EX-13 65 ex13-7_pe.txt ANNUAL REPORT - PENELEC EXHIBIT 13.7 PENNSYLVANIA ELECTRIC COMPANY 2001 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 is being 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.............................. 2-8 Consolidated Statements of Income................................. 9 Consolidated Balance Sheets....................................... 10 Consolidated Statements of Capitalization......................... 11 Consolidated Statements of Common Stockholder's Equity............ 12 Consolidated Statements of Preferred Stock........................ 12 Consolidated Statements of Cash Flows............................. 13 Consolidated Statements of Taxes.................................. 14 Notes to Consolidated Financial Statements........................ 15-22 Reports of Independent Public Accountants......................... 23-24 PENNSYLVANIA ELECTRIC COMPANY SELECTED FINANCIAL DATA
Years Ended December 31, Nov. 7 - Jan. 1 - -------------------------------------------------- Dec. 31, 2001 Nov. 6, 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Operating Revenues............................. $ 140,062 | $ 834,548 $ 901,881 $ 921,965 $ 1,032,226 $ 1,052,936 =========== | =========== =========== ========== =========== =========== | Operating Income............................... $ 14,341 | $ 70,049 $ 80,336 $ 140,925 $ 125,623 $ 157,950 =========== | =========== =========== ========== =========== =========== | Income Before Extraordinary Item............... $ 10,795 | $ 23,718 $ 39,250 $ 152,491 $ 58,590 $ 95,023 =========== | =========== =========== ========== =========== =========== | Net Income..................................... $ 10,795 | $ 23,718 $ 39,250 $ 152,491 $ 39,640 $ 95,023 =========== | =========== =========== ========== =========== =========== | Earnings on Common Stock....................... $ 10,795 | $ 23,718 $ 39,250 $ 151,611 $ 38,945 $ 94,358 =========== | =========== =========== ========== =========== =========== | Total Assets................................... $ 3,300,269 | $ 2,331,484 $2,463,052 $ 3,565,747 $ 2,499,703 =========== | =========== ========== =========== =========== | | Capitalization: | Common Stockholder's Equity.................... $ 1,306,576 | $ 469,837 $ 461,182 $ 767,304 $ 791,338 Cumulative Preferred Stock..................... -- | -- -- 16,681 16,681 Company-Obligated Mandatorily Redeemable | Preferred Securities........................ -- | -- -- 105,000 105,000 Company-Obligated Trust Preferred Securities... 92,000 | 100,000 100,000 -- -- Long-Term Debt................................. 472,400 | 519,481 426,795 629,027 679,716 ----------- | ----------- ---------- ----------- ----------- Total Capitalization........................... $ 1,870,976 | $ 1,089,318 $ 987,977 $ 1,518,012 $ 1,592,735 =========== | =-========= ========== =========== =========== | | Capitalization Ratios: | Common Stockholder's Equity.................... 69.8%| 43.1% 46.7% 50.5% 49.7% Cumulative Preferred Stock..................... -- | -- -- 1.1 1.0 Company-Obligated Mandatorily Redeemable | Preferred Securities........................ -- | -- -- 6.9 6.6 Company-Obligated Trust Preferred Securities... 4.9 | 9.2 10.1 -- -- Long-Term Debt................................. 25.3 | 47.7 43.2 41.5 42.7 ------ | ----- ----- ----- ------ Total Capitalization........................... 100.0%| 100.0% 100.0% 100.0% 100.0% ===== | ===== ===== ===== ===== | | Transmission and Distribution | Kilowatt-Hour deliveries (Millions): | Residential.................................... 721 | 3,264 3,949 3,864 3,756 3,801 Commercial..................................... 758 | 3,733 4,509 4,319 4,198 4,098 Industrial..................................... 685 | 3,658 4,698 4,865 4,996 4,835 Other.......................................... 7 | 34 40 43 42 45 ----- | ------- -------- ------ ------ ------ Total Retail................................... 2,171 | 10,689 13,196 13,091 12,992 12,779 Total Wholesale................................ 107 | 1,351 2,885 4,219 4,309 3,461 ----- | ------- -------- ------- ------ ------ Total.......................................... 2,278 | 12,040 16,081 17,310 17,301 16,240 ===== | ====== ======== ====== ====== ====== | | Transmission and Distribution Deliveries | Customers Served:: | Residential.................................... 502,901 | 502,052 500,930 499,484 498,229 Commercial..................................... 76,005 | 74,282 73,979 73,014 72,271 Industrial..................................... 2,652 | 2,703 2,844 2,910 2,949 Other.......................................... 1,099 | 1,110 1,110 1,111 1,117 ------- | -------- ------- ------- ------- Total.......................................... 582,657 | 580,147 578,863 576,519 574,566 ======= | ======== ======= ======= =======
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 that is subject to certain risks and uncertainties. Such 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, legislative and regulatory changes (including revised environmental requirements), the availability and cost of capital, ability to accomplish or realize anticipated benefits from strategic initiatives and other similar factors. Results of Operations --------------------- Earnings on common stock decreased 12.1% to $34.5 million in 2001 from $39.2 million in 2000. In 2001, earnings were negatively impacted by higher other operating costs, as well as lower other income. Offsetting this were higher revenues and lower net interest charges. In 2000, earnings on common stock decreased 74.1% to $39.2 million from $151.6 million in 1999. The decrease was primarily due to greater purchased power costs, the absence of a net gain related to wholesale operations from the sale of substantially all of our generating facilities in 1999, and, to a lesser extent, higher net interest charges. Lower other operating costs and depreciation expense positively affected earnings on common stock in 2000. Operating revenues increased by $72.7 million in 2001 following a $20.1 million decrease in 2000. The sources of the changes in operating revenues during 2001 and 2000, as compared to the prior year, are summarized in the following table. Sources of Revenue Changes 2001 2000 -------------------------------------------------------------------- Increase (Decrease) (In millions) Change in kilowatt-hour sales due to level of retail customers shopping for generation service.................. $134.5 $ 9.5 Change in other retail kilowatt-hour sales......... (12.2) 10.1 Decrease in wholesale sales........................ (50.6) (32.4) All other changes.................................. 1.0 (7.3) -------------------------------------------------------------------- Net Increase (Decrease) in Operating Revenues...... $ 72.7 $(20.1) ==================================================================== Electric Sales In 2001, a major source of the increase in operating revenues was the increase in retail generation kilowatt-hour sales due to a large number of customers returning to us in 2001 as full service customers, after receiving their power from alternate suppliers in 2000. In 2001, 85.3% of total retail sales were to full service customers as compared to 62.7% in 2000. Residential sales remained relatively flat, while commercial sales were slightly lower in 2001 compared to 2000, primarily due to lower usage. Industrial sales also decreased in 2001 compared to 2000 due almost evenly to a decrease in the number of customers and lower usage by existing customers. Sales to wholesale customers decreased in 2001 compared to 2000 due to a reduction in our available capacity. The primary source of the decrease in operating revenues in 2000, compared to the prior year, was lower sales to the wholesale market, as a result of us having additional power available in 1999 due to the delay of the divestiture of our generating assets. Operating revenues also increased due to higher residential and commercial sales, partially offset by lower industrial sales. Changes in kilowatt-hour sales by customer class in 2001 and 2000 are summarized in the following table: 2 Changes in Kilowatt-hour Sales 2001 2000 -------------------------------------------------- Increase (Decrease) Residential.................. 