D) LONG-TERM DEBT- The Company has a first mortgage indenture under which it issues first mortgage bonds secured by a direct first mortgage lien on substantially all of its property and franchises, other than specifically excepted property. The Company has various debt covenants under its financing arrangements. The most restrictive of the debt covenants relate to the nonpayment of interest and/or principal on debt which could trigger a default and the maintenance of minimum fixed charge ratios and debt to capitalization ratios. There also exists cross-default provisions among financing arrangements of FirstEnergy and the Company. Based on the amount of bonds authenticated by the mortgage bond trustee through December 31, 2003, the Company's annual sinking fund requirements for all bonds issued under its first mortgage indenture amounts to $9.2 million. The Company expects to deposit funds with its mortgage bond trustee in 2004 that will then be withdrawn upon the surrender for cancellation of a like principal amount of bonds, which are specifically authenticated for such purposes against unfunded property additions or against previously retired bonds. This method can result in minor increases in the amount of the annual sinking fund requirement. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) during the next five years are $92.7 million in 2004 and $1.0 million in each year 2005 through 2008. Included in these amounts are various variable interest rate long-term debt which have provisions by which individual debt holders have the option to "put back" or require the respective debt issuer to redeem their debt at those times when the interest rate may change prior to its maturity date. Those amounts are $30 million in 2004, which is the next time debt holders may exercise this provision. The Company's obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds. Certain pollution control revenue bonds are entitled to the benefit of irrevocable bank letters of credit of $10.4 million and noncancelable municipal bond insurance policies of $32.9 million to pay principal of, or interest on, the pollution control revenue bonds. To the extent that drawings are made under the letters of credit or policies, the Company is entitled to a credit against its obligation to repay the related bond. The Company pays an annual fee of 1.375% of the amount of the letters of credit to the issuing bank and is obligated to reimburse the bank for any drawings thereunder. (E) LONG-TERM DEBT: PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- Effective July 1, 2003, upon adoption of SFAS 150 (see Note 6), the Company reclassified as debt its preferred stock subject to mandatory redemption. Prior year amounts were not reclassified. The Company's 7.625% series has an annual sinking fund requirement for 7,500 shares. (F) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholder's equity except those resulting from transactions with the parent. As of 26 December 31, 2003, accumulated other comprehensive loss consisted of a minimum liability for unfunded retirement benefits of $11.8 million. 4. SHORT-TERM BORROWINGS: The Company may borrow from affiliates on a short-term basis. As of December 31, 2003, the Company had borrowed $11.3 million from its affiliates at an average interest rate of 1.7%. 5. COMMITMENTS AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $143 million for property additions and improvements from 2004-2006, of which approximately $64 million is applicable to 2004. Investments for additional nuclear fuel during the 2004-2006 period are estimated to be approximately $34 million, of which approximately $20 million applies to 2004. During the same periods, the Company's nuclear fuel investments are expected to be reduced by approximately $35 million and $17 million, respectively, as the nuclear fuel is consumed. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its ownership interests in the Beaver Valley Station and the Perry Plant, the Company's maximum potential assessment under the industry retrospective rating plan (assuming the other affiliate co-owners contribute their proportionate shares of any assessments under the retrospective rating plan) would be $84.5 million per incident but not more than $8.4 million in any one year for each incident. The Company is also insured as to its interest in Beaver Valley and Perry under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Company has also obtained approximately $222.1 million of insurance coverage for replacement power costs for its interests in Beaver Valley and Perry. Under these policies, the Company can be assessed a maximum of approximately $11.9 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Company's plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. (C) ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Company with regard to air and water quality and other environmental matters. The effects of compliance on the Company with regard to environmental matters could have a material adverse effect on the Company's earnings and competitive position. These environmental regulations affect the Company's earnings and competitive position to the extent that it competes with companies that are not subject to such regulations and therefore do not bear the risk of costs associated with compliance, or failure to comply, with such regulations. Overall, the Company believes it is in material compliance with existing regulations but is unable to predict future change in regulatory policies and what, if any, the effects of such change would be. Generation operations and any related additional capital expenditures for environmental compliance are the responsibility of FirstEnergy's competitive services business unit. Clean Air Act Compliance The Company is required to meet federally approved sulfur dioxide (SO2) regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $31,500 for each day the unit is in violation. The Environmental Protection Agency (EPA) has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Company cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. The Company is complying with SO2 reduction requirements under the Clean Air Act Amendments of 1990 by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or using emission allowances. NOx reductions required by the 1990 Amendments are being achieved through combustion controls and the generation of 27 more electricity at lower-emitting plants. In September 1998, the EPA finalized regulations requiring additional NOx reductions from the Company's Ohio and Pennsylvania facilities. The EPA's NOx Transport Rule imposes uniform reductions of NOx emissions (an approximate 85% reduction in utility plant NOx emissions from projected 2007 emissions) across a region of nineteen states (including Ohio and Pennsylvania) and the District of Columbia based on a conclusion that such NOx emissions are contributing significantly to ozone pollution in the eastern United States. State Implementation Plans (SIP) must comply by May 31, 2004 with individual state NOx budgets established by the EPA. Pennsylvania submitted a SIP that required compliance with the NOx budgets at the Company's Pennsylvania facilities by May 1, 2003. The Company's Pennsylvania facilities complied with the NOx budgets in 2003 and all facilities will comply with the NOx budgets in 2004 and thereafter. Ohio submitted a SIP that requires compliance with the NOx budgets at the Company's Ohio facilities by May 31, 2004. National Ambient Air Quality Standards In July 1997, the EPA promulgated changes in the National Ambient Air Quality Standard (NAAQS) for ozone and proposed a new NAAQS for fine particulate matter. On December 17, 2003, the EPA proposed the "Interstate Air Quality Rule" covering a total of 29 states (including Ohio and Pennsylvania) and the District of Columbia based on proposed findings that air pollution emissions from 29 eastern states and the District of Columbia significantly contribute to nonattainment of the NAAQS for fine particles and/or the "8-hour" ozone NAAQS in other states. The EPA has proposed the Interstate Air Quality Rule to "cap-and-trade" NOx and SO2 emissions in two phases (Phase I in 2010 and Phase II in 2015). According to the EPA, power plant SO2 emissions would be reduced by approximately 3.6 million tons in 2010, across states covered by the rule, with reductions ultimately reaching more than 5.5 million tons annually. NOx emission reductions would measure about 1.5 million tons in 2010 and 1.8 million tons in 2015. The future cost of compliance with these proposed regulations may be substantial and will depend if and how they are ultimately implemented by the states in which the Company operates affected facilities. Mercury Emissions In December 2000, the EPA announced it would proceed with the development of regulations regarding hazardous air pollutants from electric power plants, identifying mercury as the hazardous air pollutant of greatest concern. On December 15, 2003, the EPA proposed two different approaches to reduce mercury emissions from coal-fired power plants. The first approach would require plants to install controls known as "maximum achievable control technologies" (MACT) based on the type of coal burned. According to the EPA, if implemented, the MACT proposal would reduce nationwide mercury emissions from coal-fired power plants by fourteen tons to approximately thirty-four tons per year. The second approach proposes a cap-and-trade program that would reduce mercury emissions in two distinct phases. Initially, mercury emissions would be reduced by 2010 as a "co-benefit" from implementation of SO2 and NOx emission caps under the EPA's proposed Interstate Air Quality Rule. Phase II of the mercury cap-and-trade program would be implemented in 2018 to cap nationwide mercury emissions from coal-fired power plants at fifteen tons per year. The EPA has agreed to choose between these two options and issue a final rule by December 15, 2004. The future cost of compliance with these regulations may be substantial. W. H. Sammis Plant In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a Compliance Order to nine utilities covering 44 power plants, including the W. H. Sammis Plant. In addition, the U.S. Department of Justice filed eight civil complaints against various investor-owned utilities, which included a complaint against the Company and OE in the U.S. District Court for the Southern District of Ohio. The NOV and complaint allege violations of the Clean Air Act based on operation and maintenance of the W. H. Sammis Plant dating back to 1984. The complaint requests permanent injunctive relief to require the installation of "best available control technology" and civil penalties of up to $27,500 per day of violation. On August 7, 2003, the United States District Court for the Southern District of Ohio ruled that 11 projects undertaken at the W. H. Sammis Plant between 1984 and 1998 required pre-construction permits under the Clean Air Act. The ruling concludes the liability phase of the case, which deals with applicability of Prevention of Significant Deterioration provisions of the Clean Air Act. The remedy phase, which is currently scheduled to be ready for trial beginning July 19, 2004, will address civil penalties and what, if any, actions should be taken to further reduce emissions at the plant. In the ruling, the Court indicated that the remedies it "may consider and impose involved a much broader, equitable analysis, requiring the Court to consider air quality, public health, economic impact, and employment consequences. The Court may also consider the less than consistent efforts of the EPA to apply and further enforce the Clean Air Act." The potential penalties that may be imposed, as well as the capital expenditures necessary to comply with substantive remedial measures that may be required, could have a material adverse impact on the Company's financial condition and results of operations. Management is unable to predict the ultimate outcome of this matter and no liability has been accrued as of December 31, 2003. 28 Regulation of Hazardous Waste As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending the EPA's evaluation of the need for future regulation. The EPA subsequently determined that regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the EPA announced that it will develop national standards regulating disposal of coal ash under its authority to regulate nonhazardous waste. Climate Change In December 1997, delegates to the United Nations' climate summit in Japan adopted an agreement, the Kyoto Protocol (Protocol), to address global warming by reducing the amount of man-made greenhouse gases emitted by developed countries by 5.2% from 1990 levels between 2008 and 2012. The United States signed the Protocol in 1998 but it failed to receive the two-thirds vote of the U.S. Senate required for ratification. However, the Bush administration has committed the United States to a voluntary climate change strategy to reduce domestic greenhouse gas intensity - the ratio of emissions to economic output - by 18% through 2012. The Company cannot currently estimate the financial impact of climate change policies although the potential restrictions on carbon dioxide (CO2) emissions could require significant capital and other expenditures. However, the CO2 emissions per kilowatt-hour of electricity generated by the Company is lower than many regional competitors due to the Company's diversified generation sources which includes low or non-CO2 emitting gas-fired and nuclear generators. Clean Water Act Various water quality regulations, the majority of which are the result of the federal Clean Water Act and its amendments, apply to the Company's plants. In addition, Ohio and Pennsylvania have water quality standards applicable to the Company's operations. As provided in the Clean Water Act, authority to grant federal National Pollutant Discharge Elimination System water discharge permits can be assumed by a state. Ohio and Pennsylvania have assumed such authority. (D) LEGAL MATTERS- Various lawsuits, claims and proceedings related to the Company's normal business operations are pending against FirstEnergy and its subsidiaries. The most significant applicable to the Company are described above. Power Outage On August 14, 2003, various states in the northeast United States and part of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest ISO and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. 29 6. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS: SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, the Company implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(E) and 1(H) for further discussions of SFAS 143. SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" In May 2003, the FASB issued SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003 and effective at the beginning of the first interim period beginning after June 15, 2003 for all other financial instruments. Upon adoption of SFAS 150, effective July 1, 2003, the Company reclassified as debt its preferred stock subject to mandatory redemption with a carrying value of approximately $14 million as of December 31, 2003. Dividends on preferred stock subject to mandatory redemption on the Company's Statements of Income, which were not included in net interest charges prior to the adoption of SFAS 150, are now included in net interest charges for the six months ended December 31, 2003. 7. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain operating results by quarter for 2003 and 2002.
March 31, June 30, September 30, December 31, Three Months Ended 2003 2003 2003 2003 (a) - --------------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues........................ $128.3 $116.6 $145.9 $136.1 Operating Expenses and Taxes.............. 130.2 110.3 126.0 113.1 - --------------------------------------------------------------------------------------------------------------- Operating Income (Loss)................... (1.9) 6.3 19.9 23.0 Other Income.............................. 0.6 0.5 0.5 1.3 Net Interest Charges...................... 3.4 3.4 3.0 2.5 - --------------------------------------------------------------------------------------------------------------- Income (Loss) Before Cumulative Effect of Accounting Change...................... (4.7) 3.4 17.4 21.8 Cumulative Effect of Accounting Change (Net of Income Taxes).................. 10.6 -- -- -- - --------------------------------------------------------------------------------------------------------------- Net Income................................ $ 5.9 $ 3.4 $ 17.4 $ 21.8 =============================================================================================================== Earnings on Common Stock.................. $ 5.0 $ 2.5 $ 16.7 $ 21.1 =============================================================================================================== March 31, June 30, September 30, December 31, Three Months Ended 2002 2002 2002 2002 - --------------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues........................ $124.3 $127.8 $131.9 $122.4 Operating Expenses and Taxes.............. 109.2 106.3 113.1 116.9 - --------------------------------------------------------------------------------------------------------------- Operating Income.......................... 15.1 21.5 18.8 5.5 Other Income.............................. 0.7 0.5 0.7 0.1 Net Interest Charges...................... 3.8 4.0 3.7 3.6 - --------------------------------------------------------------------------------------------------------------- Net Income................................ $ 12.0 $ 18.0 $ 15.8 $ 2.0 =============================================================================================================== Earnings on Common Stock.................. $ 11.0 $ 17.1 $ 14.9 $ 1.0 =============================================================================================================== (a) Net income for the three months ended December 31, 2003, was increased by $1.1 million due to adjustments that were subsequently capitalized to construction projects in the fourth quarter. The adjustments included $0.2 million, $0.3 million and $0.6 million of costs charged to expense in the first, second and third quarters, respectively. Management concluded that these adjustments were not material to the consolidated financial statements for any quarter of 2003.
30 Report of Independent Auditors To the Stockholders and Board of Directors of Pennsylvania Power Company: In our opinion, the accompanying balance sheets and statements of capitalization and the related statements of income, common stockholder's equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of Pennsylvania Power Company (a wholly owned subsidiary of Ohio Edison Company) as of December 31, 2003 and 2002, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. The financial statements of Pennsylvania Power Company for the year ended December 31, 2001, were audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on those financial statements in their report dated March 18, 2002. As discussed in Note 1(E) to the financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 31 The following report is a copy of a report previously issued by Arthur Andersen LLP (Andersen). This report has not been reissued by Andersen and Andersen did not consent to the incorporation by reference of this report into any of the Company's registration statements. Report of Independent Public Accountants To the Stockholders and Board of Directors of Pennsylvania Power Company: We have audited the accompanying balance sheets and statements of capitalization of Pennsylvania Power Company (a Pennsylvania corporation and wholly owned subsidiary of Ohio Edison Company) as of December 31, 2001 and 2000, and the related statements of income, common stockholder's equity, preferred stock, cash flows and taxes for each of the three years in the period ended December 31, 2001. 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 in accordance with auditing standards generally accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pennsylvania Power Company as of December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 32 EX-23 32 pp_ex23-2.txt EX 23-2 PENN PWC CONSENT EXHIBIT 23.2 PENNSYLVANIA POWER COMPANY CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 33-62450 and 33-65156) of Pennsylvania Power Company of our report dated February 25, 2004 relating to the financial statements, which appears in the Annual Report to Stockholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 25, 2004 relating to the financial statement schedules, which appear in this Form 10-K. PricewaterhouseCoopers LLP Cleveland, Ohio March 11, 2004 107 EX-12 33 jc_ex12-6.txt EX 12-6 JCP&L FIXED CHARGE RATIO EXHIBIT 12.6 Page 1 JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, Jan. 1- Nov. 7- Year Ended December 31, 1999 2000 Nov. 6, 2001 Dec. 31, 2001 2002 2003 --------- --------- ------------ ------------- --------- --------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items............... $172,380 $210,812 $ 34,467 | $30,041 $251,895 $ 68,017 Interest and other charges, before reduction | for amounts capitalized....................... 106,675 105,799 95,727 | 16,919 100,365 94,719 Provision for income taxes...................... 100,970 119,875 52 | 20,101 181,855 46,440 Interest element of rentals charged | to income (a)................................. 14,920 6,229 3,913 | 124 3,239 5,374 -------- -------- --------- | ------- -------- -------- Earnings as defined........................... $394,945 $442,715 $ 134,159 | $67,185 $537,354 $214,550 ======== ======== ========= | ======= ======== ======== | FIXED CHARGES AS DEFINED IN REGULATION S-K: | Interest on long-term debt...................... $ 87,196 $ 85,220 $ 77,205 | $14,234 $ 92,314 $ 87,681 Other interest expense.......................... 8,779 9,879 9,427 | 1,080 (2,643) 1,690 Subsidiary's preferred stock | dividend requirements......................... 10,700 10,700 9,095 | 1,605 10,694 5,347 Interest element of rentals charged | to income (a)................................. 14,920 6,229 3,913 | 124 3,239 5,374 -------- -------- --------- | ------- -------- -------- Fixed charges as defined...................... $121,595 $112,028 $ 99,640 | $17,043 $103,604 $100,092 ======== ======== ========= | ======= ======== ======== | CONSOLIDATED RATIO OF EARNINGS TO | FIXED CHARGES................................... 3.25 3.95 1.35 | 3.94 5.19 2.14 ==== ==== ==== | ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 99
EXHIBIT 12.6 Page 2 JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, Jan. 1- Nov. 7- Year Ended December 31, 1999 2000 Nov. 6, 2001 Dec. 31, 2001 2002 2003 --------- -------- ------------ ------------- --------- --------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items............... $ 172,380 $210,812 $ 34,467 | $30,041 $251,895 $ 68,017 Interest and other charges, before | reduction for amounts capitalized.. ......... 106,675 105,799 95,727 | 16,919 100,365 94,719 Provision for income taxes...................... 100,970 119,875 52 | 20,101 181,855 46,440 Interest element of rentals | charged to income (a)......................... 14,920 6,229 3,913 | 124 3,239 5,374 --------- -------- -------- | ------- -------- -------- Earnings as defined........................... $ 394,945 $442,715 $134,159 | $67,185 $537,354 $214,550 ========= ======== ======== | ======= ======== ======== | FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS | PREFERRED STOCK DIVIDEND REQUIREMENTS | (PRE-INCOME TAX BASIS): | Interest on long-term debt...................... $ 87,196 85,220 $ 77,205 | $14,234 $ 92,314 $ 87,681 Other interest expense.......................... 8,779 9,879 9,427 | 1,080 (2,643) 1,690 Preferred stock dividend requirements........... 19,370 17,604 13,642 | 2,303 9,230 5,235 Adjustments to preferred stock dividends | to state on a pre-income tax basis............ 5,081 3,928 7 | 467 (1,057) (77) Interest element of rentals | charged to income (a)......................... 14,920 6,229 3,913 | 124 3,239 5,374 --------- -------- -------- | ------- -------- -------- Fixed charges as defined plus preferred | preferred stock dividend requirements | (pre-income tax basis)...................... $ 135,346 $122,860 $104,194 | $18,208 $101,083 $ 99,903 ========= ======== ======== | ======= ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES | PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS | (PRE-INCOME TAX BASIS........................... 2.92 3.60 1.29 | 3.69 5.32 2.15 ==== ==== ==== | ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 100
EX-13 34 jc_ex13-5.txt EX 13-5 JCP&L ANNUAL REPORT JERSEY CENTRAL POWER & LIGHT COMPANY 2003 ANNUAL REPORT TO STOCKHOLDERS Jersey Central Power & Light Company is a wholly owned electric utility operating subsidiary of FirstEnergy Corp. It engages in the distribution and sale of electric energy in an area of approximately 3,300 square miles in New Jersey. It also engages in the sale, purchase and interchange of electric energy with other electric companies. The area it serves has a population of approximately 2.7 million. In August 2000, FirstEnergy entered into an agreement to merge with GPU, Inc., under which FirstEnergy would acquire all of the outstanding shares of GPU, Inc.'s common stock for approximately $4.5 billion in cash and FirstEnergy common stock. The merger became effective on November 7, 2001 and was accounted for by the purchase method. Prior to that time, Jersey Central Power & Light Company was a wholly owned subsidiary of GPU, Inc. Contents Page - -------- ---- Selected Financial Data............................................ 1 Management's Discussion and Analysis............................... 2-12 Consolidated Statements of Income.................................. 13 Consolidated Balance Sheets........................................ 14 Consolidated Statements of Capitalization.......................... 15 Consolidated Statements of Common Stockholder's Equity............. 16 Consolidated Statements of Preferred Stock......................... 16 Consolidated Statements of Cash Flows.............................. 17 Consolidated Statements of Taxes................................... 18 Notes to Consolidated Financial Statements......................... 19-33 Reports of Independent Auditors.................................... 34-35 JERSEY CENTRAL POWER & LIGHT COMPANY SELECTED FINANCIAL DATA
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 2000 1999 - ---------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Operating Revenues...................... $2,364,203 $2,328,415 $ 282,902 | $1,838,638 $1,979,297 $2,018,209 ========== ========== ========== | ========== ========== ========== | Operating Income........................ $ 146,271 $ 335,209 $ 43,666 | $ 292,847 $ 283,227 $ 277,420 ========== ========== ============ | ========== ========== ========== | Net Income ............................. $ 68,017 $ 251,895 $ 30,041 | $ 34,467 $ 210,812 $ 172,380 ========== ========== ========== | ========== ========== ========== | Earnings on Common Stock................ $ 68,129 $ 253,359 $ 29,343 | $ 29,920 $ 203,908 $ 162,862 ========== ========== ========== | ========== ========== ========== | Total Assets............................ $7,579,044 $8,052,755 $8,039,998 | $6,009,054 $5,587,677 ========== ========== ========== | ========== ========== | | Capitalization as of December 31: | Common Stockholder's Equity.......... $3,153,974 $3,274,069 $3,163,701 | $1,459,260 $1,385,367 Preferred Stock- | Not Subject to Mandatory Redemption 12,649 12,649 12,649 | 12,649 12,649 Subject to Mandatory Redemption.... -- -- 44,868 | 51,500 73,167 Company-Obligated Mandatorily | Redeemable Preferred Securities.... -- 125,244 125,250 | 125,000 125,000 Long-Term Debt....................... 1,095,991 1,210,446 1,224,001 | 1,093,987 1,133,760 ---------- ---------- ---------- | ---------- ---------- Total Capitalization............... $4,262,614 $4,622,408 $4,570,469 | $2,742,396 $2,729,943 ========== ========== ========== | ========== ========== | | Capitalization Ratios: | Common Stockholder's Equity.......... 74.0% 70.8% 69.2% | 53.2% 50.7% Preferred Stock- | Not Subject to Mandatory Redemption 0.3 0.3 0.3 | 0.5 0.5 Subject to Mandatory Redemption.... -- -- 1.0 | 1.9 2.7 Company-Obligated Mandatorily | Redeemable Preferred Securities.... -- 2.7 2.7 | 4.5 4.6 Long-Term Debt....................... 25.7 26.2 26.8 | 39.9 41.5 ----- ----- ----- | ----- ----- Total Capitalization............... 100.0% 100.0% 100.0% | 100.0% 100.0% ===== ===== ===== | ===== ===== | | Distribution Kilowatt-Hour Deliveries (Millions): | Residential.......................... 9,104 8,976 1,428 | 7,042 8,087 7,978 Commercial........................... 8,620 8,509 1,330 | 6,787 7,706 7,624 Industrial........................... 3,046 3,171 474 | 2,670 3,307 3,289 Other................................ 89 81 17 | 66 82 81 ------ ------ ------- | ------ ------ ------ Total Retail......................... 20,859 20,737 3,249 | 16,565 19,182 18,972 Total Wholesale...................... 6,203 5,039 295 | 1,780 2,161 1,622 ------ ------ ------- | ------ ------ ------ Total................................ 27,062 25,776 3,544 | 18,345 21,343 20,594 ====== ====== ======= | ====== ====== ====== | | Customers Served: | Residential.......................... 931,227 921,716 909,494 | 896,629 883,930 Commercial........................... 114,270 112,385 109,985 | 107,479 107,210 Industrial........................... 2,705 2,759 2,785 | 2,835 2,965 Other................................ 1,345 1,393 1,484 | 1,551 1,648 --------- --------- --------- | --------- ------- Total................................ 1,049,547 1,038,253 1,023,748 | 1,008,494 995,753 ========= ========= ========= | ========= ======= 1
JERSEY CENTRAL POWER & LIGHT COMPANY Management's Discussion and Analysis of Results of Operations and Financial Condition This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage and other similar factors. Results of Operations In 2003, earnings on common stock decreased to $68.1 million, from $253.4 million in 2002, as a result of non-cash charges aggregating $185.2 million ($109.3 million after tax) due to a rate case decision disallowing recovery of certain regulatory assets (see Regulatory Matters). In addition, higher operating revenues were more than offset by increases in purchased power and other operating costs causing a decline in earnings. In 2002, earnings on common stock increased to $253.4 million, from $59.3 million in 2001, due to higher operating revenues and the absence of a 2001 after-tax charge of $177.5 million, which reduced deferred costs in accordance with the Stipulation of Settlement related to the merger of FirstEnergy and GPU, Inc. Partially offsetting these favorable results were increased purchased power costs. Electric Sales Operating revenues increased $35.8 million or 1.5% in 2003 compared with 2002. The increase in revenues was due to a $99.7 million increase in wholesale revenues offset by lower revenues from our distribution deliveries. Our basic generation service (BGS) obligation was transferred to external parties through a February 2002 auction process authorized by the New Jersey Board of Public Utilities (NJBPU) which terminated our BGS obligation for the twelve-month period, August 1, 2002 through July 31, 2003. Subsequent BGS auctions in February 2003 and 2004 continued this transfer and extended the termination of the Company's BGS obligations through July 31, 2005. As result, we have been selling all of our self-supplied energy (from non-utility generation power contracts and owned generation) into the wholesale market and anticipate continuing to do so through July 31, 2005. Distribution deliveries increased slightly in 2003 from the previous year. Lower unit prices in 2003 more than offset the impact of the increased volume and reduced revenues by $64.1 million. In addition, revenues reflect the impact of the distribution rate decrease effective August 1, 2003, from the NJBPU's decision (see Regulatory Matters). Colder temperatures early in the year resulted, in large part, in higher residential and commercial demand, which was partially offset by a decrease in industrial demand. Generation sales revenues in 2003 compared to 2002 were lower by $23.9 million due to an 8.7% decrease in kilowatt-hour sales. The decrease reflected a 9.1 percentage point increase in customers choosing an alternate supplier in 2003 compared to 2002. This reversed the trend in 2002 where some customers who were receiving their power from alternate suppliers returned to us as full service customers. During 2002, only 0.7% of kilowatt-hours delivered were to shopping customers, whereas that percentage was 4.5% in 2001. In addition to the higher revenues from returning shopping customers, warmer summer weather in both 2002 and 2001 contributed to significant increases in retail sales. This was partially offset by a decrease in kilowatt-hour sales to industrial customers, due to a decline in economic conditions during 2002. Increases in kilowatt-hour sales to wholesale customers during 2002 were partially offset by lower average prices for energy in 2002, compared to 2001. 2 Changes in kilowatt-hour sales by customer class in 2003 and 2002 are summarized in the following table: Changes in Kilowatt-hour Sales 2003 2002 -------------------------------------------------------- Increase (Decrease) Electric Generation: Retail............................ (8.7)% 8.5% Wholesale......................... 23.1 % 42.8% -------------------------------------------------------- Total Electric Generation Sales..... (2.4)% 16.9% ======================================================== Distribution Deliveries: Residential....................... 1.4 % 6.0% Commercial........................ 1.3 % 4.9% Industrial........................ (3.9)% 0.9% -------------------------------------------------------- Total Distribution Deliveries....... 0.6 % 4.7% ======================================================== Operating Expenses and Taxes Total operating expenses and taxes increased $224.7 million in 2003, after increasing $208.2 million in 2002, compared to the prior year. These increases include the non-cash charges in 2003 for amounts disallowed by the NJBPU in its rate case decision (see Regulatory Matters), of which $152.5 million was charged to purchased power and $32.7 million was charged to depreciation and amortization. The following table presents changes in 2003 and 2002 from the prior year by expense category. Operating Expenses and Taxes - Changes 2003 2002 ----------------------------------------------------------------- Increase (Decrease) (In millions) Fuel and purchased power costs............ $256.5 $179.6 Other operating costs..................... 95.2 (5.3) ----------------------------------------------------------------- Total operation and maintenance expenses.. 351.7 174.3 Provision for depreciation and amortization 5.3 3.7 General taxes............................. (2.6) (9.4) Income taxes............................. (129.7) 39.6 ---------------------------------------------------------------- Net increase in operating expenses and taxes $224.7 $208.2 ================================================================ Excluding the disallowed deferred energy costs of $152.5 million, fuel and purchased power increased $104.0 million in 2003 compared to 2002. Increased kilowatt-hours purchased through two-party agreements and changes in the deferred energy and capacity costs were the primary contributors to the increase. Other operating expenses increased $95.2 million in 2003 compared to 2002, due to higher employee benefit costs, storm restoration expenses and costs associated with an accelerated reliability plan within the Company's service territory. Depreciation and amortization charges, excluding the disallowed costs discussed above, decreased $27.4 million due to the cessation of amortization of regulatory assets related to the previously divested Oyster Creek Nuclear Generation Station and the reduced depreciation rates effective August 1, 2003 in connection with the NJBPU rate case decision (see Regulatory Matters). In 2002, fuel and purchased power costs increased $179.6 million, compared to 2001. The increase was due primarily to more power being purchased through two-party agreements and from associated companies during 2002. The increase was partially offset by a decrease in power purchased through the PJM Power Pool, and the absence of non-utility generation contract buyout costs recognized in 2001. Other Income Other income was unchanged in 2003 and increased $183.3 million in 2002, compared to the prior year. The change in 2002 was due primarily to a 2001 charge of $300 million ($177.5 million net of tax) to reduce deferred costs in accordance with the Stipulation of Settlement related to the merger between FirstEnergy and GPU. Net Interest Charges Net interest charges decreased $5.2 million in 2003 and $5.3 million in 2002, compared to the previous year, reflecting debt redemptions of $102 million and $192 million, respectively. Those decreases were partially offset by interest on $320 million of transition bonds issued in June 2002 (see Note 4 (E)) and $150 million of senior notes issued in May 2003 which were used for redeeming outstanding securities in the second and third quarters of 2003. 3 Preferred Stock Dividend Requirements Preferred stock dividend requirements decreased $1.6 million in 2003, and $3.1 million in 2002, compared to the prior year, due to the reacquisition and redemptions of cumulative preferred stock pursuant to mandatory and optional sinking fund provisions. We realized non-cash gains of $0.6 million and $3.6 million in 2003 and 2002, respectively, on the reacquisition of preferred stock. Capital Resources and Liquidity Changes in Cash Position As of December 31, 2003, we had $0.3 million of cash and cash equivalents compared with $4.8 million as of December 31, 2002. The major sources for changes in these balances are summarized below. Cash Flows From Operating Activities Cash flows provided from operating activities totaled $180 million in 2003, $309 million in 2002 and $290 million in 2001. The sources of these changes are as follows: Operating Cash Flows 2003 2002 2001 --------------------------------------------------------- (In millions) Cash earnings (1)............. $ 369 $ 325 $219 Working capital and other..... (189) (16) 71 --------------------------------------------------------- Total................ $ 180 $ 309 $290 ========================================================= (1) Includes net income, depreciation and amortization, disallowed purchase power costs, deferred costs recoverable as regulatory assets, deferred income taxes, and investment tax credits. Net cash provided from operating activities decreased by $129 million in 2003 and increased by $19 million in 2002, as compared to the previous year. The decrease in 2003 was due to a $173 million increase in working capital and other requirements (primarily from a $170 million reduction in payables) which was partially offset by a $44 million increase in cash earnings. The increase in 2002 reflected a $106 million increase in cash earnings partially offset by an $87 million increase in working capital and other. Cash Flows From Financing Activities Net cash used for financing activities was $139 million and $140 million in 2003 and 2002, respectively. These amounts reflect redemptions of debt and preferred stock, in addition to payments of $138 million in 2003 and $191 million in 2002 for common dividends to FirstEnergy. The following table provides details regarding new issues and redemptions during 2003 and 2002: Securities Issued or Redeemed in 2003 2002 ------------------------------------------------------------- (In millions) New Issues Secured Notes..........................$150 $ -- Transition Bonds (See Note 4 (E))...... -- 320 Redemptions First Mortgage Bonds................... 150 192 Medium Term Notes...................... 102 -- Preferred Stock........................ 125 52 Other.................................. 4 ------------------------------------------------------------- Total Redemptions.................. 377 248 Short-term Borrowings, net ................. 231 (18) ------------------------------------------------------------- We had $231.0 million of short-term indebtedness at the end of 2003, compared to no short-term debt at the end of 2002. We may borrow from our affiliates on a short-term basis. We will not issue first mortgage bonds (FMB) other than as collateral for senior notes, since our senior note indentures prohibit (subject to certain exceptions) us from issuing any debt which is senior to the senior notes. As of December 31, 2003, we had the capability to issue $126 million of additional senior notes based upon FMB collateral. At year-end 2003, based upon applicable earnings coverage tests and our charter, we could issue $189 million of preferred stock (assuming no additional debt was issued). 4 We have the ability to borrow from our regulated affiliates and FirstEnergy to meet our short-term working capital requirements. FirstEnergy Service Company administers this money pool and tracks surplus funds of FirstEnergy and its regulated subsidiaries. Companies receiving a loan under the money pool agreements must repay the principal, together with accrued interest, within 364 days of borrowing the funds. The rate of interest is the same for each company receiving a loan from the pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47%. At the end of 2003, our common equity as a percentage of capitalization stood at 74%, as compared to 71% and 69% at the end of 2002 and 2001, respectively. In 2001, we experienced a significant increase in this ratio due to the allocation of the purchase price when we were acquired by FirstEnergy. Our access to capital markets and costs of financing are dependent on the ratings of our securities and that of our holding company, FirstEnergy. The following table shows our securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. Ratings of Securities - ---------------------------------------------------------------------------- Securities S&P Moody's Fitch - ---------------------------------------------------------------------------- FirstEnergy Senior unsecured BB+ Baa3 BBB- JCP&L Senior secured BBB Baa1 BBB+ Preferred stock BB Ba1 BBB - ---------------------------------------------------------------------------- On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." Fitch affirmed the ratings of JCP&L. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy, and all of the securities of its electric utility operating companies. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." On December 23, 2003, Standard & Poor's (S&P) lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". Except for Ohio Edison's senior secured issue rating, which was left unchanged, all other subsidiary ratings were lowered one notch as well. The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions of the ratings included uncertainty regarding the timing of the Ohio Rate Plan filing, the pending final report on the August 14 blackout (see Power Outages), the outcome of the remedial phase of litigation relating to the Sammis plant, and the extended Davis-Besse outage (JCP&L has no ownership interest in Davis-Besse) and the related pending subpoena. S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of the credit ratings in December 2003 triggered cash and letter-of-credit collateral calls of FirstEnergy in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2 and downgraded the senior secured debt of JCP&L to Baa1 from A2. Moody's also downgraded the preferred stock rating of JCP&L to Ba1 from Baa2. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows From Investing Activities Cash used in investing activities totaled $45.2 million in 2003 and $195.2 million in 2002, principally for property additions to support the distribution of electricity. Payments on loans from and (to) associated companies were $78 million and $(77) million in 2003 and 2002, respectively. Our capital spending for the period 2004-2006 is expected to be about $446 million, of which approximately $146 million applies to 2004. 5 Contractual Obligations Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows: 2005- 2007- Contractual Obligations Total 2004 2006 2008 Thereafter - ------------------------------------------------------------------------------ (In millions) Long-term debt.............. $1,273 $176 $ 275 $ 37 $ 785 Short-term borrowings....... 231 231 -- -- -- Operating leases............ 63 1 4 3 55 Purchases (1)............... 3,487 445 965 912 1,165 - ------------------------------------------------------------------------------ Total.................. $5,054 $853 $1,244 $952 $2,005 - ------------------------------------------------------------------------------ (1) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing. Market Risk Information We use various market risk sensitive instruments, including derivative contracts, primarily to manage the risk of price fluctuations. Our Risk Policy Committee, comprised of FirstEnergy executive officers, exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. Commodity Price Risk We are exposed to market risk primarily due to fluctuations in electricity and natural gas prices. To manage the volatility relating to these exposures, we use a variety of non-derivative and derivative instruments, including forward contracts, options and futures contracts. The derivatives are used for hedging purposes. Most of our non-hedge derivative contracts represent non-trading positions that do not qualify for hedge treatment under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." The change in the fair value of commodity derivative contracts related to energy production during 2003 is summarized in the following table: Increase (Decrease) in the Fair Value of Commodity Derivative Contracts
Non-Hedge Hedge Total --------- ----- ----- (In millions) Change in the Fair Value of Commodity Derivative Contracts Outstanding net asset as of January 1, 2003.................. $ 8.7 $ (0.1) $ 8.6 New contract value when entered.............................. -- -- -- Additions/Change in value of existing contracts.............. 4.5 -- 4.5 Change in techniques/assumptions............................. 2.3 -- 2.3 Settled contracts............................................ 0.1 0.1 0.2 ------------------------------ Net Assets - Derivatives Contracts as of December 31, 2003 (1) $15.6 $ -- $15.6 ============================== Impact of Changes in Commodity Derivative Contracts (2) Income Statement Effects:.................................... $ 0.5 $ -- $ 0.5 Balance Sheet Effects: Other Comprehensive Income (Pre-Tax)...................... $ -- $ 0.1 $ 0.1 Regulatory Liability...................................... $ 6.4 $ -- $ 6.4
(1) Includes $15.5 million in non-hedge commodity derivative contracts which are offset by a regulatory liability. (2) Represents the increase in value of existing contracts, settled contracts and changes in techniques/assumptions. Derivatives included on the Consolidated Balance Sheet as of December 31, 2003: Non-Hedge Hedge Total --------- ----- ----- (In millions) Current- Other Assets.................... $ 0.2 $ -- $ 0.2 Non-Current- Other Deferred Charges.......... 15.4 -- 15.4 ------ ------ ------ Net assets.................... $15.6 $ -- $ 15.6 ===== ====== ====== The valuation of derivative contracts is based on observable market information to the extent that such information is available. In cases where such information is not available, we rely on model-based information. The model provides estimates of future regional prices for electricity and an estimate of 6 related price volatility. We use these results to develop estimates of fair value for financial reporting purposes and for internal management decision making. Sources of information for the valuation of derivative contracts by year are summarized in the following table: Source of Information - Fair Value by Contract Year - --------------------------------------------------- 2004 2005 2006 2007 Thereafter Total ---- ---- ---- ---- ---------- ----- (In millions) Prices actively quoted(1)... $0.2 $-- $ -- $ -- $ -- $ 0.2 Other external sources(2)... 2.3 2.6 -- -- -- 4.9 Prices based on models...... -- -- 2.5 2.4 5.6 10.5 -------------------------------------------------- Total(3)................ $2.5 $2.6 $2.5 $2.4 $5.6 $15.6 ================================================= (1) Exchange traded. (2) Broker quote sheets. (3) Includes $15.5 million from an embedded option that is offset by a regulatory liability and does not affect earnings. We perform sensitivity analyses to estimate our exposure to the market risk of our commodity position. A hypothetical 10% adverse shift in quoted market prices in the near term on derivative instruments would not have had a material effect on our consolidated financial position or cash flows as of December 31, 2003. Interest Rate Risk Our exposure to fluctuations in market interest rates is reduced since our debt has fixed interest rates, as noted in the following table.
