-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WFOAzwAaWOdlasfw4Ghi/6lgBUvRbDxKGWG/Mj+72j9Nuu0z2wQ/DqG+s0bLiMXC y8a6QQPyOGDLsjAHTDMORw== 0001031296-98-000011.txt : 19980331 0001031296-98-000011.hdr.sgml : 19980331 ACCESSION NUMBER: 0001031296-98-000011 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 22 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: AMEX SROS: CSX SROS: NYSE SROS: PHLX FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRSTENERGY CORP CENTRAL INDEX KEY: 0001031296 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 341843785 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 333-21011 FILM NUMBER: 98577815 BUSINESS ADDRESS: STREET 1: 76 SOUTH MAIN ST CITY: AKRON STATE: OH ZIP: 44308-1890 BUSINESS PHONE: 8007363402 MAIL ADDRESS: STREET 1: 76 SOUTH MAIN ST CITY: AKRON STATE: OH ZIP: 44308-1890 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CLEVELAND ELECTRIC ILLUMINATING CO CENTRAL INDEX KEY: 0000020947 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 340150020 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-02323 FILM NUMBER: 98577816 BUSINESS ADDRESS: STREET 1: 55 PUBLIC SQ STREET 2: PO BOX 5000 CITY: CLEVELAND STATE: OH ZIP: 44101 BUSINESS PHONE: 2166229800 FILER: COMPANY DATA: COMPANY CONFORMED NAME: OHIO EDISON CO CENTRAL INDEX KEY: 0000073960 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 340437786 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-02578 FILM NUMBER: 98577817 BUSINESS ADDRESS: STREET 1: 76 S MAIN ST CITY: AKRON STATE: OH ZIP: 44308 BUSINESS PHONE: 2163845100 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENNSYLVANIA POWER CO CENTRAL INDEX KEY: 0000077278 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 250718810 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-03491 FILM NUMBER: 98577818 BUSINESS ADDRESS: STREET 1: 1 E WASHINGTON ST STREET 2: P O BOX 891 CITY: NEW CASTLE STATE: PA ZIP: 16103-0891 BUSINESS PHONE: 4126525531 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TOLEDO EDISON CO CENTRAL INDEX KEY: 0000352049 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 344375005 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-03583 FILM NUMBER: 98577819 BUSINESS ADDRESS: STREET 1: 300 MADISON AVE CITY: TOLEDO STATE: OH ZIP: 43652 BUSINESS PHONE: 2166229800 10-K405 1 1997 10-K405 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to to -------- -------- Commission Registrant; State of Incorporation; I.R.S. Employer File Number Address; and Telephone Number Identification No. - ----------- ----------------------------- ------------------ 333-21011 FIRSTENERGY CORP. 34-1843785 (An Ohio Corporation) 76 South Main Street Akron, Ohio 44308 Telephone (800)736-3402 1-2578 OHIO EDISON COMPANY 34-0437786 (An Ohio Corporation) 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-2323 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY 34-0150020 (An Ohio Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-3583 THE TOLEDO EDISON COMPANY 34-4375005 (An Ohio Corporation) c/o FirstEnergy Corp. 76 South Main Street Akron, OH 44308 Telephone (800)736-3402 1-3491 PENNSYLVANIA POWER COMPANY 25-0718810 (A Pennsylvania Corporation) 1 East Washington Street P. O. Box 891 New Castle, Pennsylvania 16103 Telephone (412)652-5531 SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No State the aggregate market value of the voting stock held by non-affiliates of the registrant: $6,831,426,606 as of March 6, 1998. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: OUTSTANDING CLASS AT MARCH 26, 1998 ----- ----------------- FirstEnergy Corp., $.10 par value 230,207,141 Ohio Edison Company, $9 par value 100 The Cleveland Electric Illuminating Company, no par value 79,590,689 The Toledo Edison Company, $5 par value 39,133,887 Pennsylvania Power Company, $30 par value 6,290,000 FirstEnergy Corp. is the sole holder of Ohio Edison Company, The Cleveland Electric Illuminating Company and The Toledo Edison Company common stock; Ohio Edison Company is the sole holder of Pennsylvania Power Company common stock. Documents incorporated by reference (to the extent indicated herein): PART OF FORM 10-K INTO WHICH DOCUMENT DOCUMENT IS INCORPORATED -------- ---------------------------- FirstEnergy Corp. Annual Report to Stockholders for the fiscal year ended December 31, 1997 (Pages 16-38) Part II Proxy Statement for 1998 Annual Meeting of Stockholders to be held April 30, 1998 Part III SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Name of Each Exchange Registrant Title of Each Class on Which Registered ---------- --------------------- --------------------- FirstEnergy Corp. Common Stock, $.10 par value New York Stock Exchange Ohio Edison Company Cumulative Preferred Stock, $100 par value 3.90% Series All series 4.40% Series registered on New 4.44% Series York Stock 4.56% Series Exchange and Chicago Stock Exchange Cumulative Preferred Stock, $25 par value 7.75% Series Registered on New York Stock Exchange and Chicago Stock Exchange The Cleveland Electric Cumulative Serial Illuminating Preferred Stock, Company without par value: $7.40 Series A All series $7.56 Series B registered on New Adjustable Rate, York Stock Series L Exchange Depositary Shares: 1993 Series A, each share New York Stock representing 1/20 of Exchange a share of Serial Preferred Stock, $42.40 Series T (without par value) First Mortgage Bonds: 8-3/4% Series due 2005 New York Stock Exchange 8-3/8% Series due 2011 New York Stock Exchange 8-3/8% Series due 2012 New York Stock Exchange The Toledo Edison Cumulative Preferred Company Stock, par value $100 per share: All series 4-1/4% Series registered on 8.32% Series American Stock 7.76% Series Exchange 10% Series Cumulative Preferred Stock, par value $25 per share: 8.84% Series All series $2.365 Series registered on Adjustable Rate, New York Stock Series A Exchange Adjustable Rate, Series B First Mortgage Bonds: 7-1/2% Series All series due 2002 registered on 8% Series New York Stock due 2003 Exchange Pennsylvania Power Cumulative Preferred Company Stock, $100 par value: 4.24% Series All series 4.25% Series registered on 4.64% Series Philadelphia 7.64% Series Stock Exchange, 8.00% Series Inc. This combined Form 10-K is separately filed by FirstEnergy Corp., Ohio Edison Company, Pennsylvania Power Company, The Cleveland Electric Illuminating Company and The Toledo Edison Company. Information contained herein relating to any individual registrant is filed by such registrant on its own behalf. No registrant makes any representation as to information relating to any other registrant, except that information relating to any of the four FirstEnergy subsidiaries is also attributed to FirstEnergy. FORM 10-K TABLE OF CONTENTS Page Part I Item 1. Business 1 The Company 1 Utility Regulation 1 PUCO Rate Matters 2 PPUC Rate Matters 3 FERC Rate Matters 3 Fuel Recovery Procedures 3 Capital Requirements 4 Central Area Power Coordination Group 6 Nuclear Regulation 7 Nuclear Insurance 7 Environmental Matters 9 Air Regulation 9 Water Regulation 10 Waste Disposal 10 Summary 10 Fuel Supply 11 System Capacity and Reserves 12 Regional Reliability 12 Competition 13 Research and Development 13 Executive Officers 14 Item 2. Properties 15 Item 3. Legal Proceedings 16 Item 4. Submission of Matters to a Vote of Security Holders 16 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 16 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 8. Financial Statements and Supplementary Data 17 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 17 Part III Item 10. Directors and Executive Officers of the Registrant 17 Item 11. Executive Compensation 18 Item 12. Security Ownership of Certain Beneficial Owners and Management 23 Item 13. Certain Relationships and Related Transactions 24 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 