0.9% 2.2% Commercial................... (0.4)% 4.4% Industrial................... (7.6)% (3.4)% -------------------------------------------------- Total Retail................. (2.5)% 0.8% Wholesale.................... (49.5)% (31.6)% -------------------------------------------------- Total Sales.................. (11.0)% (7.1)% -------------------------------------------------- Operating Expenses and Taxes Total operating expenses and taxes increased $68.7 million in 2001 and $40.5 million in 2000, compared to the preceding year. Higher purchased power costs accounted for the majority of the increased costs in 2001. Purchased power costs also increased significantly in 2000 but were partially offset by lower nuclear costs, other operating costs and depreciation expenses. Purchased power costs increased $54.5 million in 2001, compared to 2000. The higher costs resulted from increased quantities of power purchased through the PJM Power Pool due to a large number of customers returning to us in 2001 after receiving their power from alternate suppliers in 2000, as well as higher average prices of power purchased under two-party agreements. Also included in 2001 purchased power costs was a $16 million charge related to the termination of a wholesale energy contract with Allegheny Electric Cooperative. Offsetting these increases was the effect of the Pennsylvania Public Utility Commission's (PPUC) June 2001 order that allowed us to defer, for future rate recovery from customers, energy costs in excess of our fixed generation tariff rates, retroactive to January 1, 2001, in connection with our provider of last resort (PLR) obligation. In 2000, fuel and purchased power costs increased $183.2 million over 1999. The majority of the increase was due to the need to purchase substantially all of our energy requirements following the sales of generating assets in 1999, and the absence of deferred accounting treatment for these costs. An offsetting decrease in fuel costs also resulted from the sales of generating assets. The sale of Unit 1 of the Three Mile Island Nuclear Plant, completed in December 1999, eliminated essentially all of our nuclear operating costs in 2000. Other operating costs increased $9.9 million in 2001, compared to 2000, primarily due the absence in 2001 of a pension curtailment gain associated with employees who were terminated at the time of the sale of our generating assets. This gain was realized in 2000 as a result of the PPUC's Phase II Order. Other operating costs also increased due to costs related to Voluntary Enhanced Retirement Programs offered to certain bargaining unit employees. In 2000, other operating costs decreased $68.7 million compared to the previous year. The primary reason for the decline was a reduction in expenses associated with the operation of generating stations due to the sale of all our remaining generating assets in 1999. Other operating costs were also reduced as a result of the net impact of the PPUC's Phase II Order issued in December 2000, which allowed us to realize the pension curtailment gain discussed above, offset by a write-off for the disallowance of a portion of our stranded costs. The sale of generating assets in 1999 was also the cause for a decrease in depreciation expense of $21.9 million in 2000 from the previous year. Other Income Other income decreased $10.3 million in 2001 from the previous year. The decrease was attributed to charges for a sustainable energy fund and renewable energy projects in accordance with the Stipulation of Settlement related to the merger of FirstEnergy and GPU, Inc. Also contributing to the decrease was lower interest income. In 2000, other income decreased $48.9 million from the previous year. The decrease was due to the absence in 2000 of net gains related to wholesale operations as a result of the sale of substantially all our generating stations and lower interest income. Partially offsetting these reductions was the reversal of an estimated 1999 tax penalty. Net Interest Charges Net interest charges decreased by $1.5 million in 2001 after increasing $3.7 million in 2000 compared to the prior year. In 2001, the decrease was due to the absence of prior year expense associated with a federal income tax deficiency, higher deferred interest income, and lower short-term borrowing levels. These decreases were partially offset by additional interest expense on $93 million of senior notes issued during 2000. The issuance of the $93 million of senior notes during 2000 was also responsible for the increase in interest expense in 2000 compared to 1999. 3 Capital Resources and Liquidity ------------------------------- We had approximately $39 million of cash and temporary investments and $77.6 million of short-term indebtedness on December 31, 2001. 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, 2001, we had the capability to issue $450 million of additional senior notes based upon FMB collateral. We have no restrictions on the issuance of preferred stock. At the end of 2001, our common equity as a percentage of capitalization, including debt relating to assets held for sale, stood at 70% compared to 43% at the end of 2000. This increase resulted from the allocation of the purchase price in the merger between FirstEnergy and GPU. Following approval of the merger of FirstEnergy and GPU by the New Jersey Board of Public Utilities on September 26, 2001, Standard and Poor's adjusted our corporate credit rating from A/A-1 to BBB/A-2, and our senior unsecured debt rating from A to BBB. The lower credit ratings reflect Standard & Poor's consolidated rating methodology, which resulted in essentially the same corporate credit rating for all of FirstEnergy's electric utility operating companies. The credit rating outlook of Standard & Poor's is stable. On February 22, 2002, Moody's announced a change in its outlook for our credit ratings from stable to negative based upon a decision by the Commonwealth Court of Pennsylvania to reverse the PPUC's decision to grant us rate relief (see Regulatory Matters). Our cash requirements in 2002 for operating expenses, construction expenditures, scheduled debt maturities and preferred stock redemptions are expected to be met without increasing our net debt and preferred stock outstanding. Major contractual obligations for future cash payments are summarized in the following table: Contractual Obligations 2002 2003 2004 2005 2006 Thereafter Total ------------------------------------------------------------------------------- (In millions) Long-term debt..................$ 50 $ -- $125 $ 8 $ -- $ 336 $ 519 Mandatory preferred stock....... 100 100 Capital leases ................. 1 1 -- -- -- -- 2 Unconditional power purchases... 415 261 200 194 197 1,882. 3,149 ------------------------------------------------------------------------------- $466 $262 $325 $202 $197 $2,318 $3,770 =============================================================================== Our capital spending for the period 2002-2006 is expected to be about $375 million, of which approximately $72 million applies to 2002. 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 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 derivative instruments, including options, futures contracts and swaps. These derivatives are used principally for hedging purposes. The change in the fair value of commodity derivative contracts related to energy production during 2001 is summarized in the table below: Increase (Decrease)in the Fair Value of Commodity Derivative Contracts ----------------------------------------------------------------------- Nov. 7-Dec. 31 Jan. 1-Nov. 6 2001 2001 ----------------------------------------------------------------------- (In millions) Outstanding as of beginning of period with SFAS 133 cumulative adjustment.............. $3.6 $12.8 Contract value when entered................... 0.3 5.2 Decrease in value of existing contracts....... (2.5) (3.5) Change in techniques/assumptions.............. -- (10.6) Settled contracts............................. (0.1) (0.3) ----------------------------------------------------------------------- Outstanding as of end of period............... $1.3 $3.6 ======================================================================= 4 While the valuation of derivative contracts is always based on active market prices when they are available, longer-term contracts can require the use of model-based estimates of prices in later years due to the absence of published market prices. Currently, substantially all of our derivatives are valued based on active market prices. 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 our derivative instruments would not have had a material effect on our consolidated financial position or cash flows as of December 31, 2001. 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. We are subject to the inherent interest rate risks related to refinancing maturing debt by issuing new debt securities. Changes in the market value of our nuclear decommissioning trust funds are recognized by making corresponding changes to the decommissioning liability, as described in Note 1 to the consolidated financial statements. Comparison of Carrying Value to Fair Value -------------------------------------------------------------------------------- There- Fair 2002 2003 2004 2005 2006 after Total Value -------------------------------------------------------------------------------- (Dollars in millions) Investments other than Cash and Cash Equivalents: Fixed Income............. -- -- -- -- -- $192 $192 $194 Average interest rate.. 4.7% 4.7% -------------------------------------------------------------------------------- ________________________________________________________________________________ Liabilities -------------------------------------------------------------------------------- Long-term Debt: Fixed rate............... $ 50 -- $125 $ 8 -- $336 $519 $509 Average interest rate.. 6.5% 5.8% 7.5% 6.4% 6.3% Variable rate............ Average interest rate.. Short-term Borrowings.... $ 78 -- -- -- -- -- $ 78$ 78 Average interest rate.. 4.9% 4.9% -------------------------------------------------------------------------------- Preferred Stock.......... -- -- -- -- -- $100 $100 $ 90 Average dividend rate.. 7.4% 7.4% -------------------------------------------------------------------------------- Interest Rate Swap Agreements We use interest rate swap agreements to manage the risk of increases in variable interest rates. All of the agreements convert variable rate debt to fixed rate debt. As of December 31, 2001, interest rate swaps had a weighted average fixed interest rate of 7.16%. The swap agreements in effect as of December 31, 2001 had a notional amount of $50 million, a maturity date of 2002 and a fair value of ($1.8) million. Outlook ------- Our industry continues to transition to a more competitive environment. As of January 1, 1999, all of our customers could select alternative energy suppliers. We continue to deliver power to homes and businesses through our existing distribution system, which remains regulated. The 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 Matters In June 2001, we entered into a settlement agreement with major parties in the combined merger and rate proceedings that, in addition to resolving certain issues concerning the PPUC's approval of our merger with FirstEnergy, also addressed our request for PLR relief. We are permitted to defer, for future recovery, the difference between our actual energy costs and those reflected in our capped generation rates. Those costs will continue to be deferred through December 31, 2005. If energy costs incurred during that period are below our capped generation rates, the difference would be used to reduce our recoverable deferred costs. Our PLR obligation was extended through December 31, 2010. Our CTC 5 revenues will be applied first to PLR costs, then to stranded costs other than for non-utility generation (NUG) and finally to NUG stranded costs through December 31, 2010. We would be permitted to recover any remaining stranded costs through a continuation of the CTC after December 31, 2010; however, such recovery would extend to no later than December 31, 2015. Any amounts not expected to be recovered by December 31, 2015 would be written off at the time such nonrecovery becomes probable. Several parties had appealed this PPUC decision to the Commonwealth Court of Pennsylvania. On February 21, 2002, the Court affirmed the PPUC decision regarding approval of the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. The Court reversed the PPUC's decision regarding our PLR obligation, and denied our related requests for rate relief. We are considering our response to the Court's decision, which could include asking the Pennsylvania Supreme Court to review the decision. We are unable to predict the outcome of these matters. Supply Plan As part of our Restructuring Order, we are obligated to supply electricity to customers who do not choose an alternate supplier. The total forecasted peak of this obligation in 2002 is 2,300 megawatts (MW). Our current supply portfolio contains approximately 400 MW of long-term purchases from NUGs, and our remaining obligation is expected to be met through a mix of multi-year forward purchases, short-term forward (less than one year) purchases and spot market purchases. Environmental Matters Various environmental liabilities have been recognized on the Consolidated Balance Sheet as of December 31, 2001, 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. 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. Federal law provides that all PRPs for a particular site be held liable on a joint and several basis. We have total accrued liabilities aggregating approximately $1 million as of December 31, 2001. We do not believe environmental remediation costs will have a material adverse effect on our financial condition, cash flows or results of operations. Legal Matters Various lawsuits, claims and proceedings related to our normal business operations are pending against us, the most significant of which is described below. We have a 25% ownership interest in Unit 2 of the Three Mile Island Nuclear Plant (TMI-2), which was damaged during a 1979 accident. As a result of the accident, claims for alleged personal injury were filed against us, Jersey Central Power & Light Company, Metropolitan Edison Company and GPU in the U.S. District Court for the Middle District of Pennsylvania. In 1996, the District Court granted a motion for summary judgment filed by the defendants and dismissed the ten initial "test cases" which had been selected for a test case trial, as well as all of the remaining 2,100 pending claims. In November 1999, the U.S. Court of Appeals for the Third Circuit affirmed the District Court's dismissal of the ten test cases, but set aside the dismissal of the additional pending claims, remanding them to the District Court for further proceedings. Following the resolution of judicial proceedings dealing with admissible evidence, we have again requested summary judgment of the remaining 2,100 claims in the District Court. On January 15, 2002, the District Court granted our motion. On February 14, 2002, the plaintiffs filed a notice of appeal of this decision (see Note 6 - Other Legal Proceedings). Although unable to predict the outcome of this litigation, we believe that any liability to which we might be subject by reason of the TMI-2 accident will not exceed our financial protection under the Price-Anderson Act. Significant Accounting Policies ------------------------------- We prepare our consolidated financial statements in accordance with accounting principles 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 continually 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 On November 7, 2001, the merger between FirstEnergy and GPU became effective, and we became a wholly owned subsidiary of FirstEnergy. The merger 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 6 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 are subject to adjustment in 2002 when finalized, 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, which will be reviewed for impairment at least annually. As of December 31, 2001, we had recorded goodwill of approximately $797.4 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 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. As of December 31, 2001, we had regulatory assets of $769.8 million. 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 legislation, 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 must be documented. Derivative contracts that are determined to fall within the scope of Statement of Financial Accounting Standards (SFAS) No. 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 commodities 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 year. The determination of unbilled revenues requires management to make various estimates including: - Net energy purchased or generated for retail load - Losses of energy over distribution lines - Mix of kilowatt-hour usage by residential, commercial and industrial customers - Kilowatt-hour usage of customers receiving electricity from alternative suppliers Recently Issued Accounting Standards ------------------------------------ The Financial Accounting Standards Board (FASB) approved SFAS 141, "Business Combinations," and SFAS 142, "Goodwill and Other Intangible Assets," on June 29, 2001. SFAS 141 requires that all business combinations initiated after June 30, 2001 be accounted for using purchase accounting. The provisions of the new standard relating to the determination of goodwill and other intangible assets have been applied to our 2001 merger, which was accounted for as a purchase transaction. Under SFAS 142, amortization of existing goodwill will cease January 1, 2002. Instead, goodwill will be tested for impairment at least on an annual basis, and no impairment of goodwill is anticipated as a result of a preliminary analysis. We did not have any goodwill prior to our 2001 merger, and we did not amortize goodwill associated with the merger under the provisions of the new standard. In July 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement Obligations." The new statement provides accounting standards for retirement obligations associated with tangible long-lived assets, with adoption required by January 1, 2003. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recorded 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. Upon retirement, a gain or loss will be recorded if the cost to settle the retirement obligation differs from the carrying amount. We are currently assessing the new standard and have not yet determined the impact on our financial statements. 7 In September 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The Statement also supersedes the accounting and reporting provisions of APB 30. Our adoption of this Statement, effective January 1, 2002, will result in our accounting for any future impairments or disposals of long-lived assets under the provisions of SFAS 144, but will not change the accounting principles used in previous asset impairments or disposals. Application of SFAS 144 is not anticipated to have a major impact on accounting for impairments or disposal transactions compared to the prior application of SFAS 121 or APB 30. 8 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF INCOME