Comparison of Carrying Value to Fair Value - ------------------------------------------------------------------------------------------------------------------- There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - ------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets - ------------------------------------------------------------------------------------------------------------------- Investments Other Than Cash and Cash Equivalents- Fixed Income............... $212 $ 212 $ 212 Average interest rate...... 5.0% 5.0% - ------------------------------------------------------------------------------------------------------------------- Liabilities - ------------------------------------------------------------------------------------------------------------------- Long-term Debt and Other Long-Term Obligations: Fixed rate.................... $176 $67 $208 $18 $19 $785 $1,273 $1,190 Average interest rate ..... 6.9% 6.1% 6.3% 4.2% 5.4% 6.5% 6.5% Short-term Borrowings......... $231 $ 231 $ 231 Average interest rate...... 1.7% 1.7% - -------------------------------------------------------------------------------------------------------------------
Equity Price Risk Included in nuclear decommissioning trusts are marketable equity securities carried at their market value of approximately $69 million and $52 million at December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges would result in a $7 million reduction in fair value as of December 31, 2003. (See Note 1 (K) - "Cash and Financial Instruaments") Outlook Beginning in 1999, all of our customers were able to select alternative energy suppliers. We continue to deliver power to homes and businesses through our existing distribution system, which remains regulated. To support customer choice, rates were restructured into unbundled service charges and additional non-bypassable charges to recover stranded costs. Regulatory assets are costs which have been authorized by the NJBPU and the Federal Energy Regulatory Commission (FERC) for recovery from customers in future periods and, without such authorization, would have been charged to income when incurred. All of our regulatory assets are expected to continue to be recovered under the provisions of the regulatory proceedings discussed below. Our regulatory assets totaled $2.6 billion and $3.1 billion as of December 31, 2003 and December 31, 2002, respectively. 7 Regulatory Matters Under New Jersey transition legislation, all electric distribution companies were required to file rate cases to determine the level of unbundled rate components to become effective August 1, 2003. Our two August 2002 rate filings requested increases in base electric rates of approximately $98 million annually and requested the recovery of deferred energy costs that exceeded amounts being recovered under the current market transition charge (MTC) and societal benefits charge (SBC) rates; one proposed method of recovery of these costs is the securitization of the deferred balance. This securitization methodology is similar to the Oyster Creek securitization. On July 25, 2003, the NJBPU announced its JCP&L base electric rate proceeding decision which reduced our annual revenues by approximately $62 million effective August 1, 2003. The NJBPU decision also provided for an interim return on equity of 9.5 percent on our rate base for the next six to twelve months. During that period, we will initiate another proceeding to request recovery of additional costs incurred to enhance system reliability. In that proceeding, the NJBPU could increase the return on equity to 9.75% or decrease it to 9.25%, depending on its assessment of the reliability of our service. Any reduction would be retroactive to August 1, 2003. The revenue decrease in the decision consists of a $223 million decrease in the electricity delivery charge, a $111 million increase due to the August 1, 2003 expiration of annual customer credits previously mandated by the New Jersey transition legislation, a $49 million increase in the MTC tariff component, and a net $1 million increase in the SBC charge. The MTC allows for the recovery of $465 million in deferred energy costs over the next ten years on an interim basis, disallowing $153 million of the $618 million provided for in a preliminary settlement agreement between certain parties. As a result, we recorded charges to net income for the year ended December 31, 2003, aggregating $185 million ($109 million net of tax) consisting of the $153 million deferred energy costs and other regulatory assets. We filed a motion for rehearing and reconsideration with the NJBPU on August 15, 2003 with respect to the following issues: (1) the disallowance of the $153 million deferred energy costs; (2) the reduced rate of return on equity; and (3) $42.7 million of disallowed costs to achieve merger savings. On October 10, 2003, the NJBPU held the motion in abeyance until the final NJBPU decision and order is issued, which is expected in the first quarter of 2004. On July 5, 2003, we experienced a series of 34.5 kilo-volt sub-transmission line faults that resulted in outages on the New Jersey shore. The NJBPU instituted an investigation into these outages, and directed that a Special Reliability Master be hired to oversee the investigation. On December 8, 2003, the Special Reliability Master issued his Interim Report recommending that we implement a series of actions to improve reliability in the area affected by the outages. The NJBPU adopted the findings and recommendations of the Interim Report on December 17, 2003, and ordered us to implement the recommended actions on a staggered basis, with initial actions to be completed by March 31, 2004. We expect to spend approximately $12.5 million implementing these actions during 2004. FERC Regulatory Matters On December 19, 2002, the FERC granted unconditional Regional Transmission Organization status to PJM Interconnection, LLC which includes us as transmission owners. PJM and the Midwest Independent System Operator, Inc. (MISO) were ordered by the FERC to develop a common market between the regions by October 31, 2004. The FERC also initiated a Section 206 investigation into the reasonableness of the "through-and-out" transmission rates charged by PJM and MISO. By order issued November 17, 2003, MISO, PJM and certain unaffiliated transmission owners in the Midwest were directed to eliminate rates for point-to-point service between the two RTOs effective April 1, 2004. A settlement judge has been appointed by the FERC to resolve compliance filings by the affected transmission providers. AEP, Commonwealth Edison and other utilities have appealed the FERC's November 17, 2003 order to the federal court of appeals for the District of Columbia. Environmental Matters We have been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, our proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. We have accrued liabilities aggregating approximately $45 million as of December 31, 2003. We do not believe environmental remediation costs will have a material adverse effect on our financial condition, cash flows or results of operations. Power Outages In July 1999, the Mid-Atlantic states experienced a severe heat storm which resulted in power outages throughout the service territories of many electric utilities, including JCP&L's territory. In an investigation into the causes of the outages and the reliability of the transmission and distribution systems of all four New Jersey electric utilities, the NJBPU concluded that there was not a prima facie case demonstrating that, overall, JCP&L provided unsafe, inadequate or improper service to its customers. Two class action lawsuits (subsequently consolidated into a single proceeding) 8 were filed in New Jersey Superior Court in July 1999 against JCP&L, GPU and other GPU companies, seeking compensatory and punitive damages arising from the July 1999 service interruptions in the JCP&L territory. Since July 1999, this litigation has involved a substantial amount of legal discovery including interrogatories, request for production of documents, preservation and inspection of evidence, and depositions of the named plaintiffs and many JCP&L employees. In addition, there have been many motions filed and argued by the parties involving issues such as the primary jurisdiction and findings of the NJBPU, consumer fraud by JCP&L, strict product liability, class decertification, and the damages claimed by the plaintiffs. In January 2000, the NJ Appellate Division determined that the trial court has proper jurisdiction over this litigation. In August 2002, the trial court granted partial summary judgment to JCP&L and dismissed the plaintiffs' claims for consumer fraud, common law fraud, negligent misrepresentation, and strict products liability. In November 2003, the trial court granted JCP&L's motion to decertify the class and denied plaintiffs' motion to permit into evidence their class-wide damage model indicating damages in excess of $50 million. These class decertification and damage rulings have been appealed to the Appellation Division and oral argument is scheduled for May 2004. FirstEnergy is unable to predict the outcome of these matters and no liability has been accrued as of December 31, 2003. On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the PUCO ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which are described above. Management Changes On December 11, 2003, we named a new president, to whom the Central and Northern regional presidents will report. The new organizational structure creates clearer lines of responsibility and accountability for our operations. Critical Accounting Policies We prepare our consolidated financial statements in accordance with accounting principles that are generally accepted in the United States (GAAP). Application of these principles often requires a high degree of judgment, estimates and assumptions that affect financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting these specific factors. Our more significant accounting policies are described below. Purchase Accounting The merger between FirstEnergy and GPU was accounted for by the purchase method of accounting, which requires judgment regarding the allocation of the purchase price based on the fair values of the assets acquired (including intangible assets) and the liabilities assumed. The fair values of the acquired assets and assumed liabilities were based primarily on estimates. The adjustments reflected in our records primarily consist of: (1) revaluation of certain property, plant and equipment; (2) adjusting preferred stock subject to mandatory redemption and long-term debt to 9 estimated fair value; (3) recognizing additional obligations related to retirement benefits; and (4) recognizing estimated severance and other compensation liabilities. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill. Based on the guidance provided by SFAS 142, "Goodwill and Other Intangible Assets," we evaluate goodwill for impairment at least annually and would make such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. If impairment were indicated, we would recognize a loss - calculated as the difference between the implied fair value of its goodwill and the carrying value of the goodwill. Our annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in our evaluation of goodwill reflect operations consistent with our general business assumptions. Unanticipated changes in those assumptions could have a significant effect on our future evaluations of goodwill. As of December 31, 2003, we had recorded goodwill of approximately $2.0 billion related to the merger. Regulatory Accounting We are subject to regulation that sets the prices (rates) we are permitted to charge our customers based on the costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. As a result of the changing regulatory framework in New Jersey, a significant amount of regulatory assets have been recorded - $2.6 billion as of December 31, 2003. We regularly review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Derivative Accounting Determination of appropriate accounting for derivative transactions requires the involvement of management representing operations, finance and risk assessment. In order to determine the appropriate accounting for derivative transactions, the provisions of the contract need to be carefully assessed in accordance with the authoritative accounting literature and management's intended use of the derivative. New authoritative guidance continues to shape the application of derivative accounting. Management's expectations and intentions are key factors in determining the appropriate accounting for a derivative transaction and, as a result, such expectations and intentions are documented. Derivative contracts that are determined to fall within the scope of SFAS 133, as amended, must be recorded at their fair value. Active market prices are not always available to determine the fair value of the later years of a contract, requiring that various assumptions and estimates be used in their valuation. We continually monitor our derivative contracts to determine if our activities, expectations, intentions, assumptions and estimates remain valid. As part of our normal operations, we enter into commodity contracts, as well as interest rate swaps, which increase the impact of derivative accounting judgments. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for kilowatt-hours that have been delivered but not yet billed through the end of the accounting period. The determination of unbilled revenues requires management to make various estimates including: o Net energy generated or purchased for retail load o Losses of energy over distribution lines o Allocations to distribution companies within the FirstEnergy system o Mix of kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers Pension and Other Postretirement Benefits Accounting FirstEnergy's reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions (OPEB) are dependent upon numerous factors resulting from actual plan experience and certain assumptions. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions FirstEnergy makes to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, which 10 reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, FirstEnergy reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. FirstEnergy's assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by their pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. FirstEnergy's pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and their pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, our accrued pension costs as of June 30, 2003 increased by $79 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $22 million, recording an increase of $59,000 in an intangible asset and crediting OCI by $13 million (offsetting previously recorded deferred tax benefits by $9 million). The remaining balance in OCI of $48 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $68 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, FirstEnergy will not be required to fund their pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. FirstEnergy's pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 1(H)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining their trend rate assumptions, FirstEnergy included the specific provisions of their health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in their health care plans, and projections of future medical trend rates. The effect on FirstEnergy's pension and OPEB costs and liabilities from changes in key assumptions are as follows: Increase in Costs from Adverse Changes in Key Assumptions - ------------------------------------------------------------------------------- Assumption Adverse Change Pension OPEB Total - ------------------------------------------------------------------------------- (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 5 $ 15 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% n/a $26 $ 26 Increase in Minimum Liability Discount rate................ Decrease by 0.25% $104 n/a $104 - ------------------------------------------------------------------------------- Long-Lived Assets In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying 11 value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. Nuclear Decommissioning In accordance with SFAS 143, we recognize an ARO for the future decommissioning of TMI-2. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. The scenarios consider settlement of the ARO at the expiration of the nuclear power plants' current license and settlement based on an extended license term New Accounting Standards And Interpretations Adopted FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. FIN 46R requires adoption for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. Adoption of FIN 46R for all other types of entities is effective March 31, 2004. We are evaluating entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. These entities are non-utility generators in which we have neither debt nor equity investments but are generally the sole purchaser of their power. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, we implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Note 1(E) for further discussion of SFAS 143. DIG Implementation Issue No. C20 for SFAS 133, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) Regarding Contracts with a Price Adjustment Feature" In June 2003, the FASB cleared DIG Issue C20 for implementation in fiscal quarters beginning after July 10, 2003. The issue supersedes earlier DIG Issue C11, "Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception." DIG Issue C20 provides guidance regarding when the presence of a general index, such as the Consumer Price Index, in a contract would prevent that contract from qualifying for the normal purchases and normal sales exception under SFAS 133, as amended, and therefore exempt from the mark-to-market treatment of certain contracts. Adoption of DIG Issue C20 did not impact our financial statements. 12 JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED STATEMENTS OF INCOME
Nov 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - ---------------------------------------------------------------------------------------------------------------------- (In thousands) | OPERATING REVENUES (Note 1(J))............................ $2,364,203 $2,328,415 $282,902 | $1,838,638 ---------- ---------- -------- | ---------- | OPERATING EXPENSES AND TAXES: | Fuel and purchased power (Note 1(J))................... 1,504,558 1,248,012 136,123 | 932,300 Other operating costs (Note 1(J))...................... 368,041 272,890 40,670 | 237,513 ---------- ---------- -------- | ----------- Total operation and maintenance expenses............. 1,872,599 1,520,902 176,793 | 1,169,813 Provision for depreciation and amortization............ 250,013 244,759 35,124 | 205,918 General taxes.......................................... 53,481 56,049 8,919 | 56,582 Income taxes........................................... 41,839 171,496 18,400 | 113,478 ---------- ---------- -------- | ----------- Total operating expenses and taxes................... 2,217,932 1,993,206 239,236 | 1,545,791 ---------- ---------- -------- | ----------- | OPERATING INCOME.......................................... 146,271 335,209 43,666 | 292,847 | OTHER INCOME (EXPENSE).................................... 7,530 7,653 1,186 | (176,875) ---------- ---------- -------- | ----------- | INCOME BEFORE NET INTEREST CHARGES........................ 153,801 342,862 44,852 | 115,972 ---------- ---------- -------- | ----------- | NET INTEREST CHARGES: | Interest on long-term debt............................. 87,681 92,314 14,234 | 77,205 Allowance for borrowed funds used during | construction......................................... (296) (583) 135 | (1,665) Deferred interest ..................................... (8,639) (8,815) (2,243) | (12,557) Other interest expense................................. 1,691 (2,643) 1,080 | 9,427 Subsidiary's preferred stock dividend requirements..... 5,347 10,694 1,605 | 9,095 ---------- ---------- -------- | ----------- Net interest charges................................. 85,784 90,967 14,811 | 81,505 ---------- ---------- -------- | ----------- | NET INCOME................................................ 68,017 251,895 30,041 | 34,467 | PREFERRED STOCK DIVIDEND REQUIREMENTS..................... 500 2,125 698 | 4,547 | GAIN ON PREFERRED STOCK REACQUISITION..................... (612) (3,589) -- | -- ---------- ---------- -------- | ----------- | EARNINGS ON COMMON STOCK.................................. $ 68,129 $ 253,359 $ 29,343 | $ 29,920 ========== ========== ======== | =========== | The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
13 JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------ (In thousands) ASSETS UTILITY PLANT: In service..................................................................... $3,642,467 $3,478,803 Less-Accumulated provision for depreciation.................................... 1,367,042 1,203,043 ---------- ---------- 2,275,425 2,275,760 ---------- ---------- Construction work in progress.................................................. 48,985 20,687 ---------- ---------- 2,324,410 2,296,447 ---------- ---------- OTHER PROPERTY AND INVESTMENTS: Nuclear plant decommissioning trusts........................................... 125,945 106,820 Nuclear fuel disposal trust.................................................... 155,774 149,738 Long-term notes receivable from associated companies........................... 19,579 20,333 Other.......................................................................... 18,744 18,202 ---------- ---------- 320,042 295,093 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents...................................................... 271 4,823 Receivables- Customers (less accumulated provisions of $4,296,000 and $4,509,000 respectively, for uncollectible accounts).................................. 198,061 247,624 Associated companies......................................................... 70,012 318 Other (less accumulated provisions of $1,183,000 in 2003).................... 46,411 20,134 Notes receivable from associated companies..................................... -- 77,358 Materials and supplies, at average cost........................................ 2,480 1,341 Prepayments and other.......................................................... 49,360 37,719 ---------- ---------- 366,595 389,317 ---------- ---------- NONCURRENT LIABILITIES: Regulatory assets.............................................................. 2,558,214 3,058,209 Goodwill....................................................................... 2,001,302 2,000,875 Other.......................................................................... 8,481 12,814 ---------- ---------- 4,567,997 5,071,898 ---------- ---------- $7,579,044 $8,052,755 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholder's equity.................................................... $3,153,974 $3,274,069 Preferred stock not subject to mandatory redemption............................ 12,649 12,649 Company-obligated mandatorily redeemable preferred securities.................. -- 125,244 Long-term debt................................................................. 1,095,991 1,210,446 ---------- ---------- 4,262,614 4,622,408 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt............................................... 175,921 173,815 Short-term borrowings (Note 5)- Associated companies......................................................... 230,985 -- Accounts payable- Associated companies......................................................... 42,410 170,803 Other........................................................................ 105,815 106,504 Accrued taxes................................................................. 919 13,844 Accrued interest............................................................... 14,843 27,161 Other.......................................................................... 58,094 112,408 ---------- ---------- 628,987 604,535 ---------- ---------- NONCURRENT LIABILITIES: Accumulated deferred income taxes.............................................. 640,208 691,721 Accumulated deferred investment tax credits.................................... 7,711 9,939 Power purchase contract loss liability ........................................ 1,473,070 1,710,968 Nuclear fuel disposal costs.................................................... 167,936 166,191 Asset retirement obligation.................................................... 109,851 -- Retirement benefits............................................................ 159,219 -- Nuclear plant decommissioning costs............................................ -- 135,355 Other.......................................................................... 129,448 111,638 ---------- ---------- 2,687,443 2,825,812 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Notes 3 and 6)............................................................... ---------- ---------- $7,579,044 $8,052,755 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets. 14
JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION
As of December 31, 2003 2002 - ----------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDER'S EQUITY: Common stock, par value $10 per share, authorized 16,000,000 shares 15,371,270 shares outstanding.................................................... $ 153,713 $ 153,713 Other paid-in capital.............................................................. 3,029,894 3,029,218 Accumulated other comprehensive loss (Note 4(F))................................... (51,765) (865) Retained earnings (Note 4(A))...................................................... 22,132 92,003 ---------- ----------- Total common stockholder's equity................................................ 3,153,974 3,274,069 ---------- ----------- Number of Shares Optional Outstanding Redemption Price ---------------- -------------------- 2003 2002 Per Share Aggregate ---- ---- --------- --------- PREFERRED STOCK (Note 4(C)): Cumulative, without par value- Authorized 125,000 shares Not Subject to Mandatory Redemption: 4% Series...................... 125,000 125,000 $106.50 $13,313 12,649 12,649 ======= ======= ======= ======= ---------- ----------- Company obligated mandatorily redeemablE Preferred securities of subsidiary LIMITED PARTNERSHIP Holding solely company subordinated Debentures Cumulative, $25 par value - Authorized 5,000,000 shares Subject to Mandatory Redemption: 8.56% due 2044.................................................................. -- 125,244 ---------- ----------- LONG-TERM DEBT (Note 4(D)): First mortgage bonds: 6.375% due 2003................................................................... -- 150,000 7.125% due 2004................................................................... 160,000 160,000 6.780% due 2005................................................................... 50,000 50,000 6.850% due 2006................................................................... 40,000 40,000 8.250% due 2006................................................................... -- 23,053 7.900% due 2007................................................................... -- 18,361 7.125% due 2009................................................................... 6,300 6,300 7.100% due 2015................................................................... 12,200 12,200 9.200% due 2021................................................................... -- 22,963 8.320% due 2022................................................................... 40,000 40,000 8.550% due 2022................................................................... -- 13,623 7.980% due 2023................................................................... 40,000 40,000 7.500% due 2023................................................................... 125,000 125,000 8.450% due 2025................................................................... 50,000 50,000 6.750% due 2025................................................................... 150,000 150,000 ---------- ----------- Total first mortgage bonds...................................................... 673,500 901,500 ---------- ----------- Secured notes: 6.450% due 2006................................................................... 150,000 150,000 4.190% due 2007................................................................... 67,312 91,111 5.390% due 2010................................................................... 52,297 52,297 5.810% due 2013................................................................... 77,075 77,075 6.160% due 2017................................................................... 99,517 99,517 4.800% due 2018................................................................... 150,000 -- ---------- ----------- Total secured notes............................................................. 596,201 470,000 ---------- ----------- Unsecured notes: 7.69% due 2039.................................................................... 2,968 2,984 ---------- ----------- Net unamortized premium (discount) on debt.......................................... (757) 9,777 ---------- ----------- Long-term debt due within one year.................................................. (175,921) (173,815) ---------- ----------- Total long-term debt............................................................ 1,095,991 1,210,446 ---------- ----------- TOTAL CAPITALIZATION................................................................... $4,262,614 $4,622,408 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 15
JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
Common Stock Accumulated ------------------- Other Other Comprehensive Number Par Paid-In Comprehensive Retained Income of Shares Value Capital Income (Loss) Earnings ------------- ---------- -------- ---------- ------------- -------- (Dollars in thousands) Balance, January 1, 2001........................... 15,371,270 $153,713 $ 510,769 $ (8) $ 794,786 Net income...................................... $ 34,467 34,467 Net unrealized gain on investments.............. 2 2 Net unrealized gain on derivative instruments... 768 768 -------- Comprehensive income............................ $ 35,237 -------- Cash dividends on preferred stock............... (4,547) Cash dividends on common stock ................ (175,000) - ------------------------------------------------------------------------------------------------------------------------------- Balance, November 6, 2001.......................... 15,371,270 153,713 510,769 762 649,706 Purchase accounting fair value adjustment....... 2,470,348 (762) (649,706) _______________________________________________________________________________________________________________________________ Balance, November 7, 2001.......................... 15,371,270 153,713 2,981,117 -- -- Net income...................................... $ 30,041 30,041 Net unrealized loss on derivative instruments... (472) (472) -------- Comprehensive income............................ $ 29,569 -------- Cash dividends on preferred stock............... (698) - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001......................... 15,371,270 153,713 2,981,117 (472) 29,343 Net income...................................... $251,895 251,895 Net unrealized loss on derivative instruments... (393) (393) -------- Comprehensive income............................ $251,502 -------- Cash dividends on preferred stock............... 1,465 Cash dividends on common stock.................. (190,700) Purchase accounting fair value adjustment....... 48,101 - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002......................... 15,371,270 153,713 3,029,218 (865) 92,003 Net income...................................... $ 68,017 68,017 Net unrealized loss on derivative instruments... (3,020) (3,020) Minimum liability for unfunded retirement benefits, net of $(32,998,000) of income taxes.................................. (47,880) (47,880) -------- Comprehensive income............................ $ 17,117 -------- Cash dividends on preferred stock............... (500) Cash dividends on common stock.................. (138,000) Gain on preferred stock reacquisition........... Purchase accounting fair value adjustment ...... 676 612 - ------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003......................... 15,371,270 $153,713 $3,029,894 $(51,765) $ 22,132 ===============================================================================================================================
CONSOLIDATED STATEMENTS OF PREFERRED STOCK
Not Subject to Subject to Mandatory Redemption Mandatory Redemption -------------------- -------------------- Number Carrying Number Carrying of Shares Value of Shares Value --------- -------- --------- -------- (Dollars in thousands) Balance, January 1, 2001............ 125,000 $12,649 5,623,334 $ 187,333 Redemptions- 7.52% Series.................... (25,000) (2,500) 8.65% Series.................... (83,333) (8,333) Purchase accounting fair value adjustment.............. 4,451 ----------------------------------------------------------------------------------------- Balance, December 31, 2001.......... 125,000 12,649 5,515,001 $ 180,951 Redemptions- 7.52% Series.................... (265,000) (28,951) 8.65% Series.................... (250,001) (26,750) Amortization of fair market value adjustment.............. (6) ----------------------------------------------------------------------------------------- Balance, December 31, 2002.......... 125,000 12,649 5,000,000 $ 125,244 Redemptions- 8.56% Series.................... (5,000,000) (125,242) Amortization of fair market value adjustment.............. (2) ----------------------------------------------------------------------------------------- Balance, December 31, 2003.......... 125,000 $12,649 -- $ -- ========================================================================================= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 16
JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - -------------------------------------------------------------------------------------------------------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: | Net Income.................................................... $ 68,017 $ 251,895 $ 30,041 | $ 34,467 Adjustments to reconcile net income to net | cash from operating activities: | Provision for depreciation and amortization.............. 250,013 244,759 35,124 | 205,918 Other amortization....................................... 64 849 1,360 | 23,025 Deferred costs recoverable as regulatory assets.......... (164,290) (285,065) (25,471) | (29,312) Deferred income taxes, net............................... 64,600 115,866 5,609 | (58,132) Investment tax credits, net.............................. (2,228) (3,551) (540) | (3,057) Receivables.............................................. 4,528 (14,542) 7,050 | 27,177 Materials and supplies................................... (1,139) 7 2 | (842) Accounts payable......................................... (153,953) 16,399 (5,060) | (44,498) Retail rate refunds obligation payments.................. (71,984) (43,016) -- | -- Disallowed purchased power costs......................... 152,500 -- -- | -- Accrued retirement benefit obligation.................... 8,381 -- -- | -- Accrued compensation, net................................ 19,864 (59) -- | -- Other (Note 7)........................................... 5,579 25,433 20,563 | 66,328 --------- --------- -------- | --------- Net cash provided from operating activities............ 179,952 308,975 68,678 | 221,074 --------- --------- -------- | --------- | CASH FLOWS FROM FINANCING ACTIVITIES: | New Financing- | Long-term debt........................................... 150,000 318,106 -- | 148,796 Short-term borrowings, net............................... 230,985 -- -- | -- Redemptions and Repayments- | Preferred stock.......................................... (125,244) (51,500) -- | (10,833) Long-term debt........................................... (251,815) (196,033) (40,000) | -- Short-term borrowings, net............................... -- (18,149) (1,851) | (9,200) Dividend Payments- | Common stock............................................. (138,000) (190,700) -- | (175,000) Preferred stock.......................................... (5,235) (2,125) (698) | (4,547) --------- --------- -------- | --------- Net cash used for financing activities................. (139,309) (140,401) (42,549) | (50,784) --------- --------- -------- | --------- | CASH FLOWS FROM INVESTING ACTIVITIES: | Property additions......................................... (122,930) (97,346) (21,487) | (141,030) Contributions to decommissioning trusts.................... (2,630) -- (202) | (1,004) Loan payments from (to) associated companies, net.......... 78,112 (77,358) -- | -- Other...................................................... 2,253 (20,471) (1,078) | (2,215) --------- --------- -------- | --------- Net cash used for investing activities................. (45,196) (195,175) (22,767) | (144,249) --------- --------- -------- | --------- | | Net increase (decrease) in cash and cash equivalents.......... (4,552) (26,601) 3,362 | 26,041 Cash and cash equivalents at beginning of period.............. 4,823 31,424 28,062 | 2,021 --------- --------- -------- | --------- Cash and cash equivalents at end of period.................... $ 271 $ 4,823 $ 31,424 | $ 28,062 ========= ========= ======== | ========= | SUPPLEMENTAL CASH FLOWS INFORMATION: | Cash Paid During the Year- | Interest (net of amounts capitalized).................... $ 101,432 $ 92,152 $ 4,787 | $ 95,509 ========= ========= ======== | ========= Income taxes............................................. $ 16,883 $ 83,776 $ 20,586 | $ 19,365 ========= ========= ======== | ========= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 17
JERSEY CENTRAL POWER & LIGHT COMPANY CONSOLIDATED STATEMENTS OF TAXES
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - -------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: | New Jersey Transitional Energy Facilities Assessment*......... $ 38,668 $ 39,387 $ 6,765 | $ 42,418 Real and personal property.................................... 3,889 4,362 283 | 3,589 State gross receipts.......................................... -- -- 1,269 | -- Social security and unemployment.............................. 4,826 -- (1) | 7 Other ....................................................... 6,098 12,300 603 | 10,568 -------- -------- -------- | --------- Total general taxes.................................... $ 53,481 $ 56,049 $ 8,919 | $ 56,582 ======== ======== ======== | ========= | PROVISION FOR INCOME TAXES: | Currently payable (receivable)- | Federal.................................................... $(15,687) $ 55,731 $ 11,827 | $ 41,826 State...................................................... (245) 13,809 3,205 | 19,415 -------- -------- -------- | --------- (15,932) `69,540 15,032 | 61,241 -------- -------- -------- | --------- Deferred, net- | Federal.................................................... 54,252 88,758 4,268 | (36,210) State...................................................... 10,348 27,108 1,341 | (21,922) -------- -------- -------- | --------- 64,600 115,866 5,609 | (58,132) -------- -------- -------- | --------- Investment tax credit amortization............................ (2,228) (3,551) (540) | (3,057) -------- -------- -------- | --------- Total provision for income taxes....................... $ 46,440 $181,855 $ 20,101 | $ 52 ======== ======== ======== | ========= | INCOME STATEMENT CLASSIFICATION | OF PROVISION FOR INCOME TAXES: | Operating income.............................................. $ 41,839 $171,496 $ 18,400 | $ 113,478 Other income.................................................. 4,601 10,359 1,701 | (113,426) -------- -------- -------- | --------- Total provision for income taxes....................... $ 46,440 $181,855 $ 20,101 | $ 52 ======== ======== ======== | ========= | RECONCILIATION OF FEDERAL INCOME TAX | EXPENSE AT STATUTORY RATE TO TOTAL | PROVISION FOR INCOME TAXES: | Book income before provision for income taxes................. $114,457 $433,749 $ 50,142 | $ 34,519 ======== ======== ======== | ========= Federal income tax expense at statutory rate.................. $ 40,060 $151,812 $ 17,550 | $ 12,082 Increases (reductions) in taxes resulting from- | Amortization of investment tax credits..................... (2,228) (3,551) (540) | (3,057) Depreciation............................................... 3,315 7,154 226 | 3,563 State income tax, net of federal benefit................... 7,178 27,111 3,077 | 4,355 Allocated share of consolidated tax savings................ -- -- -- | (8,509) Other, net................................................. (1,885) (671) (212) | (8,382) -------- -------- -------- | --------- Total provision for income taxes....................... $ 46,440 $181,855 $ 20,101 | $ 52 ======== ======== ======== | ========= | ACCUMULATED DEFERRED INCOME TAXES AT | DECEMBER 31: | Property basis differences.................................... $371,811 $297,983 $288,255 | Nuclear decommissioning....................................... 34,663 44,775 59,716 | Deferred sale and leaseback costs............................. (16,651) (16,451) (16,240) | Purchase accounting basis difference.......................... (1,253) (1,253) (71,900) | Sale of generation assets..................................... (17,861) (17,861) 184,625 | Regulatory transition charge.................................. 197,729 224,117 123,042 | Provision for rate refund..................................... -- (29,370) (46,942) | Customer receivables for future income taxes.................. (4,519) (5,336) 16,749 | Oyster Creek securitization................................... 193,558 202,448 -- | Other comprehensive income.................................... (32,998) -- -- | Employee benefits............................................. (29,129) -- -- | Other......................................................... (55,142) (7,331) (23,089) | -------- -------- -------- | Net deferred income tax liability...................... $640,208 $691,721 $514,216 | ======== ======== ======== | * Collected from customers through regulated rates and included in revenue on the Consolidated Statements of Income. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include Jersey Central Power & Light Company (Company) and its wholly owned subsidiaries. The Company is a wholly owned subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the issued and outstanding common shares of its other principal electric utility operating subsidiaries, including Ohio Edison Company (OE), The Cleveland Electric Illuminating Company (CEI), The Toledo Edison Company (TE), American Transmission Systems, Inc. (ATSI), Metropolitan Edison Company (Met-Ed) and Pennsylvania Electric Company (Penelec). The Company, Met-Ed and Penelec were formerly wholly owned subsidiaries of GPU, Inc., which merged with FirstEnergy on November 7, 2001. Pre-merger and post-merger period financial results are separated by a heavy black line. The Company follows the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the New Jersey Board of Public Utilities (NJBPU) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. (A) CONSOLIDATION- The Company consolidates all majority-owned subsidiaries, over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) over which the Company has the ability to exercise significant influence, but not control, are accounted for on the equity basis. (B) REVENUES- The Company's principal business is providing electric service to customers in New Jersey. The Company's retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. See Note 7 - Other Information for discussion of reporting of independent system operator transactions. Receivables from customers include sales to residential, commercial and industrial customers and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of the Company's customers. Total customer receivables were $198 million (billed - $119 million and unbilled - $79 million) and $248 million (billed - $154 million and unbilled - $94 million) as of December 31, 2003 and 2002, respectively. (C) REGULATORY MATTERS- The Company's 2001 Final Decision and Order (Final Order) with respect to its rate unbundling, stranded cost and restructuring filings confirmed rate reductions set forth in its 1999 Summary Order, which had been in effect at increasing levels through July 2003. The Final Order also confirmed the establishment of a non-bypassable societal benefits charge (SBC) to recover costs which include nuclear plant decommissioning and manufactured gas plant remediation, as well as a non-bypassable market transition charge (MTC) primarily to recover stranded costs. The NJBPU has deferred making a final determination of the net proceeds and stranded costs related to prior generating asset divestitures until the Company's request for an Internal Revenue Service (IRS) ruling regarding the treatment of associated federal income tax benefits is acted upon. Should the IRS ruling support the return of the tax benefits to customers, there would be no effect to the Company's net income since the contingency existed prior to the merger and there would be an adjustment to goodwill. In addition, the Final Order provided for the ability to securitize stranded costs associated with the divested Oyster Creek Nuclear Generating Station. Under NJBPU authorization in 2002, the Company issued through its wholly owned subsidiary, JCP&L Transition Funding LLC, $320 million of transition bonds (recognized on the Consolidated Balance Sheet) which securitized the recovery of these costs and which provided for a usage-based non-bypassable transition bond charge (TBC) and for the transfer of the bondable transition property to another entity. Prior to August 1, 2003, the Company's provider of last resort (PLR) obligation to provide basic generation service (BGS) to non-shopping customers was supplied almost entirely from contracted and open market purchases. The Company is permitted to defer for future collection from customers the amounts by which its costs of supplying BGS to non-shopping customers and costs incurred under nonutility generation (NUG) agreements exceed amounts collected through 19 BGS and MTC rates. As of December 31, 2003, the accumulated deferred cost balance totaled approximately $440 million, after the charge discussed below. The NJBPU also allowed securitization of the Company's deferred balance to the extent permitted by law upon application by the Company and a determination by the NJBPU that the conditions of the New Jersey restructuring legislation are met. There can be no assurance as to the extent, if any, that the NJBPU will permit such securitization. Under New Jersey transition legislation, all electric distribution companies were required to file rate cases to determine the level of unbundled rate components to become effective August 1, 2003. The Company's two August 2002 rate filings requested increases in base electric rates of approximately $98 million annually and requested the recovery of deferred costs that exceeded amounts being recovered under the current MTC and SBC rates; one proposed method of recovery of these costs is the securitization of the deferred balance. This securitization methodology is similar to the Oyster Creek securitization discussed above. On July 25, 2003, the NJBPU announced its decision in the Company's base electric rate proceeding decision, which reduced the Company's annual revenues by approximately $62 million effective August 1, 2003. The NJBPU decision also provided for an interim return on equity of 9.5 percent on the Company's rate base for 6 to 12 months. During that period, the Company will initiate another proceeding to request recovery of additional costs incurred to enhance system reliability. In that proceeding, the NJBPU could increase the return on equity to 9.75 percent or decrease it to 9.25 percent, depending on its assessment of the reliability of the Company's service. Any reduction would be retroactive to August 1, 2003. The net revenue decrease from the NJBPU's decision consists of a $223 million decrease in the electricity delivery charge, a $111 million increase due to the August 1, 2003 expiration of annual customer credits previously mandated by the New Jersey transition legislation, a $49 million increase in the MTC tariff component, and a net $1 million increase in the SBC charge. The MTC allows for the recovery of $465 million in deferred energy costs over the next ten years on an interim basis, thus disallowing $153 million of the $618 million provided for in a preliminary settlement agreement between certain parties. As a result, the Company recorded charges to net income for the year ended December 31, 2003, aggregating $185 million ($109 million net of tax) consisting of the $153 million deferred energy costs and other regulatory assets. the Company filed a motion for rehearing and reconsideration with the NJBPU on August 15, 2003 with respect to the following issues: (1) the disallowance of the $153 million deferred energy costs; (2) the reduced rate of return on equity; and (3) $42.7 million of disallowed costs to achieve merger savings. On October 10, 2003, the NJBPU held the motion in abeyance until the final NJBPU decision and order which is expected to be issued in the first quarter of 2004. The Company's BGS obligation for the twelve month period beginning August 1, 2003 was auctioned in February 2003. The auction covered a fixed price bid (applicable to all residential and smaller commercial and industrial customers) and an hourly price bid (applicable to all large industrial customers) process. JCP&L sells all self-supplied energy (NUGs and owned generation) to the wholesale market with offsetting credits to its deferred energy balances. The BGS auction for the subsequent period was completed in February 2004. The NJBPU adjusted the generation component of the Company's retail rates on August 1, 2003 to reflect the result of the BGS auction. On July 5, 2003, the Company experienced a series of 34.5 kilovolts sub-transmission line faults that resulted in outages on the New Jersey shore. The NJBPU instituted an investigation into these outages, and directed that a Special Reliability Master be hired to oversee the investigation. On December 8, 2003, the Special Reliability Master issued his Interim Report recommending that the Company implement a series of actions to improve reliability in the area affected by the outages. The NJBPU adopted the findings and recommendations of the Interim Report on December 17, 2003, and ordered the Company to implement the recommended actions on a staggered basis, with initial actions to be completed by March 31, 2004. The Company expects to spend $12.5 million implementing these actions during 2004. Regulatory Assets- The Company recognizes, as regulatory assets, costs which the FERC and the NJBPU have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are expected to continue to be recovered from customers under the Company's regulatory plan. The Company continues to bill and collect cost-based rates for its transmission and distribution services, which remain regulated; accordingly, it is appropriate that the Company continue the application of Statement of Financial Accounting Standards No.(SFAS) 71 , "Accounting for the Effects of Certain Types of Regulation," to those operations. 20 Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2003 2002 --------------------------------------------------------------------- (In millions) Regulatory transition charge................... $2,457 $2,802 Societal benefits charge....................... 82 144 Property losses and unrecovered plant costs.... 70 88 Customer receivables for future income taxes... -- 34 Employee postretirement benefit costs.......... 30 33 Loss on reacquired debt........................ 15 17 Component fuel disposal costs.................. 3 9 Component removal costs........................ (150) (141) Other.......................................... 51 72 -------------------------------------------------------------------- Total....................................... $2,558 $3,058 ==================================================================== Regulatory Accounting for Generation Operations- The application of SFAS 71 was discontinued in 1999 with respect to the Company's generation operations. The Company subsequently divested substantially all of its generating assets. The SEC issued interpretive guidance regarding asset impairment measurement, providing that any supplemental regulated cash flows such as a Competitive Transition Charge should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. Net assets included in utility plant relating to operations for which the application of SFAS 71 was discontinued were $42 million as of December 31, 2003. (D) PROPERTY, PLANT AND EQUIPMENT- As a result of the merger, a portion of the Company's property, plant and equipment was adjusted to reflect fair value. The majority of the Company's property, plant and equipment is reflected at original cost since such assets remain subject to rate regulation on a historical cost basis. In addition to its wholly owned facilities, the Company holds a 50% ownership interest in Yards Creek Pumped Storage Facility, and its net book value was approximately $20.7 million as of December 31, 2003. The Company's accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. The Company provides for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The annualized composite rate was approximately 2.8% in 2003, 3.5% in 2002 and 3.4% in 2001. The 2003 rate reflects the rate depreciation reduction from the NJBPU August 2003 rate decision. (E) ASSET RETIREMENT OBLIGATION- In January 2003, the Company implemented SFAS 143, "Accounting for Asset Retirement Obligations", which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. The Company identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning. The ARO liability as of the date of adoption of SFAS 143 was $103.9 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, the Company recognized decommissioning liabilities of $129.9 million. The Company expects substantially all nuclear decommissioning costs to be recoverable through regulated rates. Therefore, a regulatory liability of $26 million was recognized upon adoption of SFAS 143. Accretion during 2003 was $5.9 million, bringing the ARO liability as of December 31, 2003 to $109.8 million. The ARO includes the Company's obligation for the nuclear decommissioning of Three Mile Island Unit 2 (TMI-2). The Company's share of the obligation to decommission TMI-2 was developed based on a site-specific study performed by an independent engineer. The Company utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Company maintains nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $125.9 million. In accordance with SFAS 143, the Company ceased the accounting practice of depreciating non-regulated generation assets using a cost of removal component in the depreciation rates. That practice recognized accumulated depreciation in excess of the historical cost of an asset because the removal 21 cost would exceed the estimated salvage value. Beginning in 2003, the cost of removal related to non-regulated generation assets is charged to expense rather than to the accumulated provision for depreciation. In accordance with SFAS 71, the cost of removal on regulated plant assets continues to be accounted for as a component of depreciation rates and is recognized as a regulatory liability. If SFAS 143 had been applied during 2002 and 2001, there would have been no impact to the Company's Statements of Income. The following table provides the year-end balance of the ARO related to nuclear decommissioning for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 -------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002 $ 98.4 Accretion in 2002 5.5 -------------------------------------------------------- Ending balance as of December 31, 2002 $103.9 -------------------------------------------------------- In addition to the nuclear decommissioning ARO, FirstEnergy has also recognized estimated liabilities for post defueling monitored storage at TMI-2 of $26 million and decontamination and decommissioning of nuclear enrichment facilities of $28 million. Under terms of the NRC license, FirstEnergy is required to monitor and maintain TMI-2 to ensure that there is no deterioration of the facility. As required by the Energy Policy Act of 1992, FirstEnergy participates in the decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy. (F) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 4(B)). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date, resulting in substantially no intrinsic value. If FirstEnergy had accounted for employee stock options under the fair value method of SFAS 123, "Accounting for Stock Compensation," a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 ------------------------------------------------------------- Valuation assumptions: Expected option term (years). 7.9 8.1 8.3 Expected volatility.......... 26.91% 23.31% 23.45% Expected dividend yield...... 5.09% 4.36% 5.00% Risk-free interest rate...... 3.67% 4.60% 4.67% Fair value per option.......... $5.09 $6.45 $4.97 ------------------------------------------------------------- The effects of applying fair value accounting to the FirstEnergy's stock options would not materially affect the Company's net income. (G) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. Results for the period January 1, 2001 through November 6, 2001 were included in the final consolidated federal income tax return of GPU, and results for the period November 7, 2001 through December 31, 2001 were included in FirstEnergy's 2001 consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with the Company recognizing the tax benefit for any tax losses or credits it contributes to the consolidated return. 22 (H) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of the Company's employees. The trusteed plans provide defined benefits based on years of service and compensation levels. FirstEnergy's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company recognizes the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. The following sets forth the funded status of the plans and amounts recognized on FirstEnergy's Consolidated Balance Sheets as of December 31:
Obligations and Funded Status Pension Benefits Other Benefits ---------------- -------------- As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $ 1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition (Note 2)................. -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------- Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $ 2,077 ====== ====== ======= ======= Change in fair value of plan assets Fair value of plan assets at beginning of year................................ $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------- Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ======= Funded status............................ $ (847) $ (977) $(1,831) $(1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit) 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ ------- ------- Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= =======
23
Amounts Recognized in the Consolidated Balance Sheets As of December 31 ---------------------------------------- Accrued benefit cost..................... $(438) $(548) $(975) $(867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ----- ----- ------ ----- Net amount recognized.................... $ 144 $ 287 $(975) $(867) ===== ===== ===== ===== Company's share of net amount recognized. $ 13 $ -- $ (89) $ -- ===== ===== ===== ===== Increase (decrease) in minimum liability included in other comprehensive income (net of tax)........................... $(145) $ 444 $ -- $ -- Weighted-Average Assumptions Used to Determine Benefit Obligations As of December 31 ---------------------------------------- Discount rate........................... 6.25% 6.75% 6.25% 6.75% Rate of compensation increase........... 3.50% 3.50% Allocation of Plan Assets As of December 31 ---------------------------------------- Asset Category Equity securities..................... 70% 61% 71% 58% Debt securities....................... 27 35 22 29 Real estate........................... 2 2 -- -- Other................................. 1 2 7 13 --- ---- ----- ---- Total................................. 100% 100% 100% 100% === === === ===
Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 ----------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889
FirstEnergy's net pension and other postretirement benefit costs for the three years ended December 31, 2003 were computed as follows: Pension Benefits Other Benefits ---------------------- -------------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 --------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset) -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ----- ------ ----- ----- ---- ----- Net periodic cost (income).............. $ 142 $ (29) $ (24) $ 177 $114 $ 92 ===== ===== ===== ===== ==== ===== Company's share of net benefit costs (income) (see Note 7) Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31 --------------------------------------- Discount rate.......................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase.......... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy. 24 Assumed health care cost trend rates As of December 31 2003 2002 - ------------------------------------------------------------------------------ Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2008-2010 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Increase Point Decrease - -------------------------------------------------------------------------------- (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of GPU Service Inc. (GPUS) merging with FirstEnergy Service Company (FESC) in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, the accrued pension costs for the Company as of June 30, 2003 increased by $79 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of our pension plan assets, the Company reduced its minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $22 million, recording an increase of $59,000 in an intangible asset and crediting OCI by $13 million (offsetting previously recorded deferred tax benefits by $9 million). The remaining balance in OCI of $48 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $68 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. (I) GOODWILL- In a business combination, excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Under SFAS 142, "Goodwill and Other Intangible Assets," amortization of existing goodwill ceased January 1, 2002. Instead, the Company evaluates its goodwill for impairment at least annually and makes such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. When impairment is indicated, the Company would recognize a loss - calculated as the difference between the implied fair value of its goodwill and the carrying value of the goodwill indicated. The Company's annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in the Company's evaluation of goodwill reflect operations consistent with its general business assumptions. Unanticipated changes in those assumptions could have a significant effect on JCP&L's future evaluations of goodwill. As of December 31, 2003, the Company had recorded goodwill of $2.0 billion related to the merger. (J) TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and other income included transactions with affiliated companies, primarily FESC, GPUS and FirstEnergy Solutions (FES). GPUS (until it ceased operations in mid-2003) and FESC have provided legal, accounting, financial and other services to the Company. The 25 Company also entered into sale and purchase transactions with affiliates (Met-Ed and Penelec) during the period. Through the BGS auction process, FES is a supplier of power to the Company. See Note 7 for further discussion of transactions with affiliated companies. FirstEnergy does not bill directly or allocate any of its costs to any subsidiary company. Costs are allocated to the Company from its affiliates, GPUS and FESC, both subsidiaries of FirstEnergy Corp. and both "mutual service companies" as defined in Rule 93 of the Public Utility Holding Company Act of 1935 (PUHCA). The majority of costs are directly billed or assigned at no more than cost as determined by PUHCA Rule 91. The remaining costs are for services that are provided on behalf of more than one company, or costs that cannot be precisely identified and are allocated using formulas that are filed annually with the SEC on Form U-13-60. The current allocation or assignment formulas used and their bases include multiple factor formulas: each company's proportionate amount of FirstEnergy's aggregate direct payroll, number of employees, asset balances, revenues, number of customers, other factors and specific departmental charge ratios. Management believes that these allocation methods are reasonable. Intercompany transactions with FirstEnergy and its other subsidiaries are generally settled under commercial terms within 30 day, except for a net $26 million receivable from affiliates for pension and OPEB obligations. (K) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Consolidated Balance Sheets at cost, which approximates their fair market value. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Consolidated Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31:
2003 2002 - ---------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value (In millions) Long-term debt.................................. $1,273 $1,190 $1,374 $1,415 Preferred stock................................. $ -- $ -- $ 125 $ 127 Investments other than cash and cash equivalents $ 283 $ 283 $ 258 $ 258 - ----------------------------------------------------------------------------------------------------------
The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by corporations with credit ratings similar to the Company's ratings. In 2001, long-term debt and preferred stock subject to mandatory redemption were recognized at fair value in connection with the merger. The fair value of investments other than cash and cash equivalents represents cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. The Company has no securities held for trading purposes. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "Investments other than cash and cash equivalents" in the table above) consist of equity securities ($69 million) and fixed income securities ($57 million) as of December 31, 2003. Realized and unrealized gains and losses applicable to the decommissioning trusts have been recognized in the trust investment with a corresponding change to regulatory assets. For 2003 and 2002, net realized gains (losses) were approximately $0.8 million and $(0.06) million and interest and dividend income totaled approximately $3.8 million and $3.6 million, respectively. On January 1, 2001, the Company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities -- an amendment of FASB Statement No. 133." The adoption resulted in the recognition of derivative assets on the Consolidated Balance Sheet as of January 1, 2001 in the amount of $21.8 million with offsetting amounts, net of tax, recorded in Accumulated Other Comprehensive Income, of $5.1 million, and in Regulatory Assets, of $13 million. The Company is exposed to financial risks resulting from the fluctuation of commodity prices, including electricity and natural gas. To manage the volatility relating to these exposures, the Company uses a variety of non-derivative and derivative instruments, including forward contracts, options and futures contracts. These derivatives are used principally for hedging 26 purposes. The Company has a Risk Policy Committee, comprised of FirstEnergy executive officers, which exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. The Company uses derivatives to hedge the risk of price fluctuations. The Company's primary ongoing hedging activity involves cash flow hedges of electricity and natural gas purchases. The majority of the Company's forward commodity contracts are considered "normal purchases and sales," as defined by SFAS 133, and are therefore excluded from the scope of SFAS 138. The forward contracts, options and futures contracts determined to be within the scope of SFAS 133 are accounted for as cash flow hedges and expire on various dates through 2003. Gains and losses from hedges of commodity price risks are included in net income when the underlying hedged commodities are delivered. The Company may also use derivatives to hedge anticipated debt issuances or existing debt. There was a net deferred loss of $3.9 million included in Accumulated Other Comprehensive Loss as of December 31, 2003 which is primarily related to a cash flow hedge of a 2003 debt issuance. This deferred loss is being amortized over the fifteen year life of the related debt. 2. MERGER: On November 7, 2001, the merger of FirstEnergy and GPU became effective pursuant to the Agreement and Plan of Merger, dated August 8, 2000. As a result of the merger, GPU's former wholly owned subsidiaries, including the Company, became wholly owned subsidiaries of FirstEnergy. The merger was accounted for by the purchase method of accounting. The assets acquired and liabilities assumed were recorded at estimated fair values as determined by FirstEnergy's management based on information currently available and on current assumptions as to future operations. Merger purchase accounting adjustments recorded in the records of the Company primarily consist of: (1) revaluation of certain property, plant and equipment; (2) adjusting preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (3) recognizing additional obligations related to retirement benefits; and (4) recognizing estimated severance and other compensation liabilities. Other assets and liabilities were not adjusted since they remain subject to rate regulation on a historical cost basis. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill. During 2002 and 2003, certain pre-acquisition contingencies and other final adjustments to the fair values of the assets acquired and liabilities assumed were reflected in the final allocations of the purchase price. These adjustments primarily related to: (1) final actuarial calculations related to pension and postretirement benefit obligations and (2) return to accrual adjustments for income taxes. As a result of these adjustments, goodwill increased by approximately $74.3 million. As of December 31, 2003, the Company had recorded goodwill of $2.0 billion related to the merger. 3. LEASES: Consistent with regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. The Company's most significant operating lease relates to the sale and leaseback of a portion of its ownership interest in the Merrill Creek Reservoir project. The interest element related to this lease was $1.4 million, $1.2 million and $1.2 million for the years 2003, 2002 and 2001, respectively. As of December 31, 2003, the future minimum lease payments on the Company's Merrill Creek operating lease, net of reimbursements from subleases, are: $1.2 million, $1.7 million, $1.6 million, $1.6 million and $1.6 million for the years 2004 through 2008, respectively, and $55.1 million for the years thereafter. The Company is recovering its Merrill Creek lease payments, net of reimbursements, through its distribution rates. 4. CAPITALIZATION: (A) RETAINED EARNINGS- The merger purchase accounting adjustments included resetting the retained earnings balance to zero as of the November 7, 2001 merger date. In general, the Company's first mortgage bond (FMB) indentures restrict the payment of dividends or distributions on or with respect to the Company's common stock to amounts credited to earned surplus since approximately the date of its indenture. On that date, the Company had a $1.7 million balance in its earned surplus account, which would not be available for dividends or other distributions. As of December 31, 2003, the Company had retained earnings available to pay common stock dividends of $20.4 million, net of amounts restricted under the Company's FMB indentures. 27 (B) STOCK COMPENSATION PLANS- FirstEnergy administers the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Several other stock compensation plans have been acquired through the mergers with GPU and Centerior - GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan), 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan) and Centerior Equity Plan. No further stock-based compensation can be awarded under these plans. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 2003 2002 2001 -------------------------------------------------------------------------- Restricted common shares granted..... -- 36,922 133,162 Weighted average market price ........ n/a (1) $36.04 $35.68 Weighted average vesting period (years) n/a (1) 3.2 3.7 Dividends restricted.................. n/a (1) Yes -- (2) -------------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price -------------------------------------------------------------------------- Balance, January 1, 2001............... 5,021,862 $24.09 (473,314 options exercisable).......... 24.11 Options granted...................... 4,240,273 28.11 Options exercised.................... 694,403 24.24 Options forfeited.................... 120,044 28.07 Balance, December 31, 2001............. 8,447,688 26.04 (1,828,341 options exercisable)........ 24.83 Options granted...................... 3,399,579 34.48 Options exercised.................... 1,018,852 23.56 Options forfeited.................... 392,929 28.19 Balance, December 31, 2002............. 10,435,486 28.95 (1,400,206 options exercisable)........ 26.07 Options granted...................... 3,981,100 29.71 Options exercised.................... 455,986 25.94 Options forfeited.................... 311,731 29.09 Balance, December 31, 2003............. 13,648,869 29.27 (1,919,662 options exercisable)........ 29.67 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. Options outstanding by plan and range of exercise price as of December 31, 2003 were as follows: 28 Range of Options FirstEnergy Program Exercise Prices Outstanding -------------------------------------------------------------------- FE plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU plan $23.75 - $35.92 501,734 Other plans 27,673 ------------------------------------------------------------------- Total 13,648,869 =================================================================== No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 1(F) - Stock-Based Compensation. (C) PREFERRED AND PREFERENCE STOCK- Preferred stock may be redeemed by the Company, in whole or in part, with 30-90 days' notice. (D) LONG-TERM DEBT- The Company's FMB indenture, which secures all of the Company's FMBs, serve as a direct first mortgage lien on substantially all of the Company's property and franchises, other than specifically excepted property. The Company has various debt covenants under its financing arrangements. The most restrictive of these relate to the nonpayment of interest and/or principal on debt, which could trigger a default. Cross-default provisions also exist between FirstEnergy and the Company. Based on the amount of bonds authenticated by the Trustee through December 31, 2003 the Company's annual sinking fund requirements for all bonds issued under the mortgage amount to $16 million. The Company expects to fulfill its sinking fund obligation by providing refundable bonds to the Trustee. Sinking fund requirements for FMBs and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) --------------------------------- 2004................ $176 2005................ 67 2006................ 208 2007................ 18 2008................ 19 ---------------------------------- (E) SECURITIZED TRANSITION BONDS- On June 11, 2002, JCP&L Transition Funding LLC (Issuer), a wholly owned limited liability company of the Company, sold $320 million of transition bonds to securitize the recovery of the Company's bondable stranded costs associated with the previously divested Oyster Creek Nuclear Generating Station. The Company does not own nor did it purchase any of the transition bonds, which are included in long-term debt on the Company's Consolidated Balance Sheets. The transition bonds represent obligations only of the Issuer and are collateralized solely by the equity and assets of the Issuer, which consist primarily of bondable transition property. The bondable transition property is solely the property of the Issuer. Bondable transition property represents the irrevocable right of a utility company to charge, collect and receive from its customers, through a non-bypassable TBC, the principal amount and interest on the transition bonds and other fees and expenses associated with their issuance. The Company, as servicer, manages and administers the bondable transition property, including the billing, collection and remittance of the TBC, pursuant to a servicing agreement with the Issuer. The Company is entitled to a quarterly servicing fee of $100,000 that is payable from TBC collections. (F) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholder's equity except those resulting from transactions with the Company's parent. As of 29 December 31, 2003, accumulated other comprehensive loss consisted of unrealized losses on derivative instrument hedges of $(3.9) million and a minimum liability for unfunded retirement benefits of $(47.9) million. 5. SHORT-TERM BORROWINGS: The Company may borrow from its affiliates on a short-term basis. As of December 31, 2003, the Company had total short-term borrowings outstanding of $231 million from its affiliates with an interest rate of 1.7%. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $446 million for property additions and improvements from 2004 through 2006, of which approximately $146 million is applicable to 2004. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its present ownership interest in TMI-2, the Company is exempt from any potential assessment under the industry retrospective rating plan. The Company is also insured as to its interest in TMI-2 under a policy issued to the operating company for the plant. Under this policy, $150 million is provided for property damage and decontamination and decommissioning costs. Under this policy, the Company can be assessed a maximum of approximately $0.2 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at TMI-2 exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. (C) ENVIRONMENTAL MATTERS- The Company has been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, potential environmental liabilities have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Company's proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. In addition, the Company has accrued liabilities for environmental remediation of former manufactured gas plants in New Jersey; those costs are being recovered through a non-bypassable societal benefits charge. The Company has total accrued liabilities aggregating approximately $45.5 million as of December 31, 2003. The Company accrues for environmental costs only when it can conclude that it is probable that they have an obligation for such costs and can reasonably determine the amount of such costs. Unasserted claims are reflected in the Company's determination of environmental liabilities and are accrued in the period that they are both probable and reasonably estimable. The Company does not believe environmental remediation costs will have a material adverse effect on its financial condition, cash flows or results of operations. (D) OTHER LEGAL PROCEEDINGS- Various lawsuits, claims and proceedings related to the Company's normal business operations are pending against the Company, the most significant of which are described below. Power Outages In July 1999, the Mid-Atlantic states experienced a severe heat storm which resulted in power outages throughout the service territories of many electric utilities, including JCP&L's territory. In an investigation into the causes of the outages and the reliability of the transmission and distribution systems of all four New Jersey electric utilities, the NJBPU concluded that there was not a prima facie case demonstrating that, overall, JCP&L provided unsafe, inadequate or improper service to its customers. Two class action lawsuits (subsequently consolidated into a single proceeding) were filed in New Jersey Superior Court in July 1999 against JCP&L, GPU and other GPU companies, seeking compensatory and punitive damages arising from the July 1999 service interruptions in the JCP&L territory. 30 Since July 1999, this litigation has involved a substantial amount of legal discovery including interrogatories, request for production of documents, preservation and inspection of evidence, and depositions of the named plaintiffs and many JCP&L employees. In addition, there have been many motions filed and argued by the parties involving issues such as the primary jurisdiction and findings of the NJBPU, consumer fraud by JCP&L, strict product liability, class decertification, and the damages claimed by the plaintiffs. In January 2000, the NJ Appellate Division determined that the trial court has proper jurisdiction over this litigation. In August 2002, the trial court granted partial summary judgment to JCP&L and dismissed the plaintiffs' claims for consumer fraud, common law fraud, negligent misrepresentation, and strict products liability. In November 2003, the trial court granted JCP&L's motion to decertify the class and denied plaintiffs' motion to permit into evidence their class-wide damage model indicating damages in excess of $50 million. These class decertification and damage rulings have been appealed to the Appellation Division and oral argument is scheduled for May 2004. FirstEnergy is unable to predict the outcome of these matters and no liability has been accrued as of December 31, 2003. On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, the Public Utilities Commission of Ohio (PUCO) ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. 7. OTHER INFORMATION: The following represents the financial data which includes supplemental unaudited prior years' information as compared to consolidated financial statements and notes previously reported in 2001. (A) CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 ---- ---- ---- ---- (Unaudited) (Unaudited) (In thousands) Other Cash Flows from Operating Activities: Accrued taxes............................. $(12,925) $(21,939) $ 2,675 | $ 24,272 Accrued interest.......................... (12,319) 1,625 9,501 | (7,590) Prepayments and other..................... (11,640) (21,149) 16,436 | 63,909 All other................................. 42,463 66,896 (8,049) | (14,263) --------- ---------- --------- | ---------- Other cash provided from | operating activities................. $ 5,579 $ 25,433 $20,563 | $ 66,328 ========= ========= ======= | ========
(B) REVENUES - INDEPENDENT SYSTEM OPERATOR (ISO) TRANSACTIONS The Company records purchase and sales transactions with PJM Interconnection ISO, an independent system operator, on a gross basis in accordance with EITF Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." The aggregate purchase and sales transactions for the three years ended December 31, 2003, are summarized as follows: 31 Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 ------------------------------------------------------------------------ (Unaudited) (Unaudited) (In millions) | Sales.......... $270 $136 $ 2 | $ 28 Purchases...... -- 101 16 | 188 ------------------------------------------------------------------------ The Company's revenues on the Consolidated Statements of Income include wholesale electricity sales revenues from the PJM ISO from power sales (as reflected in the table above) during periods when the Company had additional available power capacity. Revenues also include sales by the Company of power sourced from the PJM ISO (reflected as purchases in the table above) during periods when the Company required additional power to meet its retail load requirements. (C) TRANSACTIONS WITH AFFILIATED COMPANIES- The primary affiliated companies transactions are as follows: Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 - ------------------------------------------------------------------------------- (Unaudited) (Unaudited) (In millions) Operating Revenues: Wholesale sales-affiliated companies. $ 36 $ 18 $ 2 | $ 17 | Operating Expenses: | Service Company support services..... 101 140 21 | 120 Power purchased from other affiliates -- 26 3 | 16 Power purchased from FES............. 55 18 8 | -- - ------------------------------------------------------------------------------- (D) RETIREMENTS BENEFITS (1) Net pension and other postretirement benefit costs (income) for the three years ended December 31, 2003 are approximately as follows: Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 - ------------------------------------------------------------------------------ (Unaudited) (Unaudited) (In millions) | Pension Benefits.................... $12 $(20) $(7) | $(33) Other Postretirement Benefits....... 12 5 2 | 8 - ---------------------------------------------------------------------------- (1) Includes estimated portion of benefit costs included in billings from GPUS. 8. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS: FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. FIN 46R requires adoption for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. Adoption of FIN 46R for all other types of entities is effective March 31, 2004. The Company is evaluating entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. These entities are non-utility generators in which we have neither debt nor equity investments but are generally the sole purchaser of their power. 32 SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, the Company implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Note 1(E) for further discussions of SFAS 143. DIG Implementation Issue No. C20 for SFAS 133, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) Regarding Contracts with a Price Adjustment Feature" In June 2003, the FASB cleared DIG Issue C20 for implementation in fiscal quarters beginning after July 10, 2003. The issue supersedes earlier DIG Issue C11, "Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception." DIG Issue C20 provides guidance regarding when the presence of a general index, such as the Consumer Price Index, in a contract would prevent that contract from qualifying for the normal purchases and normal sales exception under SFAS 133, as amended, and therefore exempt from the mark-to-market treatment of certain contracts. Adoption of DIG Issue C20 did not impact JCP&L's financial statements. 9. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The quarterly financial information for the first three quarters of 2003 have been restated to correct costs that should have been capitalized to construction projects but were improperly recorded as operating expenses. These corrections have resulted in restated earnings increases of $0.1 million, $1.8 million and $3.4 million during the quarters ended March 31, 2003, June 30, 2003 and September 30, 2003, respectively.The impact of these adjustments was not material to the Company's consolidated balance sheets or consolidated statements of cash flows for any quarter of 2003. The following summarizes certain consolidated operating results by quarter for 2003 and 2002.
Three Months Ended March 31, 2003 June 30, 2003(a) September 30, 2003 December 31, 2003 - ------------------------------------------------------------------------------------------------------------------ As Previously As As Previously As As Previously As Reported Restated Reported Restated Reported Restated -------- -------- -------- -------- -------- -------- (In millions) Operating Revenues......... $656.9 $656.9 $542.8 $542.8 $743.1 $743.1 $421.4 Operating Expenses and Taxes................... 581.7 581.6 566.3 564.5 659.5 656.1 415.7 - ------------------------------------------------------------------------------------------------------------ Operating Income (Loss).... 75.2 75.3 (23.5) (21.7) 83.6 87.0 5.7 Other Income .............. 1.2 1.2 2.3 2.3 1.1 1.1 2.9 Net Interest Charges....... 22.5 22.5 22.4 22.4 20.5 20.5 20.4 - ------------------------------------------------------------------------------------------------------------ Net Income (Loss).......... $ 53.9 $ 54.0 $(43.6) $(41.8) $ 64.2 $ 67.6 $(11.8) ============================================================================================================= Earnings (Loss) Applicable to Common Stock......... $ 53.8 $ 53.9 $(43.2) $(41.4) $ 64.0 $ 67.4 $(11.9) ============================================================================================================= March 31, June 30, September 30, December 31, Three Months Ended 2002 2002 2002 2002 - ------------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues.......................... $450.7 $501.3 $779.9 $596.5 Operating Expenses and Taxes................ 389.4 423.1 658.6 522.1 - ------------------------------------------------------------------------------------------------------------- Operating Income............................ 61.3 78.2 121.3 74.4 Other Income ............................... 2.8 2.2 1.2 1.5 Net Interest Charges........................ 24.1 23.0 21.8 22.1 - ------------------------------------------------------------------------------------------------------------- Net Income.................................. $ 40.0 $ 57.4 $100.7 $ 53.8 ============================================================================================================= Earnings on Common Stock.................... $ 39.2 $ 57.0 $103.5 $ 53.7 =============================================================================================================
(a) The net loss for the second quarter of 2003 included a charge resulting from the NJBPU's decision to disallow recovery by the Company of $153 million in deferred energy costs. 33 Report of Independent Auditors To the Stockholders and Board of Directors of Jersey Central Power & Light Company: In our opinion, the accompanying consolidated balance sheets and consolidated statements of capitalization and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of Jersey Central Power & Light Company (a wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. The consolidated financial statements of Jersey Central Power & Light Company and subsidiaries for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger) were audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on those financial statements in their report dated March 18, 2002. As discussed in Note 1(E) to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 34 The following report is a copy of a report previously issued by Arthur Andersen LLP (Andersen). This report has not been reissued by Andersen and Andersen did not consent to the incorporation by reference of this report into any of the Company's registration statements. Report of Previous Independent Public Accountants To the Stockholders and Board of Directors of Jersey Central Power & Light Company: We have audited the accompanying consolidated balance sheet and consolidated statement of capitalization of Jersey Central Power & Light Company (a New Jersey corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2001 (post-merger), and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger). 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 audit. The financial statements of Jersey Central Power & Light Company and subsidiary as of December 31, 2000 and for each of the two years in the period ended December 31, 2000 (pre-merger), were audited by other auditors whose report dated January 31, 2001, expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2001 financial statements referred to above present fairly, in all material respects, the financial position of Jersey Central Power & Light Company and subsidiaries as of December 31, 2001 (post-merger), and the results of their operations and their cash flows for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger), in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 35 EX-21 35 jc_ex21-4.txt EX 21-4 JCP&L LIST OF SUBS Exhibit 21.4 JERSEY CENTRAL POWER & LIGHT COMPANY SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 2003 STATE OF NAME OF SUBSIDIARY BUSINESS ORGANIZATION ------------------ -------- ------------ JCP&L PREFERRED CAPITAL, INC. SPECIAL-PURPOSE FINANCE DELAWARE JCP&L CAPITAL, L.P. SPECIAL-PURPOSE FINANCE DELAWARE JCP&L TRANSITION FUNDING LLC SPECIAL-PURPOSE FINANCE DELAWARE Note: JCP&L, along with its affiliates Met-Ed and Penelec, collectively own all of the common stock of Saxton Nuclear Experimental Corporation, a Pennsylvania nonprofit corporation organized for nuclear experimental purposes which is now inactive. The carrying value of the owners' investment has been written down to a nominal value. EX-31 36 jc_ex31-3.txt EX 31-3 JCP&L CEO CERT LETTER (SEM) Exhibit 31.3 Certification I, Stephen E. Morgan, certify that: 1. I have reviewed this annual report on Form 10-K of Jersey Central Power & Light Company; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal year that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial data; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 15, 2004 /s/Stephen E. Morgan -------------------------------------- Stephen E. Morgan Chief Executive Officer EX-32 37 jc_ex32-2.txt EX 32-2 CEO/CFO CERT - JCP&L Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the Annual Report of Jersey Central Power & Light Company ("Company") on Form 10-K for the year ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each undersigned officer of the Company does hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that to the best of his knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/Stephen E. Morgan ------------------------------------ Stephen E. Morgan President (Chief Executive Officer) March 15, 2004 /s/Richard H. Marsh ------------------------------------ Richard H. Marsh Senior Vice President and Chief Financial Officer March 15, 2004 113 EX-4 38 me_ex4-10.txt EX 4-10 MET-ED SI METROPOLITAN EDISON COMPANY TO THE BANK OF NEW YORK, SUCCESSOR TRUSTEE -------------------- SUPPLEMENTAL INDENTURE (First Mortgage Bonds, Senior Note Series E) -------------------- Dated as of March 1, 2003 THIS SUPPLEMENTAL INDENTURE, dated as of March 1, 2003, made and entered into by and between METROPOLITAN EDISON COMPANY, a corporation of the Commonwealth of Pennsylvania (hereinafter sometimes called the "Company"), party of the first part, and THE BANK OF NEW YORK (as successor to United States Trust Company of New York), a bank and trust company organized under the laws of the State of New York as Successor Trustee under the Mortgage (hereinafter sometimes called the "Trustee"), party of the second part. WHEREAS, the Company has heretofore executed and delivered its Indenture (hereinafter called the "Original Indenture"), dated as of the first day of November, 1944, to Guaranty Trust Company of New York, as trustee, which was duly amended and supplemented by various indentures supplemental thereto, and which is hereby further supplemented by this Supplemental Indenture, all of which are herein collectively referred to as the "Mortgage"; and WHEREAS, The Bank of New York is now the Successor Trustee under the Mortgage; and WHEREAS, the Company has entered into an Indenture dated as of July l, 1999 (the "Senior Note Indenture") with The Bank of New York (as successor to United States Trust Company of New York), as trustee (the "Senior Note Trustee"), providing for the issuance of notes thereunder (the "Senior Notes") from time to time, and pursuant to the Senior Note Indenture the Company has agreed to issue to the Senior Note Trustee, as security for the Senior Notes, a new series of bonds under the Mortgage at the time of authentication of each series of Senior Notes issued prior to the Release Date (as defined in the Senior Note Indenture); and WHEREAS, for such purposes the Company desires to issue one or more tranches of a new series of bonds and by appropriate corporate action in conformity with the terms of the Mortgage has duly determined to create a separate series of bonds, which shall be designated as "First Mortgage Bonds, Senior Note Series E" (hereinafter sometimes referred to as the "Senior Note Series E Bonds"), which said Senior Note Series E Bonds are to be substantially in the form set forth in Article II hereof with the insertion of numbers, denominations, date or dates from which interest shall accrue, maturities, interest rates (or method of determination thereof), interest payment dates and other terms as determined in accordance with the terms of the Mortgage; and WHEREAS, the Senior Note Series E Bonds shall be issued to the Senior Note Trustee in connection with the concurrent issuance by the Company of a like aggregate principal amount of its Senior Notes (the "New Senior Notes"); and WHEREAS, all acts and things prescribed by law and by the charter and by-laws of the Company necessary to make the Senior Note Series E Bonds, when executed by the Company and authenticated by the Trustee, as in the Mortgage provided, valid, binding and legal obligations of the Company, entitled in all respects to the security of the Mortgage, have been performed or will have been performed prior to execution of such Senior Note Series E Bonds by the Company and authentication thereof by the Trustee; and NOW, THEREFORE, THIS SUPPLEMENTAL INDENTURE WITNESSETH: That in consideration of the premises, and of the sum of One Dollar ($1.00) to the Company duly paid by the Trustee at or before the ensealing and delivery of these presents, and for other valuable considerations, the receipt whereof is hereby acknowledged, the Company hereby covenants and agrees to and with the Trustee and its successors in the trusts under the Mortgage, as follows: Article I SENIOR NOTE SERIES E BONDS SECTION 1. The Company hereby creates a series of bonds to be issued under and secured by the Mortgage, to be designated and to be distinguished from bonds of all other series by the title "First Mortgage Bonds, Senior Note Series E." SECTION 2. An unlimited principal amount of Senior Note Series E Bonds, being authenticated and delivered from time to time, may forthwith be executed by the Company and delivered to the Trustee and shall be authenticated by the Trustee and delivered (either before or after the filing or recording hereof) to or upon the order of the designated officer or officers of the Company specifying, among other things, the principal amount of the Senior Notes Series E Bonds to be issued on the specified date of issuance, the numbers, denominations, date or dates from which interest shall accrue, maturities, interest rates (or method of determination thereof), interest payment dates and other terms of such Senior Note Series E Bonds, upon receipt by the Trustee of the cash, resolutions, certificates, opinions and documents required to be delivered upon the issue of bonds from time to time as provided in the Mortgage. SECTION 3. Each Senior Note Series E Bond shall be dated the date of its authentication ("issue date") and shall bear interest from the issue date of said bond or from the most recent interest payment date to which interest has been paid or duly provided for with respect to the Senior Note Series E Bonds, except that so long as there is no existing default in the payment of interest on the Senior Note Series E Bonds, any Senior Note Series E Bond authenticated by the Trustee between the record date (as hereinafter defined) for any interest payment date for such bond and such interest payment date shall bear interest from such interest payment date; provided, however, that if and to the extent the Company shall default in payment of the interest due on such interest payment date, then any such Senior Note Series E Bond shall bear interest from the most recent interest payment date to which interest has been paid or duly provided for with respect to the Senior Note Series E Bonds, or, if no interest has been paid on the Senior Note Series E Bonds, then from its issue date. Unless previously redeemed pursuant to the provisions hereof and of the Mortgage, each Senior Note Series E Bond shall be payable on their respective maturity dates, in such coin or currency of the United States of America as at the time of payment is legal tender for the payment of public and private debts, and shall bear interest payable in like coin or currency at the interest rate specified in such Senior Note Series E Bonds from the date specified in such Senior Note Series E Bonds, payable semi-annually on each interest payment date specified in such Senior Note Series E Bonds, until the maturity date specified in such Senior Note Series E Bonds, and at maturity at the highest rate of interest borne by any of the bonds outstanding under the Mortgage from such date of maturity until they shall be paid or payment thereof shall have been duly provided for, and (to the extent that payment of such interest is enforceable under applicable law) interest on any overdue installment of interest shall be 2 payable at the highest rate of interest borne by any of the bonds outstanding under the Mortgage. Principal of and interest on the Senior Note Series E Bonds shall be payable at the office or agency of the Company in the Borough of Manhattan, The City of New York. The persons in whose names the Senior Note Series E Bonds are registered at the close of business on any record date (as hereinafter defined) with respect to any interest payment date shall be entitled to receive the interest payable on such interest payment date (except that in case of any redemption of the Senior Note Series E Bonds as provided for herein on a date subsequent to the record date and prior to such interest payment date, interest on such redeemed bonds shall be payable only to the date fixed for redemption thereof and only against surrender of such bonds for redemption in accordance with the notice of such redemption) notwithstanding the cancellation of any Senior Note Series E Bonds upon any registration of transfer or exchange subsequent to the record date and prior to such interest payment date; provided, however, that if, and to the extent, the Company shall default in the payment of the interest due on any interest payment date, such defaulted interest shall be paid to the persons in whose names outstanding Senior Note Series E Bonds are registered on the day immediately preceding the date of payment of such defaulted interest or, at the election of the Company, on a subsequent record date established by notice given by mail by or on behalf of the Company to the holders of Senior Note Series E Bonds not less than fifteen (15) days preceding such subsequent record date. Unless otherwise specified in the written order of the Company delivered pursuant to Section 4.07(a) of the Original Indenture with respect to any Senior Note Series E Bonds, the term "record date" shall mean, with respect to any regular interest payment date, the close of business on the 15th day of the calendar month next preceding such interest payment date or, in the case of defaulted interest, the close of business on any subsequent record date established as provided above. SECTION 4. Upon any payment of the principal of, premium, if any, and interest on, all or any portion of the New Senior Notes, whether at maturity or prior to maturity by redemption or otherwise or upon provision for the payment thereof having been made in accordance with Section 5.01(a) of the Senior Note Indenture, Senior Note Series E Bonds in a principal amount equal to the principal amount of such New Senior Notes shall, to the extent of such payment of principal, premium, if any, and interest, be deemed paid and the obligation of the Company thereunder to make such payment shall be discharged to such extent and, in the case of the payment of principal (and premium, if any), the Senior Note Series E Bonds in a principal amount equal to the related New Senior Notes shall be surrendered to the Company for cancellation as provided in Section 4.06 of the Senior Note Indenture. The Trustee may at any time and all times conclusively assume that the obligation of the Company to make payments with respect to the principal of and premium, if any, and interest, on the Senior Note Series E Bonds, so far as such payments at the time have become due, has been fully satisfied and discharged pursuant to the foregoing sentence unless and until the Trustee shall have received a written notice from the Senior Note Trustee signed by one of its officers stating (i) that timely payment of principal of, or premium or interest on, the New Senior Notes has not been so made, (ii) that the Company is in arrears as to the payments required to be made by it to the Senior Note Trustee pursuant to the Senior Note Indenture, and (iii) the amount of the arrearage. 3 SECTION 5. Each Senior Note Series E Bond is to be issued to and registered in the name of The Bank of New York, as the Senior Note Trustee, or a successor trustee thereto, under the Senior Note Indenture to secure any and all obligations of the Company under the New Senior Notes and any other series of Senior Notes from time to time outstanding under the Senior Note Indenture. SECTION 6. Except (i) as required to effect an assignment to a successor Trustee under the Senior Note Indenture, (ii) pursuant to Section 4.03 or Section 4.06 of the Senior Note Indenture, or (iii) in compliance with a final order of a court of competent jurisdiction in connection with any bankruptcy or reorganization proceeding of the Company, the Senior Note Series E Bonds are not transferable. The Senior Note Series E Bonds shall be exchangeable for other registered bonds of the same series and for the same aggregate principal amount, in the manner and upon the conditions prescribed in the Mortgage, upon the surrender of such bonds at the "office" or agency of the Company in the Borough of Manhattan, The City of New York. The Company covenants and agrees that, notwithstanding Section 2.03 of the Original Indenture, it will not charge any sum for or in connection with any exchange or transfer of any Senior Note Series E Bond. SECTION 7. (a) Senior Note Series E Bonds shall not be redeemed except (i) as set forth in Article I, Section 8 hereof; and (ii) by the surrender thereof by the Senior Note Trustee to the Trustee for cancellation at a redemption price of zero upon redemption of all other series of bonds pursuant to Section 8.08 of the Mortgage. (b) In the event the Company redeems any New Senior Notes prior to maturity in accordance with the provisions of the Senior Note Indenture, the Senior Note Trustee shall on the same date deliver to the Company the Senior Note Series E Bonds in principal amounts corresponding to the New Senior Notes so redeemed, as provided in Section 4.06 of the Senior Note Indenture. (c) Senior Note Series E Bonds are not redeemable by the operation of the improvement fund pursuant to Section 5.07 and Section 9.06 of the Mortgage or otherwise, by operation of the maintenance and replacement provisions pursuant to Sections 5.08 and 9.06 of the Mortgage or otherwise, or with the proceeds of released property pursuant to Section 9.06 of the Mortgage or otherwise. SECTION 8. The Senior Note Series E Bonds shall be immediately redeemed at a redemption price of 100% of the principal amount thereof, plus interest accrued to the redemption date, in whole, upon a written demand for redemption by the Senior Note Trustee stating that the principal of all Senior Notes then outstanding under the Senior Note Indenture has been declared to be immediately due and payable pursuant to the provisions of the first sentence of Section 8.01(a) thereof. SECTION 9. For purposes of Section 4.07 of the Senior Note Indenture, the Senior Note Series E Bonds shall be deemed to be the "Related Senior Note First Mortgage Bonds" in respect of the New Senior Notes. 