24 PART I ITEM 1. BUSINESS The Company FirstEnergy Corp. (Company) was organized under the laws of the State of Ohio in 1996 and became a holding company on November 8, 1997 in connection with the merger of Ohio Edison Company (OE) and Centerior Energy Corporation (Centerior). The Company's principal business is the holding, directly or indirectly, of all of the outstanding common stock of its four principal electric utility operating subsidiaries, OE, The Cleveland Electric Illuminating Company (CEI), Pennsylvania Power Company (Penn) and The Toledo Edison Company (TE). These utility subsidiaries are referred to throughout as "Companies." Nearly all of the Company's consolidated operating revenues are derived from electric service provided by its utility operating subsidiaries. In addition, the Company holds all of the outstanding common stock of its other seven direct subsidiaries, FirstEnergy Services Corp. (whose subsidiaries include Roth Bros., Inc., a major provider of energy equipment, management and control systems), Centerior Service Company (CSC), Centerior Properties Company, Centerior Enterprises Corporation, FirstEnergy Trading and Power Marketing, Inc., FirstEnergy Telecom Corp., and FirstEnergy Securities Transfer Company. The Companies' combined service areas encompass approximately 13,200 square miles in central and northern Ohio and western Pennsylvania. The areas they serve have combined populations of approximately 5,577,000. OE was organized under the laws of the State of Ohio in 1930 and owns property and does business as an electric public utility in that state. OE also has ownership interests in certain generating facilities located in the Commonwealth of Pennsylvania. OE furnishes electric service to communities in a 7,500 square mile area of central and northeastern Ohio. It also provides transmission services and electric energy for resale to certain municipalities in OE's service area and transmission services to certain rural cooperatives. OE also engages in the sale, purchase and interchange of electric energy with other electric companies. The area it serves has a population of approximately 2,542,000. OE owns all of the outstanding common stock of Penn, a Pennsylvania corporation, which furnishes electric service to communities in a 1,500 square mile area of western Pennsylvania. Penn also provides transmission services and electric energy for resale to certain municipalities in Pennsylvania. The area served by Penn has a population of approximately 343,000. CEI was organized under the laws of the State of Ohio in 1892 and does business as an electric public utility in that state. It also has ownership interests in certain generating facilities in Pennsylvania. CEI furnishes electric service in an area of approximately 1,700 square miles in northeastern Ohio, including the City of Cleveland. The area CEI serves has a population of approximately 2,007,000. TE was organized under the laws of the State of Ohio in 1901 and does business as an electric public utility in that state. It also has ownership interests in certain generating facilities in Pennsylvania. TE furnishes electric service in an area of approximately 2,500 square miles in northwestern Ohio, including the City of Toledo. The area TE serves has a population of approximately 685,000. Utility Regulation The Companies are subject to broad regulation as to rates and other matters by the Public Utilities Commission of Ohio (PUCO) and the Pennsylvania Public Utility Commission (PPUC). With respect to their wholesale and interstate electric operations and rates, the Companies are subject to regulation, including regulation of their accounting policies and practices, by the Federal Energy Regulatory Commission (FERC). Under Ohio law, municipalities may regulate rates, subject to appeal to the PUCO if not acceptable to the utility. In 1986, a law was passed which extended the jurisdiction of the PUCO to nonutility affiliates of holding companies exempt under Section 3(a)(1) and 3(a)(2) of the Public Utility Holding Company Act of 1935 (1935 Act) to the extent that the activities of such affiliates affect or relate to the cost of providing electric utility service in Ohio. The law, among other things, requires PUCO approval of investments in, or the transfer of assets to, nonutility affiliates. Investments in such affiliates are limited to 15% of the aggregate capitalization of the holding company on a consolidated basis. The Company is an exempt holding company under Section 3(a)(1) of the 1935 Act, but the law has not had any effect on its operations as they are currently conducted. The Energy Policy Act of 1992 (1992 Act) amended portions of the 1935 Act, providing independent power producers and other nonregulated generating facilities easier entry into electric generation markets. The 1992 Act also amended portions of the Federal Power Act, authorizing the FERC, under certain circumstances, to mandate access to utility-owned transmission facilities. Following the enactment of the 1992 Act, the FERC has ordered all utilities to file open access tariffs applicable to transmission facilities, including provisions which require utilities to offer comparable services on a nondiscriminatory basis. The FirstEnergy system has such an open access tariff currently in effect (see "FERC Rate Matters"). PUCO Rate Matters OE's Rate Reduction and Economic Development Plan was approved by the PUCO in 1995 and a Rate Reduction and Economic Development Plan for CEI and TE was approved in January 1997. These plans are designed to enhance and accelerate economic development within the Companies' Ohio service areas and to assure the Companies' customers in those service areas of long- term competitive pricing for energy services. These plans initially maintain current base electric rates for OE, CEI and TE through December 31, 2005, unless additional revenues are needed to recover the costs of changes in environmental, regulatory or tax laws or regulations. At the end of the plan periods, OE base rates will be reduced by $300 million (approximately 20 percent below current levels) and CEI and TE base rates will be reduced by a combined $310 million (approximately 15 percent below current levels). As part of these plans, transition rate credits were implemented for customers, which are expected to reduce operating revenues for OE by approximately $600 million and CEI and TE by approximately $391 million during the plan period. The plans also established revised fuel recovery rate formulas which eliminated the automatic pass-through of fuel costs to their retail customers (see "Fuel Recovery Procedures"). All of OE's regulatory assets and CEI's and TE's regulatory assets related to their nonnuclear operations are being recovered under provisions of these plans. In addition, the PUCO has authorized OE to recognize additional capital recovery related to its generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the plan period of at least $2 billion more than the amount that would have been recognized if OE's plan were not in effect. These additional amounts are being recovered through current rates. CEI and TE recognized fair value purchase accounting adjustments to reduce nuclear plant by $1.71 billion and $.84 billion, respectively, in connection with the FirstEnergy merger; these fair value adjustments recognized for financial reporting purposes will ultimately satisfy the asset reduction commitments of at least $1.4 billion for CEI and $0.6 billion for TE contained in the CEI and TE plan. For regulatory purposes, CEI and TE will recognize accelerated amortization over the plan period. Based on the Ohio plans, at this time, OE, CEI and TE believe they will continue to be able to bill and collect cost- based rates (with