Nov 7 - Jan. 1 - For the Years Ended Dec.31, Dec. 31, 2001 Nov. 6, 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------------- (In thousands) OPERATING REVENUES........................................ $140,062 | $834,548 $901,881 $921,965 -------- | -------- -------- -------- | OPERATING EXPENSES AND TAXES: | Fuel and purchased power............................... 79,815 | 519,838 545,117 361,901 Nuclear operating costs................................ -- | -- -- 30,626 Other operating costs.................................. 20,015 | 138,543 148,698 217,408 -------- | -------- -------- -------- Total operation and maintenance expenses............. 99,830 | 658,381 693,815 609,935 Provision for depreciation and amortization............ 8,613 | 49,191 56,505 78,384 General taxes.......................................... 6,281 | 39,532 45,890 42,046 Income taxes........................................... 10,997 | 17,395 25,335 50,675 -------- | -------- -------- --------- Total operating expenses and taxes................... 125,721 | 764,499 821,545 781,040 -------- | -------- -------- -------- | OPERATING INCOME.......................................... 14,341 | 70,049 80,336 140,925 | OTHER INCOME (EXPENSE).................................... 3,049 | (6,610) 6,716 55,641 -------- | -------- -------- -------- | INCOME BEFORE NET INTEREST CHARGES........................ 17,390 | 63,439 87,052 196,566 -------- | -------- -------- -------- | NET INTEREST CHARGES: | Subsidiaries preferred dividends....................... 1,101 | 6,239 7,034 8,953 Interest on long-term debt............................. 3,972 | 28,751 29,964 31,837 Allowance for borrowed funds used during | construction......................................... 47 | (494) (742) (1,074) Deferred interest income............................... (504) | (783) -- -- Other interest expense ................................ 1,979 | 6,008 11,546 4,359 -------- | -------- -------- -------- Net interest charges................................... 6,595 | 39,721 47,802 44,075 -------- | -------- -------- -------- | NET INCOME................................................ 10,795 | 23,718 39,250 152,491 | PREFERRED STOCK DIVIDEND | REQUIREMENTS........................................... -- | -- -- 154 -------- | -------- -------- -------- | LOSS ON PREFERRED STOCK REACQUISITION..................... -- | -- -- 726 -------- | -------- -------- -------- | EARNINGS ON COMMON STOCK.................................. $ 10,795 | $ 23,718 $ 39,250 $151,611 ======== | ======== ======== ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
9 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED BALANCE SHEETS
As of December 31, 2001 2000 ------------------------------------------------------------------------------------------------------------------ (In thousands) ASSETS UTILITY PLANT: In service..................................................................... $1,845,187 | $1,794,259 Less-Accumulated provision for depreciation.................................... 630,957 | 588,377 ---------- | ---------- 1,214,230 | 1,205,882 ---------- - ---------- Construction work in progress- | Electric plant............................................................... 12,857 | 25,895 ---------- | ---------- 1,227,087 | 1,231,777 ---------- | ---------- OTHER PROPERTY AND INVESTMENTS: | Nonutility generation trusts................................................... 154,067 | 190,710 Nuclear plant decommissioning trusts........................................... 96,610 | 98,426 Long-term notes receivable from associated companies........................... 15,515 | 15,515 Other.......................................................................... 2,265 | 833 ---------- | ---------- 268,457 | 305,484 ---------- | ---------- CURRENT ASSETS: | Cash and cash equivalents...................................................... 39,033 | 581 Receivables- | Customers (less accumulated provisions of $14,719,000 and $14,851,000 | respectively, for uncollectible accounts)................................. 107,170 | 117,515 Associated companies......................................................... 40,203 | 9,558 Other........................................................................ 14,842 | 21,205 Prepayments ................................................................... 8,605 | 11,868 ---------- | ---------- 209,853 | 160,727 ---------- | ---------- DEFERRED CHARGES: | Regulatory assets.............................................................. 769,807 | 614,182 Goodwill....................................................................... 797,362 | -- Other.......................................................................... 27,703 | 19,314 ---------- | ---------- 1,594,872 | 633,496 ---------- | ---------- $3,300,269 | $2,331,484 ---------- | ---------- CAPITALIZATION AND LIABILITIES | | CAPITALIZATION (See Consolidated Statements of Capitalization): | Common stockholder's equity.................................................... $1,306,576 | $ 469,837 Company-obligated trust preferred securities................................... 92,000 | 100,000 Long-term debt................................................................. 472,400 | 519,481 ---------- | ---------- 1,870,976 | 1,089,318 ---------- | ---------- CURRENT LIABILITIES: | Currently payable long-term debt and preferred stock........................... 50,756 | 499 Short-term borrowings (Note 5)- | Associated companies......................................................... 77,623 | -- Other........................................................................ -- | 55,800 Accounts payable- | Associated companies......................................................... 126,390 | 29,788 Other........................................................................ 38,720 | 49,452 Accrued taxes.................................................................. 29,255 | 23,895 Accrued interest............................................................... 12,284 | 11,582 Other.......................................................................... 10,993 | 7,970 ---------- | ---------- 346,021 | 178,986 ---------- | ---------- DEFERRED CREDITS: | Accumulated deferred income taxes.............................................. 21,682 | 25,013 Accumulated deferred investment tax credits.................................... 11,956 | 13,098 Nuclear plant decommissioning costs............................................ 135,483 | 132,717 Nuclear fuel disposal costs.................................................... 18,453 | 17,728 Power purchase contract loss liability......................................... 867,046 | 846,992 Other.......................................................................... 28,652 | 27,632 ---------- | ---------- 1,083,272 | 1,063,180 ---------- | ---------- COMMITMENTS AND CONTINGENCIES | (Notes 3 and 6) ---------- | ---------- $3,300,269 | $2,331,484 ========== | ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
10 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION
As of December 31, 2001 2000 ------------------------------------------------------------------------------------------------------------------- (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............................................................ 1,188,190 | 320,487 Accumulated other comprehensive income (Note 4E)................................. 1,779 | 23 Retained earnings (Note 4A)...................................................... 10,795 | 43,515 ---------- | ---------- Total common stockholder's equity.............................................. 1,306,576 | 469,837 ---------- | ---------- | COMPANY OBLIGATED TRUST | PREFERRED SECURITIES | OF SUBSIDIARY TRUST | (NOTE 4C): | 7.34% due 2039................................................................. 92,000 | 100,000 | LONG-TERM DEBT (Note 4D): | First mortgage bonds: | 6.125% due 2007................................................................ 4,110 | 4,110 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................................................... 73,420 | 73,420 ---------- | ---------- | Unsecured notes: | 6.42% due 2002................................................................. 25,000 | 25,000 6.47% due 2002................................................................. 25,000 | 25,000 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 7.69% due 2039................................................................. 2,998 | 3,012 ---------- | ---------- Total senior notes........................................................... 445,998 | 446,012 ---------- | ---------- | Capital lease obligations (Note 3)............................................... 1,670 | 2,153 ---------- | ---------- Net unamortized premium (discount) on debt....................................... 2,068 | (1,605) ---------- | ---------- Long-term debt due within one year............................................... (50,756) | (499) ---------- | ---------- Total long-term debt............................................................. 472,400 | 519,481 ---------- | ---------- TOTAL CAPITALIZATION................................................................ $1,870,976 | $1,089,318 ========== | ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