4 SECTION 10. At any time a New Senior Note shall cease to be entitled to any lien, benefit or security under the Senior Note Indenture pursuant to Section 5.01(b) thereof and the Company shall have provided the Senior Note Trustee with notice thereof, the Senior Note Trustee shall surrender an equal principal amount of the Related Senior Note First Mortgage Bonds, subject to the limitations of Section 4.06 of the Senior Note Indenture, to the Company for cancellation. SECTION 11. As provided in Section 4.09 of the Senior Note Indenture, from and after the Release Date, the obligations of the Company with respect to the Senior Note Series E Bonds shall be deemed to be satisfied and discharged, the Senior Note Series E Bonds shall cease to secure in any manner any Senior Notes outstanding under the Senior Note Indenture, and, pursuant to Section 4.06 of the Senior Note Indenture, the Senior Note Trustee shall forthwith deliver the Senior Note Series E Bonds to the Company for cancellation. Article II FORM OF THE SENIOR NOTE SERIES E BONDS SECTION 1. Unless otherwise specified in the written order of the Company delivered pursuant to Section 4.07(a) of the Original Indenture with respect to any Senior Note Series E Bonds, the form of the Senior Note Series E Bonds and the Trustee's authentication certificate to be endorsed thereon shall be substantially as follows, the maturity date or dates, denominations, interest rates (or a method of determination thereof), other terms and numbers thereof to be appropriately inserted as provided in Section 2.01 of the Original Indenture: [FORM OF SENIOR NOTE SERIES E BONDS] METROPOLITAN EDISON COMPANY FIRST MORTGAGE BOND, SENIOR NOTE SERIES E $ No. ORIGINAL ISSUE DATE: MATURITY DATE: INTEREST RATE: INTEREST PAYMENT DATES: METROPOLITAN EDISON COMPANY, a corporation of the Commonwealth of Pennsylvania (hereinafter called the "Company"), for value received, hereby promises to pay to The Bank of New York, as successor Trustee under the Company's Indenture dated as of July 1, 1999, or registered assigns ___________, Dollars on the Maturity Date set forth above, unless this Bond shall have been duly called for previous redemption in whole or in part and payment of the 5 redemption price shall have been duly made or provided for, at the office or agency of the Company in the Borough of Manhattan, The City of New York, in such coin or currency of the United States of America as at the time of payment shall be legal tender for the payment of public and private debts, and to pay to the registered holder hereof interest thereon semi-annually on the Interest Payment Dates set forth above (commencing with the Interest Payment Date next succeeding the Original Issue Date specified above) at the Interest Rate set forth above, at said office or agency, in like coin or currency, from the Original Issue Date specified above, or from the most recent interest payment date to which interest has been paid or duly provided for (subject to certain exceptions provided in the Mortgage hereinafter mentioned), until maturity, and at maturity, according to its terms or on prior redemption or by declaration or otherwise, and at the highest rate of interest borne by any of the bonds outstanding under the Mortgage hereinafter mentioned from such date of maturity until this bond shall be paid or the payment hereof shall have been duly provided for, and to the extent permitted by law, to pay interest on overdue interest at the highest rate of interest borne by any of the bonds outstanding under the Mortgage hereinafter mentioned. This bond is one of an issue of bonds of the Company (hereinafter referred to as the "bonds"), not limited in principal amount, except as provided in the Mortgage hereinafter defined which may mature at different times, may bear interest at different rates, and may otherwise vary as in the Mortgage hereinafter mentioned provided, and is one of a series known as its First Mortgage Bonds, Senior Note Series E (herein called the "Senior Note Series E Bonds"), all bonds issued and to be issued under and equally and ratably secured (except insofar as any sinking fund or analogous fund, established in accordance with the provisions of the Mortgage hereinafter mentioned, may afford additional security for the bonds of any particular series) by an Indenture (herein, together with any indentures supplemental thereto, including the Supplemental Indenture hereinafter mentioned, called the "Mortgage") dated November 1, 1944, executed by the Company to GUARANTY TRUST COMPANY OF NEW YORK under which THE BANK OF NEW YORK (as successor to United States Trust Company of New York), is Successor Trustee (herein called the "Trustee"), to which Mortgage reference is made for a description of the property mortgaged and pledged, the nature and extent of the security, the rights and limitations of rights of the holders of the bonds and of the Company in respect thereof, the rights, duties and immunities of the Trustee, and the terms and conditions upon which the bonds are, and are to be, issued and secured. The Senior Note Series E Bonds are described in the Supplemental Indenture dated as of March 1, 2003 between the Company and the Trustee (the "Supplemental Indenture"). Under an Indenture dated as of July 1, 1999 (hereinafter sometimes referred to as the "Senior Note Indenture"), between the Company and The Bank of New York (as successor to United Trust Company of New York), as trustee (hereinafter sometimes called the "Senior Note Trustee"), the Company will issue, concurrently with the issuance of this bond, an issue of notes under the Senior Note Indenture entitled " % Senior Notes due 20 " (the "New Senior Notes"). Pursuant to Article IV of the Senior Note Indenture, this bond is issued to the Senior Note Trustee to secure any and all obligations of the Company under the New Senior Notes. Payment of principal of, or premium, if any, or interest on, the New Senior Notes shall constitute payments on this bond as further provided herein and in the Supplemental Indenture. As provided in Section 4.09 of the Senior Note Indenture, from and after the Release Date (as defined in the Senior Note Indenture), the 6 obligations of the Company with respect to this bond shall be deemed to be satisfied and discharged, this bond shall cease to secure in any manner any senior notes outstanding under the Senior Note Indenture, and, pursuant to Section 4.06 of the Senior Note Indenture, the Senior Note Trustee shall forthwith deliver this bond to the Company for cancellation. Upon any payment of the principal of, premium, if any, and interest on, all or any portion of the New Senior Notes, whether at maturity or prior to maturity by redemption or otherwise or upon provision for the payment thereof having been made in accordance with Section 5.01(a) of the Senior Note Indenture, Senior Note Series E Bonds in a principal amount equal to the principal amount of such New Senior Notes and having both a corresponding maturity date and interest rate shall, to the extent of such payment of principal, premium, if any, and interest, be deemed paid and the obligation of the Company thereunder to make such payment shall be discharged to such extent and, in the case of the payment of principal (and premium, if any)), Senior Note Series E Bonds in a principal amount equal to the related New Senior Notes shall be surrendered to the Company for cancellation as provided in Section 4.06 of the Senior Note Indenture. The Trustee may at any time and all times conclusively assume that the obligation of the Company to make payments with respect to the principal of and premium, if any, and interest on the Senior Note Series E Bonds, so far as such payments at the time have become due, has been fully satisfied and discharged pursuant to the foregoing sentence unless and until the Trustee shall have received a written notice from the Senior Note Trustee signed by one of its officers stating (i) that timely payment of principal of, or premium or interest on, the New Senior Notes has not been made, (ii) that the Company is in arrears as to the payments required to be made by it to the Senior Note Trustee pursuant to the Senior Note Indenture, and (iii) the amount of the arrearage. For purposes of Section 4.07 of the Senior Note Indenture, this bond shall be deemed to be the "Related Senior Note First Mortgage Bond" in respect of the New Senior Notes. The Mortgage contains provisions permitting the holders of not less than seventy-five per centum (75%) in principal amount of all the bonds at the time outstanding, determined and evidenced as provided in the Mortgage, or in case the rights under the Mortgage of the holders of bonds of one or more, but less than all, of the series of bonds outstanding shall be affected, then with the consent of the holders of not less than seventy-five per centum (75%) in principal amount of the outstanding bonds of such one or more series affected, except that if any such action would affect the bonds of two or more series, the holders of not less than seventy-five per centum (75%) in principal amount of outstanding bonds of such two or more series, which need not include seventy-five per centum (75%) in principal amount of outstanding bonds of each of such series, determined and evidenced as provided in the Mortgage, on behalf of the holders of all the bonds, to waive any past default under the Mortgage and its consequences except a completed default, as defined in the Mortgage, in respect of the payment of the principal of or interest on any bond or a default arising from the creation of any lien ranking prior to or equal with the lien of the Mortgage on any of the mortgaged property, subject to the condition that, in case the rights of the holders of less than all of the series of bonds outstanding shall be affected, no waiver of any past default or its consequences shall be effective unless approved by the holders of not less than a majority of 7 all the bonds at the time outstanding. The Mortgage also contains provisions permitting the Company and the Trustee, with the consent of the holders of not less than seventy-five per centum (75%) in principal amount of all the bonds at the time outstanding, determined and evidenced as provided in the Mortgage, or in case the rights under the Mortgage of the holders of bonds of one or more, but less than all, of the series of bonds outstanding shall be affected, then with the consent of the holders of not less than seventy-five per centum (75%) in principal amount of the outstanding bonds of such one or more series affected, except that if any such action would affect the bonds of two or more series, the holders of not less than seventy-five per centum (75%) in principal amount of outstanding bonds of such two or more series, which need not include seventy-five per centum (75%) in principal amount of outstanding bonds of each of such series, determined and evidenced as provided in the Mortgage, to execute supplemental indentures adding any provisions to or changing in any manner or eliminating any of the provisions of the Mortgage or modifying in any manner the rights of the holders of the bonds and coupons thereunto appertaining; provided, however, that no such supplemental indenture shall (i) extend the fixed maturity of any bonds, or reduce the rate or extend the time of payment of interest thereon, or reduce the principal amount thereof, or, subject to the provisions of the Mortgage, limit the right of a bondholder to institute suit for the enforcement of payment of principal or interest in accordance with the terms of the bonds, without the express consent of the holder of each bond so affected, or (ii) reduce the aforesaid percentage of bonds, the holders of which are required to consent to any such supplemental indenture, without the consent of the holders of all bonds then outstanding, or (iii) permit the creation of any lien ranking prior to or equal with the lien of the Mortgage on any of the mortgaged property without the consent of the holders of all bonds then outstanding, or (iv) deprive the holder of any outstanding bond of the lien of the Mortgage on any of the mortgaged property. Any such waiver or consent by the holder of this bond (unless effectively revoked as provided in the Mortgage) shall be conclusive and binding upon such holder and upon all future holders of this bond, irrespective of whether or not any notation of such waiver or consent is made upon this bond. No reference herein to the Mortgage and no provision of this bond or of the Mortgage shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of and interest on this bond at the time and place and at the rate and in the coin or currency herein prescribed. The Senior Note Series E Bonds are issuable only in fully registered form in denominations of $1,000 and integral multiples thereof. The Senior Note Series E Bonds shall not be redeemed except as set forth below and except by the surrender thereof by the Senior Note Trustee to the Trustee for cancellation at a redemption price of zero upon redemption of all other series of bonds pursuant to Section 8.08 of the Mortgage. In the event the Company redeems any New Senior Notes prior to maturity in accordance with the provisions of the Senior Note Indenture, the Senior Note Trustee shall on the same date deliver to the Company Senior Note Series E Bonds in principal amounts corresponding to the New Senior Notes so redeemed, as provided in Section 4.06 of the Senior Note Indenture. Senior Note Series E Bonds are not redeemable by the operation of the improvement fund pursuant to Section 5.07 and Section 9.06 of the Mortgage or otherwise, by operation of the maintenance and replacement provisions pursuant to Sections 5.08 and 9.06 of the Mortgage or otherwise, or with the proceeds of released property pursuant to Section 9.06 of the Mortgage or otherwise. 8 The Senior Note Series E Bonds shall be immediately redeemed at a redemption price of 100% of the principal amount thereof, plus interest accrued to the redemption date, in whole, upon a written demand for redemption by the Senior Note Trustee stating that the principal of all Senior Notes then outstanding under the Senior Note Indenture have been declared to be immediately due and payable pursuant to the provisions of the first sentence of Section 8.01(a) thereof. The Mortgage provides that if the Company shall deposit with the Trustee in trust for the purpose funds sufficient to pay the principal of all of the bonds of any series, or such of the bonds of any series as have been or are to be called for redemption, and premium, if any, thereon, and all interest payable on such bonds to the date on which they become due and payable, at maturity or upon redemption or otherwise, and complies with the other provisions of the Mortgage in respect thereof, then from the date of such deposit such bonds shall no longer be secured by the lien of the Mortgage. The principal hereof may be declared or may become due prior to the express date of the maturity hereof on the conditions, in the manner and at the time set forth in the Mortgage, upon the occurrence of a completed default as in the Mortgage provided. This bond is not transferable except (i) as required to effect an assignment to a successor Trustee under the Senior Note Indenture, (ii) pursuant to Section 4.03 or Section 4.06 of the Senior Note Indenture, or (iii) in compliance with a final order of a court of competent jurisdiction in connection with any bankruptcy or reorganization proceeding of the Company. This bond shall be exchangeable for other registered bonds of the same series and for the same aggregate principal amount, in the manner and upon the conditions prescribed in the Mortgage, upon the surrender of such bonds at the "office" or agency of the Company in the Borough of Manhattan, the City of New York. However, notwithstanding the provisions of Section 2.05 of the Mortgage, no charge shall be made upon any registration of transfer or exchange of bonds of said series. The Company and the Trustee, any paying agent and any bond registrar may deem and treat the person in whose name this bond is registered as the absolute owner hereof, whether or not this bond shall be overdue, for the purpose of receiving payment and for all other purposes and neither the Company nor the Trustee nor any paying agent nor any bond registrar shall be affected by any notice to the contrary. No recourse under or upon any obligation, covenant or agreement contained in the Mortgage, or in any bond or coupon thereby secured, or because of any indebtedness thereby secured, shall be had against any incorporator, or against any past, present or future stockholder, officer or director, as such, of the Company or of any successor corporation, either directly or through the Company or any successor corporation under any rule of law, statute or constitution, or by the enforcement of any assessment or by any legal or equitable proceeding or otherwise; it being expressly agreed and understood that the Mortgage, and the obligations thereby secured, are solely corporate obligations, and that no personal liability whatever shall attach to, or be incurred by, such incorporators, stockholders, officers or directors, as such, of the Company or of any successor corporation, or any of them because of the incurring of the indebtedness thereby authorized or under or by reason of any of the obligations, covenants or agreements contained in the Mortgage or in any of the bonds or coupons thereby secured, or implied therefrom. 9 This bond shall not become valid or obligatory for any purpose until THE BANK OF NEW YORK, the Trustee under the Mortgage, or its successor thereunder, shall have signed the certificate of authentication endorsed hereon. 10 IN WITNESS WHEREOF, METROPOLITAN EDISON COMPANY has caused this bond to be signed in its name by the manual or facsimile signature of its President or one of its Vice Presidents and its corporate seal, or a facsimile thereof, to be affixed hereto and attested by the manual or facsimile signature of its Secretary or one of its Assistant Secretaries. Dated: METROPOLITAN EDISON COMPANY By ------------------------- (Vice President) Attest: - ---------------------------------- (Assistant) Secretary 11 [FORM OF TRUSTEE'S CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds of the series herein designated, provided for in the within-mentioned Mortgage. THE BANK OF NEW YORK By: --------------------------------- Authorized Officer [END OF FORM OF SENIOR NOTE SERIES E BOND] Article III Subjecting Certain Property Specifically to the Lien Of The Mortgage AND THIS SUPPLEMENTAL INDENTURE FURTHER WITNESSETH: That in consideration of the premises, and of the sum of One Dollar ($1.00) to the Company duly paid by the Trustee at or before the ensealing and delivery of these presents, Metropolitan Edison Company has granted, bargained, sold, aliened, enfeoffed, released, conveyed, assigned, transferred, pledged, set over and confirmed, and by these presents does grant, bargain, sell, alien, enfeoff, release, convey, assign, transfer, pledge, set over and confirm, unto The Bank of New York, as Trustee, and to its successors and assigns forever, all of the following described property, to wit: All property, real, personal and mixed, tangible and intangible, owned by the Company, or in which it owns an interest, on the date of the execution hereof, or (subject to the provisions of Article XIII of the Mortgage) which may hereafter be acquired by it, wheresoever situate, and necessary or appropriate to the public utility plant and business of the Company and to its operation as a going concern, except such property as is hereinafter expressly excepted an excluded from the lien and operation of the Mortgage. The property covered by the lien of the Mortgage shall include particularly, among other property, without prejudice to the generality of the language hereinbefore or hereinafter contained, the following described property: 12 FIRST. Also all power houses, plants, buildings, distributing stations, substations, transforming stations and other structures for or used for or intended for use in connection with the manufacture, generation, transmission or furnishing of electricity, and the machinery, fixtures, fittings and equipment thereof or appurtenant thereto, including, without limiting the generality of the foregoing, all dynamos, engines, turbines, boilers, pumps, generators, transformers, converters, regulators, exciters, meters, shafting and belting and all other apparatus and appliances for generating or producing electricity, which are owned by the Company, or in which it owns an interest, on the date of the execution hereof or (subject to the provision of Article XIII of the Mortgage) which may be hereafter acquired by it, wheresoever situate, and necessary or appropriate to the public utility plant and business of the Company and to its operation as a going concern, except such property as is hereinafter expressly excepted and excluded from the lien and operation of the Mortgage. SECOND. Also all transmission and distribution lines and systems, whether underground, surface or overhead, for or used for or intended for use in connection with the transmission and distribution of electricity, and the conduits, poles, cross arms, insulators, transformers, cables, wires, meters, fixtures, tools, supplies and all other apparatus and appliances connected therewith or appurtenant thereto which are owned by the Company, or in which it owns an interest, on the date of the execution hereof or (subject to the provisions of Article XIII of the Mortgage) which may be hereafter acquired by it. THIRD. Also all franchises, immunities, privileges, permits, licenses, easements and rights of way authorizing, permitting or facilitating the erection, maintenance or operation upon, over or under any streets, avenues, highways, alleys, lanes, walks, parks and other public places in any county, city, borough, town, township or village or upon, over or under any private property of poles, towers, wires, conduits, mains, pipes or other structures or apparatus for the transmission or distribution of electricity or otherwise relating to the business of producing, transmitting and distributing electricity, which are owned by the Company, or in which it owns an interest, on the date of the execution hereof or (subject to the provisions of Article XIII of the Mortgage) which may be hereafter acquired by it. GENERAL SUBJECT CLAUSES. SUBJECT, HOWEVER, to the reservations, mining rights, exceptions, conditions, limitations and restrictions contained in the several deeds, franchises and contracts or other instruments through which the Company acquired or claims title to or enjoys the use of said properties; to statutory and municipal requirements relating to land and buildings; to the rights of the public and others in streets, roads and highways, opened, or laid out but unopened, crossing or bounding any of the said parcels; to the rights of owners abutting thereon in any stream, drain or ditch crossing or bounding any of the said parcels; to the rights of the Commonwealth of Pennsylvania in and to any of the lands located in any streams or rivers abutting any of the said parcels; and 13 to the rights of electric, gas, telephone, telegraph and pipeline companies to maintain and operate pole lines and gas and petroleum products mains and pipes over or through any of the said parcels or on or in the streets, roads or highways abutting thereon as the same existed at the time of acquisition of said parcels by the Company; and to any easements visible on the ground at the time of such acquisition, but not evidenced by recorded agreements or grants. EXCEPTED PROPERTY EXPRESSLY EXCEPTING, AND EXCLUDING, HOWEVER, from this Supplemental Indenture and from the lien and operation hereof, all property of every kind and type excepted and excluded from the Mortgage by subdivisions II (to the extent that such real estate is still owned by the Company) and III under the heading "Excepted Property" therein to the extent there indicated and reference is hereby made to said Mortgage for a description thereof. TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any wise appertaining to the property covered by this Supplemental Indenture or intended so to be, or any part thereof, with the reversion and reversions, remainder and remainders and (subject to the provisions of Section 9.01 of the Mortgage) the tolls, rents, revenues, issues, earnings, income, product and profits thereof, and all the estate, right, title and interest an claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to the property covered by this Supplemental Indenture or intended so to be and every part and parcel thereof. TO HAVE AND TO HOLD the property covered by this Supplemental Indenture or intended so to be to the Trustee, its successors and assigns, forever, upon and subject to the trusts, uses, condition, covenants and provisions of the Mortgage. ARTICLE IV MISCELLANEOUS SECTION 1. The Trustee, for itself and its successors in said trusts, hereby accepts the conveyance, transfer and assignment of the property included in this Supplemental Indenture upon the trusts, terms and conditions expressed in the Mortgage. SECTION 2. For all purposes hereof except as the context may otherwise require, (a) all terms contained herein shall have the meanings given such terms in, and (b) all references herein to sections of the Original Indenture shall be deemed to be to such sections of, the Original Indenture as the same heretofore has been or hereafter may be amended by an indenture or indentures supplemental thereto. SECTION 3. As amended and supplemented by the aforesaid indentures supplemental thereto and by this Supplemental Indenture, the Original Indenture is in all respects ratified and confirmed and the Original Indenture and the aforesaid indentures supplemental thereto and this Supplemental Indenture shall be read, taken and construed as one and the same instrument. 14 SECTION 4. This Supplemental Indenture shall be simultaneously executed in several counterparts, and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. SECTION 5. The recitals of fact contained herein and in the Senior Note Series E Bonds (other than the Trustee's certificate of authentication and certification of residence) shall be taken as the statements of the Company and the Trustee assumes no responsibility for the correctness of the same. 15 IN WITNESS WHEREOF, METROPOLITAN EDISON COMPANY, party of the first part, has caused this instrument to be signed in its name and behalf by its President or a Vice President, and its corporate seal to be hereunto affixed and attested by its Corporate Secretary or an Assistant Corporate Secretary, and THE BANK OF NEW YORK, as Successor Trustee as aforesaid, party of the second part, has caused this instrument to be signed in its name and behalf by an Authorized Officer and its corporate seal to be hereunto affixed and attested by an Authorized Officer, all as of the day and year first above written. ATTEST: METROPOLITAN EDISON COMPANY By: - ------------------------ ---------------------------------------- David W. Whitehead Richard H. Marsh Corporate Secretary Senior Vice President and Chief Financial Officer [CORPORATE SEAL] Signed, sealed and delivered by said Metropolitan Edison Company in the presence of: - ------------------------------------- Amit D. Patel - ------------------------------------- Carol L. Daniels 16 ATTEST: THE BANK OF NEW YORK As Successor Trustee as aforesaid By: - ------------------------------------- ------------------------------- Print Name: Print Name: Assistant Secretary Vice President [CORPORATE SEAL] Signed, sealed and delivered by said The Bank of New York in the presence of: - ------------------------------------- Print Name: - ------------------------------------- Print Name: 17 STATE OF OHIO ) : ss.: COUNTY OF SUMMIT ) On the 13 day of March in the year 2003 before me, the undersigned, personally appeared Richard H. Marsh and David W. Whitehead, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. ---------------------------------- Susie M. Hoisten, Notary Public Residence Summit County Statewide Jurisdiction Ohio My commission expires Dec. 9, 2006 [SEAL] STATE OF NEW YORK ) :ss.. COUNTY OF NEW YORK ) On the 13th day of March in the year 2003 before me, the undersigned, personally appeared ______________ and _______________, personally known to me or proved to me on the basis of satisfactory evidence to be the individuals whose names are subscribed to the within instrument and acknowledged to me that they executed the same in their capacity, and that by their signatures on the instrument, the individuals, or the person upon behalf of which the individuals acted, executed the instruments. --------------------------------- [name] Notary Public, State of New York No. ___________ Qualified in _________ County Commission Expires ___________ [SEAL] CERTIFICATE OF RESIDENCE The Bank of New York, Mortgagee and Trustee within named, hereby certifies that its precise residence is 101 Barclay Street, _______________________, in the Borough of Manhattan, in The City of New York, in the State of New York. THE BANK OF NEW YORK By ---------------------- Print Name: Vice President This document was prepared by FirstEnergy Corp. EX-12 39 me_ex12-7.txt EX 12-7 MET-ED FIXED CHARGE RATIO EXHIBIT 12.7 Page 1 METROPOLITAN EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, Jan. 1- Nov. 7- Year Ended December 31, 1999 2000 Nov. 6, 2001 Dec. 31, 2001 2002 2003 --------- -------- ------------ ------------- --------- --------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items.............. $ 95,123 $ 81,895 $ 62,381 | $14,617 $ 63,224 $ 60,953 Interest and other charges, before | reduction for amounts capitalized............ 61,842 55,181 48,568 | 8,461 50,969 46,281 Provision for income taxes..................... 61,396 44,088 39,449 | 10,905 44,372 44,006 Interest element of rentals charged | to income (a)................................ 4,381 1,543 284 | (693) 515 437 -------- -------- -------- | ------- -------- -------- Earnings as defined.......................... $222,742 $182,707 $150,682 | $33,290 $159,080 $151,677 ======== ======== ======== | ======= ======== ======== | FIXED CHARGES AS DEFINED IN REGULATION S-K: | Interest on long-term debt..................... $ 45,996 $ 37,886 $ 33,101 | $ 5,615 $ 40,774 $ 36,661 Other interest expense......................... 2,527 10,639 9,219 | 1,744 2,636 5,841 Subsidiary's preferred stock dividend | requirements................................. 13,319 6,656 6,248 | 1,102 7,559 3,779 Interest element of rentals charged | to income (a)................................ 4,381 1,543 284 | (693) 515 437 -------- -------- -------- | ------- -------- -------- Fixed charges as defined....................... $ 66,223 $ 56,724 $ 48,852 | $ 7,768 $ 51,484 $ 46,718 ======== ========= ======== | ======= ======== ======== | CONSOLIDATED RATIO OF EARNINGS TO FIXED | CHARGES........................................ 3.36 3.22 3.08 | 4.29 3.09 3.25 ==== ==== ==== | ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 101
EXHIBIT 12.7 Page 2 METROPOLITAN EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, Jan. 1- Nov. 7- Year Ended December 31, 1999 2000 Nov. 6, 2001 Dec. 31, 2001 2002 2003 ---------- -------- ------------ ------------- --------- -------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items................ $ 95,123 $ 81,895 $ 62,381 | $14,617 $ 63,224 $ 60,953 Interest and other charges, before | reduction for amounts capitalized.............. 61,842 55,181 48,568 | 8,461 50,969 46,281 Provision for income taxes....................... 61,396 44,088 39,449 | 10,905 44,372 44,006 Interest element of rentals charged | to income (a).................................. 4,381 1,543 284 | (693) 515 437 -------- -------- -------- | ------- -------- -------- Earnings as defined............................ $222,742 $182,707 $150,682 | $33,290 $159,080 $151,677 ======== ======== ======== | ======= ======== ======== | FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS | PREFERRED STOCK DIVIDEND REQUIREMENTS | (PRE-INCOME TAX BASIS): | Interest on long-term debt....................... $ 45,996 $ 37,886 $ 33,101 | $ 5,615 $ 40,774 $ 36,661 Other interest expense........................... 2,527 10,639 9,219 | 1,744 2,636 5,841 Preferred stock dividend requirements............ 13,319 6,656 6,248 | 1,102 7,559 3,779 Adjustments to preferred stock dividends | to state on a pre-income tax basis............ 43 -- -- | -- -- -- Interest element of rentals charged | to income (a).................................. 4,381 1,543 284 | (693) 515 437 -------- -------- -------- | ---------- -------- -------- Fixed charges as defined plus preferred stock | dividend requirements (pre-income | tax basis)................................... $ 66,266 $ 56,724 $ 48,852 | $ 7,768 $ 51,484 $ 46,718 ======== ======== ======== | ======= ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES | PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS | (PRE-INCOME TAX BASIS)........................... 3.36 3.22 3.08 | 4.29 3.09 3.25 ==== ==== ==== | ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 102
EX-13 40 me_ex13-6.txt EX 13-6 MET-ED ANNUAL REPORT METROPOLITAN EDISON COMPANY 2003 ANNUAL REPORT TO STOCKHOLDERS Metropolitan Edison Company is a wholly owned electric utility operating subsidiary of FirstEnergy Corp. It engages in the distribution and sale of electric energy in an area of approximately 3,300 square miles in eastern Pennsylvania. It also engages in the sale, purchase and interchange of electric energy with other electric companies. The area it serves has a population of approximately 1.3 million. In August 2000, FirstEnergy entered into an agreement to merge with GPU, Inc., under which FirstEnergy would acquire all of the outstanding shares of GPU, Inc.'s common stock for approximately $4.5 billion in cash and FirstEnergy common stock. The merger became effective on November 7, 2001 was being accounted for by the purchase method. Prior to that time, Metropolitan Edison Company was a wholly owned subsidiary of GPU, Inc. Contents Page - -------- ---- Selected Financial Data.......................................... 1 Management's Discussion and Analysis............................. 2-12 Consolidated Statements of Income................................ 13 Consolidated Balance Sheets...................................... 14 Consolidated Statements of Capitalization........................ 15 Consolidated Statements of Common Stockholder's Equity........... 16 Consolidated Statements of Preferred Stock....................... 16 Consolidated Statements of Cash Flows............................ 17 Consolidated Statements of Taxes................................. 18 Notes to Consolidated Financial Statements....................... 19-34 Reports of Independent Auditors.................................. 35-36 METROPOLITAN EDISON COMPANY SELECTED FINANCIAL DATA
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 2000 1999 - ---------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Operating Revenues..................... $ 971,020 $ 986,608 $ 143,760 | $ 824,556 $ 842,333 $ 902,827 ========== ========== ========== | ========= ========== =========== | Operating Income....................... $ 83,084 $ 91,271 $ 17,367 | $ 102,247 $ 135,211 $ 154,774 ========== ========== ========== | ========= ========== =========== | Income Before Cumulative Effect | of Accounting Change................ $ 60,953 $ 63,224 $ 14,617 | $ 62,381 $ 81,895 $ 95,123 ========== ========== ========== | ========= ========== ============ | Net Income............................. $ 61,170 $ 63,224 $ 14,617 | $ 62,381 $ 81,895 $ 95,123 ========== ========== ========== | ========= ========== ============ | Earnings on Common Stock............... $ 61,170 $ 63,224 $ 14,617 | $ 62,381 $ 81,895 $ 94,515 ========== ========== ========== | ========= ========== ============ | Total Assets........................... $3,473,987 $3,564,805 $3,607,187 | $2,708,062 $2,747,059 ========== ========== ========== | ========== ========== | | Capitalization as of December 31: | Common Stockholder's Equity......... $1,292,667 $1,315,586 $1,288,953 | $ 537,013 $ 501,417 Company-Obligated Trust Preferred | Securities........................ -- 92,409 92,200 | 100,000 100,000 Long-Term Debt...................... 636,301 538,790 583,077 | 496,860 496,883 ---------- ---------- ---------- | ---------- ------------ Total Capitalization.............. $1,928,968 $1,946,785 $1,964,230 | $1,133,873 $1,098,300 ========== ========== ========== | ========== ========== | | Capitalization Ratios: | Common Stockholder's Equity......... 67.0% 67.6% 65.6%| 47.4% 45.7% Company-Obligated Trust Preferred | Securities.......................... -- 4.7 4.7 | 8.8 9.1 Long-Term Debt...................... 33.0 27.7 29.7 | 43.8 45.2 ----- ----- ----- | ----- ----- Total Capitalization.............. 100.0% 100.0% 100.0%| 100.0% 100.0% ===== ===== ===== | ===== ===== | | Distribution Kilowatt-Hour Deliveries (Millions): | Residential......................... 4,900 4,738 793 | 3,712 4,377 4,265 Commercial.......................... 4,034 3,991 652 | 3,203 3,699 3,488 Industrial.......................... 4,047 3,972 662 | 3,506 4,412 4,085 Other............................... 36 35 6 | 27 38 107 ------ ------ ----- | ------ ------ ------ Total Retail........................ 13,017 12,736 2,113 | 10,448 12,526 11,945 Total Wholesale..................... -- 840 195 | 1,067 2,120 4,597 ------ ------ ----- | ------ ------ ------ Total............................... 13,017 13,576 2,308 | 11,515 14,646 16,542 ====== ====== ===== | ====== ====== ====== | | Customers Served: | Residential......................... 455,073 448,334 442,763 | 436,573 430,746 Commercial.......................... 58,825 58,010 57,278 | 56,080 54,969 Industrial.......................... 1,906 1,936 1,961 | 1,967 2,073 Other............................... 732 728 819 | 810 1,057 ------- ------- ------- | ------- ------- Total............................... 516,536 509,008 502,821 | 495,430 488,845 ======= ======= ======= | ======= ======= 1
METROPOLITAN EDISON COMPANY Management's Discussion and Analysis of Results of Operations and Financial Condition This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage, a denial of or material change to the Company's Application related to its Rate Stabilization Plan, and other similar factors. Results of Operations Net income decreased 3.3% to $61.2 million in 2003, compared to $63.2 million in 2002, due to lower operating revenues and increased operating expenses, including higher employee benefit costs and storm restoration expenses. These reductions to operating income were partially offset by lower purchased power costs, principally due to reduced quantities of power purchased through two-party agreements. Net interest charges were lower in 2003 due to debt redemptions and the refinancing of higher-rate debt. Operating revenues decreased by $15.6 million in 2003, following an $18.3 million increase in 2002. The decrease in 2003 was the result of wholesale sales revenues decreasing $25.4 million principally due to a reduction in kilowatt-hour sales to affiliate companies and other wholesale customers. An increase in the number of commercial and industrial customers receiving their power from alternate suppliers also contributed to the decrease in operating revenues. Distribution deliveries benefited from higher demand by residential (3.4%), commercial (1.0%), and industrial (1.9%) customers due in large part to colder temperatures in early 2003, which were partially offset by milder summer weather. In 2002, reductions in the number of residential and commercial customers who received their power from alternate suppliers, and therefore returned to us as full service retail customers, resulted in increased operating revenues. During 2002, 13.7% of total kilowatt-hours delivered were to shopping customers, compared with 16.2% in 2001. In addition to the higher revenues from returning shopping customers, warmer summer weather in 2002 contributed to an increase in retail sales, as did a slight increase in the number of residential and commercial customers. Partially offsetting these 2002 increases were lower sales to industrial customers due to a decline in economic conditions. Revenues from wholesale sales were lower in 2002 compared to 2001 due to a decrease in kilowatt-hours available for sale to other parties, as well as lower average prices for energy in 2002. Changes in kilowatt-hour sales by customer class are summarized in the following table: Changes in Kilowatt-Hour Sales 2003 2002 ------------------------------------------------------------------ Increase (Decrease) Electric Generation: Retail.................................. 1.2% 4.8% Wholesale............................... (100.0)% (33.4)% ------------------------------------------------------------------ Total Electric Generation Sales........... (6.1)% 0.7% ================================================================== Distribution Deliveries: Residential............................. 3.4% 5.2% Commercial.............................. 1.0% 3.5% Industrial.............................. 1.9% (4.7)% ------------------------------------------------------------------ Total Distribution Deliveries............. 2.2% 1.4% ------------------------------------------------------------------ Operating Expenses and Taxes Total operating expenses and taxes decreased $7.4 million in 2003, after increasing $46.6 million in 2002, compared to the preceding year. In 2003, the majority of the decrease was attributed to decreases in purchase power, 2 offset in part by higher other operating costs and regulatory asset amortization. In 2002, the majority of the change was attributed to increases in purchased power costs, regulatory asset amortization and general taxes, offset in part by a decrease in other operating costs. Purchased power costs decreased by $44.2 million in 2003, compared with 2002, because of fewer kilowatt-hours required for customer needs during 2003, partially offset by slightly higher unit costs. The increase in depreciation and amortization charges in 2003, compared to 2002, reflected higher amortization of regulatory assets being recovered through the competitive transition charge (CTC), partially offset by lower depreciation expense on a reduced asset base. Other operating costs increased by $31.4 million in 2003, compared with 2002, primarily due to increased costs to restore customer service resulting from significant storm activity and higher employee benefit costs. Higher purchased power costs of $42.1 million in 2002, compared to the prior year, were primarily due to increased energy costs of $40.2 million incurred in 2002 that otherwise would have been deferred absent a Pennsylvania Commonwealth Court decision (see Regulatory Matters). This increase was partially offset by a reduction in power purchased during 2002. Other operating costs decreased $23.8 million in 2002, compared to the previous year. The decrease resulted principally from reduced uncollectible accounts expense, personnel reductions, the absence of employee severance costs recognized in 2001 and the absence of costs related to the use of portable generators at substations under a 2001 pilot program. In 2002, the provision for depreciation and amortization increased $20.6 million, compared to the prior year, primarily due to an increase in amortization related to the recovery of regulatory assets. A $20.4 million increase in general taxes in 2002, compared to the prior year, was the result of an increase in Pennsylvania gross receipts taxes. Other Income Other income increased $0.9 million in 2003, compared to 2002, due to reduced losses on futures contracts in 2003 that occurred in 2002. The increase in 2002 was primarily due to contract work performed during 2002, a reduction in net losses on futures contracts and options, and the absence of a 2001 payment for a sustainable energy fund (which was made in accordance with the Stipulation of Settlement related to the FirstEnergy merger with GPU). Net Interest Charges Net interest charges decreased by $5.0 million in 2003, compared to 2002. The decrease reflects the refinancing of higher-cost debt in the first quarter of 2003, through the issuance of $250 million of new senior notes in March 2003. The refinancing of higher-cost debt included the redemption of $40 million and $20 million of notes in the first and second quarters of 2003, respectively. Net interest charges decreased $6.1 million in 2002, compared to the prior year, primarily due to reduced short-term borrowing levels and the amortization of purchase accounting fair market value adjustments recorded in connection with the merger. An additional reduction was attributable to the redemption of $30 million of notes in the first quarter of 2002; however, those reductions were partially offset by increased interest on long-term debt due to the issuance of $100 million of notes in September 2001 and $50 million of notes in May 2002, which were used to refinance $30 million of notes in July 2002. Cumulative Effect of Accounting Change Results in 2003 include an after-tax credit to net income of approximately $0.2 million upon the adoption of SFAS 143, "Accounting for Asset Retirement Obligations," in January 2003. We identified applicable legal obligations as defined under the new accounting standard for nuclear power plant decommissioning. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $186 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $186 million. ARO liability at the date of adoption was $198 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, we recorded decommissioning liabilities of $260 million. We expect substantially all of our nuclear decommissioning costs to be recoverable in rates over time. Therefore, we recognized a regulatory liability of $61 million upon adoption of SFAS 143 for the transition amounts related to establishing the ARO for nuclear decommissioning. The remaining cumulative effect adjustment for unrecognized depreciation and accretion offset by the reduction in the liabilities was a $0.4 million increase to income, or $0.2 million net of income taxes. Capital Resources and Liquidity Changes in Cash Position As of December 31, 2003, we had $0.1 million of cash and cash equivalents compared with $15.7 million as of December 31, 2002. The major sources for changes in these balances are summarized below. 3 Cash Flows From Operating Activities Cash flows provided from operating activities totaled $132 million in 2003 and $102 million in 2002. The sources of these changes are as follows: Operating Cash Flows 2003 2002 2001 ----------------------------------------------------------------- (In millions) Cash earnings (1).......... $180 $146 $102 Working capital............ (48) (44) (72) ----------------------------------------------------------------- Total.............. $132 $102 $30 ================================================================= (1) Includes net income, depreciation and amortization, deferred costs recoverable as regulatory assets, deferred income taxes, investment tax credits and major noncash charges. Net cash provided from operating activities increased $30 million during 2003, compared with 2002. The increase consisted of $34 million in higher cash earnings, partially offset by a $4 million decrease from changes in working capital. Cash Flows From Financing Activities In 2003, net cash used for financing activities of $87.7 million reflects redemptions of long-term debt of $260 million, and $52.0 million in common stock dividend payments to FirstEnergy, partially offset by $248 million in proceeds from the issuance of secured notes. In 2002, net cash used for financing activities of $54.0 million reflects redemption of debt of $60 million and $60.0 million in common stock dividend payments to FirstEnergy, partially offset by $50 million in proceeds from the issuance of secured notes. The following table provides details regarding new issues and redemptions during 2003 and 2002: Securities Issued or Redeemed 2003 2002 --------------------------------------------------------------- (In millions) New Issues Secured notes........................... $248 $50 --------------------------------------------------------------- Redemptions First Mortgage Bonds.................... 260 60 --------------------------------------------------------------- Short-term Borrowings, net (use)/source of cash.. (23) 16 --------------------------------------------------------------- We had $65.3 million of short-term indebtedness at the end of 2003, compared to $88.3 million at the end of 2002. We will not issue first mortgage bonds (FMB) other than as collateral for senior notes, since our senior note indentures prohibit (subject to certain exceptions) us from issuing any debt which is senior to the senior notes. As of December 31, 2003, we had the capability to issue $189 million of additional senior notes based upon FMB collateral. We have no restrictions on the issuance of preferred stock. We have the ability to borrow from our regulated affiliates and FirstEnergy to meet our short-term working capital requirements. FirstEnergy Service Company administers this money pool and tracks surplus funds of FirstEnergy and its regulated subsidiaries. Companies receiving a loan under the money pool agreements must repay the principal, together with accrued interest, within 364 days of borrowing the funds. The rate of interest is the same for each company receiving a loan from the pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47%. Our access to capital markets and costs of financing are dependent on the ratings of our securities and that of our holding company, FirstEnergy. The following table shows our securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. Ratings of Securities - --------------------------------------------------------------------------- Securities S&P Moody's Fitch - --------------------------------------------------------------------------- FirstEnergy Senior unsecured BB+ Baa3 BBB- Met-Ed Senior secured BBB Baa1 BBB+ - --------------------------------------------------------------------------- 4 On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." Fitch also lowered the senior secured rating of Met-Ed. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy, and all of the securities of its electric utility operating companies. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." On December 23, 2003, Standard & Poor's (S&P) lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". Met-Ed's rating was lowered one notch as well (see table above). The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions of the ratings included uncertainty regarding the timing of the Ohio Rate Plan filing, the pending final report on the August 14 blackout (see Power Outage), the outcome of the remedial phase of litigation relating to the Sammis plant, and the extended Davis-Besse outage and the related pending subpoena. S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of the credit ratings in December 2003 triggered cash and letter-of-credit collateral calls of FirstEnergy in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2 and downgraded the senior secured debt of Met-Ed to Baa1 from A2. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows From Investing Activities Cash used for investing activities totaled $60.3 million in 2003 and $57.5 million in 2002. The net cash flows used for investing activities during 2003 resulted from property additions, decommissioning trust investments, and loans to associated companies. Cash used for investing activities during 2002 were for property additions primarily to support our energy delivery operations and decommissioning trust investments. Our cash requirements in 2004 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without increasing our net debt and preferred stock outstanding. Over the next three years, we expect to meet our contractual obligations with cash from operations. Thereafter, we expect to use a combination of cash from operations and funds from the capital markets. Our capital spending for the period 2004 through 2006 is expected to be about $168 million, of which approximately $55 million applies to 2004. Contractual Obligations Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows: 2005- 2007- Contractual Obligations Total 2004 2006 2008 Thereafter - ---------------------------------------------------------------------------- (In millions) Long-term debt............. $ 672 $ 40 $181 $ 57 $ 394 Short-term borrowings...... 65 65 -- -- -- Operating leases (1)....... 51 1 3 3 44 Purchases (2).............. 3,075 181 691 811 1,392 - ---------------------------------------------------------------------------- Total................. $3,863 $287 $875 $871 $1,830 - ---------------------------------------------------------------------------- (1) Operating lease payments are net of reimbursements from sublessees (see Note 3) (2) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing 5 Market Risk Information We use various market risk sensitive instruments, including derivative contracts, primarily to manage the risk of price fluctuations. Our Risk Policy Committee, comprised of FirstEnergy executive officers, exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. Commodity Price Risk We are exposed to market risk primarily due to fluctuations in electricity and natural gas prices. To manage the volatility relating to these exposures, we use a variety of non-derivative and derivative instruments, including options and futures contracts. The derivatives are used for hedging purposes. Most of our non-hedge derivative contracts represent non-trading positions that do not qualify for hedge treatment SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." The change in the fair value of commodity derivative contracts related to energy production during 2003 is summarized in the following table: Increase (Decrease) in the Fair Value of Commodity Derivative Contracts
Non-Hedge Hedge Total --------- ----- ----- (In millions) Change in the Fair Value of Commodity Derivative Contracts Outstanding net asset as of January 1, 2003................. $ 17.4 $ 0.1 $ 17.5 New contract value when entered............................. -- -- -- Additions/Increase in value of existing contracts........... 8.9 -- 8.9 Change in techniques/assumptions............................ 4.6 -- 4.6 Settled contracts........................................... -- (0.1) (0.1) ----------------------------- Net Assets - Derivatives Contracts as of December 31, 2003 (1) $30.9 $ -- $ 30.9 ============================= Impact of Changes in Commodity Derivative Contracts (2) Income Statement Effects (Pre-Tax).......................... $ 0.8 $ -- $ 0.8 Balance Sheet Effects: Other Comprehensive Income (Pre-Tax)..................... $ -- $(0.1) $ (0.1) Regulatory Liability..................................... $ 12.7 $ -- $ 12.7
(1) Includes $30.7 million in non-hedge commodity derivative contracts which are offset by a regulatory liability. (2) Represents the increase in value of existing contracts, settled contracts and changes in techniques/assumptions. Derivatives included on the Consolidated Balance Sheet as of December 31, 2003: Non-Hedge Hedge Total --------- ----- ----- (In millions) Current- Other Assets................... $ -- $ -- $ -- Non-Current- Other Deferred Charges......... 30.9 -- 30.9 ----- ---- ----- Net assets................... $30.9 $ -- $30.9 ===== ==== ===== The valuation of derivative contracts is based on observable market information to the extent that such information is available. In cases where such information is not available, we rely on model-based information. The model provides estimates of future regional prices for electricity and an estimate of related price volatility. We use these results in developing estimates of fair value for financial reporting purposes and for internal management decision making. Sources of information for the valuation of derivative contracts by year are summarized in the following table: Source of Information - Fair Value by Contract Year - ---------------------------------------------------
2004 2005 2006 2007 Thereafter Total ---- ---- ---- ---- ---------- ----- (In millions) Prices based on external sources(1)... $4.7 $5.1 $-- $-- $-- $ 9.8 Prices based on models................ -- -- 4.9 4.7 11.5 21.1 ----------------------------------------------------------- Total(2).......................... $4.7 $5.1 $4.9 $4.7 $11.5 $30.9 ===========================================================
(1) Broker quote sheets. (2) Includes $30.7 million from an embedded option that is offset by a regulatory liability and does not affect earnings. 6 We perform sensitivity analyses to estimate our exposure to the market risk of our commodity position. A hypothetical 10% adverse shift in quoted market prices in the near term on derivative instruments would not have had a material effect on our consolidated financial position or cash flows as of December 31, 2003. Interest Rate Risk Our exposure to fluctuations in market interest rates is reduced since our debt has fixed interest rates, as noted in the following table.