the exception of CEI's and TE's nuclear operations); accordingly, it is appropriate that they continue the application of SFAS No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). However, as discussed under "Competition" below, changes in the regulatory environment are on the horizon in Ohio. The Companies do not expect any changes in Ohio regulation to be effective within the next two years and cannot assess what the ultimate impact may be. CEI's and TE's plan does not provide for full recovery of their nuclear operations. As a result, in October 1997 CEI and TE discontinued application of SFAS 71 for their nuclear operations and decreased their regulatory assets of customer receivables for future income taxes related to the nuclear assets by $499 million and $295 million, respectively, in addition to the fair value adjustments referred to above. PPUC Rate Matters Penn's Rate Stability and Economic Development Plan was approved by the PPUC in the second quarter of 1996. This plan initially maintains current base electric rates for Penn through June 20, 2006 and revised its fuel recovery method (see "Fuel Recovery Procedures"). All of Penn's regulatory assets are being recovered under provisions of the plan. In addition, the PPUC has authorized Penn to recognize additional capital recovery related to its generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the plan period of at least $358 million more than the amounts that would have been recognized if the plan were not in effect. These additional amounts are being recovered through current rates. In December 1996, Pennsylvania enacted "The Electricity Generation Customer Choice and Competition Act," which permitted customers, including Penn's customers, to choose their electric generation supplier, while transmission and distribution services will continue to be supplied by their current providers. In accordance with this law, on September 30, 1997, Penn filed a restructuring plan with the PPUC. The plan describes how Penn will restructure its rates and provide customers with direct access to alternative electricity suppliers; customer choice is to be phased in over three years beginning in 1999, after completion of a two-year pilot program. Penn will continue to deliver power to homes and businesses through its transmission and distribution system, which remains regulated by the PPUC. Penn also plans to sell electricity and energy-related services in its own territory and throughout Pennsylvania as an alternative supplier through its nonregulated subsidiary, Penn Power Energy, Inc. Through the restructuring plan, Penn is seeking recovery of $293 million of stranded costs through a competitive transition charge starting in 1999 and ending in 2005, which is consistent with Penn's regulatory plan. The PPUC plans to hold public hearings on Penn's restructuring plan early in 1998. Based on the changing regulatory environment in Pennsylvania, Penn is expected to discontinue its application of SFAS 71 for its generation operations, possibly as early as 1998. The impact of Penn discontinuing SFAS 71 is not expected to be material. However, Penn believes that this legislation will continue to provide for cost recovery in a manner which meets the criteria for application of SFAS 71 for all non-generation operations as described above. FERC Rate Matters Rates for wholesale customers are regulated by the FERC. The FirstEnergy merger was approved by the FERC on October 29, 1997, and the Companies have operated as a single utility system since December 1997. An open access transmission tariff and joint dispatch agreement for the FirstEnergy system are currently in effect, subject to refund, pending the outcome of hearings before the FERC. A decision is expected on this proceeding in late 1998. Fuel Recovery Procedures In accordance with their respective plans, OE's, CEI's and TE's fuel recovery rates have been frozen, subject only to limited periodic adjustments. The respective rates are adjusted annually based on changes in the GDP Implicit Price Deflator, unless significant changes in environmental, regulatory or tax laws or regulations increase or decrease the cost of fuel. Such changes in laws, regulations and/or taxes would require PUCO approval in order to be reflected as an adjustment to the Electric Fuel Component (EFC) rate. Furthermore, for the period through June 30, 2000, the OE EFC rate will be limited to the average fuel cost rate of certain utilities within the state. Commencing July 1, 2000, the OE EFC rate will be limited to 97% of the average fuel cost rate of these companies. The average fuel cost rate for these utilities may be adjusted by the PUCO to reflect any significant changes in the Phase II environmental compliance plans of such companies involving capital additions or equipment utilization. After January 1, 2000, the respective EFC rates in effect for CEI and TE will be reduced to reflect the elimination of annual fixed charges related to a Bruce Mansfield Plant coal supply contract (see "Fuel Supply"), which amounts to $13.96 million for CEI and $8.74 million for TE. The resulting reduced EFC rates would be used as the basis for the annual GDP adjustment, but, in no event, would either company's annual EFC rate exceed 1.465 cents per kWh during the plan period. Under its plan, Penn eliminated its energy cost rate for the recovery of fuel and net purchased power costs as a separate component of customer charges. Energy costs were rolled into Penn's base electric rates at their projected 1996-1997 level. Capital Requirements The Companies' respective total 1997 construction costs, excluding nuclear fuel, are shown on the following table. Such costs included expenditures for the betterment of existing facilities and for the construction of transmission lines, distribution lines, substations and other additions. For the years 1998 -2002, such construction costs related to their regulated businesses are also shown on the following table. The Company also expects to invest approximately $300 million during 1998-2002 ($65 million in 1998) relating to various nonregulated business ventures. See "Environmental Matters" below with regard to possible environment-related expenditures not included in this estimate. 1997 1998-2002 Construction Forecast Actual ---------------------------------- ------ 1998 1999-2002 Total ---- --------- ----- (In millions) OE $107 $147 $363 $ 510 Penn 15 18 72 90 CEI 135 * 105 325 430 TE 52 * 50 150 200 ---- ---- ------ Total $320 $910 $1,230 * Includes CEI's and TE's costs of approximately $17 million and $13 million, respectively, for the period from the November 8, 1997 merger date to December 31, 1997. During the 1998 -2002 period, maturities of, and sinking fund requirements for, long-term debt and preferred stock of the Companies are: Preferred Stock and Long-Term Debt 1998-2002 Redemption Schedule ---------------------------------- 1998 1999-2002 Total ---- --------- ----- (In millions) OE $166 $901 $1,067 Penn 1 27 28 CEI 81 775 856 TE 40 402 442 ---- ------ ------ Total $288 $2,105 $2,393 OE's and Penn's nuclear fuel purchases are financed through OES Fuel (a wholly owned subsidiary of OE) commercial paper and loans, both of which are supported by a $225 million long-term bank credit agreement. CEI and TE severally lease their respective portions of nuclear fuel and pay for the fuel as it is consumed. The Companies' respective investments for additional nuclear fuel, and nuclear fuel investment reductions as the fuel is consumed, during the 1998 -2002 period are represented in the following table. The table also shows the Companies' net operating lease commitments for the 1998-2002 period. The Companies recover the cost of nuclear fuel consumed and operating leases through their electric rates.