11 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, 1999....................... 5,290,596 $105,812 $ 285,487 $8,353 $ 367,653 Net income.................................. $152,491 152,491 Net unrealized gain (loss) on investments... 2,101 2,101 Minimum pension liability................... 165 165 -------- Comprehensive income........................ 154,757 -------- Loss on preferred stock reacquisition....... (725) Cash dividends on preferred stock........... (154) Cash dividends on common stock.............. (460,000) ----------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1999..................... 5,290,596 105,812 285,487 10,619 59,265 Net income.................................. 39,250 39,250 Net unrealized gain (loss) on investments... (10,596) (10,596) -------- Comprehensive income........................ 28,654 -------- Contributions from parent company........... 35,000 Cash dividends on common stock.............. (55,000) ----------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2000..................... 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 gain (loss) on derivative instruments............................... (1,064) (1,064) -------- Comprehensive income........................ 22,666 -------- Contributions from parent company........... 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 gain (loss) on investments... (2) (2) Net unrealized gain (loss) 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 ============================================================================================================================= 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, 1999............ 165,485 $16,681 4,200,000 $105,000 Redemptions- 4.40% Series B................ (29,678) (3,026) 3.70% Series C................ (49,568) (4,983) 4.05% Series D................ (28,219) (2,852) 4.70% Series E................ (14,103) (1,411) 4.50% Series F................ (17,081) (1,714) 4.60% Series G................ (26,836) (2,695) 8.75% Series.................. (4,200,000) (105,000) Issuances- 7.34% Series.................... 4,000,000 100,000 ---------------------------------------------------------------------------------------- Balance, December 31, 1999.......... -- -- 4,000,000 100,000 ======================================================================================== Balance, December 31, 2000.......... -- -- 4,000,000 100,000 ======================================================================================== Purchase accounting fair value adjustment............... (8,000) ---------------------------------------------------------------------------------------- Balance, December 31, 2001.......... -- $ -- 4,000,000 $ 92,000 ======================================================================================== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
12 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS Nov. 7 - Jan. 1 - For the Years Ended Dec. 31, Dec. 31, 2001 Nov. 6, 2001 2000 1999 ------------------------------------------------------------------------------------------------------------------------- (In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: Net Income...........................................................$ 10,795 | $ 23,718 $ 39,250 $ 152,491 Adjustments to reconcile net income to net | cash from operating activities: | Provision for depreciation and amortization..................... 8,613 | 49,191 56,505 78,384 Nuclear fuel and lease amortization............................. -- | -- -- 6,036 Other amortization.............................................. 309 | 1,672 347 -- Impact of PPUC rate order, net.................................. -- | -- (21,550) -- Deferred costs, net............................................. (7,467) | (143,462) (76,957) (57,474) Deferred income taxes, net...................................... (23,127) | 60,170 15,946 (394,872) Investment tax credits, net..................................... (171) | (970) (1,142) (22,687) Receivables..................................................... (26,592) | 16,566 (19,089) (11,216) Materials and supplies.......................................... -- | -- -- 56,559 Accounts payable................................................ (19,382) | 29,462 (20,608) 6,110 Other........................................................... 41,590 | (36,884) (89,125) (81,187) --------- | ---------- --------- ---------- Net cash used for operating activities........................ (15,432) | (537) (116,423) (267,856) --------- | ---------- --------- ---------- | CASH FLOWS FROM FINANCING ACTIVITIES: | New Financing- | Long-term debt.................................................. -- | -- 118,000 348,218 Short-term borrowings, net...................................... 2,623 | 19,200 2,200 -- Company-obligated trust preferred securities.................... -- | -- -- 96,535 Contributions from parent....................................... -- | 50,000 35,000 -- Redemptions and Repayments- | Preferred stock................................................. -- | -- -- 17,406 Long-term debt.................................................. -- | -- 25,000 600,011 Short-term borrowings, net...................................... -- | -- -- 32,423 Company-obligated mandatorily redeemable | preferred securities......................................... -- | -- -- 105,383 Capital lease principal payments................................ -- | -- -- 7,907 Dividend Payments- | Common stock.................................................... -- | -- 55,000 460,000 Preferred stock................................................. -- | -- -- 154 -------- | ---------- --------- ---------- Net cash used for (provided from) financing activities........ (2,623) | (69,200) (75,200) 778,531 -------- | ---------- --------- ---------- | CASH FLOWS FROM INVESTING ACTIVITIES: | Property additions................................................... 9,687 | 50,543 73,247 78,331 Contributions to (proceeds from) nonutility generation trusts........ (29,944) | (18,339) (75,991) 266,701 Contributions to decommissioning trusts.............................. -- | 15 40 75,926 Sale of investments.................................................. -- | -- -- (1,493,444) Other................................................................ 246 | 5,194 (6,617) (1,002) -------- | ---------- --------- ---------- Net cash used for (provided from) investing activities........ (20,011) | 37,413 (9,321) (1,073,488) -------- | ---------- --------- ---------- Net increase (decrease) in cash and cash equivalents................. 7,202 | 31,250 (31,902) 27,101 Cash and cash equivalents at beginning of period..................... 31,831 | 581 32,483 5,382 -------- | ---------- --------- ---------- Cash and cash equivalents at end of period...........................$ 39,033 | $ 31,831 $ 581 $ 32,483 ======== | ========== ========= ========== | SUPPLEMENTAL CASH FLOWS INFORMATION: | Cash Paid During the Year- | Interest (net of amounts capitalized)...........................$ 2,018 | $ 35,134 $ 33,409 $ 46,826 ======== | ========== ========= ========== Income taxes (refund)...........................................$(12,176) | $ (14,542) $ 110,395 $ 413,810 ======== | ========== ========= ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
13 PENNSYLVANIA ELECTRIC COMPANY CONSOLIDATED STATEMENTS OF TAXES
Nov. 7 - Jan. 1 - For the Years Ended Dec. 31, Dec. 31, 2001 Nov. 6, 2001 2000 1999 -------------------------------------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: Real and personal property......................................... $ (146) | $ 1,622 $ 1,139 $ 5,998 State gross receipts............................................... 5,560 | 30,932 37,222 27,498 Other.............................................................. 867 | 6,978 7,529 8,550 -------- | ---------- --------- ---------- Total general taxes......................................... $ 6,281 | $ 39,532 $ 45,890 $ 42,046 ======== | ========== ========= ========== | PROVISION FOR INCOME TAXES: | Currently payable- | Federal......................................................... $ 23,861 | $ (36,615) $ 11,593 $ 358,267 State........................................................... 7,667 | (3,183) 3,357 113,675 -------- | ---------- --------- ---------- 31,528 | (39,798) 14,950 471,942 -------- | ---------- --------- ---------- Deferred, net- | Federal......................................................... (17,511) | 46,346 11,732 (298,890) State........................................................... (5,616) | 13,824 4,214 (95,982) -------- | ---------- --------- ---------- (23,127) | 60,170 15,946 (394,872) -------- | ---------- --------- ---------- Investment tax credit amortization................................. (171) | (970) (1,142) (22,687) -------- | ---------- --------- ---------- Total provision for income taxes............................ $ 8,230 | $ 19,402 $ 29,754 $ 54,383 ======== | ========== ========= ========== | INCOME STATEMENT CLASSIFICATION | OF PROVISION FOR INCOME TAXES: | Operating income................................................... $ 10,997 | $ 17,395 $ 25,335 $ 50,675 Other income....................................................... (2,767) | 2,007 4,419 3,708 -------- | ---------- --------- ---------- Total provision for income taxes............................ $ 8,230 | $ 19,402 $ 29,754 $ 54,383 ======== | ========== ========= ========== | RECONCILIATION OF FEDERAL INCOME TAX | EXPENSE AT STATUTORY RATE TO TOTAL | PROVISION FOR INCOME TAXES: | Book income before provision for income taxes $ 19,025 | $ 43,120 $ 69,003 $ 206,875 ======== | ========== ========= ========== Federal income tax expense at statutory rate....................... $ 6,659 | $ 15,092 $ 24,151 $ 72,406 Increases (reductions) in taxes resulting from- | Amortization of investment tax credits.......................... (171) | (969) (1,140) (22,686) Depreciation.................................................... 