Comparison of Carrying Value to Fair Value - ------------------------------------------------------------------------------------------------------------------- There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - ------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets - ------------------------------------------------------------------------------------------------------------------- Investments Other Than Cash and Cash Equivalents- Fixed Income............... $ 78 $ 78 $ 78 Average interest rate...... 4.7% 4.7% - ------------------------------------------------------------------------------------------------------------------- Liabilities - ------------------------------------------------------------------------------------------------------------------- Long-term Debt and Other Long-Term Obligations: Fixed rate.................... $ 40 $ 30 $151 $50 $ 7 $394 $672 $697 Average interest rate ..... 6.3% 6.8% 5.9% 5.9% 6.0% 5.7% 5.9% Short-term Borrowings......... $ 65 $ 65 $ 65 Average interest rate...... 1.7% 1.7% - -------------------------------------------------------------------------------------------------------------------
We are subject to the inherent interest rate risks related to refinancing maturing debt by issuing new debt securities. Equity Price Risk Included in nuclear decommissioning trusts are marketable equity securities carried at their market value of approximately $114 million and $81 million as of December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges would result in an $11 million reduction in fair value as of December 31, 2003 (see Note 1 (L) - "Cash and Financial Instruments"). Outlook Beginning in 1999, all of our customers were able to select alternative energy suppliers. We continue to deliver power to homes and businesses through our existing distribution system, which remains regulated. The Pennsylvania Public Utility Commission (PPUC) authorized our rate restructuring plan, establishing separate charges for transmission, distribution, generation and stranded cost recovery, which is recovered through a competitive transition charge (CTC). Customers electing to obtain power from an alternative supplier have their bills reduced based on the regulated generation component, and the customers receive a generation charge from the alternative supplier. We have a continuing responsibility to provide power to those customers not choosing to receive power from an alternative energy supplier, subject to certain limits, which is referred to as our PLR obligation. Regulatory assets are costs which have been authorized by the PPUC and the Federal Energy Regulatory Commission (FERC) for recovery from customers in future periods and, without such authorization, would have been charged to income when incurred. All of our regulatory assets are expected to continue to be recovered under the provisions of the regulatory plan as discussed below. Our regulatory assets totaled $1.0 billion and $1.2 billion as of December 31, 2003 and December 31, 2002, respectively. Regulatory Matters In June 2001, the PPUC approved the Settlement Stipulation with all of the major parties in the combined merger and rate proceedings which approved the FirstEnergy/GPU merger and provided PLR deferred accounting treatment for energy costs, permitting us to defer, for future recovery, energy costs in excess of amounts reflected in our capped generation rates retroactive to January 1, 2001. This PLR deferral accounting procedure was later reversed in a February 2002 Commonwealth Court of Pennsylvania decision. The court decision affirmed the PPUC decision regarding approval of the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. In 2002, the Company established a $103.0 million reserve for its PLR deferred energy costs incurred prior to its acquisition by FirstEnergy. The reserve reflected the potential adverse impact of a then pending Pennsylvania Supreme Court decision whether to review the Commonwealth Court ruling. The reserve increased goodwill by an aggregate net of tax amount of $60.3 million. 7 On April 2, 2003, the PPUC remanded the issue relating to merger savings to the Office of Administrative Law Judge (ALJ) for hearings, directed us to file a position paper on the effect of the Commonwealth Court order on the Settlement Stipulation and allowed other parties to file responses to the position paper. We filed a letter with the ALJ on June 11, 2003, voiding the Stipulation in its entirety and reinstating our restructuring settlement previously approved by the PPUC. On October 2, 2003, the PPUC issued an order concluding that the Commonwealth Court reversed the PPUC's June 20, 2001 order in its entirety. The PPUC directed us to file tariffs within thirty days of the order to reflect the CTC rates and shopping credits that were in effect prior to the June 21, 2001 order to be effective upon one day's notice. In response to that order, we filed these supplements to our tariffs to become effective October 24, 2003. On October 8, 2003, we filed a petition for clarification relating to the October 2, 2003 order on two issues: to establish June 30, 2004 as the date to fully refund the NUG trust fund and to clarify that the ordered accounting treatment regarding the CTC rate/shopping credit swap should follow the ratemaking, and that the PPUC's findings would not impair our rights to recover all of our stranded costs. On October 9, 2003, ARIPPA (an intervenor in the proceedings) petitioned the PPUC to direct us to reinstate accounting for the CTC rate/shopping credit swap retroactive to January 1, 2002. Several other parties also filed petitions. On October 16, 2003, the PPUC issued a reconsideration order granting the date requested by us for the NUG trust fund refund and, denying our other clarification requests and granting ARIPPA's petition with respect to the retroactive accounting treatment of the changes to the CTC rate/shopping credit swap. On October 22, 2003, we filed an Objection with the Commonwealth Court asking that the Court reverse the PPUC's finding that requires us to treat the stipulated CTC rates that were in effect from January 1, 2002 on a retroactive basis. We are considering filing an appeal to the Commonwealth Court on the PPUC orders as well. On October 27, 2003, one Commonwealth Court judge issued an Order denying our objection without explanation. Due to the vagueness of the Order, on October 31, 2003, we filed an Application for Clarification with the judge. Concurrent with this filing, in order to preserve our rights, we also filed with the Commonwealth Court both a Petition for Review of the PPUC's October 16 and October 22 Orders, and an application for reargument, if the judge, in his clarification order, indicates that our objection was intended to be denied on the merits. In addition to these findings, in compliance with the PPUC's Orders, we filed revised PPUC quarterly reports for the twelve months ended December 31, 2001 and 2002, and for the first two quarters of 2003, reflecting balances consistent with the PPUC's findings in their Orders. Effective September 1, 2002, we assigned our PLR responsibility to our FirstEnergy Solutions Corp. (FES) affiliate through a wholesale power sale agreement. The PLR sale will be automatically extended for each successive calendar year unless any party elects to cancel the agreement by November 1 of the preceding year. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by us under our NUG contracts and other power contracts with nonaffiliated third party suppliers. This arrangement reduces our exposure to high wholesale power prices by providing power at a fixed price for our uncommitted PLR energy costs during the term of the agreement with FES. FES has hedged most of our unfilled PLR on-peak obligation through 2004 and a portion of 2005, the period during which deferred accounting was previously allowed under the PPUC's order. We are authorized to continue deferring differences between NUG contract costs and current market prices. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reliability reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. We are currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of our level of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. We are unable to predict the outcome of the investigation or the impact of the PPUC Order. 8 FERC Regulatory Matters On December 19, 2002, the FERC granted unconditional Regional Transmission Organization status to PJM Interconnection, LLC which includes us as transmission owners. PJM and the Midwest Independent System Operator, Inc. (MISO) were ordered by the FERC to develop a common market between the regions by October 31, 2004. The FERC also initiated a Section 206 investigation into the reasonableness of the "through-and-out" transmission rates charged by PJM and MISO. By order issued November 17, 2003, MISO, PJM and certain unaffiliated transmission owners in the Midwest were directed to eliminate rates for point-to-point service between the two RTOs effective April 1, 2004. A settlement judge has been appointed by the FERC to resolve compliance filings by the affected transmission providers. AEP, Commonwealth Edison and other utilities have appealed the FERC's November 17, 2003 order to the federal court of appeals for the District of Columbia. Environmental Matters We have been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, our proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. We have accrued liabilities aggregating approximately $59,000 as of December 31, 2003. We do not believe environmental remediation costs will have a material adverse effect on our financial condition, cash flows or results of operations. Power Outage On August 14, 2003, various states in the northeast United States and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest ISO and PJM Interconnection) to provide effective diagnostic support. We believe that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. On November 25, 2003, the Public Utilities Commission of Ohio (PUCO) ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which are described above. Critical Accounting Policies We prepare our consolidated financial statements in accordance with accounting principles that are generally accepted in the United States. Application of these principles often requires a high degree of judgment, estimates and assumptions that affect financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting these specific factors. Our more significant accounting policies are described below. 9 Purchase Accounting The merger between FirstEnergy and GPU was accounted for by the purchase method of accounting, which requires judgment regarding the allocation of the purchase price based on the fair values of the assets acquired (including intangible assets) and the liabilities assumed. The fair values of the acquired assets and assumed liabilities were based primarily on estimates. The adjustments reflected in our records, which were finalized in the fourth quarter of 2002, primarily consist of: (1) revaluation of certain property, plant and equipment; (2) adjusting preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (3) recognizing additional obligations related to retirement benefits; and (4) recognizing estimated severance and other compensation liabilities. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill. Based on the guidance provided by SFAS 142, "Goodwill and Other Intangible Assets," we evaluate goodwill for impairment at least annually and would make such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. If impairment were indicated, we would recognize a loss - calculated as the difference between the implied fair value of its goodwill and the carrying value of the goodwill. Our annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in our evaluation of goodwill reflect operations consistent with our general business assumptions. Unanticipated changes in those assumptions could have a significant effect on our future evaluations of goodwill. As of December 31, 2003, we had recorded goodwill of approximately $884 million related to the merger. Regulatory Accounting We are subject to regulation that sets the prices (rates) we are permitted to charge our customers based on the costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. As a result of the changing regulatory framework in Pennsylvania, a significant amount of regulatory assets have been recorded - $1.0 billion as of December 31, 2003. We regularly review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Derivative Accounting Determination of appropriate accounting for derivative transactions requires the involvement of management representing operations, finance and risk assessment. In order to determine the appropriate accounting for derivative transactions, the provisions of the contract need to be carefully assessed in accordance with the authoritative accounting literature and management's intended use of the derivative. New authoritative guidance continues to shape the application of derivative accounting. Management's expectations and intentions are key factors in determining the appropriate accounting for a derivative transaction and, as a result, such expectations and intentions are documented. Derivative contracts that are determined to fall within the scope of SFAS 133, as amended, must be recorded at their fair value. Active market prices are not always available to determine the fair value of the later years of a contract, requiring that various assumptions and estimates be used in their valuation. We continually monitor our derivative contracts to determine if our activities, expectations, intentions, assumptions and estimates remain valid. As part of our normal operations, we enter into commodity contracts which increase the impact of derivative accounting judgments. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for kilowatt-hours that have been delivered but not yet billed through the end of the accounting period. The determination of unbilled revenues requires management to make various estimates including: o Net energy generated or purchased for retail load o Losses of energy over distribution lines o Allocations to distribution companies within the FirstEnergy system o Mix of kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers Pension and Other Postretirement Benefits Accounting FirstEnergy's reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions (OPEB) are dependent upon numerous factors resulting from actual plan experience and certain assumptions. 10 Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions FirstEnergy makes to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, FirstEnergy reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. FirstEnergy's assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by their pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. FirstEnergy's pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and their pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, our accrued pension costs as of June 30, 2003 increased by $47 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $7 million, recording an increase of $13,000 in an intangible asset and crediting OCI by $4 million (offsetting previously recorded deferred tax benefits by $3 million). The remaining balance in OCI of $33 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $45 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, FirstEnergy will not be required to fund their pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. FirstEnergy's pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 1(I)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining their trend rate assumptions, FirstEnergy included the specific provisions of their health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in their health care plans, and projections of future medical trend rates. The effect on FirstEnergy's pension and OPEB costs and liabilities from changes in key assumptions are as follows: 11 Increase in Costs from Adverse Changes in Key Assumption - -------------------------------------------------------------------------------- Assumption Adverse Change Pension OPEB Total (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 5 $ 15 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% na $26 $ 26 Increase in Minimum Liability Discount rate................ Decrease by 0.25% $104 na $104 - -------------------------------------------------------------------------------- Long-Lived Assets In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. Nuclear Decommissioning In accordance with SFAS 143, we recognize an ARO for the future decommissioning of TMI-2. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. New Accounting Standards and Interpretations Adopted FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, we adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. We will adopt FIN 46R for all other types of entities effective March 31, 2004. As described in Note 4(E), we created a statutory business trust to issue trust preferred securities in the amount of $93 million. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. Therefore, we have deconsolidated the trust and recognized an equity investment in the trust of $3 million and subordinated debentures to the trust of $96 million as of December 31, 2003. We are evaluating entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. These entities are non-utility generators in which we have neither debt nor equity investments but are generally the sole purchaser of their power. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, we implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(E) and 1(H) for further discussions of SFAS 143. DIG Implementation Issue No. C20 for SFAS 133, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) Regarding Contracts with a Price Adjustment Feature" In June 2003, the FASB cleared DIG Issue C20 for implementation in fiscal quarters beginning after July 10, 2003. The issue supersedes earlier DIG Issue C11, "Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception." DIG Issue C20 provides guidance regarding when the presence of a general index, such as the Consumer Price Index, in a contract would prevent that contract from qualifying for the normal purchases and normal sales exception under SFAS 133, as amended, and therefore exempt from the mark-to-market treatment of certain contracts. Adoption of DIG Issue C20 did not impact our financial statements. 12 METROPOLITAN EDISON COMPANY CONSOLIDATED STATEMENTS OF INCOME
Nov 7 - Jan.1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - ------------------------------------------------------------------------------------------------------------------------- (In thousands) OPERATING REVENUES (Note 1(K))............................ $971,020 $986,608 $143,760 | $824,556 -------- -------- -------- | -------- | OPERATING EXPENSES AND TAXES: | Fuel and purchased power (Note 1(K))................... 560,083 604,305 83,275 | 478,954 Other operating costs (Note 1(K))...................... 146,765 115,371 16,122 | 123,094 -------- -------- -------- | -------- Total operation and maintenance expenses............. 706,848 719,676 99,397 | 602,048 Provision for depreciation and amortization............ 86,514 81,419 8,903 | 51,867 General taxes.......................................... 67,207 66,795 6,509 | 39,845 Income taxes........................................... 27,367 27,447 11,584 | 28,549 -------- -------- -------- | -------- Total operating expenses and taxes................... 887,936 895,337 126,393 | 722,309 -------- -------- -------- | -------- | OPERATING INCOME.......................................... 83,084 91,271 17,367 | 102,247 | OTHER INCOME.............................................. 22,640 21,742 5,465 | 7,807 -------- -------- -------- | -------- | INCOME BEFORE NET INTEREST CHARGES........................ 105,724 113,013 22,832 | 110,054 -------- -------- -------- | -------- | NET INTEREST CHARGES: | Interest on long-term debt............................. 36,661 40,774 5,615 | 33,101 Allowance for borrowed funds used during | construction......................................... (323) (470) 30 | (574) Deferred interest...................................... (1,187) (710) (276) | (321) Other interest expense ................................ 5,841 2,636 1,744 | 9,219 Subsidiary's preferred stock dividend requirements..... 3,779 7,559 1,102 | 6,248 -------- -------- -------- | -------- Net interest charges................................. 44,771 49,789 8,215 | 47,673 -------- -------- -------- | -------- | INCOME BEFORE CUMULATIVE EFFECT OF | ACCOUNTING CHANGE...................................... 60,953 63,224 14,617 | 62,381 | Cumulative effect of accounting change (net of income | taxes of $154,000) (Note 1(H))......................... 217 -- -- | -- -------- -------- -------- | -------- | NET INCOME................................................ $ 61,170 $ 63,224 $ 14,617 | $ 62,381 ======== ======== ======== | ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 13
METROPOLITAN EDISON COMPANY CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------ (In thousands) ASSETS UTILITY PLANT: In service..................................................................... $1,838,567 $1,620,613 Less-Accumulated provision for depreciation.................................... 772,123 547,925 ---------- ---------- 1,066,444 1,072,688 Construction work in progress.................................................. 21,980 16,078 ---------- ---------- 1,088,424 1,088,766 ---------- ---------- OTHER PROPERTY AND INVESTMENTS: Nuclear plant decommissioning trusts........................................... 192,409 155,690 Long-term notes receivable from associated companies........................... 9,892 12,418 Other.......................................................................... 34,922 19,206 ---------- ---------- 237,223 187,314 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents...................................................... 121 15,685 Receivables- Customers (less accumulated provisions of $4,943,000 and $4,810,000 respectively, for uncollectible accounts)................................. 118,933 120,868 Associated companies......................................................... 45,934 23,219 Notes receivable from associated companies................................... 10,467 -- Other (less accumulated provisions of $68,000 and $0 respectively, for uncollectible accounts)................................................ 22,750 18,235 Prepayments and other.......................................................... 6,600 9,731 ---------- ---------- 204,805 187,738 ---------- ---------- DEFERRED CHARGES: Regulatory assets.............................................................. 1,028,432 1,179,125 Goodwill....................................................................... 884,279 885,832 Other.......................................................................... 30,824 36,030 ---------- ---------- 1,943,535 2,100,987 ---------- ---------- $3,473,987 $3,564,805 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholder's equity.................................................... $1,292,667 $1,315,586 Company-obligated mandatorily redeemable preferred securities.................. -- 92,409 Long-term debt and other long-term obligations- Subordinated debentures to affiliated trusts................................. 95,711 -- Other........................................................................ 540,590 538,790 ---------- ---------- 1,928,968 1,946,785 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt............................................... 40,469 60,467 Short-term borrowings (Note 5)- Associated companies......................................................... 65,335 88,299 Accounts payable- Associated companies......................................................... 45,459 56,861 Other........................................................................ 33,878 28,583 Accrued taxes................................................................. 8,762 16,096 Accrued interest............................................................... 11,848 16,448 Other.......................................................................... 22,162 11,690 ---------- ---------- 227,913 278,444 ---------- ---------- NONCURRENT LIABILITIES: Accumulated deferred income taxes.............................................. 297,140 316,757 Accumulated deferred investment tax credits.................................... 11,696 12,518 Power purchase contract loss liability......................................... 584,340 660,507 Nuclear fuel disposal costs.................................................... 37,936 37,541 Nuclear plant decommissioning costs............................................ -- 270,611 Asset retirement obligation.................................................... 210,178 -- Pensions and other postretirement benefits..................................... 105,552 1,354 Other.......................................................................... 70,264 40,288 ---------- ---------- 1,317,106 1,339,576 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Notes 3 and 6)................................................................ ---------- ---------- $3,473,987 $3,564,805 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets. 14
METROPOLITAN EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION
As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------ (Dollars in thousands, except per share amounts) COMMON STOCKHOLDER'S EQUITY: Common stock, without par value, authorized 900,000 shares 859,500 shares outstanding........................................................ $1,298,130 $1,297,784 Accumulated other comprehensive loss (Note 4(F)).................................... (32,474) (39) Retained earnings (Note 4(A))....................................................... 27,011 17,841 ---------- ---------- Total common stockholder's equity................................................. 1,292,667 1,315,586 ---------- ---------- Company obligated TRUST Preferred securities of subsidiary trust (NOTE 4(E)): 7.35% due 2039.................................................................... -- 92,409 ---------- ---------- LONG-TERM DEBT (Note 4(D)): First mortgage bonds: 6.60% due 2003.................................................................... -- 20,000 7.22% due 2003.................................................................... -- 40,000 6.34% due 2004.................................................................... 40,000 40,000 6.77% due 2005.................................................................... 30,000 30,000 7.35% due 2005.................................................................... -- 20,000 6.36% due 2006.................................................................... 17,000 17,000 6.40% due 2006.................................................................... 33,000 33,000 6.00% due 2008.................................................................... 8,265 8,700 6.10% due 2021.................................................................... 28,500 28,500 8.60% due 2022.................................................................... -- 30,000 8.80% due 2022.................................................................... -- 30,000 6.97% due 2023.................................................................... -- 30,000 7.65% due 2023.................................................................... -- 30,000 8.15% due 2023.................................................................... -- 60,000 5.95% due 2027.................................................................... 13,690 13,690 ---------- ---------- Total first mortgage bonds...................................................... 170,455 430,890 Secured notes: 5.72% due 2006.................................................................... 100,000 100,000 5.93% due 2007.................................................................... 50,000 50,000 4.45% due 2010.................................................................... 100,000 -- 4.95% due 2013.................................................................... 150,000 -- ---------- ---------- Total secured notes............................................................. 400,000 150,000 Unsecured notes: 7.69% due 2039.................................................................... 5,936 5,968 7.35% due 2039.................................................................... 95,711 -- ---------- ---------- Total unsecured notes........................................................... 101,647 5,968 Net unamortized premium on debt..................................................... 4,668 12,399 Long-term debt due within one year.................................................. (40,469) (60,467) ---------- ---------- Total long-term debt ........................................................... 636,301 538,790 ---------- ---------- TOTAL CAPITALIZATION................................................................... $1,928,968 $1,946,785 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 15
METROPOLITAN EDISON COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
Common Stock Accumulated --------------------- Other Other Comprehensive Number Carrying Paid-In Comprehensive Retained Income of Shares Value Capital Income (Loss) Earnings ------------- --------- -------- ------- ------------- -------- (Dollars in thousands) Balance, January 1, 2001....................... 859,500 $ 66,273 $ 400,200 64 $ 70,476 Net income.................................. $ 62,381 62,381 Net unrealized gain on investments.......... 5 5 Net unrealized loss on derivative instruments .............................. (174) (174) -------- Comprehensive income........................ $ 62,212 -------- Cash dividends on common stock.............. (65,000) - ---------------------------------------------------------------------------------------------------------------------------- Balance, November 6, 2001...................... 859,500 66,273 400,200 (105) 67,857 Purchase accounting fair value adjustment... 1,208,052 (400,200) 105 (67,857) Balance, November 7, 2001...................... 859,500 1,274,325 -- -- -- Net income.................................. $ 14,617 14,617 Net unrealized gain on investments.......... 22 22 Net unrealized loss on derivative instruments .............................. (11) (11) -------- Comprehensive income........................ $ 14,628 - ---------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001..................... 859,500 1,274,325 -- 11 14,617 Net income.................................. $ 63,224 63,224 Net unrealized gain on investment........... 17 17 Net unrealized loss on derivative instruments .............................. (67) (67) -------- Comprehensive income........................ $ 63,174 -------- Cash dividends on common stock.............. (60,000) Purchase accounting fair value adjustment... 23,459 - ---------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002..................... 859,500 1,297,784 -- (39) 17,841 - ---------------------------------------------------------------------------------------------------------------------------- Net income.................................. $ 61,170 61,170 Net unrealized gain on investments.......... 2 2 Net unrealized gain on derivative instruments. ............................. 78 78 Minimum liability for unfunded retirement benefits, net of $(23,062,000) of income taxes ............................. (32,515) (32,515) -------- Comprehensive income........................ $ 28,735 -------- Cash dividends on common stock.............. (52,000) Purchase accounting fair value adjustment... 346 - ---------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003..................... 859,500 $1,298,130 $ -- $(32,474) $ 27,011 ============================================================================================================================
CONSOLIDATED STATEMENTS OF PREFERRED STOCK Subject to Mandatory Redemption -------------------- Number Carrying of Shares Value --------- -------- (Dollars in thousands) Balance, January 1, 2001............ 4,000,000 $100,000 ============================================================= Purchase accounting fair value adjustment................ (7,800) ------------------------------------------------------------- Balance, December 31, 2001.......... 4,000,000 92,200 Amortization of fair market value adjustment................ 209 ------------------------------------------------------------- Balance, December 31, 2002.......... 4,000,000 $ 92,409 ============================================================= FIN 46 Deconsolidation 7.35% Series.................... (4,000,000) (92,618) Amortization of fair market value adjustment................ 209 ------------------------------------------------------------- Balance, December 31, 2003.......... -- $ -- ============================================================= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 16
METROPOLITAN EDISON COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - ------------------------------------------------------------------------------------------------------------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 61,170 $ 63,224 $ 14,617 | $ 62,381 Adjustments to reconcile net income to net | cash from operating activities: | Provision for depreciation and amortization.............. 86,514 81,419 8,903 | 51,867 Other amortization....................................... -- (2,528) 154 | 1,147 Deferred costs recoverable as regulatory assets.......... (15,321) (18,938) 1,045 | (91,182) Deferred income taxes, net............................... 46,654 23,356 906 | 53,464 Investment tax credits, net.............................. (822) (792) (128) | (721) Cumulative effect of accounting change (Note 1(H))....... (371) -- -- | -- Receivables.............................................. 10,380 (24,672) 10,213 | 33,714 Accounts payable......................................... (20,988) (18,657) (4,339) | (60,868) Other (Note 7)........................................... (34,728) (538) 8,286 | (59,313) --------- -------- -------- | -------- Net cash provided from (used for) operating | activities. ......................................... 132,488 101,874 39,657 | (9,511) --------- -------- -------- | -------- | CASH FLOWS FROM FINANCING ACTIVITIES: | New Financing- | Long-term debt........................................... 247,696 49,750 -- | 99,500 Short-term borrowings, net............................... -- 16,288 -- | 51,400 Redemptions and Repayments- | Long-term debt........................................... (260,466) (60,000) -- | -- Short-term borrowings, net............................... (22,964) -- (25,989) | -- Dividend Payments- | Common stock............................................. (52,000) (60,000) -- | (65,000) --------- -------- -------- | -------- Net cash provided from (used for) financing | activities. ......................................... (87,734) (53,962) (25,989) | 85,900 --------- -------- -------- | -------- | CASH FLOWS FROM INVESTING ACTIVITIES: | Property additions......................................... (43,558) (44,533) (7,787) | (47,660) Contributions to decommissioning trusts.................... (9,483) (12,644) -- | (7,113) Loans to associated companies, net......................... (7,941) -- -- | -- Other...................................................... 664 (324) (453) | (5,209) --------- -------- -------- | -------- Net cash used for investing activities................. (60,318) (57,501) (8,240) | (59,982) --------- -------- -------- | -------- | Net increase (decrease) in cash and cash equivalents.......... (15,564) (9,589) 5,428 | 16,407 Cash and cash equivalents at beginning of period.............. 15,685 25,274 19,846 | 3,439 --------- --------- -------- | -------- Cash and cash equivalents at end of period.................... $ 121 $ 15,685 $ 25,274 | $ 19,846 ========= ======== ======== | ======== | SUPPLEMENTAL CASH FLOWS INFORMATION: | Cash Paid During the Year- | Interest (net of amounts capitalized).................... $ 51,505 $ 46,266 $ -- | $ 41,473 ========= ======== ======== | ======== Income taxes (refund).................................... $ (25,085) $ 34,385 $ (2,990) | $ 7,486 ========= ======== ======== | ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 17
METROPOLITAN EDISON COMPANY CONSOLIDATED STATEMENTS OF TAXES
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - ------------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: State gross receipts *.......................................... $ 53,462 $ 56,043 $ 5,730 | $ 31,353 Real and personal property...................................... 2,510 1,384 5 | 1,236 Social security and unemployment................................ 2,448 1 (1) | 14 Other........................................................... 8,787 9,367 775 | 7,242 --------- -------- -------- | -------- Total general taxes...................................... $ 67,207 $ 66,795 $ 6,509 | $ 39,845 ========= ======== ======== | ======== | PROVISION FOR INCOME TAXES: | Currently payable- | Federal...................................................... $ (3,435) $ 15,371 $ 7,693 | $(11,534) State........................................................ 1,763 6,437 2,433 | (1,760) --------- -------- -------- | -------- (1,672) 21,808 10,126 | (13,294) --------- -------- -------- | -------- Deferred, net- | Federal...................................................... 38,863 19,615 934 | 41,297 State........................................................ 7,791 3,741 (28) | 12,167 --------- -------- -------- | -------- 46,654 23,356 906 | 53,464 --------- -------- ------- | -------- Investment tax credit amortization.............................. (822) (792) (128) | (721) --------- -------- -------- | -------- Total provision for income taxes......................... $ 44,160 $ 44,372 $ 10,904 | $ 39,449 ========= ======== ======== | ======== | INCOME STATEMENT CLASSIFICATION | OF PROVISION FOR INCOME TAXES: | Operating income................................................ $ 27,367 $ 27,447 $ 11,584 | $ 28,549 Other income.................................................... 16,639 16,925 (680) | 10,900 Cumulative effect of accounting change.......................... 154 -- -- | -- --------- -------- -------- | -------- Total provision for income taxes......................... $ 44,160 $ 44,372 $ 10,904 | $ 39,449 ========= ======== ======== | ======== | RECONCILIATION OF FEDERAL INCOME TAX | EXPENSE AT STATUTORY RATE TO TOTAL | PROVISION FOR INCOME TAXES: | Book income before provision for income taxes................... $ 105,330 $107,596 $ 25,521 | $101,831 ========= ======== ======== | ======== Federal income tax expense at statutory rate.................... $ 36,866 $ 37,659 $ 8,932 | $ 35,641 Increases (reductions) in taxes resulting from- | Amortization of investment tax credits....................... (822) (792) (128) | (721) Depreciation................................................. 1,736 1,362 304 | 926 State income tax, net of federal benefit..................... 6,289 6,107 938 | 7,388 Allocated share of consolidated tax savings.................. -- -- -- | (3,151) Other, net................................................... 91 36 858 | (634) --------- -------- -------- | -------- Total provision for income taxes......................... $ 44,160 $ 44,372 $ 10,904 | $ 39,449 ========= ======== ======== | ======== | ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: | Property basis differences...................................... $ 250,779 $217,351 $211,394 | Nuclear decommissioning......................................... (6,405) (4,247) (5,623) | Deferred sale and leaseback costs............................... (10,986) (11,366) (12,077) | Non-utility generation costs.................................... 2,287 (4,832) 36,099 | Purchase accounting basis difference............................ (642) (642) (37,143) | Sale of generation assets....................................... (1,419) (1,419) (1,420) | Regulatory transition charge.................................... 88,020 88,315 85,414 | Customer receivables for future income taxes.................... 46,010 50,259 49,755 | Other comprehensive income...................................... (23,062) -- -- | Employee benefits............................................... (17,252) -- -- | Other........................................................... (30,190) (16,662) (25,961) | --------- -------- -------- | Net deferred income tax liability........................ $ 297,140 $316,757 $300,438 | ========= ======== ======== | * Collected from customers through regulated rates and included in revenue on the Consolidated Statements of Income. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include Metropolitan Edison Company (Company) and its wholly owned subsidiaries. The Company is a wholly owned subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the issued and outstanding common shares of its other principal electric utility operating subsidiaries, including Ohio Edison Company (OE), The Cleveland Electric Illuminating Company (CEI), The Toledo Edison Company (TE), American Transmission Systems, Inc. (ATSI), Jersey Central Power & Light Company (JCP&L) and Pennsylvania Electric Company (Penelec). The Company, JCP&L and Penelec were formerly wholly owned subsidiaries of GPU, Inc., which merged with FirstEnergy on November 7, 2001. Pre-merger period and post-merger period financial results are separated by a heavy black line. The Company follows the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. (A) CONSOLIDATION- The Company consolidates all majority-owned subsidiaries, over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) over which the Company has the ability to exercise significant influence, but not control, are accounted for on the equity basis. (B) REVENUES- The Company's principal business is providing electric service to customers in Pennsylvania. The Company's retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. See Note 7 - Other Information for discussion of reporting of independent system operator transactions. Receivables from customers include sales to residential, commercial and industrial customers and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of the Company's customers. Total customer receivables were $119 million (billed - $70 million and unbilled - $49 million) and $121 million (billed - $76 million and unbilled - $45 million) as of December 31, 2003 and 2002, respectively. (C) REGULATORY PLAN- Pennsylvania enacted its electric utility competition law in 1996 with the phase-in of customer choice for generation suppliers completed as of January 1, 2001. The PPUC authorized a 1998 rate restructuring plan for the Company. In 2000, the PPUC disallowed a portion of the requested additional stranded costs above those amounts granted in the Company's 1998 rate restructuring plan orders. The PPUC required the Company to seek an IRS ruling regarding the return of certain unamortized investment tax credits and excess deferred income tax benefits to customers. If the IRS ruling ultimately supports returning these tax benefits to customers, there would be no effect to the Company's net income since the contingency existed prior to the merger and there would be an adjustment to goodwill. In June 2001, the PPUC approved the Settlement Stipulation with all of the major parties in the combined merger and rate relief proceedings which approved the FirstEnergy/GPU merger and provided provider of last resort (PLR) deferred accounting treatment for energy costs, permitting the Company to defer, for future recovery, energy costs in excess of amounts reflected in its capped generation rates retroactive to January 1, 2001. This PLR deferral accounting procedure was later denied in a February 2002 Commonwealth Court of Pennsylvania decision. The court decision also affirmed the PPUC decision regarding approval of the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. In 2002, the Company established a $103.0 million reserve for its PLR deferred energy costs incurred prior to its acquisition by FirstEnergy. The reserve reflected the potential adverse impact of a then pending Pennsylvania Supreme Court decision whether to review the Commonwealth Court ruling. The reserve increased goodwill by an aggregate net of tax amount of $60.3 million. On April 2, 2003, the PPUC remanded the issue relating to merger savings to the Office of Administrative Law for hearings, directed the Company to file a position paper on the effect of the Commonwealth Court order on the 19 Settlement Stipulation and allowed other parties to file responses to the position paper. The Company filed a letter with the Administrative Law Judge (ALJ) on June 11, 2003, voiding the Stipulation in its entirety and reinstating its restructuring settlement previously approved by the PPUC. On October 2, 2003, the PPUC issued an order concluding that the Commonwealth Court reversed the PPUC's June 20, 2001 order in its entirety. The PPUC directed the Company to file tariffs within thirty days of the order to reflect the competitive transition charge (CTC) rates and shopping credits that were in effect prior to the June 21, 2001 order to be effective upon one day's notice. In response to that order, the Company filed the supplements to its tariffs to become effective October 24, 2003. On October 8, 2003, the Company filed a petition for clarification relating to the October 2, 2003 order on two issues: to establish June 30, 2004 as the date to fully refund the nonutility generation (NUG) trust fund and to clarify that the ordered accounting treatment regarding the CTC rate/shopping credit swap should follow the ratemaking, and that the PPUC's findings would not impair its rights to recover all of its stranded costs. On October 9, 2003, ARIPPA (an intervenor in the proceedings) petitioned the PPUC to direct the Company to reinstate accounting for the CTC rate/shopping credit swap retroactive to January 1, 2002. Several other parties also filed petitions. On October 16, 2003, the PPUC issued a reconsideration order granting the date requested by the Company for the NUG trust fund refund; and, denying the Company's other clarification requests and granting ARIPPA's petition with respect to the accounting treatment of the changes to the CTC rate/shopping credit swap. On October 22, 2003, the Company filed an Objection with the Commonwealth Court asking that the Court reverse the PPUC's finding that requires the Company to treat the stipulated CTC rates that were in effect from January 1, 2002 on a retroactive basis. The Company is considering filing an appeal to the Commonwealth Court on the PPUC orders as well. On October 27, 2003, one Commonwealth Court judge issued an Order denying the Company's objection without explanation. Due to the vagueness of the Order, the Company, on October 31, 2003, filed an Application for Clarification with the judge. Concurrent with this filing, the Company, in order to preserve its rights, also filed with the Commonwealth Court both a Petition for Review of the PPUC's October 16 and 22 Orders, and an application for reargument, if the judge, in his clarification order, indicates that the Company's objection was intended to be denied on the merits. In addition to these findings, the Company, in compliance with the PPUC's Orders, filed revised PPUC quarterly reports for the twelve months ended December 31, 2001 and 2002, and for the first two quarters of 2003, reflecting balances consistent with the PPUC's findings in its Orders. Effective September 1, 2002, the Company assigned its PLR responsibility to its FirstEnergy Solutions Corp. (FES) affiliate through a wholesale power sale agreement. The PLR sale will be automatically extended for each successive calendar year unless any party elects to cancel the agreement by November 1 of the preceding year. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by the Company under its NUG contracts and other power contracts with nonaffiliated third party suppliers. This arrangement reduces the Company's exposure to high wholesale power prices by providing power at a fixed price for their uncommitted PLR energy costs during the term of the agreement with FES. FES has hedged most of the Company's unfilled PLR on-peak obligation through 2004 and a portion of 2005, the period during which deferred accounting was previously allowed under the PPUC's order. The Company' is authorized to continue deferring differences between NUG contract costs and current market prices. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. The Company is currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of the Company's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. The Company is unable to predict the outcome of the investigation or the impact of the PPUC Order. Regulatory Assets- The Company recognizes, as regulatory assets, costs which the FERC and the PPUC have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are expected to continue to be recovered from customers under the Company's regulatory plan. The Company continues to bill and collect cost-based rates for its transmission and distribution services, which 20 remain regulated; accordingly, it is appropriate that the Company continue the application of Statement of Financial Accounting Standards No. (SFAS) 71, "Accounting for the Effects of Certain Types of Regulation," to those operations. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2003 2002 ------------------------------------------------------------------ (In millions) Regulatory transition charge................... $ 926 $ 986 Customer receivables for future income taxes... 103 116 Nuclear decommissioning costs.................. (26) 54 Employee postretirement benefit costs.......... 18 20 Loss on reacquired debt........................ 8 4 Other.......................................... (1) (1) ------------------------------------------------------------------ Total....................................... $1,028 $1,179 ================================================================= Regulatory Accounting for Generation Operations- The application of SFAS 71 was discontinued in 1998 with respect to the Company's generation operations. The Company subsequently divested substantially all of its generating assets. The SEC issued interpretive guidance regarding asset impairment measurement, providing that any supplemental regulated cash flows such as a CTC should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. Net assets included in utility plant relating to the operations for which the application of SFAS 71 was discontinued were $15 million as of December 31, 2003. (D) PROPERTY, PLANT AND EQUIPMENT- As a result of the merger, a portion of the Company's property, plant and equipment was adjusted to reflect fair value. The majority of the Company's property, plant and equipment continues to be reflected at original cost since such assets remain subject to rate regulation on a historical cost basis. The Company's accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. The Company provides for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The annualized composite rate was approximately 2.7% in 2003 and 3.0% in 2002 and 2001. (E) ASSET RETIREMENT OBLIGATION- In January 2003, the Company implemented SFAS 143, "Accounting for Asset Retirement Obligations," which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. The Company identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning. The ARO liability as of the date of adoption of SFAS 143 was $198.3 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, the Company recognized decommissioning liabilities of $259.6 million. The Company expects substantially all nuclear decommissioning costs to be recoverable through regulated rates. Therefore, a regulatory liability of $61.3 million was recognized upon adoption of SFAS 143. Accretion during 2003 was $11.9 million, bringing the ARO liability as of December 31, 2003 to $210.2 million. The ARO includes the Company's obligation for nuclear decommissioning of Three Mile Island Unit 2 (TMI-2). The Company's share of the obligation to decommission TMI-2 was developed based on a site-specific study performed by an independent engineer. The Company utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Company maintains nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $192.4 million. 21 The following table provides the year-end balance of the ARO related to nuclear decommissioning for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 ------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002 $187.1 Accretion in 2002 11.2 ------------------------------------------------------- Ending balance as of December 31, 2002 $198.3 ------------------------------------------------------- (F) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 4(B)). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date, resulting in substantially no intrinsic value. If FirstEnergy had accounted for employee stock options under the fair value method of SFAS 123, "Accounting for Stock Compensation," a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 --------------------------------------------------------------- Valuation assumptions: Expected option term (years) 7.9 8.1 8.3 Expected volatility......... 26.91% 23.31% 23.45% Expected dividend yield..... 5.09% 4.36% 5.00% Risk-free interest rate..... 3.67% 4.60% 4.67% Fair value per option......... $5.09 $6.45 $4.97 --------------------------------------------------------------- The effects of applying fair value accounting to the FirstEnergy's stock options would not materially affect the Company's net income. (G) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. Results for the period January 1, 2001 through November 6, 2001 were included in the final consolidated federal income tax return of GPU, and results for the period November 7, 2001 through December 31, 2001 were included in FirstEnergy's 2001 consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with the Company recognizing the tax benefit for any tax losses or credits it contributes to the consolidated return. (H) CUMULATIVE EFFECT OF ACCOUNTING CHANGE As a result of adopting SFAS 143 in January 2003, asset retirement costs were recorded in the amount of $186 million as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $186 million. The ARO liability on the date of adoption was $198 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. The remaining cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $0.4 million increase to income, $0.2 million net of tax in the year ended December 31, 2003. If SFAS 143 had been applied during 2002 and 2001, the impact would not have been material to the Company's Consolidated Statements of Income. 22 (I) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of the Company's employees. The trusteed plans provide defined benefits based on years of service and compensation levels. FirstEnergy's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company recognizes the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. The following sets forth the funded status of the plans and amounts recognized on FirstEnergy's Consolidated Balance Sheets as of December 31: 23
Obligations and Funded Status Pension Benefits Other Benefits ---------------- -------------- As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $ 1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition (Note 2)................. -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------- Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $ 2,077 ====== ====== ======= ======= Change in fair value of plan assets Fair value of plan assets at beginning of year...................... $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------- Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ======= Funded status............................ $ (847) $ (977) $(1,831) (1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit) 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ ------- ------- Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Amounts Recognized in the Consolidated Balance Sheets As of December 31 ---------------------------------------- Accrued benefit cost..................... $ (438) $ (548) $ (975) $(867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ------ ------ ------- ----- Net amount recognized.................... $ 144 $ 287 $ (975) $(867) ====== ====== ======= ===== Company's share of net amount recognized. $ 10 $ -- $ (59) $ -- ====== ====== ======= ===== Increase (decrease) in minimum liability included in other comprehensive income (net of tax)........................... $ (145) $ 444 -- $ -- Weighted-Average Assumptions Used to Determine Benefit Obligations As of December 31 ---------------------------------------- Discount rate............................ 6.25% 6.75% 6.25% 6.75% Rate of compensation increase............ 3.50% 3.50% Allocation of Plan Assets As of December 31 ---------------------------------------- Asset Category Equity securities........................ 70% 61% 71% 58% Debt securities.......................... 27 35 22 29 Real estate.............................. 2 2 -- -- Other.................................... 1 2 7 13 ---- ---- ---- ---- Total.................................... 100% 100% 100% 100% ==== ==== ==== ==== Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 ----------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889 FirstEnergy's net pension and other postretirement benefit costs for the three years ended December 31, 2003 were computed as follows:
24
Pension Benefits Other Benefits --------------------- -------------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 ------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset).................... -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ----- ----- ----- ----- ---- ---- Net periodic cost (income).............. $ 142 $ (29) $ (24) $ 177 $114 $ 92 ===== ===== ===== ===== ==== ==== Company's share of net periodic cost (income) (see Note 7) Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31 ---------------------------------------- Discount rate........................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets........................... 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase........... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy.