Short-term borrowings outstanding at December 31, 1997, consisted of $182.2 million of OE's bank borrowings and $120.0 million of OES Capital, Incorporated commercial paper. OES Capital is a wholly owned subsidiary of OE whose borrowings are secured by customer accounts receivable. OES Capital can borrow up to $120 million under a receivables financing agreement at rates based on certain bank commercial paper. The Company and its utility operating subsidiaries also had $162 million (Company- $125 million, OE-$35 million and Penn-$2 million) available under revolving lines of credit as of December 31, 1997. The Company plans to transfer any of its borrowings under its $125 million line of credit to CEI and/or TE. In addition, $26 million (OE-$14 million and Penn-$12 million) was available through bank facilities that provide for borrowings on a short-term basis at the banks' discretion. Based on their present plans, the Companies could provide for their cash requirements in 1998 from the following sources: funds to be received from operations; available cash and temporary cash investments (approximate amounts as of December 31, 1997: Company's nonutility subsidiaries-$37 million, OE-$4 million, Penn-$1 million, CEI-$34 million and TE-$22 million); the issuance of long-term debt (for refunding purposes) and funds available under revolving credit arrangements. The extent and type of future financings will depend on the need for external funds as well as market conditions, the maintenance of an appropriate capital structure and the ability of the Companies to comply with coverage requirements in order to issue first mortgage bonds and preferred stock. The Companies will continue to monitor financial market conditions and, where appropriate, may take advantage of economic opportunities to refund debt and preferred stock to the extent that their financial resources permit. The coverage requirements contained in the first mortgage indentures under which the Companies issue first mortgage bonds provide that, except for certain refunding purposes, the Companies may not issue first mortgage bonds unless applicable net earnings (before income taxes), calculated as provided in the indentures, for any period of twelve consecutive months within the fifteen calendar months preceding the month in which such additional bonds are issued, are at least twice annual interest requirements on outstanding first mortgage bonds, including those being issued. Under OE's first mortgage indenture, the availability of property additions is more restrictive than the earnings test at the present time and would limit the amount of first mortgage bonds issuable against property additions to $350 million. OE is currently able to issue $1.05 billion principal amount of first mortgage bonds against previously retired bonds without the need to meet the above restrictions. Under Penn's first mortgage indenture, other requirements also apply and are more restrictive than the earnings test at the present time. Penn is currently able to issue $248 million principal amount of first mortgage bonds, with up to $111 million of such amount issuable against property additions; the remainder could be issued against previously retired bonds. Purchase accounting revaluation applied to CEI's and TE's net assets under the merger reduced CEI's and TE's available bondable property so that first mortgage bonds cannot currently be issued against property additions. OE's , Penn's and TE's respective articles of incorporation prohibit the sale of preferred stock unless applicable gross income, calculated as provided in the articles of incorporation, is equal to at least 1-1/2 times the aggregate of the annual interest requirements on indebtedness and annual dividend requirements on preferred stock outstanding immediately thereafter. Based upon earnings for 1997 and at an assumed dividend rate of 8.5%, OE and Penn would be permitted, under the earnings coverage test contained in their respective charters, to issue at least $1.3 billion and $107 million of preferred stock, respectively. Based on its 1997 earnings, TE could not issue additional preferred stock. There are no restrictions on CEI's ability to issue preferred stock. To the extent that coverage requirements or market conditions restrict the Companies' abilities to issue desired amounts of first mortgage bonds or preferred stock, the Companies may seek other methods of financing. Such financings could include the sale of preferred or and preference stock or of such other types of securities as might be authorized by applicable regulatory authorities which would not otherwise be sold and could result in annual interest charges and/or dividend requirements in excess of those that would otherwise be incurred. Central Area Power Coordination Group (CAPCO) In September 1967, the CAPCO companies, which consists of the Companies and Duquesne Light Company (Duquesne), announced a program for joint development of power generation and transmission facilities. Included in the program are Unit 7 at the W. H. Sammis Plant, Unit 5 at the Eastlake Plant, Units 1, 2 and 3 at the Bruce Mansfield Plant, Units 1 and 2 at the Beaver Valley Power Station, the Perry Nuclear Power Plant and the Davis-Besse Nuclear Power Station, each now in service. The present CAPCO Basic Operating Agreement provides, among other things, for coordinated maintenance responsibilities among the CAPCO companies, a limited and qualified mutual backup arrangement in the event of outage of CAPCO units and certain capacity and energy transactions among the CAPCO companies. The agreements among the CAPCO companies generally treat OE and Penn as a single system as between them and the other three CAPCO companies, but, in agreements between the CAPCO companies and others, all five companies are treated as separate entities. Subject to any rights that might arise among the CAPCO companies as such, each member company, severally and not jointly, is obligated to pay only its proportionate share of the costs associated with the facilities and the cost of required fuel. The CAPCO companies have agreed that any modification of their arrangements or of their agreed-upon programs requires their unanimous consent. Should any member become unable to continue to pay its share of the costs associated with a CAPCO facility, each of the other CAPCO companies could be adversely affected in varying degrees because it may become necessary for the remaining members to assume such costs for the account of the defaulting member. Under the agreements governing the construction and operation of CAPCO generating units, the responsibility is assigned to a specific CAPCO company. CEI has such responsibilities for Perry and Eastlake Unit 5, Duquesne is responsible for Beaver Valley Units 1 and 2, TE is responsible for Davis-Besse, OE for Sammis Unit 7 and Penn for Bruce Mansfield Units 1, 2 and 3. The Companies monitor activities in connection with Beaver Valley Units 1 and 2 but must rely to a significant degree on Duquesne for necessary information. The Companies in their oversight role as a practical matter cannot be privy to every detail; it is Duquesne that must directly supervise activities and then exercise its reporting responsibilities to the co-owners. The Companies critically review the information given to it by Duquesne, but they cannot be absolutely certain that things they would have considered significant have been reported or that they always would have reached exactly the same conclusion about matters that are reported. In addition, the time that is necessarily part of the compiling and analyzing process creates a lag between the occurrence of events and the time the Companies becomes aware of their significance. Nuclear Regulation The construction and operation of nuclear generating units are subject to the regulatory jurisdiction of the Nuclear Regulatory Commission (NRC) including the issuance by it of construction permits and operating licenses. The NRC's procedures with respect to application for construction permits and operating licenses afford opportunities for interested parties to request public hearings on health, safety, environmental and antitrust issues. In this connection, the NRC may require substantial changes in operation or the installation of additional equipment to meet safety or environmental standards