555 | 1,407 1,183 109 State income tax, net of federal tax............................ 1,404 | 7,156 3,590 14,951 Allocated share of consolidated tax savings..................... -- | (2,912) -- (880) Other, net...................................................... (217) | (372) 1,970 (9,517) -------- | ---------- --------- ---------- Total provision for income taxes............................ $ 8,230 | $ 19,402 $ 29,754 $ 54,383 ======== | ========== ========= ========== | ACCUMULATED DEFERRED INCOME TAXES AT | DECEMBER 31: | Property basis differences......................................... $256,951 | $ 250,410 $ 257,820 Nuclear decommissioning............................................ (42,138) | (35,495) 2,693 Non-utility generation costs....................................... (214,492) | (112,291) (103,621) Purchase accounting basis difference............................... (38,407) | -- -- Sale of generation assets.......................................... 5,302 | 5,302 (245,097) Regulatory transition charge....................................... (9,329) | (9,329) 22,904 Customer receivables for future income taxes....................... 61,493 | 65,506 68,816 Other.............................................................. 2,302 | (139,090) 14,250 -------- | --------- ---------- Net deferred income tax liability........................... $ 21,682 | $ 25,013 $ 17,765 ======== | ========= ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
14 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. All significant intercompany transactions have been eliminated. The Company is a wholly owned subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the issued and outstanding common shares of 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 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 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 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. 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 through the end of the year. 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, 2001 or 2000, with respect to any particular segment of the Company's customers. 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 rate restructuring plan for the Company in 1998 which essentially resulted in the deregulation of the Company's generation business. The Company has 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 the Company's provider of last resort (PLR) obligation. 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 order. 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 ratepayers. If the IRS ruling ultimately supports returning these tax benefits to ratepayers, the Company would then reduce stranded costs by $25 million plus interest and record a corresponding charge to income. As a result of its generating asset divestitures, the Company obtains its supply of electricity to meet its PLR obligation almost entirely from contracted and open market purchases. During 2000, the Company's purchased power costs substantially exceeded the amounts it could recover under its capped generation rates, which are in effect for varying periods, pursuant to its 1998 rate restructuring plan. In November 2000, the Company filed a petition with the PPUC seeking permission to defer for future recovery its energy costs in excess of amounts reflected in its capped generation rates. In January 2001, the PPUC consolidated this petition with the merger proceeding (see Note 2 - Merger) for consideration and resolution in accordance with the FirstEnergy and GPU merger procedural schedule. In June 2001, the Company entered into a Settlement Stipulation with all of the major parties in the combined merger and rate relief proceedings, that, in addition to resolving certain issues concerning the PPUC's approval of the merger, also addressed the Company's request for PLR relief. On June 20, 2001, the PPUC entered orders approving the Settlement Stipulation, which approved the merger and provided PLR relief. The Company is permitted to defer for future recovery the difference between its actual energy costs and those reflected in its capped generation rates, retroactive to January 1, 2001. Deferral accounting will continue for such cost differences through December 31, 2005 and, should energy costs incurred by the Company during that period be below its capped generation rates, the difference would be used to reduce its recoverable deferred costs. The Company's PLR obligation has been extended through December 31, 2010. The Company's competitive transition charge (CTC) revenues will be applied first to PLR costs, then to stranded costs other than for non-utility generation (NUG) and finally to NUG stranded costs through December 31, 2010. The Company would be permitted to recover any remaining stranded costs through a continuation of the CTC after December 31, 2010; however, such recovery would extend to no later than December 31, 2015. Any amounts not expected to be recovered by December 31, 2015 would be written off at the time such nonrecovery becomes probable. 15 Several parties had filed Petitions for Review with the Commonwealth Court of Pennsylvania regarding the PPUC's orders. On February 21, 2002, the Court affirmed the PPUC decision regarding approval of the merger, remanding the decision to the PPUC only with respect to the issue of merger savings. The Court reversed the PPUC's decision regarding the Company's PLR obligation, and denied the Company's related requests for rate relief. The Company is considering its response to the Court's decision, which could include asking the Pennsylvania Supreme Court to review the decision. The Company is unable to predict the outcome of these matters. The application of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation," was discontinued in 1998 with respect to the Company's generation operations. The Company subsequently divested substantially all of its generating assets. The Securities and Exchange Commission issued interpretive guidance regarding asset impairment measurement, concluding 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. All of the Company's regulatory assets are expected to continue to be recovered under provisions of the Company's regulatory orders. PROPERTY, PLANT AND EQUIPMENT- As a result of the merger, certain of the Company's property, plant and equipment have been 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. 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 2.9% in 2001, 2.7% in 2000 and 2.8% in 1999. Annual depreciation expense in 2001 included approximately $1.5 million for future decommissioning costs applicable to the Company's ownership in Unit 2 of the Three Mile Island Nuclear Plant (TMI-2), a demonstration nuclear reactor owned by a wholly owned subsidiary of the Company (in conjunction with JCP&L and Met-Ed) and decommissioning liabilities for its previously divested nuclear generating units. The Company's share of the future obligation to decommission these units is approximately $128.1 million in current dollars and (using a 4.0% escalation rate) approximately $211.8 million in future dollars. The estimated obligation and the escalation rate were developed based on site specific studies. Decommissioning of the demonstration nuclear reactor is expected to be completed in 2003; payments for decommissioning of TMI-2 are expected to begin in 2014, when actual decommissioning work is expected to begin. The Company has recovered approximately $50 million for decommissioning through its electric rates from customers through December 31, 2001. The Company has also recognized an estimated liability of approximately $2.3 million related to decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy, as required by the Energy Policy Act of 1992. In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS 143, "Accounting for Asset Retirement Obligations." The new statement provides accounting treatment for retirement obligations associated with tangible long-lived assets with adoption required as of January 1, 2003. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recorded 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. Upon retirement, a gain or loss will be recorded if the costs to settle the retirement obligation differs from the carrying amount. Under the new standard, additional assets and liabilities relating principally to nuclear decommissioning obligations will be recorded, the pattern of expense recognition will change and income from the external decommissioning trusts will be recorded as investment income. The Company is currently assessing the new standard and has not yet quantified the impact on its financial statements. INCOME TAXES- Details of the total provision for income taxes are shown on the Consolidated Statements of Taxes. Deferred income taxes result from timing differences in the recognition of revenues and expenses for tax and accounting purposes. Investment tax credits, which were deferred when utilized, are being amortized over the recovery period of the related property. The liability method is used to account for deferred income taxes. Deferred income tax liabilities related to tax and accounting basis differences 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 are included in the final consolidated federal income tax return of GPU, and results for the period November 7, 2001 through December 31, 2001 are included in FirstEnergy's 2001 consolidated federal income tax return. In both cases, 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 contributed to the consolidated return. 