Assumed health care cost trend rates As of December 31 2003 2002 -------------------------------------------------------------------------------- Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2007-2009
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- -Percentage- Point Increase Point Decrease ------------------------------------------------------------------------- (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of GPU Service Inc. merging with FirstEnergy Service Company (FESC) in the second quarter of 2003, operating company employees of GPU Service (GPUS) were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, the accrued pension costs for the Company as of June 30, 2003 increased by $47 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of its pension plan assets, the Company reduced its minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $7 million, recording an increase of $13,000 in an intangible asset and crediting OCI by $4 million (offsetting previously recorded deferred tax 25 benefits by $3 million). The remaining balance in OCI of $33 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $45 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. (J) GOODWILL- In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Under SFAS 142, "Goodwill and Other Intangible Assets," amortization of existing goodwill ceased January 1, 2002. Instead, the Company evaluates goodwill for impairment at least annually and makes such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. When impairment is indicated, the Company recognizes a loss - calculated as the difference between the implied fair value of a reporting unit's goodwill and the carrying value of the goodwill. The Company's annual review was completed in the third quarter of 2003. The forecasts used in the Company's evaluations of goodwill reflect operations consistent with its general business assumptions. Unanticipated changes in those assumptions could have a significant effect on the Company's future evaluations of goodwill. As of December 31, 2003, the Company had $884 million of goodwill. (K) TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and other income included transactions with affiliated companies, primarily FESC, GPUS and FES. GPUS (until it ceased operations in mid-2003) and FESC have provided legal, accounting, financial and other services to the Company. The Company also entered into sale and purchase transactions with affiliates (JCP&L and Penelec) during the period. Effective September 1, 2002, the Company assigned its PLR responsibility to FES through a wholesale power sale agreement. See Note 7 for affiliated companies' transactions schedule. FirstEnergy does not bill directly or allocate any of its costs to any subsidiary company. Costs are allocated to the Company from its affiliates, GPUS and FESC, both subsidiaries of FirstEnergy Corp. and both "mutual service companies" as defined in Rule 93 of the Public Utility Holding Company Act of 1935 (PUHCA). The vast majority of costs are directly billed or assigned at no more than cost as determined by PUHCA Rule 91. The remaining costs are for services that are provided on behalf of more than one company, or costs that cannot be precisely identified and are allocated using formulas that are filed annually with the SEC on Form U-13-60. The current allocation or assignment formulas used and their bases include multiple factor formulas: each company's proportionate amount of FirstEnergy's aggregate direct payroll, number of employees, asset balances, revenues, number of customers, other factors and specific departmental charge ratios. Management believes that these allocation methods are reasonable. Intercompany transactions with FirstEnergy and its other subsidiaries are generally settled under commercial terms within thirty days, except for a net $20 million receivable from affiliates for pension and OPEB obligations. (L) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Consolidated Balance Sheets at cost, which approximates their fair market value. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Consolidated Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31: 2003 2002 --------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value --------------------------------------------------------------------------- (In millions) Long-term debt..................... $672 $697 $587 $598 Preferred stock.................... $ -- $ -- $ 92 $100 Investments other than cash and cash equivalents............. $195 $195 $156 $156 --------------------------------------------------------------------------- The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by corporations with credit ratings similar to the Company's ratings. Long-term debt and preferred stock subject to mandatory redemption were recognized at fair value in connection with the merger. 26 The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. The Company has no securities held for trading purposes. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "Investments other than cash and cash equivalents" in the table above) consist of equity securities ($114 million) and fixed income securities ($78 million) as of December 31, 2003. Realized and unrealized gains and losses applicable to the decommissioning trusts have been recognized in the trust investment with a corresponding change to regulatory assets. For 2003 and 2002, net realized gains (losses) were approximately $0.5 million and $(0.4) million and interest and dividend income totaled approximately $5.1 million and $4.7 million, respectively. On January 1, 2001, the Company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities -- an amendment of FASB Statement No. 133." The adoption resulted in the recognition of derivative assets on the Consolidated Balance Sheet at January 1, 2001 in the amount of $13.0 million, with a substantially offsetting amount recorded in Regulatory Assets of $12.2 million. As of January 1, 2001, a cumulative effect of accounting change was recognized as an expense in Other Income on the Consolidated Statement of Income in the amount of $0.1 million. The Company is exposed to financial risks resulting from the fluctuation of commodity prices, including electricity and natural gas. To manage the volatility relating to these exposures, the Company uses a variety of non-derivative and derivative instruments, including options and futures contracts. These derivatives are used principally for hedging purposes. The Company has a Risk Policy Committee, comprised of FirstEnergy executive officers, which exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. The Company uses derivatives to hedge the risk of price fluctuations. The Company's primary ongoing hedging activity involves cash flow hedges of electricity and natural gas purchases. The majority of the Company's forward commodity contracts are considered "normal purchases and sales," as defined by SFAS 133, and are therefore excluded from the scope of SFAS 138. The options and futures contracts determined to be within the scope of SFAS 133 are accounted for as cash flow hedges and expire on various dates through 2003. Gains and losses from hedges of commodity price risks are included in net income when the underlying hedged commodities are delivered. There was no deferred gain or loss in Accumulated Other Comprehensive Loss as of December 31, 2003 related to derivative hedging activity. 2. MERGER: On November 7, 2001, the merger of FirstEnergy and GPU became effective pursuant to the Agreement and Plan of Merger, dated August 8, 2000. As a result of the merger, GPU's former wholly owned subsidiaries, including the Company, became wholly owned subsidiaries of FirstEnergy. The merger was accounted for by the purchase method of accounting. The assets acquired and liabilities assumed were recorded at estimated fair values as determined by FirstEnergy's management based on information currently available and on current assumptions as to future operations. Merger purchase accounting adjustments recorded in the records of the Company primarily consist of: (1) revaluation of certain property, plant and equipment; (2) adjusting preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (3) recognizing additional obligations related to retirement benefits; and (4) recognizing estimated severance and other compensation liabilities. Other assets and liabilities were not adjusted since they remain subject to rate regulation on a historical cost basis. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill. During 2002 and 2003, certain pre-acquisition contingencies and other final adjustments to the fair values of the assets acquired and liabilities assumed were reflected in the final allocations of the purchase price. These adjustments primarily related to: (1) final actuarial calculations related to pension and postretirement benefit obligations; (2) establishment of a reserve for deferred energy costs recognized prior to the merger; and (3) return to accrual adjustments for income taxes. As a result of these adjustments, goodwill increased by approximately $101.4 million. As of December 31, 2003, the Company had recorded goodwill of approximately $884.3 million related to the merger. 27 3. LEASES: Consistent with regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. The Company's most significant operating lease relates to the sale and leaseback of a portion of its ownership interest in the Merrill Creek Reservoir project. The interest element related to this lease was $1.6 million, $0.2 million and $1.9 million for the years 2003, 2002 and 2001. As of December 31, 2003, the future minimum lease payments on the Company's Merrill Creek operating lease, net of reimbursements from sublessees, are: $1.2 million, $1.5 million, $1.5 million, $1.5 million and $1.5 million for the years 2004 through 2008, respectively, and $43.7 million for the years thereafter. The Company's Merrill Creek lease payments were offset against the actual net divestiture proceeds received from the 1999 sales of its generating assets. 4. CAPITALIZATION: (A) RETAINED EARNINGS- The merger purchase accounting adjustments included resetting the retained earnings balance to zero as of the November 7, 2001 merger date. In general, the Company's first mortgage bond (FMB) indentures restrict the payment of dividends or distributions on or with respect to the Company's common stock to amounts credited to earned surplus since approximately the date of its indenture. At such date, the Company had a balance of $3.4 million in its earned surplus account, which would not be available for dividends or other distributions. As of December 31, 2003, the Company had retained earnings available to pay common stock dividends of $23.6 million, net of amounts restricted under the Company's FMB indentures. (B) STOCK COMPENSATION PLANS- FirstEnergy administers the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Several other stock compensation plans have been acquired through the mergers with GPU and Centerior - GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan), 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan) and Centerior Equity Plan. No further stock-based compensation can be awarded under these plans. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 2003 2002 2001 ----------------------------------------------------------------------- Restricted common shares granted..... -- 36,922 133,162 Weighted average market price ........ n/a (1) $36.04 $35.68 Weighted average vesting period (years) n/a (1) 3.2 3.7 Dividends restricted.................. n/a (1) Yes -- (2) ----------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares; MYR Plan dividends are paid as unrestricted cash on 128,662 shares Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. 28 Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price -------------------------------------------------------------------- Balance, January 1, 2001......... 5,021,862 $24.09 (473,314 options exercisable).... 24.11 Options granted................ 4,240,273 28.11 Options exercised.............. 694,403 24.24 Options forfeited.............. 120,044 28.07 Balance, December 31, 2001....... 8,447,688 26.04 (1,828,341 options exercisable).. 24.83 Options granted................ 3,399,579 34.48 Options exercised.............. 1,018,852 23.56 Options forfeited.............. 392,929 28.19 Balance, December 31, 2002...... 10,435,486 28.95 (1,400,206 options exercisable).. 26.07 Options granted................ 3,981,100 29.71 Options exercised.............. 455,986 25.94 Options forfeited.............. 311,731 29.09 Balance, December 31, 2003...... 13,648,869 29.27 (1,919,662 options exercisable).. 29.67 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. Options outstanding by plan and range of exercise price as of December 31, 2003 were as follows: Range of Options FirstEnergy Program Exercise Prices Outstanding ------------------------------------------------------------------- FE plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU plan $23.75 - $35.92 501,734 Other plans 27,673 ------------------------------------------------------------------- Total 13,648,869 ==================================================================- No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 1(F) - Stock-Based Compensation. (C) PREFERRED AND PREFERENCE STOCK- The Company's preferred stock authorization consists of 10 million shares without par value. No preferred shares are currently outstanding. (D) LONG-TERM DEBT- The Company's FMB indenture, which secures all of the Company's FMBs, serve as a direct first mortgage lien on substantially all of the Company's property and franchises, other than specifically excepted property. The Company has various debt covenants under its financing arrangements. The most restrictive of these relate to the nonpayment of interest and/or principal on debt, which could trigger a default. Cross-default provisions also exist between FirstEnergy and the Company. Based on the amount of bonds authenticated by the Trustee through December 31, 2003 the Company's annual sinking fund requirements for all bonds issued under the mortgage amount to $6 million. The Company expects to fulfill its sinking fund obligation by providing refundable bonds to the Trustee. Sinking fund requirements for FMBs and maturing long-term debt (excluding capital leases) for the next five years are: 29 (In millions) ---------------------------------- 2004................ $ 40 2005................ 30 2006................ 151 2007................ 50 2008................ 7 ---------------------------------- The Company's obligations to repay certain pollution control revenue bonds are secured by several series of FMBs. Certain pollution control revenue bonds are entitled to the benefit of noncancelable municipal bond insurance policies of $42 million to pay principal of, or interest on, the pollution control revenue bonds. (E) LONG-TERM DEBT: SUBORDINATED DEBENTURES TO AFFILIATED TRUST- The Company formed a statutory business trust to sell preferred securities and invest the gross proceeds in subordinated debentures. Ownership of the Company's trust is through a separate wholly owned limited partnership. In this transaction, the trust invested the gross proceeds from the sale of its preferred securities in the preferred securities of the limited partnership, which in turn invested those proceeds in the 7.35% subordinated debentures of the Company. The Company has effectively provided a full and unconditional guarantee of obligations under the trust's preferred securities. The trust's preferred securities are redeemable at the option of the Company beginning in May 2004 at 100% of their principal amount. Interest on the subordinated debentures (and therefore distributions on the trust's preferred securities) may be deferred for up to 60 months, but the Company may not pay dividends on, or redeem or acquire, any of its cumulative preferred or common stock until deferred payments on its subordinated debentures are paid in full. Upon adoption of FIN 46R "Consolidation of Variable Interest Entities", the limited partnership and statutory business trust discussed above are not consolidated on the Company's financial statements as of December 31, 2003 (see Note 8). (F) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholder's equity except those resulting from transactions with the Company's parent. As of December 31, 2003, accumulated other comprehensive loss consisted of a minimum liability for unfunded retirement benefits of $32.5 million. 5. SHORT-TERM BORROWINGS: The Company may borrow from its affiliates on a short-term basis. As of December 31, 2003, the Company had total short-term borrowings of $65.3 million from its affiliates. The weighted average interest rates on short-term borrowings outstanding at December 31, 2003 and 2002 were 1.7% and 1.8%, respectively. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $168 million for property additions and improvements from 2004 through 2006, of which approximately $55 million is applicable to 2004. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its present ownership interest in TMI-2, the Company is exempt from any potential assessment under the industry retrospective rating plan. The Company is also insured as to its interest in TMI-2 under a policy issued to the operating company for the plant. Under this policy, $150 million is provided for property damage and decontamination and decommissioning costs. Under this policy, the Company can be assessed a maximum of approximately $0.3 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at TMI-2 exceed the policy limits of the 30 insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. (C) ENVIRONMENTAL MATTERS- The Company has been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, potential environmental liabilities have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Company's proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. The Company has accrued liabilities aggregating approximately $59,000 as of December 31, 2003. The Company accrues for environmental costs only when it can conclude that it is probable that they have an obligation for such costs and can reasonably determine the amount of such costs. Unasserted claims are reflected in the Company's determination of environmental liabilities and are accrued in the period that they are both probable and reasonably estimable. The Company does not believe environmental remediation costs will have a material adverse effect on its financial condition, cash flows or results of operations. (D) OTHER LEGAL PROCEEDINGS- Various lawsuits, claims and proceedings related to the Company's normal business operations are pending against the Company, the most significant of which is described above. On August 14, 2003, various states and parts of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest Independent System Operator and PJM Interconnection) to provide effective diagnostic support. FirstEnergy believes that the interim report falls far short of providing a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. FirstEnergy remains convinced that the outage cannot be explained by events on any one utility's system. On November 25, 2003, The Public Utillity Commission of Ohio (PUCO) ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study is to examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, it is unknown what the cost of such study will be, or the impact of the results. 7. OTHER INFORMATION : The following represents the financial data which includes supplemental unaudited prior years' information as compared to consolidated financial statements and notes previously reported in 2001. 31 (A) CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 ---- ---- ---- ---- (Unaudited) (Unaudited) (In thousands) Other cash flows from operating activities: Accrued retirement benefit obligations.... $ (3,284) $ 63 $ 1 | $ (15) Accrued compensation, net................. 5,531 (2,491) -- | (1,238) Accrued taxes............................. (7,334) 9,059 5,229 | (18,960) Accrued interest.......................... (4,600) (1,020) 5,629 | (2,536) Prepayments and other..................... 3,131 2,508 10,456 | (15,140) Other..................................... (28,172) (8,657) (13,029) | (21,424) -------- ------- --------- | -------- Other cash provided from (used for) operating activities.................. $(34,728) $ (538) $ 8,286 | $(59,313) ======== ======== ======== | =========
(B) REVENUES - INDEPENDENT SYSTEM OPERATOR (ISO) TRANSACTIONS- The Company records purchase and sales transactions with PJM Interconnection ISO, an independent system operator, on a gross basis in accordance with EITF Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." The aggregate purchase and sales transactions for the three years ended December 31, 2003, are summarized as follows: Nov. 7-Dec. 31, Jan. 1-Nov. 6, 2003 2002 2001 2001 -------------------------------------------------------------------------- (Unaudited) (Unaudited) (In millions) | Sales............. $ 3 $ 9 $ 1 | $11 Purchases......... 13 67 13 | 81 -------------------------------------------------------------------------- The Company's revenues on the Consolidated Statements of Income include wholesale electricity sales revenues from the PJM ISO from power sales (as reflected in the table above) during periods when the Company had additional available power capacity. Revenues also include sales by the Company of power sourced from the PJM ISO (reflected as purchases in the table above) during periods when the Company required additional power to meet its retail load requirements. (C) TRANSACTIONS WITH AFFILIATED COMPANIES- The primary affiliated companies transactions are as follows: Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 - -------------------------------------------------------------------------------- (Unaudited) (Unaudited) (In millions) Operating Revenues: Wholesale sales-affiliated companies... $ -- $ 18.6 $3.2 | $8.4 | Operating Expenses: | Power purchased from FES............... 276.7 171.9 10.6 | -- Service Company support services....... 49.5 68.1 14.0 | 81.0 Power purchased from other affiliates.. 2.2 9.5 1.9 | 9.2 - -------------------------------------------------------------------------------- (D) RETIREMENTS BENEFITS (1) Net pension and other postretirement benefit costs (income) for the three years ended December 31, 2003 are approximately as follows: Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 - -------------------------------------------------------------------------------- (Unaudited) (Unaudited) (In millions) Pension Benefits....................... $5 $(11) $(3) $(8) Other Postretirement Benefits.......... 7 3 1 8 - ------------------------------------------------------------------------------- (1) Includes estimated portion of benefit costs included in billings from GPUS. 8. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS: 32 FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, the Company adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. The Company will adopt FIN 46R for all other types of entities effective March 31, 2004. As described in Note 4(E), the Company created a statutory business trust to issue trust preferred securities in the amount of $93 million. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. Therefore, the Company has deconsolidated the trust and recognized an equity investment in the trust of $3 million and subordinated debentures to the trust of $96 million as of December 31, 2003. The Company is evaluating entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. These entities are non-utility generators in which we have neither debt nor equity investments but are generally the sole purchaser of their power. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, the Company implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(E) and 1(H) for further discussions of SFAS 143. DIG Implementation Issue No. C20 for SFAS 133, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) Regarding Contracts with a Price Adjustment Feature" In June 2003, the FASB cleared DIG Issue C20 for implementation in fiscal quarters beginning after July 10, 2003. The issue supersedes earlier DIG Issue C11, "Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception." DIG Issue C20 provides guidance regarding when the presence of a general index, such as the Consumer Price Index, in a contract would prevent that contract from qualifying for the normal purchases and normal sales exception under SFAS 133, as amended, and therefore exempt from the mark-to-market treatment of certain contracts. Adoption of DIG Issue C20 did not impact the Company's financial statements. 33 9. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 2003 and 2002.
March 31, June 30, Sept. 30, Dec. 31, Three Months Ended 2003 2003 2003 2003 (a) - ------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues.......................... $251.2 $217.7 $261.7 $240.4 Operating Expenses and Taxes................ 227.2 199.1 242.7 218.9 - ------------------------------------------------------------------------------------------------------- Operating Income............................ 24.0 18.6 19.0 21.5 Other Income................................ 5.2 5.3 5.4 6.8 Net Interest Charges........................ 12.4 11.0 10.7 10.7 - ------------------------------------------------------------------------------------------------------- Income Before Cumulative Effect of Accounting Change........................ 16.8 12.9 13.7 17.6 Cumulative Effect of Accounting Change (Net of Income Taxes).................... 0.2 -- -- -- - ------------------------------------------------------------------------------------------------------- Net Income.................................. $ 17.0 $ 12.9 $ 13.7 $ 17.6 =====================================================================================================-- March 31, June 30, Sept. 30, Dec. 31, Three Months Ended 2002 2002 2002 2002 - ----------------------------------------------------------------------------------------------------- (In millions) Operating Revenues.......................... $245.8 $240.0 $281.5 $219.3 Operating Expenses and Taxes................ 212.3 216.8 267.9 198.3 - ----------------------------------------------------------------------------------------------------- Operating Income............................ 33.5 23.2 13.6 21.0 Other Income................................ 5.2 5.5 5.9 5.1 Net Interest Charges........................ 12.1 12.7 12.4 12.6 - ----------------------------------------------------------------------------------------------------- Net Income.................................. $ 26.6 $ 16.0 $ 7.1 $ 13.5 =====================================================================================================
(a)......Net income for the three months ended December 31, 2003, was increased by $1.6 million due to adjustments that were subsequently capitalized to construction projects in the fourth quarter. The adjustments included $0.4 million and $1.2 million of costs charged to expense in the second and third quarters, respectively. Management concluded that the adjustments were not material to the consolidated financial statements for any quarter of 2003. 34 Report of Independent Auditors To the Stockholders and Board of Directors of Metropolitan Edison Company: In our opinion, the accompanying consolidated balance sheets and consolidated statements of capitalization and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of Metropolitan Edison Company (a wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. The consolidated financial statements of Metropolitan Edison Company and subsidiaries for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger), were audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on those financial statements in their report dated March 18, 2002. As discussed in Note 1(E) to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003. As discussed in Note 8 to the consolidated financial statements, the Company changed its method of accounting for the consolidation of variable interest entities as of December 31, 2003. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 35 The following report is a copy of a report previously issued by Arthur Andersen LLP (Andersen). This report has not been reissued by Andersen and Andersen did not consent to the incorporation by reference of this report into any of the Company's registration statements. Report of Previous Independent Public Accountants To the Stockholders and Board of Directors of Metropolitan Edison Company: We have audited the accompanying consolidated balance sheet and consolidated statement of capitalization of Metropolitan Edison Company (a Pennsylvania corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2001 (post-merger), and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger). 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 audit. The financial statements of Metropolitan Edison Company and subsidiaries as of December 31, 2000 and for each of the two years in the period ended December 31, 2000 (pre-merger), were audited by other auditors whose report dated January 31, 2001, expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2001 financial statements referred to above present fairly, in all material respects, the financial position of Metropolitan Edison Company and subsidiaries as of December 31, 2001 (post-merger), and the results of their operations and their cash flows for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger), in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 36 EX-21 41 me_ex21-5.txt EX 21-5 MET-ED LIST OF SUBS Exhibit 21.5 METROPOLITAN EDISON COMPANY SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 2003 STATE OF NAME OF SUBSIDIARY BUSINESS ORGANIZATION ------------------ -------- ------------ YORK HAVEN POWER COMPANY HYDROELECTRIC GENERATION NEW YORK MET-ED PREFERRED CAPITAL II, INC. SPECIAL-PURPOSE FINANCE DELAWARE MET-ED CAPITAL II, L.P. SPECIAL-PURPOSE FINANCE DELAWARE MET-ED CAPITAL TRUST SPECIAL-PURPOSE FINANCE DELAWARE Note: Met-Ed, along with its affiliates JCP&L and Penelec, collectively own all of the common stock of Saxton Nuclear Experimental Corporation, a Pennsylvania nonprofit corporation organized for nuclear experimental purposes which is now inactive. The carrying value of the owners' investment has been written down to a nominal value. EX-12 42 pn_ex12-8.txt EX 12-8 PENELEC FIXED CHARGE RATIO EXHIBIT 12.8 Page 1 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, Jan. 1- Nov. 7- Year Ended December 31, 1999 2000 Nov. 6, 2001 Dec. 31, 2001 2002 2003 -------- -------- ------------ ------------- --------- --------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items............... $152,491 $ 39,250 $23,718 | $10,795 $ 50,910 $ 20,237 Interest and other charges, before | reduction for amounts capitalized.... ........ 45,149 48,544 40,998 | 7,052 42,373 37,660 Provision for income taxes...................... 54,383 29,754 19,402 | 8,231 34,248 24,836 Interest element of rentals charged | to income (a)................................. 4,306 3,020 891 | 311 1,849 3,076 -------- -------- ------- | ------- -------- -------- Earnings as defined........................... $256,329 $120,568 $85,009 | $26,389 $129,380 $ 85,809 ======== ======== ======= | ======= ======== ======== | FIXED CHARGES AS DEFINED IN REGULATION S-K: | Interest on long-term debt...................... $ 31,837 $ 29,964 $28,751 | $ 3,972 31,758 $ 29,565 Other interest expense.......................... 4,359 11,546 6,008 | 1,979 3,061 4,318 Subsidiary's preferred stock | dividend requirements......................... 8,953 7,034 6,239 | 1,101 7,554 3,777 Interest element of rentals charged | to income (a)................................. 4,306 3,020 891 | 311 1,849 3,076 -------- -------- ------- | ------- -------- -------- Fixed charges as defined...................... $ 49,455 $ 51,564 $41,889 | $ 7,363 $ 44,222 $ 40,736 ======== ======== ======= | ====== ======== ======== | CONSOLIDATED RATIO OF EARNINGS TO FIXED | CHARGES......................................... 5.18 2.34 2.03 | 3.58 2.93 2.11 ==== ==== ==== | ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 103
EXHIBIT 12.8 Page 2 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, Jan. 1- Nov. 7- Year Ended December 31, 1999 2000 Nov. 6, 2001 Dec. 31, 2001 2002 2003 --------- -------- ------------ ------------- --------- --------- (Dollars in thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items............... $152,491 $ 39,250 $23,718 | $10,795 $ 50,910 $ 20,237 Interest and other charges, before | reduction for amounts capitalized............. 45,149 48,544 40,998 | 7,052 42,373 37,660 Provision for income taxes...................... 54,383 29,754 19,402 | 8,231 34,248 24,836 Interest element of rentals charged | to income (a)................................ 4,306 3,020 891 | 311 1,849 3,076 -------- -------- ------- | ------- -------- -------- Earnings as defined........................... $256,329 $120,568 $85,009 | $26,389 $129,380 $ 85,809 ======== ======== ======= | ======= ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS | PREFERRED STOCK DIVIDEND REQUIREMENTS | (PRE-INCOME TAX BASIS): | Interest on long-term debt...................... $ 31,837 $ 29,964 $28,751 | $ 3,972 $ 31,758 $ 29,565 Other interest expense.......................... 4,359 11,546 6,008 | 1,979 3,061 4,318 Preferred stock dividend requirements........... 9,107 7,034 6,239 | 1,101 7,554 3,777 Adjustments to preferred stock dividends | to state on a pre-income tax basis............ 55 -- -- | -- -- -- Interest element of rentals charged | to income (a)................................. 4,306 3,020 891 | 311 1,849 3,076 -------- -------- ------- | ------- -------- -------- Fixed charges as defined plus preferred | stock dividend requirements | (pre-income tax basis)...................... $ 49,664 $ 51,564 $41,889 | $ 7,363 $ 44,222 $ 40,736 ======== ======== ======= | ======= ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES | PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS | (PRE-INCOME TAX BASIS)........................ 5.16 2.34 2.03 | 3.58 2.93 2.11 ==== ==== ==== | ==== ==== ==== - ------------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. 104
EX-13 43 pn_ex13-7.txt EX 13-7 PENELEC ANNUAL REPORT PENNSYLVANIA ELECTRIC COMPANY 2003 ANNUAL REPORT TO STOCKHOLDERS Pennsylvania Electric Company is a wholly owned electric utility operating subsidiary of FirstEnergy Corp. It engages in the distribution and sale of electric energy in an area of approximately 17,600 square miles in western Pennsylvania. It also engages in the sale, purchase and interchange of electric energy with other electric companies. The area it serves has a population of approximately 1.6 million. The Company, as lessee of the property of the Waverly Electric Light & Power Company, also serves a population of about 13,400 in Waverly, New York and vicinity. In August 2000, FirstEnergy entered into an agreement to merge with GPU, Inc., under which FirstEnergy would acquire all of the outstanding shares of GPU, Inc.'s common stock for approximately $4.5 billion in cash and FirstEnergy common stock. The merger became effective on November 7, 2001 and was accounted for by the purchase method. Prior to that time, Pennsylvania Electric Company was a wholly owned subsidiary of GPU, Inc. Contents Page - -------- ---- Selected Financial Data........................................... 1 Management's Discussion and Analysis.............................. 2-12 Consolidated Statements of Income................................. 13 Consolidated Balance Sheets....................................... 14 Consolidated Statements of Capitalization......................... 15 Consolidated Statements of Common Stockholder's Equity............ 16 Consolidated Statements of Preferred Stock........................ 16 Consolidated Statements of Cash Flows............................. 17 Consolidated Statements of Taxes.................................. 18 Notes to Consolidated Financial Statements........................ 19-34 Reports of Independent Auditors................................... 35-36 PENNSYLVANIA ELECTRIC COMPANY SELECTED FINANCIAL DATA
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 2000 1999 - ---------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Operating Revenues..................... $ 976,855 $ 1,027,102 $ 140,062 | $ 834,548 $ 901,881 $ 921,965 =========== =========== ========== | ========= ========= ========== | Operating Income....................... $ 60,210 $ 88,190 $ 14,341 | $ 70,049 $ 80,336 $ 140,925 =========== =========== ========== | ========= ========== ========== | Income Before Cumulative Effect | of Accounting Change................ $ 20,237 $ 50,910 $ 10,795 | $ 23,718 $ 39,250 $ 152,491 =========== =========== ========== | ========= ========== ========== | Net Income............................. $ 21,333 $ 50,910 $ 10,795 | $ 23,718 $ 39,250 $ 152,491 =========== =========== ========== | ========= ========== ========== | Earnings on Common Stock............... $ 21,333 $ 50,910 $ 10,795 | $ 23,718 $ 39,250 $ 151,611 =========== =========== ========== | ========= ========== ========== | Total Assets........................... $ 3,052,243 $ 3,163,254 $3,300,269 | $2,331,484 $2,463,052 =========== =========== ========== | ========== ========== | | Capitalization as of December 31: | Common Stockholder's Equity......... $ 1,297,332 $ 1,353,704 $1,306,576 | $ 469,837 $ 461,182 Company-Obligated Trust Preferred | Securities........................ -- 92,214 92,000 | 100,000 100,000 Long-Term Debt...................... 438,764 470,274 472,400 | 519,481 426,795 ----------- ----------- ---------- | ---------- ---------- Total Capitalization.............. $ 1,736,096 $ 1,916,192 $1,870,976 | $1,089,318 $ 987,977 =========== =========== ========== | ========== ========== | | Capitalization Ratios: | Common Stockholder's Equity......... 74.7% 70.7% 69.8% | 43.1% 46.7% Company-Obligated Trust Preferred | Securities........................ -- 4.8 4.9 | 9.2 10.1 Long-Term Debt...................... 25.3 24.5 25.3 | 47.7 43.2 ----- ----- ----- | ----- ----- Total Capitalization.............. 100.0% 100.0% 100.0% | 100.0% 100.0% ===== ===== ===== | ===== ===== | | Distribution Kilowatt-Hour Deliveries (Millions): | Residential......................... 4,166 4,196 721 | 3,264 3,949 3,864 Commercial.......................... 4,748 4,753 758 | 3,733 4,509 4,319 Industrial.......................... 4,443 4,336 685 | 3,658 4,698 4,865 Other............................... 41 42 7 | 34 40 43 ------ ------ ----- | ------ ------ ------ Total Retail........................ 13,398 13,327 2,171 | 10,689 13,196 13,091 Total Wholesale..................... 2 516 107 | 1,351 2,885 4,219 ------- ----- ----- | ------ ------ ------ Total............................... 13,400 13,843 2,278 | 12,040 16,081 17,310 ====== ====== ===== | ====== ====== ====== | | Customers Served: | Residential......................... 503,738 503,007 502,901 | 502,052 500,930 Commercial.......................... 77,737 77,125 76,005 | 74,282 73,979 Industrial.......................... 2,545 2,605 2,652 | 2,703 2,844 Other............................... 1,069 1,081 1,099 | 1,110 1,110 ------- ------- ------- | ------- ------- Total............................... 585,089 583,818 582,657 | 580,147 578,863 ======= ======= ======= | ======= ======= 1
PENNSYLVANIA ELECTRIC COMPANY Management's Discussion and Analysis of Results of Operations and Financial Condition This discussion includes forward-looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy and commodity market prices, replacement power costs being higher than anticipated or inadequately hedged, maintenance costs being higher than anticipated, legislative and regulatory changes (including revised environmental requirements), adverse regulatory or legal decisions and the outcome of governmental investigations, availability and cost of capital, the inability to accomplish or realize anticipated benefits from strategic goals, the ability to improve electric commodity margins and to experience growth in the distribution business, the ability to access the public securities market, further investigation into the causes of the August 14, 2003, regional power outage and the outcome, cost and other effects of present and potential legal and administrative proceedings and claims related to the outage, a denial of or material change to the Company's Application related to its Rate Stabilization Plan, and other similar factors. Results of Operations Net income decreased by 58.1% to $21.3 million in 2003, compared to $50.9 million in 2002, as a result of lower operating revenues and higher other operating costs, general taxes and net interest charges. Net income increased by 47.5% to $50.9 million in 2002 from $34.5 million in 2001. In 2002, earnings were higher due to increased operating revenues and lower other operating costs. Partially offsetting these results was the absence of deferral accounting for energy costs in 2002 (see Regulatory Matters), as well as higher general taxes. Electric Sales Operating revenues decreased $50.2 million in 2003, following a $52.5 million increase in 2002. The decrease resulted from lower kilowatt-hour sales in all customer classifications -- residential, commercial and industrial, as well as a significant reduction in kilowatt-hour sales to wholesale customers. Wholesale sales revenues decreased by $32.1 million in 2003, primarily attributable to lower sales to non-affiliated companies. Total retail generation kilowatt-hour sales decreased 2.5% ($21.9 million in operating revenues) as a result of decreases in industrial sales (7.2%), residential sales (0.7%) and commercial sales (0.6%). The decrease in industrial sales was primarily due to more industrial customers being served by alternative suppliers. Distribution deliveries increased by 0.5% due to an increase in industrial deliveries as a result of a slightly improving economy - partially offset by lower deliveries to residential, commercial and street light customers. Changes in kilowatt-hour sales by customer class in 2003 and 2002 are summarized in the following table: Changes in Kilowatt-Hour Sales 2003 2002 ----------------------------------------------------------------- Increase (Decrease) Electric Generation: Retail.................. (2.5)% 13.7% Wholesale............... (99.5)% (64.7)% ----------------------------------------------------------------- Total Electric Generation Sales (6.4)% 4.5% ================================================================= Distribution Deliveries: Residential............. (.7)% 5.3% Commercial.............. (.1)% 5.8% Industrial.............. 2.5% (.2)% ----------------------------------------------------------------- Total Distribution Deliveries (.5)% 3.6% ================================================================= Operating Expenses and Taxes Total operating expenses and taxes decreased by 2.4% or $22.3 million in 2003 and increased 5.5% or $48.7 million in 2002, compared to the preceding year. Lower purchased power costs, depreciation and income taxes, offset in part by increased other operating costs and general taxes, accounted for the decrease in 2003. In 2002, the increase was due to higher purchased power costs and general taxes, offset in part by a decrease in other operating costs. 2 Purchased power costs decreased by 6.3% or $40.7 million in 2003, compared to the prior year. The decrease was due primarily to a reduction in kilowatt-hours purchased to support lower kilowatt-hour sales to retail and wholesale customers. Purchased power costs increased $50.1 million in 2002, compared to the prior year. The increase was due primarily to energy costs of $32.8 million incurred in 2002 that otherwise would have been deferred absent a Pennsylvania Commonwealth Court decision (see Regulatory Matters). That increase was partially offset by a reduction in power purchased during 2002, as well as by the absence of a one-time $16.0 million pre-tax charge related to the termination of a wholesale energy contract with Allegheny Electric Cooperative in 2001. Other operating costs increased by 23.7% or $31.5 million in 2003, compared to 2002. The increase was primarily due to increased costs to restore customer service resulting from significant storm activity and higher employee benefit costs. Other operating costs decreased $25.6 million in 2002, compared to the previous year. The decrease was primarily due to reduced uncollectible accounts, personnel reductions and the absence of employee severance costs accrued in 2001. Other Income The increase in other income in 2002 of $5.3 million was primarily due to the absence of 2001 charges for a sustainable energy fund and renewable energy projects (which were required by the Stipulation of Settlement related to the FirstEnergy/GPU merger) and the absence of 2001 net losses on futures contracts and options. That increase was partially offset by a decrease in interest income. Net Interest Charges Net interest charges increased $2.9 million in 2003, compared to the prior year. The increase was due to a lower level of deferred interest costs, offset in part by lower preferred stock dividend requirements. In 2002, net interest charges decreased $7.3 million, compared to the previous year, due to reduced short-term borrowing levels and amortization of purchase accounting fair market value adjustments recorded in connection with the merger. Cumulative Effect of Accounting Change Results in 2003 include an after-tax credit to net income of approximately $1.1 million upon the adoption of SFAS 143, "Accounting for Asset Retirement Obligations," in January 2003. We identified applicable legal obligations as defined under the new accounting standard for nuclear power plant decommissioning. As a result of adopting SFAS 143 in January 2003, asset retirement costs of $93 million were recorded as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $93 million. ARO liability at the date of adoption was $99 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, we recorded decommissioning liabilities of $130 million. We expect substantially all of our nuclear decommissioning costs to be recoverable in rates over time. Therefore, we recognized a regulatory liability of $30.8 million upon adoption of SFAS 143 for the transition amounts related to establishing the ARO for nuclear decommissioning. The remaining cumulative effect adjustment for unrecognized depreciation and accretion offset by the reduction in the liabilities was a $1.9 million increase to income, or $1.1 million net of income taxes. Capital Resources and Liquidity Changes in Cash Position As of December 31, 2003, we had $36,000 of cash and cash equivalents compared with $10.3 million as of December 31, 2002. The major sources for changes in these balances are summarized below. Cash Flows From Operating Activities Cash flows provided from operating activities totaled $16 million in 2003 and $39 million in 2002. The sources of these changes are as follows: 3 Operating Cash Flows 2003 2002 2001 -------------------------------------------------------------- (In millions) Cash earnings (1)........ $ 88 $97 $(21) Working capital.......... (72) (58) 5 -------------------------------------------------------------- Total.................... $ 16 $39 $(16) ============================================================== (1) Includes net income, depreciation and amortization, deferred costs recoverable as regulatory assets, deferred income taxes, investment tax credits, cumulative effect of accounting change and pension changes. Cash Flows From Financing Activities In 2003, net cash used for financing activities of $49 million reflects $36 million of common stock dividend payments to FirstEnergy and reduced short-term borrowings. The following table provides details regarding new issues and redemptions during 2003 and 2002: Securities Issued or Redeemed 2003 2002 -------------------------------------------------------------------- (In millions) Redemptions Unsecured notes............................. $ 1 $50 -------------------------------------------------------------------- Short-term Borrowings, net (use)/source of cash.. (12) 13 -------------------------------------------------------------------- In 2002, net cash used for financing activities totaled $66 million, reflecting $50 million redemptions of debt and $29 million of common stock dividend payments to FirstEnergy, partially offset by $13 million of short-term borrowings. We had $78.5 million of short-term indebtedness at the end of 2003, compared to $90.4 million at the end of 2002. We may borrow from our affiliates on a short-term basis. We will not issue first mortgage bonds (FMB) other than as collateral for senior notes, since our senior note indentures prohibit (subject to certain exceptions) us from issuing any debt which is senior to the senior notes. As of December 31, 2003, we had the capability to issue $23 million of additional senior notes based upon FMB collateral. We have no restrictions on the issuance of preferred stock. We have the ability to borrow from our regulated affiliates and FirstEnergy to meet our short-term working capital requirements. FirstEnergy Service Company administers this money pool and tracks surplus funds of FirstEnergy and its regulated subsidiaries. Companies receiving a loan under the money pool agreements must repay the principal, together with accrued interest, within 364 days of borrowing the funds. The rate of interest is the same for each company receiving a loan from the pool and is based on the average cost of funds available through the pool. The average interest rate for borrowings in 2003 was 1.47%. Our access to capital markets and costs of financing are dependent on the ratings of our securities and that of our holding company, FirstEnergy. The following table shows our securities' ratings following the downgrade by Moody's Investors Service in February 2004. The ratings outlook on all securities is stable. Ratings of Securities - -------------------------------------------------------------------- Securities S&P Moody's Fitch - -------------------------------------------------------------------- FirstEnergy Senior unsecured BB+ Baa3 BBB- Penelec Senior secured BBB Baa1 BBB+ Senior unsecured BBB- Baa2 BBB - -------------------------------------------------------------------- On September 30, 2003, Fitch Ratings lowered the senior unsecured ratings of FirstEnergy to "BBB-" from "BBB." Fitch also lowered the senior secured and senior unsecured ratings of Penelec. Fitch announced that the Rating Outlook is Stable for the securities of FirstEnergy and Penelec. Fitch stated that the changes to the long-term ratings were "driven by the high debt leverage of the parent, FirstEnergy. Despite management's commitment to reduce debt related to the GPU merger, subsequent cash flows have been vulnerable to unfavorable events, slowing the pace of FirstEnergy's debt reduction efforts. The Stable Outlook reflects the success of FirstEnergy's recent common equity offering and management's focus on a relatively conservative integrated utility strategy." On December 23, 2003, S&P lowered its corporate credit ratings on FirstEnergy and its regulated utility subsidiaries to "BBB-" from "BBB" and lowered FirstEnergy's senior unsecured debt rating to "BB+" from "BBB-". Penelec's ratings were lowered one notch as well (see table above). The ratings were removed from CreditWatch with negative implications, where they had been placed by S&P on August 18, 2003, and the Ratings Outlook returned to Stable. The rating action followed a revision in S&P's assessment of our consolidated business risk profile to `6' from `5' (`1' equals low risk, `10' equals high risk), with S&P citing operational and management challenges as well as 4 heightened regulatory uncertainty for its revision of our business risk assessment score. S&P's rationale for its revisions of the ratings included uncertainty regarding the timing of the Ohio Rate Plan filing, the pending final report on the August 14 blackout (see Power Outage), the outcome of the remedial phase of litigation relating to the Sammis plant, and the extended Davis-Besse outage and the related pending subpoena. S&P further stated that the restart of Davis-Besse and a supportive Ohio Rate Plan extension will be vital positive developments that would aid an upgrade of FirstEnergy's ratings. S&P's reduction of the credit ratings in December 2003 triggered cash and letter-of-credit collateral calls of FirstEnergy in addition to higher interest rates for some outstanding borrowings. On February 6, 2004, Moody's downgraded FirstEnergy senior unsecured debt to Baa3 from Baa2 and downgraded the senior secured debt of Penelec to Baa1 from A2. Moody's also downgraded the senior unsecured rating of Penelec to Baa2 from A2. Moody's said that the lower ratings were prompted by: "1) high consolidated leverage with significant holding company debt, 2) a degree of regulatory uncertainty in the service territories in which the company operates, 3) risks associated with investigations of the causes of the August 2003 blackout, and related securities litigation, and 4) a narrowing of the ratings range for the FirstEnergy operating utilities, given the degree to which FirstEnergy increasingly manages the utilities as a single system and the significant financial interrelationship among the subsidiaries." Cash Flows From Investing Activities Cash provided from investing activities totaled $22 million in 2003 and cash used for investing activities totaled approximately $2 million in 2002. In both periods, cash outflows for property additions to support the distribution of electricity were offset by proceeds from non-utility generation trusts. In addition, a net $1.7 million loan payment was received from associated companies in 2003. Our cash requirements in 2004 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without increasing our net debt and preferred stock outstanding. Over the next three years, we expect to meet our contractual obligations with cash flows from operations. Thereafter, we expect to use a combination of cash flows from operations and funds from the capital markets. Our capital spending for the period 2004-2006 is expected to be about $198 million, of which approximately $66 million applies to 2004. Contractual Obligations Our cash contractual obligations as of December 31, 2003 that we consider firm obligations are as follows: 2005- 2007- Contractual Obligations Total 2004 2006 2008 Thereafter - ------------------------------------------------------------------------------- (In millions) Long-term debt.............. $ 564 $125 $ 8 $ 3 $ 428 Short-term borrowings....... 79 79 -- -- -- Purchases (1)............... 3,628 233 750 867 1,778 - ------------------------------------------------------------------------------- Total.................. $4,271 $437 $758 $870 $2,206 - ------------------------------------------------------------------------------- (1) Fuel and power purchases under contracts with fixed or minimum quantities and approximate timing Market Risk Information We use various market risk sensitive instruments, including derivative contracts, primarily to manage the risk of price fluctuations. Our Risk Policy Committee, comprised of FirstEnergy executive officers, exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. Commodity Price Risk We are exposed to market risk primarily due to fluctuations in electricity and natural gas prices. To manage the volatility relating to these exposures, we use a variety of non-derivative and derivative instruments, including options and futures contracts. The derivatives are used for hedging purposes. Most of our non-hedge derivative contracts represent non-trading positions that do not qualify for hedge treatment SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." The change in the fair value of commodity derivative contracts related to energy production during 2003 is summarized in the following table: 5 Increase (Decrease) in the Fair Value of Derivative Contracts