with resulting delay and added costs. The possibility also exists for modification, denial or revocation of licenses or permits. Davis-Besse was placed in commercial operation in 1977, and its operating license expires in 2017. Beaver Valley Unit 1 was placed in commercial operation in 1976, and its opening license expires in 2016. Perry Unit 1 and Beaver Valley Unit 2 were placed in commercial operation in 1987, and their operating licenses expire in 2026 and 2027, respectively. The NRC has promulgated and continues to promulgate regulations related to the safe operation of nuclear power plants. The Companies cannot predict what additional regulations will be promulgated or design changes required or the effect that any such regulations or design changes, or the consideration thereof, may have upon Beaver Valley, Davis-Besse and Perry. Although the Companies have no reason to anticipate an accident at any nuclear plant in which they have an interest, if such an accident did happen, it could have a material but currently undeterminable adverse effect on the Company's consolidated financial position. In addition, such an accident at any operating nuclear plant, whether or not owned by the Companies, could result in regulations or requirements that could affect the operation or licensing of plants that the Companies do own with a consequent but currently undeterminable adverse impact, and could affect the Companies' abilities to raise funds in the capital markets. Nuclear Insurance The Price-Anderson Act limits the public liability which can be assessed with respect to a nuclear power plant to $8.92 billion (assuming 110 units licensed to operate) for a single nuclear incident, which amount is covered by: (i) private insurance amounting to $200 million; and (ii) $8.72 billion provided by an industry retrospective rating plan required by the NRC pursuant thereto. Under such retrospective rating plan, in the event of a nuclear incident at any unit in the United States resulting in losses in excess of private insurance, up to $75.5 million (but not more than $10 million per unit per year in the event of more than one incident) must be contributed for each nuclear unit licensed to operate in the country by the licensees thereof to cover liabilities arising out of the incident. Based on their present ownership and leasehold interests in Beaver Valley, Perry and Davis-Besse, the Companies' maximum potential assessment under these provisions (assuming the other co-owner were to contribute its proportionate share of any assessments under the retrospective rating plan) would be $257.7 million (OE- $84.8 million, Penn-$18.0 million, CEI-$84.8 million and TE-$70.1 million) per incident but not more than $32.5 million (OE-$10.7 million, Penn-$2.3 million, CEI-$10.7 million and TE-$8.8 million) in any one year for each incident. In addition to the public liability insurance provided pursuant to the Price-Anderson Act, the Companies have also obtained insurance coverage in limited amounts for economic loss and property damage arising out of nuclear incidents. The Companies are members of Nuclear Electric Insurance Limited (NEIL) which provides coverage (NEIL I) for the extra expense of replacement power incurred due to prolonged accidental outages of nuclear units. Under NEIL I, the Companies have policies, renewable yearly, corresponding to their respective interests in Beaver Valley, Perry and Davis-Besse, which provide an aggregate indemnity of up to approximately $809 million (OE-$180 million, Penn-$53 million, CEI-$316 million and TE-$260 million) for replacement power costs incurred during an outage after an initial 21-week (17 weeks for Davis-Besse) waiting period. Members of NEIL I pay annual premiums and are subject to assessments if losses exceed the accumulated funds available to the insurer. The Companies' present maximum aggregate assessment for incidents at any covered nuclear facility occurring during a policy year would be approximately $7.2 million (OE-$1.8 million, Penn-$.5 million, CEI-$2.7 million and TE-$2.2 million). The Companies are insured as to their respective interests in Beaver Valley, Perry and Davis-Besse under property damage insurance provided by American Nuclear Insurers, Mutual Atomic Energy Liability Underwriters and NEIL to the operating company for each plant. Under these arrangements, $2.75 billion of coverage for decontamination costs, decommissioning costs, debris removal and repair and/or replacement of property is provided for Beaver Valley, Perry and Davis-Besse. The Companies pay annual premiums for this coverage and are liable for retrospective assessments of up to approximately $29.4 million (OE-$8.9 million, Penn-$1.8 million, CEI-$10.3 million and TE- $8.4 million) during a policy year. The Companies intend to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Companies' plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Companies' insurance policies, or to the extent such insurance becomes unavailable in the future, the Companies would remain at risk for such costs. The NRC requires nuclear power plant licensees to obtain minimum property insurance coverage of $1.06 billion or the amount generally available from private sources, whichever is less. The proceeds of this insurance are required to be used first to ensure that the licensed reactor is in a safe and stable condition and can be maintained in that condition so as to prevent any significant risk to the public health and safety. Within 30 days of stabilization, the licensee is required to prepare and submit to the NRC a cleanup plan for approval. The plan is required to identify all cleanup operations necessary to decontaminate the reactor sufficiently to permit the resumption of operations or to commence decommissioning. Any property insurance proceeds not already expended to place the reactor in a safe and stable condition must be used first to complete those decontamination operations that are ordered by the NRC. The Companies are unable to predict what effect these requirements may have on the availability of insurance proceeds to the Companies for the Companies' bondholders. Environmental Matters Various federal, state and local authorities regulate the Companies with regard to air and water quality and other environmental matters. The Companies have estimated capital expenditures for environmental compliance of approximately $50 million, which is included in the construction estimate given under "Capital Requirements" for 1998 through 2002. Air Regulation Under the provisions of the Clean Air Act of 1970, both the State of Ohio and the Commonwealth of Pennsylvania adopted ambient air quality standards, and related emission limits, including limits for sulfur dioxide (SO2) and particulates. In addition, the U.S. Environmental Protection Agency (EPA) promulgated an SO2 regulatory plan for Ohio which became effective for OE's, CEI's and TE's plants in 1977. Generating plants to be constructed in the future and some future modifications of existing facilities will be covered not only by the applicable state standards but also by EPA emission performance standards for new sources. In both Ohio and Pennsylvania the construction or modification of emission sources requires approval from appropriate environmental authorities, and the facilities involved may not be operated unless a permit or variance to do so has been issued by those same authorities. The Companies are in compliance with the current SO2 and nitrogen oxides (NOx) reduction requirements under the Clean Air Act Amendments of 1990. SO2 reductions through the year 1999 will be achieved by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or purchasing emission allowances. Plans for complying with reductions required for the year 2000 and thereafter have not been finalized. EPA is conducting additional studies which could indicate the need for additional NOx reductions from the Companies' Pennsylvania facilities by the year 2003. In addition, the EPA is also considering the need for additional NOx reductions from the Companies' Ohio facilities. On November 7, 1997, the EPA proposed uniform reductions of NOx emissions across a region of twenty-two states, including Ohio and the District of Columbia (NOx Transport Rule) after determining that such NOx emissions are contributing significantly to ozone pollution in the