16 RETIREMENT BENEFITS- Effective December 31, 2001, the Company's defined benefit pension plan was merged into FirstEnergy's defined benefit pension plan. FirstEnergy's trusteed, noncontributory defined benefit pension plan covers almost all of the Company's full-time employees. Upon retirement, employees receive a monthly pension based on length of service and compensation. On December 31, 2001, the GPU pension plans were merged with the FirstEnergy plan. FirstEnergy uses the projected unit credit method for funding purposes. The assets of the pension plan consist primarily of common stocks, United States government bonds and corporate bonds. The FirstEnergy and GPU postretirement benefit plans are currently separately maintained; the information shown below is aggregated as of December 31, 2001. Costs for the year 2001 include the former GPU companies' pension and other postretirement benefit costs for the period November 7, 2001 through December 31, 2001. The Company provides a minimum amount of noncontributory life insurance to retired employees in addition to optional contributory insurance. Health care benefits, which include certain employee deductibles and copayments, are also available to retired employees, their dependents and, under certain circumstances, their survivors. The Company pays insurance premiums to cover a portion of these benefits in excess of set limits; all amounts up to the limits are paid by the Company. 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. The following sets forth the funded status of the plans and amounts recognized on FirstEnergy's Consolidated Balance Sheet as of December 31, 2001: Other Pension Benefits Postretirement Benefits ---------------- ----------------------- (In millions) Change in benefit obligation: Benefit obligation as of January 1.. $1,506.1 $ 752.0 Service cost........................ 34.9 18.3 Interest cost....................... 133.3 64.4 Plan amendments..................... 3.6 -- Actuarial loss...................... 123.1 73.3 Voluntary early retirement program.. -- 2.3 GPU acquisition..................... 1,878.3 716.9 Benefits paid....................... (131.4) (45.6) --------------------------------------------------------------------------- Benefit obligation as of December 31 3,547.9 1,581.6 --------------------------------------------------------------------------- Change in plan assets: Fair value of plan assets as of January 1................... 1,706.0 23.0 Actual return on plan assets........ 8.1 12.7 Company contribution................ -- 43.3 GPU acquisition..................... 1,901.0 462.0 Benefits paid....................... (131.4) (6.0) --------------------------------------------------------------------------- Fair value of plan assets as of December 31................... 3,483.7 535.0 --------------------------------------------------------------------------- Funded status of plan............... (64.2) (1,046.6) Unrecognized actuarial loss (gain).. 222.8 212.8 Unrecognized prior service cost..... 87.9 17.7 Unrecognized net transition obligation (asset)................ -- 101.6 --------------------------------------------------------------------------- Prepaid (accrued) benefit cost $ 246.5 $ (714.5) =========================================================================== Assumptions used as of December 31, 2001: Discount rate....................... 7.25% 7.25% Expected long-term return on plan assets.................... 10.25% 10.25% Rate of compensation increase....... 4.00% 4.00% FirstEnergy's net pension and other postretirement benefit costs for the year ended December 31, 2001 were computed as follows: Other Pension Benefits Postretirement Benefits ---------------- ----------------------- (In millions) Service cost......................... $ 34.9 $18.3 Interest cost........................ 133.3 64.4 Expected return on plan assets (204.8) (9.9) Amortization of transition obligation (asset)................. (2.1) 9.2 Amortization of prior service cost... 8.8 3.2 Recognized net actuarial loss (gain). -- 4.9 Voluntary early retirement program... 6.1 2.3 -------------------------------------------------------------------------- Net benefit cost..................... $ (23.8) $92.4 ========================================================================== The composite health care trend rate assumption is approximately 10% in 2002, 9% in 2003 and 8% in 2004, trending to 4%-6% in later years. Assumed health care cost trend rates have a significant effect on the amounts reported 17 for the health care plan. An increase in the health care trend rate assumption by one percentage point would increase FirstEnergy's total service and interest cost components by $14.6 million and the postretirement benefit obligation by $151.2 million. A decrease in the same assumption by one percentage point would decrease the total service and interest cost components by $12.7 million and the postretirement benefit obligation by $131.3 million. Pre-Merger As of December 31, 2000, the Company had on its balance sheet accrued benefit costs of $1.0 million related to pension obligations. In addition, in each of the years ended December 31, 2000 and 1999, the Company recognized in income net benefit costs/(credits) of $0.1 million for pension benefits. TRANSACTIONS WITH AFFILIATED COMPANIES- During the three years ended December 31, 2001, GPU Service, Inc., an affiliated company, provided legal, accounting, financial and other services to the Company. In addition, prior to the sales of the Company's generating assets in 1999, affiliated companies GPU Nuclear, Inc. and GPU Generation, Inc. conducted generation operations for the company. The total cost of services rendered by affiliates was $156 million, $139 million and $337 million for the years 2001, 2000 and 1999, respectively. Of these amounts, $110 million, $109 million and $259 million were charged to income for the years 2001, 2000 and 1999, respectively. SUPPLEMENTAL CASH FLOWS INFORMATION- 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: 2001 2000 ---------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value --------------------------------------------------------------------- (In millions) Long-term debt............... $519 $509 $518 $497 Preferred stock.............. $ 92 $ 90 $100 $ 97 Investments other than cash and cash equivalents....... $251 $251 $289 $289 --------------------------------------------------------------------- $862 $850 $907 $883 ===================================================================== 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. 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. Unrealized gains and losses applicable to the decommissioning trusts have been recognized in the trust investment with a corresponding change to the decommissioning liability. The Company has no securities held for trading purposes. 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 (Deductions), Net 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 18 variety Of derivative instruments, including options, futures contracts and swaps. These derivatives are used principally for hedging purposes. FirstEnergy has a Risk Policy Committee comprised of 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 and interest rate 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 2002. Gains and losses from hedges of commodity price risks are included in net income when the underlying hedged commodities are delivered. The Company also uses interest rate swap agreements to manage the risk of increases in variable interest rates. The interest rate swap agreements, which were entered into to convert variable rate debt to fixed rate debt, are accounted for as cash flow hedges under SFAS 133, and expire on various dates through 2002. There is currently a net deferred gain of $1.8 million included in Accumulated Other Comprehensive Income as of December 31, 2001 related to derivative hedging activity, which will be reclassified to earnings during the next twelve months as hedged transactions occur. REGULATORY ASSETS- The Companies recognize, 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 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 continues the application of SFAS 71 to those operations. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 2001 2000 ------------------------------------------------------------ (In millions) Regulatory transition charge...... $515.9 $439.4 Customer receivables for future income taxes............. 140.2 149.4 Provider of last resort deferrals. 83.5 -- Nuclear decommissioning costs..... 24.0 18.5 Loss on reacquired debt........... 5.8 6.6 Other............................. 0.4 0.3 ------------------------------------------------------------ Total......................... $769.8 $614.2 ============================================================ 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, which will not be amortized but will be reviewed for impairment at least annually. As of December 31, 2001, we had recorded goodwill of approximately $797.4 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 both 2001 and 2000, total rentals related to this capital lease were $0.7 million, comprised of an interest element of $0.2 million and other costs of $0.5 million. 