Non-Hedge Hedge Total --------- ----- ----- (In millions) Change in the Fair Value of Commodity Derivative Contracts Outstanding net asset as of January 1, 2003................. $ 8.7 $ 0.1 $ 8.8 New contract value when entered............................. -- -- -- Additions/Increase in value of existing contracts........... 4.5 -- 4.5 Change in techniques/assumptions............................ 2.3 -- 2.3 Settled contracts........................................... -- (0.1) (0.1) ------------------------------ Net Assets - Derivatives Contracts as of December 31, 2003(1) $15.5 $ -- $15.5 ============================== Impact of Changes in Commodity Derivative Contracts (2) Income Statement Effects (Pre-Tax).......................... $ 0.8 $ -- $ 0.8 Balance Sheet Effects: OCI (Pre-Tax)............................................ $ -- $(0.1) $(0.1) Regulatory Liability..................................... $ 6.0 $ -- $ 6.0
(1) Includes $14.5 million in non-hedge commodity derivative contracts which are offset by a regulatory liability. (2) Represents the increase in value of existing contracts and settled contracts. Derivatives included on the Consolidated Balance Sheet as of December 31, 2003: Non-Hedge Hedge Total --------- ----- ----- (In millions) Non-Current- Noncurrent Liabilities......... $15.5 $ -- $15.5 ----- ----- ---- Net liability................ $15.5 $ -- $15.5 ===== ====== ===== The valuation of derivative contracts is based on observable market information to the extent that such information is available. In cases where such information is not available, we rely on model-based information. The model provides estimates of future regional prices for electricity and an estimate of related price volatility. We utilize these results in developing estimates of fair value for financial reporting purposes and for internal management decision making. Sources of information for the valuation of derivative contracts by year are summarized in the following table: Source of Information - Fair Value by Contract Year - ---------------------------------------------------
2004 2005 2006 2007 Thereafter Total ---- ---- ---- ---- ---------- ----- (In millions) Prices based on external sources(1)... $2.3 $2.6 $ -- $ -- $ -- $ 4.9 Prices based on models................ -- -- 2.5 2.4 5.7 10.6 ---------------------------------------------------------------- Total(2).......................... $2.3 $2.6 $2.5 $2.4 $5.7 $15.5 ================================================================
(1) Broker quote sheets. (2) Includes $14.5 million from an embedded option that is offset by a regulatory liability and does not affect earnings. We perform sensitivity analyses to estimate our exposure to the market risk of our commodity position. A hypothetical 10% adverse shift in quoted market prices in the near term on derivative instruments would not have had a material effect on our consolidated financial position or cash flows as of December 31, 2003. Interest Rate Risk Our exposure to fluctuations in market interest rates is reduced since our debt has fixed interest rates, as noted in the following table. 6
Comparison of Carrying Value to Fair Value - ------------------------------------------------------------------------------------------------------------------- There- Fair Year of Maturity 2004 2005 2006 2007 2008 after Total Value - ------------------------------------------------------------------------------------------------------------------- (Dollars in millions) Assets - ------------------------------------------------------------------------------------------------------------------- Investments Other Than Cash and Cash Equivalents- Fixed Income............... $ 93 $ 93 $ 93 Average interest rate...... 2.9% 2.9% - ------------------------------------------------------------------------------------------------------------------- Liabilities - ------------------------------------------------------------------------------------------------------------------- Long-term Debt and Other Long-Term Obligations: Fixed rate.................... $125 $ 8 $ 3 $428 $564 $612 Average interest rate ..... 5.8% 7.5% 6.1% 6.8% 6.5% Short-term Borrowings......... $ 79 $ 79 $ 79 Average interest rate...... 1.7% 1.7% - -------------------------------------------------------------------------------------------------------------------
Equity Price Risk Included in nuclear decommissioning trusts, as required by the Nuclear Regulatory Commission, are marketable equity securities carried at their market value of approximately $54 million and $42 million at December 31, 2003 and 2002, respectively. A hypothetical 10% decrease in prices quoted by stock exchanges would result in a $5 million reduction in fair value as of December 31, 2003 (see Note 1 (L) - "Cash and Financial Instruments"). Outlook Beginning in 1999, all of our customers were able to select alternative energy suppliers. We continue to deliver power to homes and businesses through our existing distribution system, which remains regulated. The Pennsylvania Public Utility Commission (PPUC) authorized our rate restructuring plan, establishing separate charges for transmission, distribution, generation and stranded cost recovery, which is recovered through a competitive transition charge (CTC). Customers electing to obtain power from an alternative supplier have their bills reduced based on the regulated generation component, and the customers receive a generation charge from the alternative supplier. We have a continuing responsibility to provide power to those customers not choosing to receive power from an alternative energy supplier, subject to certain limits, which is referred to as our PLR obligation. Regulatory assets are costs which have been authorized by the PPUC and the Federal Energy Regulatory Commission (FERC) for recovery from customers in future periods and, without such authorization, would have been charged to income when incurred. All of our regulatory assets are expected to continue to be recovered under the provisions of the regulatory plan as discussed below. Our regulatory assets totaled $497 million and $600 million as of December 31, 2003 and December 31, 2002, respectively. Regulatory Matters In June 2001, the PPUC approved the Settlement Stipulation with all of the major parties in the combined merger and rate proceedings which approved the FirstEnergy/GPU merger and provided PLR deferred accounting treatment for energy costs, permitting us to defer, for future recovery, energy costs in excess of amounts reflected in our capped generation rates retroactive to January 1, 2001. This PLR deferral accounting procedure was later reversed in a February 2002 Commonwealth Court of Pennsylvania decision. The court decision affirmed the PPUC decision regarding approval of the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. In the first quarter of 2002, the Company established a $111.1 million reserve for its PLR deferred energy costs incurred prior to its acquisition by FirstEnergy. The reserve reflected the potential adverse impact of the then pending Pennsylvania Supreme Court decision whether to review the Commonwealth Court ruling. The reserve increased goodwill by an aggregate net of tax amount of $65.0 million. On April 2, 2003, the PPUC remanded the issue relating to merger savings to the Office of Administrative Law Judge (ALJ) for hearings, directed us to file a position paper on the effect of the Commonwealth Court order on the Settlement Stipulation and allowed other parties to file responses to the position paper. We filed a letter with the ALJ on June 11, 2003, voiding the Stipulation in its entirety and reinstating our restructuring settlement previously approved by the PPUC. On October 2, 2003, the PPUC issued an order concluding that the Commonwealth Court reversed the PPUC's June 20, 2001 order in its entirety. The PPUC directed us to file tariffs within thirty days of the order to reflect the CTC rates and shopping credits that were in effect prior to the June 21, 2001 order to be effective upon one day's notice. In response to that order, we filed these supplements to our tariffs to become effective October 24, 2003. 7 On October 8, 2003, we filed a petition for clarification relating to the October 2, 2003 order on two issues: to establish June 30, 2004 as the date to fully refund the NUG trust fund and to clarify that the ordered accounting treatment regarding the CTC rate/shopping credit swap should follow the ratemaking, and that the PPUC's findings would not impair our rights to recover all of our stranded costs. On October 9, 2003, ARIPPA (an intervenor in the proceedings) petitioned the PPUC to direct us to reinstate accounting for the CTC rate/shopping credit swap retroactive to January 1, 2002. Several other parties also filed petitions. On October 16, 2003, the PPUC issued a reconsideration order granting the date requested by us for the NUG trust fund refund and, denying our other clarification requests and granting ARIPPA's petition with respect to the retroactive accounting treatment of the changes to the CTC rate/shopping credit swap. On October 22, 2003, we filed an Objection with the Commonwealth Court asking that the Court reverse the PPUC's finding that requires us to treat the stipulated CTC rates that were in effect from January 1, 2002 on a retroactive basis. We are considering filing an appeal to the Commonwealth Court on the PPUC orders as well. On October 27, 2003, one Commonwealth Court judge issued an Order denying our objection without explanation. Due to the vagueness of the Order, on October 31, 2003, we filed an Application for Clarification with the judge. Concurrent with this filing, in order to preserve our rights, we also filed with the Commonwealth Court both a Petition for Review of the PPUC's October 16 and October 22 Orders, and an application for reargument, if the judge, in his clarification order, indicates that our objection was intended to be denied on the merits. In addition to these findings, in compliance with the PPUC's Orders, we filed revised PPUC quarterly reports for the twelve months ended December 31, 2001 and 2002, and for the first two quarters of 2003, reflecting balances consistent with the PPUC's findings in their Orders. Effective September 1, 2002, we assigned our PLR responsibility to our FirstEnergy Solutions Corp. (FES) affiliate through a wholesale power sale agreement. The PLR sale will be automatically extended for each successive calendar year unless any party elects to cancel the agreement by November 1 of the preceding year. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by us under our NUG contracts and other power contracts with nonaffiliated third party suppliers. This arrangement reduces our exposure to high wholesale power prices by providing power at a fixed price for our uncommitted PLR energy costs during the term of the agreement with FES. FES has hedged most of our unfilled PLR on-peak obligation through 2004 and a portion of 2005, the period during which deferred accounting was previously allowed under the PPUC's order. We are authorized to continue deferring differences between NUG contract costs and current market prices. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reliability reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. We are currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of our level of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. We are unable to predict the outcome of the investigation or the impact of the PPUC Order. FERC Regulatory Matters On December 19, 2002, the FERC granted unconditional Regional Transmission Organization status to PJM Interconnection, LLC which includes us as transmission owners. PJM and the Midwest Independent System Operator, Inc. (MISO) were ordered by the FERC to develop a common market between the regions by October 31, 2004. The FERC also initiated a Section 206 investigation into the reasonableness of the "through-and-out" transmission rates charged by PJM and MISO. By order issued November 17, 2003, MISO, PJM and certain unaffiliated transmission owners in the Midwest were directed to eliminate rates for point-to-point service between the two RTOs effective April 1, 2004. A settlement judge has been appointed by the FERC to resolve compliance filings by the affected transmission providers. AEP, Commonwealth Edison and other utilities have appealed the FERC's November 17, 2003 order to the federal court of appeals for the District of Columbia. Environmental Matters We have been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of 8 disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, environmental liabilities that are considered probable have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, our proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. We have accrued liabilities aggregating approximately $43,000 as of December 31, 2003. We do not believe environmental remediation costs will have a material adverse effect on our financial condition, cash flows or results of operations. Power Outage On August 14, 2003, various states in the northeast United States and part of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest ISO and PJM Interconnection) to provide effective diagnostic support. We believe that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. On November 25, 2003, the Public Utilities Commission of Ohio (PUCO) ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposes to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which are described above. Critical Accounting Policies We prepare our consolidated financial statements in accordance with accounting principles that are generally accepted in the United States. Application of these principles often requires a high degree of judgment, estimates and assumptions that affect financial results. All of our assets are subject to their own specific risks and uncertainties and are regularly reviewed for impairment. Assets related to the application of the policies discussed below are similarly reviewed with their risks and uncertainties reflecting these specific factors. Our more significant accounting policies are described below. Purchase Accounting The merger between FirstEnergy and GPU was accounted for by the purchase method of accounting, which requires judgment regarding the allocation of the purchase price based on the fair values of the assets acquired (including intangible assets) and the liabilities assumed. The fair values of the acquired assets and assumed liabilities were based primarily on estimates. The adjustments reflected in our records, which were finalized in the fourth quarter of 2002, primarily consist of: (1) revaluation of certain property, plant and equipment; (2) adjusting preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (3) recognizing additional obligations related to retirement benefits; and (4) recognizing estimated severance and other compensation liabilities. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill. Based on the guidance provided by SFAS 142, "Goodwill and Other Intangible Assets," we evaluate goodwill for impairment at least annually and would make such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. If impairment were indicated, we would recognize a loss - calculated as the difference between the implied fair value of its goodwill and the carrying value of the goodwill. Our annual review was completed in the third quarter of 2003, with no impairment of goodwill indicated. The forecasts used in our evaluation of goodwill reflect operations consistent with our general business assumptions. Unanticipated changes in those 9 assumptions could have a significant effect on our future evaluations of goodwill. As of December 31, 2003, we had recorded goodwill of approximately $899 million related to the merger. Regulatory Accounting We are subject to regulation that sets the prices (rates) we are permitted to charge our customers based on the costs that the regulatory agencies determine we are permitted to recover. At times, regulators permit the future recovery through rates of costs that would be currently charged to expense by an unregulated company. This rate-making process results in the recording of regulatory assets based on anticipated future cash inflows. As a result of the changing regulatory framework in Pennsylvania, a significant amount of regulatory assets have been recorded - $497 million as of December 31, 2003. We regularly review these assets to assess their ultimate recoverability within the approved regulatory guidelines. Impairment risk associated with these assets relates to potentially adverse legislative, judicial or regulatory actions in the future. Derivative Accounting Determination of appropriate accounting for derivative transactions requires the involvement of management representing operations, finance and risk assessment. In order to determine the appropriate accounting for derivative transactions, the provisions of the contract need to be carefully assessed in accordance with the authoritative accounting literature and management's intended use of the derivative. New authoritative guidance continues to shape the application of derivative accounting. Management's expectations and intentions are key factors in determining the appropriate accounting for a derivative transaction and, as a result, such expectations and intentions are documented. Derivative contracts that are determined to fall within the scope of SFAS 133, as amended, must be recorded at their fair value. Active market prices are not always available to determine the fair value of the later years of a contract, requiring that various assumptions and estimates be used in their valuation. We continually monitor our derivative contracts to determine if our activities, expectations, intentions, assumptions and estimates remain valid. As part of our normal operations, we enter into commodity contracts which increase the impact of derivative accounting judgments. Revenue Recognition We follow the accrual method of accounting for revenues, recognizing revenue for kilowatt-hours that have been delivered but not yet billed through the end of the accounting period. The determination of unbilled revenues requires management to make various estimates including: o Net energy generated or purchased for retail load o Losses of energy over distribution lines o Allocations to distribution companies within the FirstEnergy system o Mix of kilowatt-hour usage by residential, commercial and industrial customers o Kilowatt-hour usage of customers receiving electricity from alternative suppliers Pension and Other Postretirement Benefits Accounting FirstEnergy's reported costs of providing non-contributory defined pension benefits and postemployment benefits other than pensions are dependent upon numerous factors resulting from actual plan experience and certain assumptions. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions FirstEnergy makes to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs are also affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations for pension and OPEB costs. Plan amendments to retirement health care benefits in 2003 and 2002, related to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. In accordance with SFAS 87, "Employers' Accounting for Pensions" and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," changes in pension and OPEB obligations associated with these factors may not be immediately recognized as costs on the income statement, but generally are recognized in future years over the remaining average service period of plan participants. SFAS 87 and SFAS 106 delay recognition of changes due to the long-term nature of pension and OPEB obligations and the varying market conditions likely to occur over long periods of time. As such, significant portions of pension and OPEB costs recorded in any period may not reflect the actual level of cash benefits provided to plan participants and are significantly influenced by assumptions about future market conditions and plan participants' experience. 10 In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. Due to recent declines in corporate bond yields and interest rates in general, FirstEnergy reduced the assumed discount rate as of December 31, 2003 to 6.25% from 6.75% and 7.25% used as of December 31, 2002 and 2001, respectively. FirstEnergy's assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by their pension trusts. In 2003, 2002 and 2001, plan assets actually earned 24.0%, (11.3)% and (5.5)%, respectively. FirstEnergy's pension costs in 2003 were computed assuming a 9.0% rate of return on plan assets based upon projections of future returns and their pension trust investment allocation of approximately 70% equities, 27% bonds, 2% real estate and 1% cash. As a result of GPU Service Inc. merging with FirstEnergy Service Company in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, our accrued pension costs as of June 30, 2003 increased by $71 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. Due to the increased market value of our pension plan assets, we reduced our minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $20 million, recording an increase of $47,000 in an intangible asset and crediting OCI by $12 million (offsetting previously recorded deferred tax benefits by $8 million). The remaining balance in OCI of $42 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $58 million as of December 31, 2003. Based on pension assumptions and pension plan assets as of December 31, 2003, FirstEnergy will not be required to fund their pension plans in 2004. However, health care cost trends have significantly increased and will affect future OPEB costs. FirstEnergy's pension and OPEB expenses in 2004 are expected to decrease by $38 million and $34 million, respectively. These reductions reflect the actual performance of pension plan assets and amendments to the health care benefits plan announced in early 2004 which result in employees and retirees sharing more of the benefit costs. The reduction in OPEB costs for 2004 does not reflect the impact of the new Medicare law signed by President Bush in December 2003 due to uncertainties regarding some of its new provisions (see Note 1(I)). The 2003 and 2002 composite health care trend rate assumptions are approximately 10%-12% gradually decreasing to 5% in later years. In determining their trend rate assumptions, FirstEnergy included the specific provisions of their health care plans, the demographics and utilization rates of plan participants, actual cost increases experienced in their health care plans, and projections of future medical trend rates. The effect on FirstEnergy's pension and OPEB costs and liabilities from changes in key assumptions are as follows: Increase in Costs from Adverse Changes in Key Assumptions - -------------------------------------------------------------------------------- Assumption Adverse Change Pension OPEB Total - -------------------------------------------------------------------------------- (In millions) Discount rate................ Decrease by 0.25% $ 10 $ 6 $ 16 Long-term return on assets... Decrease by 0.25% $ 8 $ 1 $ 9 Health care trend rate....... Increase by 1% na $26 $ 26 Increase in Minimum Liability - ---------------------------- Discount rate................ Decrease by 0.25% $104 na $104 - -------------------------------------------------------------------------------- Long-Lived Assets In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we periodically evaluate our long-lived assets to determine whether conditions exist that would indicate that the carrying value of an asset might not be fully recoverable. The accounting standard requires that if the sum of future cash flows (undiscounted) expected to result from an asset is less than the carrying value of the asset, an asset impairment must be recognized in the financial statements. If impairment has occurred, we recognize a loss - calculated as the difference between the carrying value and the estimated fair value of the asset (discounted future net cash flows). The calculation of future cash flows is based on assumptions, estimates and judgement about future events. The aggregate amount of cash flows determines whether an impairment is indicated. The timing of the cash flows is critical in determining the amount of the impairment. 11 Nuclear Decommissioning In accordance with SFAS 143, we recognize an ARO for the future decommissioning of TMI-2. The ARO liability represents an estimate of the fair value of our current obligation related to nuclear decommissioning and the retirement of other assets. A fair value measurement inherently involves uncertainty in the amount and timing of settlement of the liability. We used an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. New Accounting Standards and Interpretations Adopted FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, we adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. We will adopt FIN 46R for all other types of entities effective March 31, 2004. As described in Note 4(E), we created a statutory business trust to issue trust preferred securities in the amount of $92 million. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. Therefore, we have deconsolidated the trust and recognized an equity investment in the trust of $3 million and subordinated debentures to the trust of $95 million as of December 31, 2003. We are evaluating entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. These entities are non-utility generators in which we have neither debt nor equity investments but are generally the sole purchaser of their power. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, we implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(E) and 1(H) for further discussions of SFAS 143. DIG Implementation Issue No. C20 for SFAS 133, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) Regarding Contracts with a Price Adjustment Feature" In June 2003, the FASB cleared DIG Issue C20 for implementation in fiscal quarters beginning after July 10, 2003. The issue supersedes earlier DIG Issue C11, "Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception." DIG Issue C20 provides guidance regarding when the presence of a general index, such as the Consumer Price Index, in a contract would prevent that contract from qualifying for the normal purchases and normal sales exception under SFAS 133, as amended, and therefore exempt from the mark-to-market treatment of certain contracts. Adoption of DIG Issue C20 did not impact our financial statements. 12 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF INCOME
Nov 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - ---------------------------------------------------------------------------------------------------------------------- (In thousands) OPERATING REVENUES (Note 1(K))............................ $976,855 $1,027,102 $140,062 | $834,548 -------- ---------- -------- | -------- | OPERATING EXPENSES AND TAXES: | Fuel and purchased power (Note 1(K))................... 609,015 649,725 79,815 | 519,838 Other operating costs (Note 1(K))...................... 164,474 132,996 20,015 | 138,543 -------- ---------- -------- | -------- Total operation and maintenance expenses............. 773,489 782,721 99,830 | 658,381 Provision for depreciation and amortization............ 53,754 61,476 8,613 | 49,191 General taxes.......................................... 66,999 65,301 6,281 | 39,532 Income taxes........................................... 22,403 29,414 10,997 | 17,395 -------- ---------- -------- | -------- Total operating expenses and taxes................... 916,645 938,912 125,721 | 764,499 -------- ---------- -------- | -------- | OPERATING INCOME.......................................... 60,210 88,190 14,341 | 70,049 | OTHER INCOME (EXPENSE).................................... 1,920 1,742 3,049 | (6,610) -------- ---------- -------- | -------- | INCOME BEFORE NET INTEREST CHARGES........................ 62,130 89,932 17,390 | 63,439 -------- ---------- -------- | -------- | NET INTEREST CHARGES: | Interest on long-term debt............................. 29,565 31,758 3,972 | 28,751 Allowance for borrowed funds used during | construction......................................... (320) (52) 47 | (494) Deferred interest ..................................... 4,553 (3,299) (504) | (783) Other interest expense ................................ 4,318 3,061 1,979 | 6,008 Subsidiary's preferred stock dividend requirements..... 3,777 7,554 1,101 | 6,239 -------- ---------- -------- | -------- Net interest charges................................. 41,893 39,022 6,595 | 39,721 -------- ---------- -------- | -------- | INCOME BEFORE CUMULATIVE | EFFECT OF ACCOUNTING CHANGE............................ 20,237 50,910 10,795 | 23,718 | Cumulative effect of accounting change (net of | income taxes of $777,000) (Note 1(H))................ 1,096 -- -- | -- -------- ---------- -------- | -------- | NET INCOME................................................ $ 21,333 $ 50,910 $ 10,795 | $ 23,718 ======== ========== ======== | ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 13
< PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------------ (In thousands) ASSETS UTILITY PLANT: In service..................................................................... $1,966,624 $1,844,999 Less-Accumulated provision for depreciation.................................... 785,715 647,581 ---------- ---------- 1,180,909 1,197,418 Construction work in progress.................................................. 29,063 19,200 ---------- ---------- 1,209,972 1,216,618 ---------- ---------- OTHER PROPERTY AND INVESTMENTS: Non-utility generation trusts.................................................. 43,864 109,881 Nuclear plant decommissioning trusts........................................... 102,673 88,818 Long-term notes receivable from associated companies........................... 13,794 15,515 Other.......................................................................... 19,635 9,425 ---------- ---------- 179,966 223,639 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents...................................................... 36 10,310 Receivables- Customers (less accumulated provisions of $5,833,000 and $6,216,000 respectively, for uncollectible accounts).................................. 124,462 128,303 Associated companies......................................................... 88,598 45,236 Other........................................................................ 15,767 16,184 Prepayments and other.......................................................... 2,511 2,551 ---------- ---------- 231,374 202,584 ---------- ---------- NONCURRENT LIABILITIES: Regulatory assets.............................................................. 497,219 599,663 Goodwill....................................................................... 898,547 898,086 Accumulated deferred income tax benefits....................................... 16,642 1,517 Other.......................................................................... 18,523 21,147 ---------- ---------- 1,430,931 1,520,413 ---------- ---------- $3,052,243 $3,163,254 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholder's equity.................................................... $1,297,332 $1,353,704 Company-obligated trust preferred securities (Note 4(E))....................... -- 92,214 Long-term debt and other long-term obligations-- Subordinated debentures to affiliated trusts (Note 4(E))..................... 95,520 -- Other........................................................................ 343,244 470,274 ---------- ---------- 1,736,096 1,916,192 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt .............................................. 125,762 813 Short-term borrowings (Note 5)- Associated companies......................................................... 78,510 90,427 Accounts payable- Associated companies......................................................... 55,831 129,906 Other........................................................................ 40,192 29,690 Accrued taxes................................................................. 8,705 21,271 Accrued interest............................................................... 12,694 12,695 Other.......................................................................... 21,764 8,409 ---------- ---------- 343,458 293,211 ---------- ---------- NONCURRENT LIABILITIES: Accumulated deferred investment tax credits.................................... 9,936 10,924 Asset retirement obligation.................................................... 105,089 -- Nuclear plant decommissioning costs............................................ -- 135,450 Nuclear fuel disposal costs.................................................... 18,968 18,771 Power purchase contract loss liability......................................... 670,482 765,063 Retirement benefits............................................................ 145,081 1,041 Other.......................................................................... 23,133 22,602 ---------- ---------- 972,689 953,851 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Notes 3 and 6)................................................................ ---------- ---------- $3,052,243 $3,163,254 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets. 14
PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION
As of December 31, 2003 2002 - ------------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDER'S EQUITY: Common stock, par value $20 per share, authorized 5,400,000 shares 5,290,596 shares outstanding........................................... $ 105,812 $ 105,812 Other paid-in capital.................................................... 1,215,667 1,215,256 Accumulated other comprehensive loss (Note 4(F))......................... (42,185) (69) Retained earnings (Note 4(A))............................................ 18,038 32,705 ---------- ---------- Total common stockholder's equity...................................... 1,297,332 1,353,704 ---------- ---------- COMPANY OBLIGATED TRUST PREFERRED SECURITIES OF SUBSIDIARY TRUST (NOTE 4(E)): 7.34% due 2039......................................................... -- 92,214 ---------- ---------- LONG-TERM DEBT (Note 4(D)): First mortgage bonds: 6.125% due 2007........................................................ 3,700 3,905 5.35% due 2010......................................................... 12,310 12,310 5.35% due 2010......................................................... 12,000 12,000 5.80% due 2020......................................................... 20,000 20,000 6.05% due 2025......................................................... 25,000 25,000 ---------- ---------- Total first mortgage bonds........................................... 73,010 73,215 ---------- ---------- Unsecured notes: 5.75% due 2004......................................................... 125,000 125,000 7.50% due 2005......................................................... 8,000 8,000 6.125% due 2009........................................................ 100,000 100,000 7.77% due 2010......................................................... 35,000 35,000 6.625% due 2019........................................................ 125,000 125,000 7.34% due 2039......................................................... 95,520 -- 7.49% due 2039......................................................... 2,968 2,984 ---------- ---------- Total unsecured notes................................................ 491,488 395,984 ---------- ---------- Capital lease obligations (Note 3)....................................... 540 1,132 Net unamortized premium discount on debt................................. (512) 756 Long-term debt due within one year....................................... (125,762) (813) ---------- ---------- Total long-term debt................................................... 438,764 470,274 ---------- ---------- TOTAL CAPITALIZATION........................................................ $1,736,096 $1,916,192 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 15
PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
Common Stock Accumulated ------------------- Other Other Comprehensive Number Par Paid-In Comprehensive Retained Income of Shares Value Capital Income (Loss) Earnings ------------- --------- ----- ------- ------------- -------- (Dollars in thousands) Balance, January 1, 2001....................... 5,290,596 $105,812 $ 320,487 $ 23 $ 43,515 Net income.................................. $ 23,718 23,718 Net unrealized gain on investments.......... 12 12 Net unrealized loss on derivative instruments .............................. ( 1,064) (1,064) -------- Comprehensive income........................ $ 22,666 -------- Equity contribution from parent............. 50,000 - --------------------------------------------------------------------------------------------------------------------------- Balance, November 6, 2001...................... 5,290,596 105,812 370,487 (1,029) 67,233 Purchase accounting fair value adjustment... 817,703 1,029 (67,233) ___________________________________________________________________________________________________________________________ Balance, November 7, 2001...................... 5,290,596 105,812 1,188,190 -- -- Net income.................................. $ 10,795 10,795 Net unrealized loss on investments.......... (2) (2) Net unrealized gain on derivative instruments .............................. 1,781 1,781 -------- Comprehensive income........................ $ 12,574 -------- - --------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001..................... 5,290,596 105,812 1,188,190 1,779 10,795 Net income.................................. $ 50,910 50,910 Net unrealized gain on investments......... 5 5 Net unrealized loss on derivative instruments .............................. (1,853) (1,853) -------- Comprehensive income........................ $ 49,062 -------- Cash dividends on common stock.............. (29,000) Purchase accounting fair value adjustment... 27,066 - --------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002..................... 5,290,596 105,812 1,215,256 (69) 32,705 Net income.................................. $ 21,333 21,333 Net unrealized gain on derivative instruments.......,,...................... 72 72 Minimum liability for unfunded retirement benefits, net of $(29,908,000) of income taxes .......................... (42,188) (42,188) -------- Comprehensive loss.......................... $(20,783) -------- Cash dividends on common stock.............. (36,000) Purchase accounting fair value adjustment... 411 - --------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003..................... 5,290,596 $105,812 $1,215,667 $(42,185) $ 18,038 ===========================================================================================================================
CONSOLIDATED STATEMENTS OF PREFERRED STOCK Subject to Mandatory Redemption ------------------------ Number Carrying of Shares Value --------- -------- (Dollars in thousands) Balance, January 1, 2001.......... 4,000,000 $100,000 ============================================================== Purchase accounting fair value adjustment.............. (8,000) -------------------------------------------------------------- Balance, December 31, 2001........ 4,000,000 92,000 ============================================================== Amortization of fair market value adjustment.............. 214 -------------------------------------------------------------- Balance, December 31, 2002........ 4,000,000 $ 92,214 ============================================================== FIN 46 Deconsolidation 7.34% Series.................. (4,000,000) (92,428) Amortization of fair market value adjustment.............. 214 -------------------------------------------------------------- Balance, December 31, 2003........ -- $ -- ============================================================== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 16
PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - --------------------------------------------------------------------------------------------------------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income................................................ $ 21,333 $ 50,910 $ 10,795 | $ 23,718 Adjustments to reconcile net income to net | cash from operating activities: | Provision for depreciation and amortization.......... 53,754 61,476 8,613 | 49,191 Other amortization, net.............................. -- 94 309 | 1,672 Deferred costs recoverable as regulatory assets...... (37,218) (58,953) (7,467) | (143,462) Deferred income taxes, net........................... 41,877 11,893 (23,127) | 60,170 Investment tax credits, net.......................... (988) (1,032) (171) | (970) Cumulative effect of accounting change (Note 1(H))... (1,873) -- -- | -- Receivables.......................................... 13,052 (27,509) (26,592) | 16,566 Accounts payable..................................... (84,700) (5,514) (19,382) | 29,462 Accrued retirement benefit obligations............... 2,727 -- -- | -- Other (Note 7)....................................... 8,012 7,947 41,590 | (36,884) -------- -------- -------- | --------- Net cash provided from (used for) operating | activities ...................................... 15,976 39,312 (15,432) | (537) -------- -------- -------- | --------- | | CASH FLOWS FROM FINANCING ACTIVITIES: | New Financing- | Short-term borrowings, net........................... -- 12,804 2,623 | 19,200 Contributions from parent............................ -- -- -- | 50,000 Redemptions and Repayments- | Long-term debt....................................... (812) (49,973) -- | -- Short-term borrowings, net........................... (11,917) -- -- | -- Dividend Payments- | Common stock......................................... (36,000) (29,000) -- | -- -------- -------- -------- | --------- Net cash provided from (used for) financing | activities ...................................... (48,729) (66,169) 2,623 | 69,200 -------- -------- -------- | --------- | | CASH FLOWS FROM INVESTING ACTIVITIES: | Property additions..................................... (44,657) (50,671) (9,687) | (50,543) Non-utility generation trusts.......................... 66,327 49,044 29,944 | 18,339 Contributions to decommissioning trust withdrawals..... -- -- -- | (15) Loan payments from associated companies, net........... 1,721 -- -- | -- Other.................................................. (912) (239) (246) | (5,194) -------- -------- -------- | --------- Net cash provided from (used for) investing | activities ...................................... 22,479 (1,866) 20,011 | (37,413) -------- -------- -------- | --------- | | | Net increase (decrease) in cash and cash equivalents...... (10,274) (28,723) 7,202 | 31,250 Cash and cash equivalents at beginning of period.......... 10,310 39,033 31,831 | 581 -------- -------- -------- | --------- Cash and cash equivalents at end of period............... $ 36 $ 10,310 $ 39,033 | $ 31,831 ======== ======== ======== | ========= | SUPPLEMENTAL CASH FLOWS INFORMATION: | Cash Paid During the Year- | Interest (net of amounts capitalized)................ $ 37,497 $ 32,695 $ 2,018 | $ 35,134 ======== ======== ======== | ========= Income taxes (refund)................................ $ 10,695 $ 43,613 $(12,176) | $ (14,542) ======== ======== ======== | ========= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 17
PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF TAXES
Nov. 7 - Jan. 1 - 2003 2002 Dec. 31, 2001 Nov. 6, 2001 - ---------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: State gross receipts*....................................... $ 53,716 $ 55,505 $ 5,560 | $ 30,932 Real and personal property.................................. 1,624 1,583 (146) | 1,622 Other....................................................... 11,659 8,213 867 | 6,978 --------- --------- --------- | -------- Total general taxes.................................. $ 66,999 $ 65,301 $ 6,281 | $ 39,532 ========= ========= ========= | ======== | PROVISION FOR INCOME TAXES: | Currently payable- | Federal.................................................. $ (15,968) $ 17,554 $ 23,861 | $(36,615) State.................................................... 692 5,833 7,667 | (3,183) --------- --------- --------- | -------- (15,276) 23,387 31,528 | (39,798) --------- --------- --------- | -------- Deferred, net- | Federal.................................................. 35,136 10,600 (17,511) | 46,346 State.................................................... 6,741 1,293 (5,616) | 13,824 --------- --------- --------- | -------- 41,877 11,893 (23,127) | 60,170 --------- --------- --------- | -------- Investment tax credit amortization.......................... (988) (1,032) (171) | (970) --------- --------- --------- | -------- Total provision for income taxes..................... $ 25,613 $ 34,248 $ 8,230 | $ 19,402 ========= ========= ========= | ======== | INCOME STATEMENT CLASSIFICATION | OF PROVISION FOR INCOME TAXES: | Operating income............................................ $ 22,403 $ 29,414 $ 10,997 | $ 17,395 Other income................................................ 2,433 4,834 (2,767) | 2,007 Cumulative effect of accounting change...................... 777 -- -- | -- --------- --------- --------- | -------- Total provision for income taxes..................... $ 25,613 $ 34,248 $ 8,230 | $ 19,402 ========= ========= ========= | ======== | RECONCILIATION OF FEDERAL INCOME TAX | EXPENSE AT STATUTORY RATE TO TOTAL | PROVISION FOR INCOME TAXES: | Book income before provision for income taxes $ 46,946 $ 85,158 $ 19,025 | $ 43,120 ========= ========= ========= | ======== Federal income tax expense at statutory rate................ $ 16,431 $ 29,805 $ 6,659 | $ 15,092 Increases (reductions) in taxes resulting from- | Amortization of investment tax credits................... (988) (1,032) (171) | (969) Depreciation............................................. 2,655 1,591 555 | 1,407 State income tax, net of federal tax..................... 4,831 4,702 1,404 | 7,156 Allocated share of consolidated tax savings.............. -- -- -- | (2,912) Other, net............................................... 2,684 (818) (217) | (372) --------- --------- --------- | -------- Total provision for income taxes..................... $ 25,613 $ 34,248 $ 8,230 | $ 19,402 ========= ========= ========= | ======== | ACCUMULATED DEFERRED INCOME TAXES AT | DECEMBER 31: | Property basis differences.................................. $ 291,752 $ 242,192 $ 256,951 | Nuclear decommissioning..................................... (39,869) (41,665) (42,138) | Non-utility generation costs................................ (223,350) (223,644) (214,492) | Purchase accounting basis difference........................ (762) (762) (38,407) | Sale of generation assets................................... 7,495 7,495 7,495 | Regulatory transition charge................................ -- -- 9,329 | Customer receivables for future income taxes................ 55,817 52,793 61,493 | Other comprehensive income.................................. (29,908) -- -- | Employee benefits........................................... (42,368) -- -- | Other....................................................... (35,449) (37,926) (18,549) | --------- --------- --------- | Net deferred income tax liability (asset)............ $ (16,642) $ (1,517) $ 21,682 | ========= ========= ========= | * Collected from customers through regulated rates and included in revenue on the Consolidated Statements of Income. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include Pennsylvania Electric Company (Company) and its wholly owned subsidiaries. The Company is a wholly owned subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the issued and outstanding common shares of its other principal electric utility operating subsidiaries, including Ohio Edison Company (OE), The Cleveland Electric Illuminating Company (CEI), The Toledo Edison Company (TE), American Transmission Systems, Inc. (ATSI), Jersey Central Power & Light Company (JCP&L) and Metropolitan Edison Company (Met-Ed). The Company, JCP&L and Met-Ed were formerly wholly owned subsidiaries of GPU, Inc., which merged with FirstEnergy on November 7, 2001. Pre-merger and post-merger period financial results are separated by a heavy black line. The Company follows the accounting policies and practices prescribed by the Securities and Exchange Commission (SEC), the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. Certain prior year amounts have been reclassified to conform with the current year presentation. (A) CONSOLIDATION- The Company consolidates all majority-owned subsidiaries, over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) over which the Company has the ability to exercise significant influence, but not control, are accounted for on the equity basis. (B) REVENUES- The Company's principal business is providing electric service to customers in Pennsylvania. The Company's retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service provided through the end of the year. See Note 7 - Other Information for discussion of reporting of independent system operator transactions. Receivables from customers include sales to residential, commercial and industrial customers and sales to wholesale customers. There was no material concentration of receivables as of December 31, 2003 or 2002, with respect to any particular segment of the Company's customers. Total customer receivables were $124 million (billed - $73 million and unbilled - $51 million) and $128 million (billed - $79 million and unbilled - $49 million) as of December 31, 2003 and 2002, respectively. (C) REGULATORY PLAN- Pennsylvania enacted its electric utility competition law in 1996 with the phase-in of customer choice for generation suppliers completed as of January 1, 2001. The PPUC authorized a 1998 rate restructuring plan for the Company. In 2000, the PPUC disallowed a portion of the requested additional stranded costs above those amounts granted in the Company's 1998 rate restructuring plan orders. The PPUC required the Company to seek an IRS ruling regarding the return of certain unamortized investment tax credits and excess deferred income tax benefits to customers. If the IRS ruling ultimately supports returning these tax benefits to customers, there would be no effect to the Company's net income since the contingency existed prior to the merger and there would be an adjustment to goodwill. In June 2001, the PPUC approved the Settlement Stipulation with all of the major parties in the combined merger and rate relief proceedings which approved the FirstEnergy/GPU merger and provided provider of last resort (PLR) deferred accounting treatment for energy costs, permitting the Company to defer, for future recovery, energy costs in excess of amounts reflected in its capped generation rates retroactive to January 1, 2001. This PLR deferral accounting procedure was later denied in a February 2002 Commonwealth Court of Pennsylvania decision. The court decision also affirmed the PPUC decision regarding the approval of merger, remanding the decision to the PPUC only with respect to the issue of merger savings. In the first quarter of 2002, the Company established a $111.1 million reserve for its PLR deferred energy costs incurred prior to its acquisition by FirstEnergy. The reserve reflected the potential adverse impact of the then pending Pennsylvania Supreme Court decision whether to review the Commonwealth Court ruling. The reserve increased goodwill by an aggregate net of tax amount of $65.0 million. 19 On April 2, 2003, the PPUC remanded the issue relating to merger savings to the Office of Administrative Law for hearings, directed the Company to file a position paper on the effect of the Commonwealth Court order on the Settlement Stipulation and allowed other parties to file responses to the position paper. The Company filed a letter with the Administrative Law Judge (ALJ) on June 11, 2003, voiding the Stipulation in its entirety and reinstating its restructuring settlement previously approved by the PPUC. On October 2, 2003, the PPUC issued an order concluding that the Commonwealth Court reversed the PPUC's June 20, 2001 order in its entirety. The PPUC directed the Company to file tariffs within thirty days of the order to reflect the competitive transition charge (CTC) rates and shopping credits that were in effect prior to the June 21, 2001 order to be effective upon one day's notice. In response to that order, the Company filed the supplements to its tariffs to become effective October 24, 2003. On October 8, 2003, the Company filed a petition for clarification relating to the October 2, 2003 order on two issues: to establish June 30, 2004 as the date to fully refund the nonutility generation (NUG) trust fund and to clarify that the ordered accounting treatment regarding the CTC rate/shopping credit swap should follow the ratemaking, and that the PPUC's findings would not impair its rights to recover all of its stranded costs. On October 9, 2003, ARIPPA (an intervenor in the proceedings) petitioned the PPUC to direct the Company to reinstate accounting for the CTC rate/shopping credit swap retroactive to January 1, 2002. Several other parties also filed petitions. On October 16, 2003, the PPUC issued a reconsideration order granting the date requested by the Company for the NUG trust fund refund; and, denying the Company's other clarification requests and granting ARIPPA's petition with respect to the accounting treatment of the changes to the CTC rate/shopping credit swap. On October 22, 2003, the Company filed an Objection with the Commonwealth Court asking that the Court reverse the PPUC's finding that requires the Company to treat the stipulated CTC rates that were in effect from January 1, 2002 on a retroactive basis. The Company is considering filing an appeal to the Commonwealth Court on the PPUC orders as well. On October 27, 2003, one Commonwealth Court judge issued an Order denying the Company's objection without explanation. Due to the vagueness of the Order, the Company, on October 31, 2003, filed an Application for Clarification with the judge. Concurrent with this filing, the Company, in order to preserve its rights, also filed with the Commonwealth Court both a Petition for Review of the PPUC's October 16 and 22 Orders, and an application for reargument, if the judge, in his clarification order, indicates that the Company's objection was intended to be denied on the merits. In addition to these findings, the Company, in compliance with the PPUC's Orders, filed revised PPUC quarterly reports for the twelve months ended December 31, 2001 and 2002, and for the first two quarters of 2003, reflecting balances consistent with the PPUC's findings in its Orders. Effective September 1, 2002, the Company assigned its PLR responsibility to its FirstEnergy Solutions Corp. (FES) affiliate through a wholesale power sale agreement. The PLR sale will be automatically extended for each successive calendar year unless any party elects to cancel the agreement by November 1 of the preceding year. Under the terms of the wholesale agreement, FES assumed the supply obligation and the supply profit and loss risk, for the portion of power supply requirements not self-supplied by the Company under its NUG contracts and other power contracts with nonaffiliated third party suppliers. This arrangement reduces the Company's exposure to high wholesale power prices by providing power at a fixed price for their uncommitted PLR energy costs during the term of the agreement with FES. FES has hedged most of the Company's unfilled PLR on-peak obligation through 2004 and a portion of 2005, the period during which deferred accounting was previously allowed under the PPUC's order. The Company' is authorized to continue deferring differences between NUG contract costs and current market prices. In late 2003, the PPUC issued a Tentative Order implementing new reliability benchmarks and standards. In connection therewith, the PPUC commenced a rulemaking procedure to amend the Electric Service Reliability Regulations to implement these new benchmarks, and create additional reporting on reliability. Although neither the Tentative Order nor the Reliability Rulemaking has been finalized, the PPUC ordered all Pennsylvania utilities to begin filing quarterly reports on November 1, 2003. The comment period for both the Tentative Order and the Proposed Rulemaking Order has closed. The Company is currently awaiting the PPUC to issue a final order in both matters. The order will determine (1) the standards and benchmarks to be utilized, and (2) the details required in the quarterly and annual reports. It is expected that these Orders will be finalized in March 2004. On January 16, 2004, the PPUC initiated a formal investigation of the Company's levels of compliance with the Public Utility Code and the PPUC's regulations and orders with regard to reliable electric service. Hearings will be held in August in this investigation and the ALJ has been directed to issue a Recommended Decision by September 30, 2004, in order to allow the PPUC time to issue a Final Order before December 16, 2004. The Company is unable to predict the outcome of the investigation or the impact of the PPUC Order. 