eastern United States. In a separate but related action, eight states filed petitions with the EPA under Section 126 of the Clean Air Act seeking reductions of NOx emissions which are alleged to contribute to ozone pollution in the eight petitioning states. A December 1997 EPA Memorandum of Agreement proposes to finalize the NOx Transport Rule by September 30, 1998, and establishes a schedule for EPA action on the Section 126 petitions. The cost of such reductions, if required, may be substantial. The Companies continue to evaluate their compliance plans and other compliance options. The Companies are required to meet federally approved SO2 regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $25,000 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Companies cannot predict what action the EPA may take in the future with respect to proposed regulations or the interim enforcement policy. In July 1997, EPA promulgated changes in the National Ambient Air Quality Standard (NAAQS)for ozone and proposed a new NAAQS for previously unregulated ultra-fine particulate matter. The cost of compliance with these regulations may be substantial and depends on the manner in which they are implemented by the states in which the Companies operate affected facilities. Water Regulation Various water quality regulations, the majority of which are the result of the federal Clean Water Act and its amendments, apply to the Companies' plants. In addition, Ohio and Pennsylvania have water quality standards applicable to the Companies' operations. As provided in the Clean Water Act, authority to grant federal National Pollutant Discharge Elimination System (NPDES) water discharge permits can be assumed by a state. Ohio and Pennsylvania have assumed such authority. Waste Disposal As a result of the Resource Conservation and Recovery Act of 1976, as amended, and the Toxic Substances Control Act of 1976, federal and state hazardous waste regulations have been promulgated. Certain fossil-fuel combustion waste products, such as coal ash, were exempted from hazardous waste disposal requirements pending EPA's evaluation of the need for future regulation. EPA has issued its final regulatory determination that regulation of coal ash as a hazardous waste is unnecessary. OE,CEI and TE have been named as "potentially responsible parties" (PRPs) at waste disposal sites which may require cleanup under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Allegations that the Companies disposed 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. CEI and TE have accrued a liability totaling $5.9 million at December 31, 1997 based on estimates of the costs of cleanup and the proportionate responsibility of other PRPs for such costs. OE, CEI and TE believe that waste disposal costs will not have a material adverse effect on their financial condition, cash flows or results of operations. In 1980, Congress passed the Low-Level Radioactive Waste Policy Act which provides that the disposal of low-level radioactive waste is the responsibility of the state where such waste is generated. The Act encourages states to form compacts among themselves to develop regional disposal facilities. Failure by a state or compact to begin implementation of a program could result in access denial to the two facilities currently accepting low-level radioactive waste. Ohio is part of the Midwest Compact and has responsibility for siting and constructing a disposal facility. On June 26, 1997, the Midwest Compact Commission (Compact) voted to cease all siting activities in the host state of Ohio and to dismantle the Ohio Low-Level Radioactive Waste Facility Development Authority, the statutory agency charged with siting and constructing the low-level radioactive waste disposal facility. While the Compact remains intact, it has no plans to site or construct a low-level radioactive waste disposal facility in the Midwest. The Companies continue to ship low-level radioactive waste from their nuclear facilities to the Barnwell, South Carolina waste disposal facility. Summary Environmental controls are still in the process of development and require, in many instances, balancing the needs for additional quantities of energy in future years and the need to protect the environment. As a result, the Companies cannot now estimate the precise effect of existing and potential regulations and legislation upon any of their existing and proposed facilities and operations or upon their ability to issue additional first mortgage bonds under their respective mortgages. These mortgages contain covenants by the Companies to observe and conform to all valid governmental requirements at the time applicable unless in course of contest, and provisions which, in effect, prevent the issuance of additional bonds if there is a completed default under the mortgage. The provisions of each of the mortgages, in effect, also require, in the opinion of counsel for the respective Companies, that certification of property additions as the basis for the issuance of bonds or other action under the mortgages be accompanied by an opinion of counsel that the company certifying such property additions has all governmental permissions at the time necessary for its then current ownership and operation of such property additions. The Companies intend to contest any requirements they deem unreasonable or impossible for compliance or otherwise contrary to the public interest. Developments in these and other areas of regulation may require the Companies to modify, supplement or replace equipment and facilities, and may delay or impede the construction and operation of new facilities, at costs which could be substantial. Fuel Supply The Companies' sources of generation during 1997 were: Coal Nuclear ---- ------- OE 76.5% 23.5% Penn 73.8% 26.2% CEI 63.0% 37.0% TE 43.0% 57.0% The Companies have long-term coal contracts providing for annual tons of approximately: OE - 6,400,000; Penn - 1,248,000; CEI - 3,900,000; and TE-1,100,000. These contracts include the Companies' portion of the coal purchase contract relating to the Bruce Mansfield Plant discussed below. This contract coal is produced primarily from mines located in Ohio, Pennsylvania, Kentucky, Wyoming and West Virginia; the contracts expire at various times through December 31, 2003. The Companies estimate their 1998 coal requirements to be approximately 18,646,000 tons (including their respective shares of the coal requirements of CAPCO's Eastlake Unit 5, Sammis Unit 7 and the Bruce Mansfield Plant). See "Environmental Matters" for factors pertaining to meeting environmental regulations affecting coal-fired generating units. The Companies have each severally guaranteed (OE's, CEI's, TE's and Penn's composite percentages being approximately 46.8%, 17.6%, 10.3% and 6.7%, respectively) certain debt and lease obligations in connection with a coal supply contract for the Bruce Mansfield Plant (see "Commitments, Guarantees and Contingencies" notes to the respective financial statements). As of December 31, 1997, the Companies' shares of the guarantees were $66.1 million. The price under the coal supply contract, which includes certain minimum payments, has been determined to be sufficient to satisfy the debt and lease obligations. This contract expires December 31, 1999. The Companies' fuel costs (excluding disposal costs) for each of the five years ended December 31, 1997, were as follows: 1997 1996 1995 1994 1993 Cost of fuel consumed per million BTUs: Coal: OE $1.31 $1.33 $1.37 $1.36 $1.37 Penn 1.27 1.31 1.30 1.34 1.37 CEI 1.41 1.50 1.56 1.50 1.40 TE 1.54 1.79 1.86 1.76 1.82 Nuclear: OE $ .58 $ .66 $ .79 $ .94 $1.04 Penn .61 .64 .77 .88 .97 CEI .76 .84 .98 .98 1.02 TE .66 .74 .91 .92 .95 Average fuel cost per kilowatt-hour generated (cents): OE 1.17 1.20 1.27 1.31 1.36 Penn 1.17 1.15 1.20 1.29 1.36 CEI 1.23 1.35 1.42 1.35 1.37 TE 1.06 1.26 1.32 1.35 1.42 OES Fuel is the sole lessor for OE's and Penn's nuclear fuel requirements (see "Capital Requirements" and Note 4G of Notes to OE's Consolidated Financial Statements). Nuclear fuel is currently financed for CEI and TE through leases with a special- purpose corporation. OE, Penn and OES Fuel have contracts for the supply of uranium sufficient to meet projected needs through 2000 and conversion services sufficient to meet projected needs through 2001. Fabrication services for