19 As of December 31, 2001, the future minimum lease payments on the Company's capital lease discussed above are: $0.7 million, $0.7 million and $0.6 million for the years 2002 through 2004. The present value of the net minimum lease payments is $1.7 million and the total interest portion is $0.3 million. 4. CAPITALIZATION: (A) RETAINED EARNINGS- The merger purchase accounting adjustments included resetting the retained earnings balance to zero at 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, 2001, the Company had retained earnings available to pay common stock dividends of $0.7 million, net of amounts restricted under the Company's FMB indentures. (B) 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. (C) COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY PARTNERSHIP PREFERRED SECURITIES- The Company has formed a statutory business trust, Penelec Capital Trust, which is owned through a wholly-owned limited partnership of the Company, Penelec Capital II, L.P., of which a wholly-owned subsidiary of the Company is the sole general partner. In this transaction, Penelec Capital Trust invested the gross proceeds from the sale of $100.0 million of its 7.34% trust preferred securities in the preferred securities of Penelec Capital II, L.P., which in turn invested those proceeds in $103.1 million of 7.34% subordinated debentures of the Company. The sole assets of Penelec Capital Trust are the preferred securities of Penelec Capital II, L.P., whose sole assets are the Company's subordinated debentures with the same rate and maturity date as the preferred securities. The Company has effectively provided a full and unconditional guarantee of its obligations under its trust's preferred securities. The trust preferred securities, which mature in 2039 and have a liquidation value of $25.00 per security, are redeemable at the option of the Company beginning in September 2004 at 100% of their principal amount. The interest on the subordinated debentures (and therefore the distributions on the 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. (D) LONG-TERM DEBT- The first mortgage indentures and their supplements, which secure all of the Company's FMBs, serve as direct first mortgage liens on substantially all property and franchises, other than specifically excepted property, owned by the Company. Based on the amount of bonds authenticated by the Trustee through December 31, 2001, the Company's annual sinking and improvement fund requirements for all bonds issued under the mortgage amount to $12.7 million. The Company expects to fulfill its sinking and improvement fund obligation by providing bondable property additions to the Trustee. Sinking fund requirements for FMBs and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) --------------------- 2002........ $ 50.2 2003........ 0.2 2004........ 125.2 2005........ 8.2 2006........ 0.2 ---------------------- 20 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 $69.3 million to pay principal of, or interest on, the pollution control revenue bonds. (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 the Company's parent. As of December 31, 2001, accumulated other comprehensive income consisted primarily of unrealized gains on derivative instrument hedges of $1.8 million. 5. SHORT-TERM BORROWINGS: The Company may borrow from its affiliates on a short-term basis. As of December 31, 2001, the Company had total short-term borrowings of $77.6 million from its affiliates with a weighted average interest rate of approximately 4.9%. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $375 million for property additions and improvements from 2002-2006, of which approximately $72 million is applicable to 2002. NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $9.5 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. ENVIRONMENTAL MATTERS- Various environmental liabilities have been recognized on the Consolidated Balance Sheet as of December 31, 2001, 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 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. Federal law provides that all PRPs for a particular site be held liable on a joint and several basis. The Company has total accrued liabilities aggregating approximately $1 million as of December 31, 2001. The Company does not believe environmental remediation costs will have a material adverse effect on its financial condition, cash flows or results of operations. 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 below. 21 TMI-2, which was damaged during a 1979 accident, is jointly owned by the Company, JCP&L and Met-Ed, with the Company having a 25% ownership percentage. Claims for alleged personal injury against the Company, JCP&L, Met-Ed and GPU (the defendants) were filed in the U.S. District Court for the Middle District of Pennsylvania. In 1996, the District Court granted a motion for summary judgment filed by the defendants and dismissed the ten initial "test cases" which had been selected for a test case trial, as well as all of the remaining 2,100 pending claims. In November 1999, the U.S. Court of Appeals for the Third Circuit affirmed the District Court's dismissal of the ten "test cases," but set aside the dismissal of the additional pending claims, remanding them to the District Court for further proceedings. In September 2000, the defendants filed for a summary judgment in the District Court. Meanwhile, the plaintiffs appealed to the Third Circuit for a review of the District Court's decision placing limitations on the remaining plaintiffs' suit. In April 2001, the Third Circuit affirmed the District Court's decision. In July 2001, the defendants renewed their motion for a summary judgment on the remaining 2,100 claims in the District Court. On January 15, 2002, the District Court granted the defendants' amended motion for summary judgment. On February 14, 2002, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Third Circuit. In addition to the approximately 2,100 claims for which summary judgment has been granted, there is other pending litigation arising out of the TMI-2 accident. This litigation consists of the following: eight personal injury cases that were not consolidated with the above-referenced approximately 2,100 claims; two class actions brought on behalf of plaintiffs alleging additional injuries diagnosed after the filing of the complaints in the above-referenced case; a case alleging exposure during the post-accident cleanup of the TMI-2 plant; and claims by individual businesses for economic loss resulting from the TMI-2 accident. Although unable to predict the outcome of this litigation, the Company believes that any liability to which it might be subject by reason of the TMI-2 accident will not exceed its financial protection under the Price-Anderson Act. 7. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 2001 and 2000.
Three Months Ended ------------------------------- March 31, June 30, September 30, Oct. 1-Nov. 6, Nov. 7-Dec. 31, 2001 2001 2001 2001 2001 ---------------------------------------------------------------------------------------------- (In millions) Operating Revenues............ $243.8 $230.6 $265.6 $94.5 | $140.1 Operating Expenses and Taxes.. 235.0 212.2 238.8 78.5 | 125.7 ----------------------------------------------------------------------------|----------------- Operating Income.............. 8.8 18.4 26.8 16.0 | 14.4 Other Income (Expense)........ 0.6 1.4 (1.2) (7.4) | 3.0 Net Interest Charges.......... 11.5 12.6 11.2 4.4 | 6.6 ----------------------------------------------------------------------------|----------------- Net Income (Loss)............. $ (2.1) $ 7.2 $ 14.4 $ 4.2 | $ 10.8 ============================================================================|=================
Three Months Ended --------------------------------------------- March 31, June 30, September 30,December 31, 2000 2000 2000 2000 ------------------------------------------------------------------------------ (In millions) Operating Revenues............ $220.1 $206.8 $236.7 $238.3 Operating Expenses and Taxes.. 184.4 193.2 237.8 206.2 ------------------------------------------------------------------------------ Operating Income (Loss)....... 35.7 13.6 (1.1) 32.1 Other Income (Expense)........ 0.3 2.0 (0.8) 5.2 Net Interest Charges.......... 9.1 11.1 12.1 15.5 ------------------------------------------------------------------------------ Net Income (Loss)............. $ 26.9 $ 4.5 $(14.0) $ 21.8 ============================================================================== 22 Report of 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. 23 Report of Independent Accountants To the Board of Directors and Stockholder of Pennsylvania Electric Company: In our opinion, the consolidated balance sheet as of December 31, 2000 and the related consolidated statements of income, and cash flows for each of the two years in the period ended December 31, 2000 (appearing on the accompanying index of the Pennsylvania Electric Company 2001 Annual Report to Stockholders incorporated by reference in this Form 10-K) present fairly, in all material respects, the financial position, results of operations and cash flows of Pennsylvania Electric Company and Subsidiary Companies at December 31, 2000 and for each of the two years in the period ended December 31, 2000, 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. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania January 31, 2001 24