20 Regulatory Assets- The Companies recognize, as regulatory assets, costs which the FERC and the PPUC have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are expected to continue to be recovered from customers under the Company's regulatory plan. The Company continues to bill and collect cost-based rates for its transmission and distribution services, which remain regulated; accordingly, it is appropriate that the Company continue the application of Statement of Financial Accounting Standards (SFAS) No. 71 (SFAS 71), "Accounting for the Effects of Certain Types of Regulation," to those operations. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2003 2002 -------------------------------------------------------------------- (In millions) Regulatory transition charge................... $366 $434 Customer receivables for future income taxes... 128 125 Nuclear decommissioning costs.................. (1) 36 Loss on reacquired debt and other.............. 4 5 ----------------------------------------------------------------- Total....................................... $497 $600 ================================================================= Regulatory Accounting for Generation Operations- The application of SFAS 71 was discontinued in 1998 with respect to the Company's generation operations. The Company subsequently divested substantially all of its generating assets. The SEC issued interpretive guidance regarding asset impairment measurement, providing that any supplemental regulated cash flows such as a CTC should be excluded from the cash flows of assets in a portion of the business not subject to regulatory accounting practices. If those assets are impaired, a regulatory asset should be established if the costs are recoverable through regulatory cash flows. (D) PROPERTY, PLANT AND EQUIPMENT- As a result of the merger, a portion of the Company's property, plant and equipment was adjusted to reflect fair value. The majority of the Company's property, plant and equipment continues to be reflected at original cost since such assets remain subject to rate regulation on a historical cost basis. The Company's accounting policy for planned major maintenance projects is to recognize liabilities as they are incurred. The Company provides for depreciation on a straight-line basis at various rates over the estimated lives of property included in plant in service. The annualized composite rate was approximately 2.7% in 2003, 3.0% in 2002 and 2.9% in 2001. (E) ASSET RETIREMENT OBLIGATION- In January 2003, the Company implemented SFAS 143, "Accounting for Asset Retirement Obligations", which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Over time the capitalized costs are depreciated and the present value of the asset retirement liability increases, resulting in a period expense. However, rate-regulated entities may recognize a regulatory asset or liability instead if the criteria for such treatment are met. Upon retirement, a gain or loss would be recognized if the cost to settle the retirement obligation differs from the carrying amount. The Company identified applicable legal obligations as defined under the new standard for nuclear power plant decommissioning. The ARO liability as of the date of adoption of SFAS 143 was $99.1 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. As of December 31, 2002, the Company recognized decommissioning liabilities of $129.9 million. The Company expects substantially all nuclear decommissioning costs to be recoverable through regulated rates. Therefore, a regulatory liability of $30.8 million was recognized upon adoption of SFAS 143. Accretion during 2003 was $6.0 million, bringing the ARO liability as of December 31, 2003 to $105.1 million. The ARO includes the Company's obligation for nuclear decommissioning of Three Mile Island Unit 2 (TMI-2). The Company's share of the obligation to decommission TMI-2 was developed based on a site-specific study performed by an independent engineer. The Company utilized an expected cash flow approach (as discussed in FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements") to measure the fair value of the nuclear decommissioning ARO. The Company maintains nuclear decommissioning trust funds that are legally restricted for purposes of settling the nuclear decommissioning ARO. As of December 31, 2003, the fair value of the decommissioning trust assets was $102.7 million. 21 The following table provides the year-end balance of the ARO for 2002, as if SFAS 143 had been adopted on January 1, 2002. Adjusted ARO Reconciliation 2002 -------------------------------------------------------- (In millions) Beginning balance as of January 1, 2002 $93.5 Accretion in 2002 5.6 -------------------------------------------------------- Ending balance as of December 31, 2002 $99.1 -------------------------------------------------------- (F) STOCK-BASED COMPENSATION- FirstEnergy applies the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock-based compensation plans (see Note 4(B)). No material stock-based employee compensation expense is reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date, resulting in substantially no intrinsic value. If FirstEnergy had accounted for employee stock options under the fair value method of SFAS 123, "Accounting for Stock Compensation,", a higher value would have been assigned to the options granted. The weighted average assumptions used in valuing the options and their resulting estimated fair values would be as follows: 2003 2002 2001 -------------------------------------------------------------------- Valuation assumptions: Expected option term (years) 7.9 8.1 8.3 Expected volatility......... 26.91% 23.31% 23.45% Expected dividend yield..... 5.09% 4.36% 5.00% Risk-free interest rate..... 3.67% 4.60% 4.67% Fair value per option......... $5.09 $6.45 $4.97 -------------------------------------------------------------------- The effects of applying fair value accounting to the FirstEnergy's stock options would not materially affect the Company's net income. (G) INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. Deferred income tax liabilities related to tax and accounting basis differences and tax credit carryforward items are recognized at the statutory income tax rates in effect when the liabilities are expected to be paid. Results for the period January 1, 2001 through November 6, 2001 were included in the final consolidated federal income tax return of GPU, and results for the period November 7, 2001 through December 31, 2001 were included in FirstEnergy's 2001 consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with the Company recognizing the tax benefit for any tax losses or credits it contributes to the consolidated return. (H) CUMULATIVE EFFECT OF ACCOUNTING CHANGE As a result of adopting SFAS 143 in January 2003, asset retirement costs were recorded in the amount of $93 million as part of the carrying amount of the related long-lived asset, offset by accumulated depreciation of $93 million. The ARO liability on the date of adoption was $99 million, including accumulated accretion for the period from the date the liability was incurred to the date of adoption. The remaining cumulative effect adjustment for unrecognized depreciation and accretion, offset by the reduction in the existing decommissioning liabilities and the reversal of accumulated estimated removal costs for non-regulated generation assets, was a $1.9 million increase to income ($1.1 million net of tax) in the year ended December 31, 2003. If SFAS 143 had been applied during 2002 and 2001, the impact would not have been material to the Company's Consolidated Statements of Income. (I) PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS FirstEnergy provides noncontributory defined benefit pension plans that cover substantially all of the Company's employees. The trusteed plans provide defined benefits based on years of service and compensation levels. FirstEnergy's funding policy is based on actuarial computations using the projected unit credit method. No pension contributions were required during the three years ended December 31, 2003. 22 FirstEnergy provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee contributions, deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company recognizes the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. Pension and OPEB costs are affected by employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Such factors may be further affected by business combinations (such as FirstEnergy's merger with GPU, Inc. in November 2001), which impacts employee demographics, plan experience and other factors. Pension and OPEB costs may also be affected by changes to key assumptions, including anticipated rates of return on plan assets, the discount rates and health care trend rates used in determining the projected benefit obligations and pension and OPEB costs. FirstEnergy uses a December 31 measurement date for the majority of its plans. Plan amendments to retirement health care benefits in 2003 and 2002, relate to changes in benefits provided and cost-sharing provisions, which reduced FirstEnergy's obligation by $123 and $121 million, respectively. In early 2004, FirstEnergy announced that it would amend the benefit provisions of its health care benefits plan and both employees and retirees would share in more of the benefit costs. On December 8, 2003, President Bush signed into law a bill that expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. FirstEnergy anticipates that the benefits it pays after 2006 will be lower as a result of the new Medicare provisions. Due to uncertainties surrounding some of the new Medicare provisions and a lack of authoritative accounting guidance about these issues, FirstEnergy deferred the recognition of the impact of the new Medicare provisions as provided by FASB Staff Position 106-1. The final accounting guidance could require changes to previously reported information. The following sets forth the funded status of the plans and amounts recognized on FirstEnergy's Consolidated Balance Sheets as of December 31: 23
Obligations and Funded Status Pension Benefits Other Benefits ---------------- -------------- As of December 31 2003 2002 2003 2002 ------------------------------------------------------------------------------------------ (In millions) Change in benefit obligation Benefit obligation at beginning of year.. $3,866 $3,548 $ 2,077 $ 1,582 Service cost............................. 66 59 43 28 Interest cost............................ 253 249 136 114 Plan participants' contributions......... -- -- 6 -- Plan amendments.......................... -- -- (123) (121) Actuarial loss........................... 222 268 323 440 GPU acquisition (Note 2)................. -- (12) -- 110 Benefits paid............................ (245) (246) (94) (76) ------ ------ ------- ------- Benefit obligation at end of year........ $4,162 $3,866 $ 2,368 $ 2,077 ====== ====== ======= ======= Change in fair value of plan assets Fair value of plan assets at beginning of year $2,889 $3,484 $ 473 $ 535 Actual return on plan assets............. 671 (349) 88 (57) Company contribution..................... -- -- 68 31 Plan participants' contribution.......... -- -- 2 -- Benefits paid............................ (245) (246) (94) (36) ------ ------ ------- ------- Fair value of plan assets at end of year. $3,315 $2,889 $ 537 $ 473 ====== ====== ======= ======== Funded status............................ $ (847) $ (977) $(1,831) $(1,604) Unrecognized net actuarial loss.......... 919 1,186 994 752 Unrecognized prior service cost (benefit) 72 78 (221) (107) Unrecognized net transition obligation... -- -- 83 92 ------ ------ ------- ------- Net asset (liability) recognized......... $ 144 $ 287 $ (975) $ (867) ====== ====== ======= ======= Amounts Recognized in the Consolidated Balance Sheets As of December 31 ---------------------------------------- Accrued benefit cost..................... $(438) $ (548) $ (975) $ (867) Intangible assets........................ 72 78 -- -- Accumulated other comprehensive loss..... 510 757 -- -- ----- ------ ------ ------- Net amount recognized.................... $ 144 $ 287 $ (975) $ (867) ===== ====== ====== ======= Company's share of net amount recognized. $ 14 $ -- $ (86) $ -- ===== ====== ====== ======= Increase (decrease) in minimum liability included in other comprehensive income (net of tax).................... $ (145) $ 444 $ -- $ -- Weighted-Average Assumptions Used to Determine Benefit Obligations As of December 31 --------------------------------------- Discount rate............................ 6.25% 6.75% 6.25% 6.75% Rate of compensation increase............ 3.50% 3.50% Allocation of Plan Assets As of December 31 --------------------------------------- Asset Category Equity securities........................ 70% 61% 71% 58% Debt securities.......................... 27 35 22 29 Real estate.............................. 2 2 -- -- Other.................................... 1 2 7 13 ----- ----- ---- ---- Total.................................... 100% 100% 100% 100% === === === === Information for Pension Plans With an Accumulated Benefit Obligation in Excess of Plan Assets 2003 2002 --------------------------------------- ---- ---- (In millions) Projected benefit obligation............. $4,162 $3,866 Accumulated benefit obligation........... 3,753 3,438 Fair value of plan assets................ 3,315 2,889 24
FirstEnergy's net pension and other postretirement benefit costs for the three years ended December 31, 2003 were computed as follows:
Pension Benefits Other Benefits ---------------------- -------------------- Components of Net Periodic Benefit Costs 2003 2002 2001 2003 2002 2001 --------------------------------------------------------------------------------------------- (In millions) Service cost............................ $ 66 $ 59 $ 35 $ 43 $ 29 $ 18 Interest cost........................... 253 249 133 137 114 65 Expected return on plan assets.......... (248) (346) (205) (43) (52) (10) Amortization of prior service cost...... 9 9 9 (9) 3 3 Amortization of transition obligation (asset)............................... -- -- (2) 9 9 9 Recognized net actuarial loss........... 62 -- -- 40 11 5 Voluntary early retirement program...... -- -- 6 -- -- 2 ------ ------ ------ ----- ---- ----- Net periodic cost (income).............. $ 142 $ (29) $ (24) $ 177 $114 $ 92 ====== ====== ====== ===== ==== ===== Company's share of net periodic cost (income) (see Note 7) Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31 --------------------------------------- Discount rate.......................... 6.75% 7.25% 7.75% 6.75% 7.25% 7.75% Expected long-term return on plan assets............................... 9.00% 10.25% 10.25% 9.00% 10.25% 10.25% Rate of compensation increase.......... 3.50% 4.00% 4.00%
In selecting an assumed discount rate, FirstEnergy considers currently available rates of return on high-quality fixed income investments expected to be available during the period to maturity of the pension and other postretirement benefit obligations. The assumed rate of return on pension plan assets considers historical market returns and economic forecasts for the types of investments held by the Company's pension trusts. The long-term rate of return is developed considering the portfolio's asset allocation strategy. Assumed health care cost trend rates As of December 31 2003 2002 - -------------------------------------------------------------------------------- Health care cost trend rate assumed for next year (pre/post-Medicare).......................... 10%-12% 10%-12% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)................. 5% 5% Year that the rate reaches the ultimate trend rate (pre/post-Medicare).......................... 2009-2011 2008-2010 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 1-Percentage- 1-Percentage- Point Increase Point Decrease - -------------------------------------------------------------------------------- (In millions) Effect on total of service and interest cost.. $ 26 $ (19) Effect on postretirement benefit obligation... $233 $(212) FirstEnergy employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small and large capitalizations. Other assets such as real estate are used to enhance long-term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner; however, derivatives are not used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured and monitored on a continuing basis through periodic investment portfolio reviews, annual liability measurements, and periodic asset/liability studies. As a result of GPU Service Inc. (GPUS) merging with FirstEnergy Service Company (FESC) in the second quarter of 2003, operating company employees of GPU Service were transferred to the former GPU operating companies. Accordingly, FirstEnergy requested an actuarial study to update the pension liabilities for each of its subsidiaries. Based on the actuary's report, the accrued pension costs for the Company as of June 30, 2003 increased by $71 million. The corresponding adjustment related to this change decreased other comprehensive income and deferred income taxes and increased the payable to associated companies. 25 Due to the increased market value of its pension plan assets, the Company reduced its minimum liability as prescribed by SFAS 87 as of December 31, 2003 by $20 million, recording an increase of $47,000 in an intangible asset and crediting OCI by $12 million (offsetting previously recorded deferred tax benefits by $8 million). The remaining balance in OCI of $42 million will reverse in future periods to the extent the fair value of trust assets exceeds the accumulated benefit obligation. The accrued pension cost was reduced to $58 million as of December 31, 2003. FirstEnergy does not expect to contribute to its pension plans in 2004 and expects to contribute $16 million to its other postretirement benefit plans in 2004. (J) GOODWILL- In a business combination, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed is recognized as goodwill. Under SFAS 142, "Goodwill and Other Intangible Assets," amortization of existing goodwill ceased January 1, 2002. Instead, the Company evaluates goodwill for impairment at least annually and makes such an evaluation more frequently if indicators of impairment should arise. In accordance with the accounting standard, if the fair value of a reporting unit is less than its carrying value (including goodwill), the goodwill is tested for impairment. When impairment is indicated, the Company recognizes a loss - calculated as the difference between the implied fair value of a reporting unit's goodwill and the carrying value of the goodwill. The Company's annual review was completed in the third quarter of 2003. The forecasts used in the Company's evaluations of goodwill reflect operations consistent with its general business assumptions. Unanticipated changes in those assumptions could have a significant effect on the Company's future evaluations of goodwill. As of December 31, 2003, the Company had $899 million of goodwill. (K) TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and other income included transactions with affiliated companies, primarily FESC, GPUS and FES. GPUS (until it ceased operations in mid-2003) and FESC have provided legal, accounting, financial and other services to the Company. The Company also entered into sale and purchase transactions with affiliates (JCP&L and Met-Ed) during the period. Effective September 1, 2002, the Company assigned its PLR responsibility to FES through a wholesale power sale agreement. See Note 7(C) for affiliated companies' transactions schedule. FirstEnergy does not bill directly or allocate any of its costs to any subsidiary company. Costs are allocated to the Company from its affiliates, GPUS and FESC, both subsidiaries of FirstEnergy Corp. and both "mutual service companies" as defined in Rule 93 of the Public Utility Holding Company Act of 1935 (PUHCA). The vast majority of costs are directly billed or assigned at no more than cost as determined by PUHCA Rule 91. The remaining costs are for services that are provided on behalf of more than one company, or costs that cannot be precisely identified and are allocated using formulas that are filed annually with the SEC on Form U-13-60. The current allocation or assignment formulas used and their bases include multiple factor formulas; each company's proportionate amount of the FirstEnergy's aggregate total for direct payroll, number of employees, asset balances, revenues, number of customers, other factors and specific departmental charge ratios. It is management's belief that allocation methods utilized are reasonable. (L) CASH AND FINANCIAL INSTRUMENTS- All temporary cash investments purchased with an initial maturity of three months or less are reported as cash equivalents on the Consolidated Balance Sheets at cost, which approximates their fair market value. All borrowings with initial maturities of less than one year are defined as financial instruments under GAAP and are reported on the Consolidated Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31: 2003 2002 - ----------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value - ----------------------------------------------------------------------------- (In millions) Long-term debt..................... $564 $612 $469 $475 Preferred stock.................... $ -- $ -- $ 92 $100 Investments other than cash and cash equivalents............. $149 $149 $199 $199 - ----------------------------------------------------------------------------- The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by corporations with credit ratings similar to the Company's ratings. Long-term debt and preferred stock 26 subject to mandatory redemption were recognized at fair value in connection with the merger. The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. The Company has no securities held for trading purposes. The investment policy for the nuclear decommissioning trust funds restricts or limits the ability to hold certain types of assets including private or direct placements, warrants, securities of FirstEnergy, investments in companies owning nuclear power plants, financial derivatives, preferred stocks, securities convertible into common stock and securities of the trust fund's custodian or managers and their parents or subsidiaries. The investments that are held in the decommissioning trusts (included as "Investments other than cash and cash equivalents" in the table above) consist of equity securities ($54 million) and fixed income securities ($49 million) as of December 31, 2003. Realized and unrealized gains and losses applicable to the decommissioning trusts have been recognized in the trust investment with a corresponding change to regulatory assets. For 2003 and 2002, net realized gains were approximately $0.8 million and $0.2 million and interest and dividend income totaled approximately $2.9 million and $2.7 million, respectively. On January 1, 2001, the Company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133." The adoption resulted in the recognition of derivative assets on the Consolidated Balance Sheet as of January 1, 2001 in the amount of $26.0 million, with an offsetting amount, net of tax, recorded in Regulatory Assets of $25.9 million. As of January 1, 2001, the Company also recorded derivative liabilities in the amount of $1.0 million as a result of adopting SFAS 133, with a substantially offsetting amount recorded in Accumulated Other Comprehensive Income, of $0.5 million. As of January 1, 2001, a cumulative effect of accounting change was recognized as an expense in Other Income (Expense), on the Consolidated Statement of Income in the amount of $0.8 million. The Company is exposed to financial risks resulting from the fluctuation of interest rates and commodity prices, including electricity and natural gas. To manage the volatility relating to these exposures, the Company uses a variety of non-derivative and derivative instruments, including options, futures contracts and swaps. These derivatives are used principally for hedging purposes. The Company has a Risk Policy Committee, comprised of FirstEnergy executive officers, which exercises an independent risk oversight function to ensure compliance with corporate risk management policies and prudent risk management practices. The Company uses derivatives to hedge the risk of price. The Company's primary ongoing hedging activity involves cash flow hedges of electricity and natural gas purchases. The majority of the Company's forward commodity contracts are considered "normal purchases and sales," as defined by SFAS 133, and are therefore excluded from the scope of SFAS 138. The options and futures contracts determined to be within the scope of SFAS 133 are accounted for as cash flow hedges and expire on various dates through 2003. Gains and losses from hedges of commodity price risks are included in net income when the underlying hedged commodities are delivered. There was no deferred gain or loss in Accumulated Other Comprehensive Income as of December 31, 2003 related to derivative hedging activity. 2. MERGER: On November 7, 2001, the merger of FirstEnergy and GPU became effective pursuant to the Agreement and Plan of Merger, dated August 8, 2000. As a result of the merger, GPU's former wholly owned subsidiaries, including the Company, became wholly owned subsidiaries of FirstEnergy. The merger was accounted for by the purchase method of accounting. The assets acquired and liabilities assumed were recorded at estimated fair values as determined by FirstEnergy's management based on information currently available and on current assumptions as to future operations. Merger purchase accounting adjustments recorded in the records of the Company primarily consist of: (1) revaluation of certain property, plant and equipment; (2) adjusting preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (3) recognizing additional obligations related to retirement benefits; and (4) recognizing estimated severance and other compensation liabilities. Other assets and liabilities were not adjusted since they remain subject to rate regulation on a historical cost basis. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill. During 2002 and 2003, certain pre-acquisition contingencies and other final adjustments to the fair values of the assets acquired and liabilities assumed were reflected in the final allocations of the purchase price. These adjustments primarily related to: (1) final actuarial calculations related to pension and postretirement benefit obligations; (2) establishment of a reserve 27 for deferred energy costs recognized prior to the merger; and (3) return to accrual adjustments for income taxes. As a result of these adjustments, goodwill increased by approximately $100.7 million. As of December 31, 2003, the Company had recorded goodwill of approximately $898.5 million related to the merger. 3. LEASES: Consistent with regulatory treatment, the rentals for capital leases are charged to operating expenses on the Consolidated Statements of Income. The Company has a capital lease for an operations building, which expires in 2004. In each of the years 2003, 2002 and 2001, total rentals related to this capital lease were $0.7 million, comprised of an interest element of $0.1 million and other costs of $0.6 million. As of December 31, 2003, the future minimum lease payments on the Company's capital lease discussed above are $0.5 million for the year 2004. 4. CAPITALIZATION: (A) RETAINED EARNINGS- The merger purchase accounting adjustments included resetting the retained earnings balance to zero as of the November 7, 2001 merger date. In general, the Company's first mortgage bond (FMB) indentures restrict the payment of dividends or distributions on or with respect to the Company's common stock to amounts credited to earned surplus since approximately the date of its indenture. At such date, the Company had a balance of $10.1 million in its earned surplus account, which would not be available for dividends or other distributions. As of December 31, 2003, the Company had retained earnings available to pay common stock dividends of $7.9 million, net of amounts restricted under the Company's FMB indentures. (B) STOCK COMPENSATION PLANS- FirstEnergy administers the FirstEnergy Executive and Director Incentive Compensation Plan (FE Plan). Under the FE Plan, total awards cannot exceed 22.5 million shares of common stock or their equivalent. Only stock options and restricted stock have been granted, with vesting periods ranging from six months to seven years. Several other stock compensation plans have been acquired through the mergers with GPU and Centerior - GPU, Inc. Stock Option and Restricted Stock Plan for MYR Group Inc. Employees (MYR Plan), 1990 Stock Plan for Employees of GPU, Inc. and Subsidiaries (GPU Plan) and Centerior Equity Plan. No further stock-based compensation can be awarded under these plans. Collectively, the above plans are referred to as the FE Programs. Restricted common stock grants under the FE Programs were as follows: 2003 2002 2001 --------------------------------------------------------------------------- Restricted common shares granted..... -- 36,922 133,162 Weighted average market price ........ n/a (1) $36.04 $35.68 Weighted average vesting period (years) n/a (1) 3.2 3.7 Dividends restricted.................. n/a (1) Yes -- (2) --------------------------------------------------------------------------- (1) Not applicable since no restricted stock was granted. (2) FE Plan dividends are paid as restricted stock on 4,500 shares. Under the Executive Deferred Compensation Plan (EDCP), covered employees can direct a portion of their Annual Incentive Award and/or Long-Term Incentive Award into an unfunded FirstEnergy Stock Account to receive vested stock units. An additional 20% premium is received in the form of stock units based on the amount allocated to the FirstEnergy Stock Account. Dividends are calculated quarterly on stock units outstanding and are paid in the form of additional stock units. Upon withdrawal, stock units are converted to FirstEnergy shares. Payout typically occurs three years from the date of deferral; however, an election can be made in the year prior to payout to further defer shares into a retirement stock account that will pay out in cash upon retirement. As of December 31, 2003, there were 410,399 stock units outstanding. 28 Stock option activities under the FE Programs for the past three years were as follows: Number of Weighted Average Stock Option Activities Options Exercise Price -------------------------------------------------------------------------- Balance, January 1, 2001............. 5,021,862 24.09 (473,314 options exercisable)........ 24.11 Options granted.................... 4,240,273 28.11 Options exercised.................. 694,403 24.24 Options forfeited.................. 120,044 28.07 Balance, December 31, 2001........... 8,447,688 26.04 (1,828,341 options exercisable)...... 24.83 Options granted..................... 3,399,579 34.48 Options exercised................... 1,018,852 23.56 Options forfeited................... 392,929 28.19 Balance, December 31, 2002............ 10,435,486 28.95 (1,400,206 options exercisable)....... 26.07 Options granted.................... 3,981,100 29.71 Options exercised.................. 455,986 25.94 Options forfeited.................. 311,731 29.09 Balance, December 31, 2003........... 13,648,869 29.27 (1,919,662 options exercisable)...... 29.67 As of December 31, 2003, the weighted average remaining contractual life of outstanding stock options was 7.6 years. Options outstanding by plan and range of exercise prices as of December 31, 2003 were as follows: Range of Options FirstEnergy Program Exercise Prices Outstanding ----------------------------------------------------------------------- FE plan $19.31 - $29.87 9,904,861 $30.17 - $35.15 3,214,601 Plans acquired through merger: GPU plan $23.75 - $35.92 501,734 Other plans 27,673 ---------------------------------------------------------------------- Total 13,648,869 ====================================================================== No material stock-based employee compensation expense is reflected in net income for stock options granted under the above plans since the exercise price was equal to the market value of the underlying common stock on the grant date. The effect of applying fair value accounting to FirstEnergy's stock options is summarized in Note 1(F) - Stock-Based Compensation. (C) PREFERRED AND PREFERENCE STOCK- The Company's preferred stock authorization consists of 11.435 million shares without par value. No preferred shares are currently outstanding. (D) LONG-TERM DEBT- The Company's FMB indenture, which secures all of the Company's FMBs, serve as a direct first mortgage lien on substantially all of the Company's property and franchises, other than specifically excepted property. The Company has various debt covenants under its financing arrangements. The most restrictive of these relate to the nonpayment of interest and/or principal on debt, which could trigger a default. Cross-default provisions also exist between FirstEnergy and the Company. Based on the amount of bonds authenticated by the Trustee through December 31, 2003, the Company's annual sinking fund requirements for all bonds issued under the mortgage amount to approximately $1 million. The Company expects to fulfill its sinking fund obligation by providing bondable property additions to the Trustee. 29 Sinking fund requirements for FMBs and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) ------------------------------- 2004................ $125 2005................ 8 2006................ -- 2007................ 3 2008................ -- ------------------------------- The Company's obligations to repay certain pollution control revenue bonds are secured by several series of FMBs. Certain pollution control revenue bonds are entitled to the benefit of noncancelable municipal bond insurance policies of $69 million to pay principal of, or interest on, the pollution control revenue bonds. (E) LONG-TERM DEBT: SUBORDINATED DEBENTURES TO AFFILIATED TRUST- The Company formed a statutory business trust to sell preferred securities and invest the gross proceeds in subordinated debentures. Ownership of the Company's trust is through a separate wholly owned limited partnership. In this transaction, the trust invested the gross proceeds from the sale of its preferred securities in the preferred securities of the limited partnership, which in turn invested those proceeds in the 7.34% subordinated debentures of the Company. The Company has effectively provided a full and unconditional guarantee of obligations under the trust's preferred securities. The trust's preferred securities are redeemable at the option of the Company beginning in September 2004 at 100% of their principal amount. Interest on the subordinated debentures (and therefore distributions on the trust's preferred securities) may be deferred for up to 60 months, but the Company may not pay dividends on, or redeem or acquire, any of its cumulative preferred or common stock until deferred payments on its subordinated debentures are paid in full. Upon adoption of "Consolidation of Variable Interest Entities" (FIN 46R), the limited partnership and statutory business trust discussed above are not consolidated on the Company's financial statements as of December 31, 2003 (see Note 8). (F) COMPREHENSIVE INCOME- Comprehensive income includes net income as reported on the Consolidated Statements of Income and all other changes in common stockholder's equity except those resulting from transactions with the Company's parent. As of December 31, 2003, accumulated other comprehensive loss consisted of a minimum liability for unfunded retirement benefits of $42.2 million. 5. SHORT-TERM BORROWINGS: The Company may borrow from its affiliates on a short-term basis. As of December 31, 2003, the Company had total short-term borrowings of $78.5 million from its affiliates. The weighted average interest rates on short-term borrowings outstanding at December 31, 2003 and 2002 were 1.7% and 1.8%, respectively. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: (A) CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $198 million for property additions and improvements from 2004 through 2006, of which approximately $66 million is applicable to 2004. (B) NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $10.9 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its present ownership interest in TMI-2, the Company is exempt from any potential assessment under the industry retrospective rating plan. The Company is also insured as to its interest in TMI-2 under a policy issued to the operating company for the plant. Under this policy, $150 million is provided for property damage and decontamination and decommissioning costs. Under this policy, the Company can be assessed a maximum of approximately $0.2 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at TMI-2 exceed the policy limits of the 30 insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. (C) ENVIRONMENTAL MATTERS- The Company has been named as a "potentially responsible party" (PRP) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations of disposal of hazardous substances at historical sites and the liability involved are often unsubstantiated and subject to dispute; however, federal law provides that all PRPs for a particular site be held liable on a joint and several basis. Therefore, potential environmental liabilities have been recognized on the Consolidated Balance Sheet as of December 31, 2003, based on estimates of the total costs of cleanup, the Company's proportionate responsibility for such costs and the financial ability of other nonaffiliated entities to pay. The Company has accrued liabilities aggregating approximately $43,000 as of December 31, 2003. The Company accrues for environmental costs only when they can conclude that it is probable that they have an obligation for such costs and can reasonably determine the amount of such costs. Unasserted claims are reflected in the Company's determination of environmental liabilities and are accrued in the period that they are both probable and reasonably estimable. The Company does not believe environmental remediation costs will have a material adverse effect on its financial condition, cash flows or results of operations. (D) OTHER LEGAL PROCEEDINGS- Various lawsuits, claims and proceedings related to the Company's normal business operations are pending against the Company. On August 14, 2003, various states in the northeast United States and part of southern Canada experienced a widespread power outage. That outage affected approximately 1.4 million customers in FirstEnergy's service area. FirstEnergy continues to accumulate data and evaluate the status of its electrical system prior to and during the outage event, and continues to cooperate with the U.S.-Canada Power System Outage Task Force (Task Force) investigating the August 14th outage. The interim report issued by the Task Force on November 18, 2003 concluded that the problems leading up to the outage began in FirstEnergy's service area. Specifically, the interim report concludes, among other things, that the initiation of the August 14th outage resulted from the coincidence on that afternoon of the following events: (1) inadequate situational awareness at FirstEnergy; (2) FirstEnergy's failure to adequately manage tree growth in its transmission rights of way; and (3) failure of the interconnected grid's reliability organizations (Midwest ISO and PJM Interconnection) to provide effective diagnostic support. We believe that the interim report does not provide a complete and comprehensive picture of the conditions that contributed to the August 14th outage and that it does not adequately address the underlying causes of the outage. On November 25, 2003, the Public Utilities Commission of Ohio (PUCO) ordered FirstEnergy to file a plan with the PUCO no later than March 1, 2004, illustrating how FirstEnergy will correct problems identified by the Task Force as events contributing to the August 14th outage and addressing how FirstEnergy proposed to upgrade its control room computer hardware and software and improve the training of control room operators to ensure that similar problems do not occur in the future. The PUCO, in consultation with the North American Electric Reliability Council, will review the plan before determining the next steps in the proceeding. On December 24, 2003, the FERC ordered FirstEnergy to pay for an independent study of part of Ohio's power grid. The study has commenced and will examine the stability of the grid in critical points in the Cleveland and Akron areas; the status of projected power reserves during summer 2004 through 2008; and the need for new transmission lines or other grid projects. The FERC ordered the study to be completed within 120 days. At this time, we do not know how the results of the study will impact FirstEnergy. 7. OTHER INFORMATION: The following represents the financial data which includes supplemental unaudited prior years' information as compared to consolidated financial statements and notes previously reported in 2001. (A) CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 - --------------------------------------------------------------------------------------------------------- (Unaudited) (Unaudited) (In millions) Other cash flows from operating activities: Accrued compensation, net............................. $ 7,956 $(1,275) $ -- | $ (619) Accrued taxes......................................... (4,215) (7,984) 26,737 | (21,377) Accrued interest...................................... -- 411 4,002 | (3,300) Prepayments and other................................. 41 6,054 13,253 | (9,990) Other................................................. 4,230 10,741 (2,402) | (1,598) ------- ------- -------- | -------- Other cash provided from (used for) operating activities $ 8,012 $ 7,947 $41,590 | $(36,884) - ----------------------------------------------------------------------------------------------------------
31 (B) REVENUES - INDEPENDENT SYSTEM OPERATOR (ISO) TRANSACTIONS- The Company records purchase and sales transactions with PJM Interconnection ISO, an independent system operator, on a gross basis in accordance with EITF Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." The aggregate purchase and sales transactions for the three years ended December 31, 2003, are summarized as follows: Nov. 7-Dec. 31, Jan. 1-Nov. 6, 2003 2002 2001 2001 ------------------------------------------------------------------------ (Unaudited) (Unaudited) (In millions) | Sales......... $13 $34 $1 | $29 Purchases..... 18 75 9 | 79 ------------------------------------------------------------------------ The Company's revenues on the Consolidated Statements of Income include wholesale electricity sales revenues from the PJM ISO from power sales (as reflected in the table above) during periods when the Company had additional available power capacity. Revenues also include sales by the Company of power sourced from the PJM ISO (reflected as purchases in the table above) during periods when the Company required additional power to meet its retail load requirements. (C) TRANSACTIONS WITH AFFILIATED COMPANIES- The primary affiliated companies transactions are as follows: Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 - -------------------------------------------------------------------------------- (Unaudited) (Unaudited) (In millions) Operating Revenues: Wholesale sales-affiliated companies... $ -- $ 9.1 $ 1.1 | $10.0 | Operating Expenses: | Power purchased from FES............... 306.6 188.2 14.6 | -- Service Company support services....... 55.3 81.5 17.0 | 93.0 Power purchased from other affiliates.. 4.5 9.7 1.5 | 8.8 - -------------------------------------------------------------------------------- (D) RETIREMENTS BENEFITS- (1) Net pension and other postretirement benefit costs (income) for the three years ended December 31, 2003 are approximately as follows: Nov. 7- Jan. 1- Dec. 31, Nov. 6, 2003 2002 2001 2001 - ------------------------------------------------------------------------------ (Unaudited) (Unaudited) (In millions) | Pension Benefits.................. $ 7 $(16) $(5) | $(15) Other Postretirement Benefits..... 10 3 1 | 3 - ----------------------------------------------------------------------------- (1) Includes estimated portion of benefit costs included in billings from GPUS. 8. NEW ACCOUNTING STANDARDS AND INTERPRETATIONS: FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities" In December 2003, the FASB issued a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", referred to as "FIN 46R", requires the consolidation of a VIE by an enterprise if that enterprise is determined to be the primary beneficiary of the VIE. As required, the Company adopted FIN 46R for interests in VIEs or potential VIEs commonly referred to as special-purpose entities effective December 31, 2003. Penelec will adopt FIN 46R for all other types of entities effective March 31, 2004. As described in Note 4(E), the Company created a statutory business trust to issue trust preferred securities in the amount of $92 million. Application of the guidance in FIN 46R resulted in the holders of the preferred securities being considered the primary beneficiaries of these trusts. 32 Therefore, the Company has deconsolidated the trust and recognized an equity investment in the trust of $3 million and subordinated debentures to the trust of $95 million as of December 31, 2003. The Company is evaluating entities that meet the deferral criteria and may be subject to consolidation under FIN 46R as of March 31, 2004. These entities are non-utility generators in which we have neither debt nor equity investments but are generally the sole purchaser of their power. SFAS 143, "Accounting for Asset Retirement Obligations" In January 2003, the Company implemented SFAS 143 which provides accounting standards for retirement obligations associated with tangible long-lived assets. This statement requires recognition of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. See Notes 1(E) and 1(H) for further discussions of SFAS 143. DIG Implementation Issue No. C20 for SFAS 133, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) Regarding Contracts with a Price Adjustment Feature" In June 2003, the FASB cleared DIG Issue C20 for implementation in fiscal quarters beginning after July 10, 2003. The issue supersedes earlier DIG Issue C11, "Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception." DIG Issue C20 provides guidance regarding when the presence of a general index, such as the Consumer Price Index, in a contract would prevent that contract from qualifying for the normal purchases and normal sales exception under SFAS 133, as amended, and therefore exempt from the mark-to-market treatment of certain contracts. Adoption of DIG Issue C20 did not impact the Company's financial statements. 9. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The quarterly financial information for the quarters ended June 30, 2003 and September 30, 2003 have been restated to correct costs that should have been capitalized to construction projects but were improperly recorded as operating expenses. These corrections have resulted in restated earnings increases of $0.4 million and $1.2 million during the quarters ended June 30, 2003 and September 30, 2003, respectively. The impact of these adjustments was not material to the Company's consolidated balance sheets or consolidated statements of cash flows for any quarter of 2003. The following summarizes certain consolidated operating results by quarter for 2003 and 2002.
Three Months Ended March 31, 2003 June 30, 2003 September 30, 2003 December 31, 2003 - ------------------------------------------------------------------------------------------------------------------ As Previously As As Previously As Reported Restated Reported Restated -------- -------- --------- -------- (In millions) Operating Revenues.................. $254.9 $231.9 $231.9 $243.0 $243.0 $247.1 Operating Expenses and Taxes........ 242.2 216.0 215.6 230.5 229.3 229.6 - ------------------------------------------------------------------------------------------------------------ Operating Income.................... 12.7 15.9 16.3 12.5 13.7 17.5 Other Income (Expense).............. (0.2) 0.5 0.5 0.6 0.6 1.0 Net Interest Charges................ 8.3 8.1 8.1 9.0 9.0 16.5 Income Before Cumulative Effect of Accounting Change...... 4.2 8.3 8.7 4.1 5.3 2.0 Cumulative Effect of Accounting Change (Net of Income Taxes)..... 1.1 -- -- -- -- -- - ------------------------------------------------------------------------------------------------------------ Net Income.......................... $ 5.3 $ 8.3 $ 8.7 $ 4.1 $ 5.3 $ 2.0 ============================================================================================================ March 31, June 30, September 30, December 31, Three Months Ended 2002 2002 2002 2002 - ------------------------------------------------------------------------------------------------------------- (In millions) Operating Revenues.......................... $242.8 $237.6 $269.4 $277.3 Operating Expenses and Taxes................ 214.3 221.7 256.4 246.5 - ------------------------------------------------------------------------------------------------------------- Operating Income ........................... 28.5 15.9 13.0 30.8 Other Income (Expense)...................... 0.3 0.8 1.0 (0.4) Net Interest Charges........................ 10.0 9.8 9.6 9.6 - ------------------------------------------------------------------------------------------------------------- Net Income ................................. $ 18.8 $ 6.9 $ 4.4 $ 20.8 =============================================================================================================
33 Report of Independent Auditors To the Stockholders and Board of Directors of Pennsylvania Electric Company: In our opinion, the accompanying consolidated balance sheets and consolidated statements of capitalization and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes present fairly, in all material respects, the financial position of Pennsylvania Electric Company (a wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the United States of America, 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 our opinion. The consolidated financial statements of Pennsylvania Electric Company and subsidiaries for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger), were audited by other independent auditors who have ceased operations. Those independent auditors expressed an unqualified opinion on those financial statements in their report dated March 18, 2002. As discussed in Note 1(E) to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of January 1, 2003. As discussed in Note 8 to the consolidated financial statements, the Company changed its method of accounting for the consolidation of variable interest entities as of December 31, 2003. PricewaterhouseCoopers LLP Cleveland, Ohio February 25, 2004 34 The following report is a copy of a report previously issued by Arthur Andersen LLP (Andersen). This report has not been reissued by Andersen and Andersen did not consent to the incorporation by reference of this report into any of the Company's registration statements. Report of Previous Independent Public Accountants To the Stockholders and Board of Directors of Pennsylvania Electric Company: We have audited the accompanying consolidated balance sheet and consolidated statement of capitalization of Pennsylvania Electric Company (a Pennsylvania corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 2001 (post-merger), and the related consolidated statements of income, common stockholder's equity, preferred stock, cash flows and taxes for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger). 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 audit. The financial statements of Pennsylvania Electric Company and subsidiaries as of December 31, 2000 and for each of the two years in the period ended December 31, 2000 (pre-merger), were audited by other auditors whose report dated January 31, 2001, expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2001 financial statements referred to above present fairly, in all material respects, the financial position of Pennsylvania Electric Company and subsidiaries as of December 31, 2001 (post-merger), and the results of their operations and their cash flows for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the period from November 7, 2001 to December 31, 2001 (post-merger), in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Cleveland, Ohio, March 18, 2002. 35 EX-21 44 pn_ex21-6.txt EX 21-6 PENELEC LIST OF SUBS Exhibit 21.6 PENNSYLVANIA ELECTRIC COMPANY SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 2003 STATE OF NAME OF SUBSIDIARY BUSINESS ORGANIZATION ------------------ -------- ------------ NINEVEH WATER COMPANY WATER SERVICE PENNSYLVANIA THE WAVERLY ELECTRIC LIGHT ELECTRIC DISTRIBUTION PENNSYLVANIA AND POWER COMPANY PENELEC PREFERRED CAPITAL II, INC. SPECIAL-PURPOSE FINANCE DELAWARE PENELEC CAPITAL II, L.P. SPECIAL-PURPOSE FINANCE DELAWARE PENELEC CAPITAL TRUST SPECIAL-PURPOSE FINANCE DELAWARE Note: Penelec, along with its affiliates JCP&L and Met-Ed, collectively own all of the common stock of Saxton Nuclear Experimental Corporation, a Pennsylvania nonprofit corporation organized for nuclear experimental purposes which is now inactive. The carrying value of the owners' investment has been written down to a nominal value. EX-23 45 pn_ex23-3.txt EX 23-3 PENELEC PWC CONSENT EXHIBIT 23.3 PENNSYLVANIA ELECTRIC COMPANY CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-62295, 333-62295-01 and 333-62295-02) of Pennsylvania Electric Company of our report dated February 25, 2004 relating to the consolidated financial statements, which appears in the Annual Report to Stockholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 25, 2004 relating to the financial statement schedules, which appear in this Form 10-K. PricewaterhouseCoopers LLP Cleveland, Ohio March 11, 2004 108 -----END PRIVACY-ENHANCED MESSAGE-----