fuel assemblies have been contracted by the CAPCO companies for the next four reloads for Beaver Valley Unit 1, three reloads for Beaver Valley Unit 2 (through approximately 2003 and 2002, respectively), the next two reloads for Perry (through approximately 2001), and the next four reloads for Davis-Besse (through approximately 2004). The Companies have a contract with U.S. Enrichment Corporation for the majority of their enrichment requirements for nuclear fuel through 2014. Prior to the expiration of existing commitments, the Companies intend to make additional arrangements for the supply of uranium and for the subsequent conversion, enrichment, fabrication, reprocessing and/or waste disposal services, the specific prices and availability of which are not known at this time. Due to the present lack of availability of domestic reprocessing services, to the continuing absence of any program to begin development of such reprocessing capability and questions as to the economics of reprocessing, the Companies are calculating nuclear fuel costs based on the assumption that spent fuel will not be reprocessed. On-site spent fuel storage facilities for Perry and Davis-Besse, are expected to be adequate through 2010 and 2017, respectively; facilities at Beaver Valley Units 1 and 2 are expected to be adequate through 2011 and 2005, respectively. After on-site storage capacity is exhausted, additional storage capacity will have to be obtained which could result in significant additional costs unless reprocessing services or permanent waste disposal facilities become available. The Federal Nuclear Waste Policy Act of 1982 provides for the construction of facilities for the disposal of high-level nuclear wastes, including spent fuel from nuclear power plants operated by electric utilities; however, the selection of a suitable site has become embroiled in the political process. Duquesne, CEI and TE have each previously entered into contracts with the U.S. Department of Energy (DOE) for the disposal of spent fuel from Beaver Valley, Perry, and Davis-Besse, respectively. On December 17, 1996, the DOE notified the Companies that it would be unable to begin acceptance of spent fuel for disposal by January 31, 1998 as mandated by Section 302(a)(5)(B) of the Nuclear Waste Policy Act (NPA). As a result, the Companies along with over 40 other nuclear utilities and more than 50 state agencies have asked for federal court approval to stop payments into the Nuclear Waste Fund and for an order requiring DOE to take immediate action to accept delivery of spent nuclear fuel. System Capacity and Reserves The respective 1997 net maximum hourly demand on each of the Companies was OE-5,389,000 kilowatts (kW) (including 387,000 kW of firm power sales which extend through 2005 as discussed under "Competition") on June 25, 1997; Penn-836,000 kW (including 63,000 kW of firm power sales) on June 25, 1997; CEI- 3,955,000 kW on June 25, 1997; and TE-1,813,000 kW on July 14 1997. Based on existing capacity plans, the load forecast made in December 1997 and anticipated term power sales to other utilities, the capacity margins during the 1998-2002 period are expected to range from about 8% to 10% for the FirstEnergy system. Regional Reliability The Companies participate with 24 other electric companies operating in nine states in the East Central Area Reliability Coordination Agreement (ECAR), which was organized for the purpose of furthering the reliability of bulk power supply in the area through coordination of the planning and operation by the ECAR members of their bulk power supply facilities. The ECAR members have established principles and procedures regarding matters affecting the reliability of the bulk power supply within the ECAR region. Procedures have been adopted regarding: i) the evaluation and simulated testing of systems' performance; ii) the establishment of minimum levels of daily operating reserves; iii) the development of a program regarding emergency procedures during conditions of declining system frequency; and iv) the basis for uniform rating of generating equipment. Competition The Companies compete with other utilities for intersystem bulk power sales and for sales to municipalities and cooperatives. The Companies compete with suppliers of natural gas and other forms of energy in connection with their industrial and commercial sales and in the home climate control market, both with respect to new customers and conversions, and with all other suppliers of electricity. To date, there has been no substantial cogeneration by the Companies' customers. Technological advances and regulatory changes are driving forces toward increasing competition in the energy market. The Pennsylvania pilot program, which allows residents to choose their electric generation supplier (see "Utility Regulation--PPUC Rate Matters") is one such regulatory change. In addition, many large electricity users continue to push for some form of retail wheeling, which would enable retail customers to purchase electricity from producers other than the local utility. In February 1996, the PUCO approved a change allowing large industrial customers that have interruptible service contracts to buy their power from other sources when they have been advised by their local utility that service will be interrupted. On January 6, 1998, the co-chairs of the Ohio General Assembly's Joint Select Committee on Electric Industry Deregulation released their draft report of a plan which proposes to give customers a choice from whom they buy electricity beginning January 1, 2000. No consensus has been reached by the full Committee; in the meantime, legislation consistent with the co-chairs' draft report may be introduced into the General Assembly by one or both of the co-chairs. In an effort to more fully utilize their facilities and hold down rates to their other customers, OE and Penn have entered into a long-term power sales agreement with another utility. Currently, OE and Penn are selling 450,000 kW annually under this contract through December 31, 2005. OE and Penn have the option to reduce this commitment by 150,000 kW, with three years' advance notice. Research and Development The Companies participate in funding the Electric Power Research Institute (EPRI), which was formed for the purpose of expanding electric research and development under the voluntary sponsorship of the nation's electric utility industry -- public, private and cooperative. Its goal is to mutually benefit utilities and their customers by promoting the development of new and improved technologies to help the utility industry meet present and future electric energy needs in environmentally and economically acceptable ways. EPRI conducts research on all aspects of electric power production and use, including fuels, generating, delivery, energy management and conservation, environmental effects and energy analysis. The major portion of EPRI research and development projects is directed toward practical solutions and their applications to problems currently facing the electric utility industry. In 1997, approximately 69% of the Companies' research and development expenditures were related to EPRI. Executive Officers The executive officers are elected at the annual organization meeting of the Board of Directors, held immediately after the annual meeting of stockholders, and hold office until the next such organization meeting, unless the Board of Directors shall otherwise determine, or unless a resignation is submitted.

At December 31, 1997, the Company's nonutility subsidiaries and the Companies had a total of 10,020 employees consisting of the following: OE-3,218, CEI - 3,162, TE - 1,532, Penn - 997 and CSC - 1,111 employees. ITEM 2. PROPERTIES The Companies' respective first mortgage indentures constitute, in the opinion of the Companies' counsel, direct first liens on substantially all of the respective Companies' physical property, subject only to excepted encumbrances, as defined in the indentures. See "Leases" and "Capitalization" notes to the respective financial statements for information concerning leases and financing encumbrances affecting certain of the Companies' properties. The Companies own, individually or together with other companies as tenants in common, and/or lease, the generating units in service as of March 1, 1998, shown on the table below.

Prolonged outages of existing generating units might make it necessary for the Companies, depending upon the demand for electric service upon their system, to use to a greater extent than otherwise, less efficient and less economic generating units, or purchased power, and in some cases may require the reduction of load during peak periods under the Companies' interruptible programs, all to an extent not presently determinable. The Companies' generating plants and load centers are connected by a transmission system consisting of elements having various voltage ratings ranging from 23 kilovolts (kV) to 345 kV. The Companies' overhead and underground transmission lines aggregate 7,505 miles. The Companies' electric distribution systems include 55,141 miles of overhead pole line and underground conduit carrying primary, secondary and street lighting circuits. They own, individually or together with one or more of the other CAPCO companies as tenants in common, substations with a total installed transformer capacity of 49,286, 125 kilovolt-amperes. The Companies' transmission lines also interconnect with those of AEP, The Dayton Power and Light Company, Duquesne, Monongahela Power Company, West Penn Power Company, Detroit Edison Company and Pennsylvania Electric Company. These interconnections make possible utilization by the Companies of generating capacity constructed as a part of the CAPCO program, as well as providing opportunities for the sale of power to other utilities. Substation Distribution Transmission Transformer Systems Lines Capacity ------------ ------------ ----------- (Miles) (kV-amperes) OE 26,220 3,873 20,603,056 Penn 5,110 606 3,938,069 CEI 23,305 2,351 16,669,000 TE 506 675 8,076,000 ------ ----- ---------- Total 55,141 7,505 49,286,125 ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required for this item for FirstEnergy and OE (through November 7, 1997) is included on page 17 of FirstEnergy's 1997 Annual Report to Stockholders (Exhibit 13). The information required for CEI, TE and Penn is not applicable because they are wholly owned subsidiaries. ITEM 6. SELECTED FINANCIAL DATA ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information called for by Items 6 through 8 is incorporated herein by reference to Selected Financial Data, Management's Discussion and Analysis of Results of Operations and Financial Condition, and Financial Statements included on the pages shown in the following table in the respective company's 1997 Annual Report to Stockholders (Exhibit 13). Item 6 Item 7 Item 8 ------ ------ ------ FirstEnergy 17 18-21 16,22-38 OE 1 2-7 8-29 Penn 1 2-4 5-16 CEI 1 2-7 8-30 TE 1 2-7 8-30 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT FirstEnergy ----------- The information required by Item 10, with respect to Identification of FirstEnergy's Directors and with respect to reports required to be filed under Section 16 of the Securities Exchange Act of 1934, is incorporated herein by reference to the Company's 1998 Proxy Statement filed with the Securities and Exchange Commission (SEC) pursuant to Regulation 14A and, with respect to Identification of Executive Officers, to "Part I, Item 1. Business- Executive Officers" herein. OE, CEI and TE -------------- W. R. Holland, H. P. Burg and A. J. Alexander are the Directors of OE, CEI, and TE since the Ohio Edison-Centerior merger. Information concerning these individuals is shown in the "Executive Officers" section of Item 1. Penn ---- The present term of office of each Penn director extends until the next succeeding annual meeting of stockholders and until his successor is elected and shall qualify. The Penn executive officers are elected at the annual organization meeting of the Penn Board of Directors, held immediately after the annual meeting of stockholders, and hold office until the next such organization meeting, unless the Board of Directors shall otherwise determine, or unless a resignation is submitted. H. Peter Burg -Age 51 President and Chief Financial Officer of the Company; and President of OE, CEI and TE since 1997. President, Chief Operating Officer and Chief Financial Officer of OE from 1996 to 1997. Senior Vice President and Chief Financial Officer of OE from 1989 to 1996. President of Penn from 1994 to 1995. Director of Penn since 1989. Mr. Burg is also a director of the Company, OE, CEI and TE. Willard R. Holland -Age 61 Chairman of the Board and Chief Executive Officer of the Company since 1997. Chairman of the Board and Chief Executive Officer, and Chief Financial Officer of Penn, since 1993. Chairman of the Board and Chief Executive Officer of OE, from 1996 to 1997. President and Chief Executive Officer of OE, from 1993 to 1996. President and Chief Operating Officer of OE from 1991 to 1993. Director of Penn since 1991. Mr. Holland is also a director of the Company, OE, CEI, TE and A. Schulman, Inc. R. Joseph Hrach -Age 49 President of Penn since 1996. Division Manager, Stark Division, of OE from 1991 to 1996. Director of Penn since 1996. Joseph J. Nowak -Age 66 Retired. Consultant to Armco Inc. during 1993 and Vice President during 1992 of Armco Inc., and Executive Vice President-Operations from 1988 to 1992 of Cyclops Industries, Inc., manufacturers of steel products. Cyclops Industries, Inc. merged with Armco Inc. in 1992. Director of Penn since 1982. Jack E. Reed -Age 55 Vice President of Penn since 1992. Director of Penn since 1992. Richard L. Werner -Age 66 Retired in 1997 as Chairman of the Board, President, and Chief Executive Officer of Werner Co., Inc., manufacturer of aluminum extrusions, ladders and scaffolding. Director of Penn since 1993. Robert P. Wushinske -Age 58 Secretary and General Counsel of Penn since 1994 and Vice President and Treasurer of Penn since 1987. David W. McKean -Age 45 Director, Budget and Financial Reporting Services of the Company since 1997. Comptroller of Penn since 1992. ITEM 11. EXECUTIVE COMPENSATION FirstEnergy - The information required by this item is incorporated herein by reference to the Company's 1998 Proxy Statement filed with the SEC pursuant to Regulation 14A. OE CEI and TE - The information required by this item follows:

CERTAIN SEVERANCE PAY AGREEMENTS Information related to severance pay agreements with each of Messrs. Holland, Burg, Alexander and Gill are incorporated herein by reference to the Company's 1998 Proxy Statement. In 1996, Centerior entered into a severance pay agreement with Mr. Lange providing for the payment of severance benefits in the event that his employment was to terminate other than for cause, death or disability as a result of a merger. This agreement was extended to November 7, 1998. The severance agreement provided that in the event of a termination of employment (other than for cause, death or disability), he shall be entitled to receive a payment equal to three times his base salary. In addition, (i) certain benefit plans would be continued for three years following termination, (ii) he would be entitled to a payment reflecting the retirement benefit he would have been entitled to had his employment continued for the three-year period following termination of his employment, and (iii) certain additional payments will be made to him if he is subject to an excise tax. Penn - The information required by this item follows: - ----

Each executive's 1997 target long-term incentive opportunity was converted into performance shares equal to an equivalent number of shares of FirstEnergy's common stock based on the average price of such stock during December 1996, and will be held in a Common Stock Equivalent Account through 2000. The Common Stock Equivalent Account was converted to FirstEnergy common stock upon the consummation of the merger of OE and Centerior Energy Corporation. At the end of this four-year performance period, this Common Stock Equivalent Account will be valued based on the average price of FirstEnergy's common stock during December 2000 and as if any dividends that would have been paid on such stock during the performance period had been reinvested on the date paid. This value may be increased or decreased based upon the total return of FirstEnergy's common stock relative to the Edison Electric Institute's Index of Investor-owned Electric Utility Companies (Index) during the period. If an executive retires, dies or otherwise leaves the employment of the Company prior to the end of the four-year period, the value will be further proportionally decreased based on the number of months worked during the period. However, an executive must work at least twelve months during the four-year period to be eligible for an award payout. The final value of an executive's account, if any, will be paid to the executive in cash early in the year 2001. The final value of an executive's account may range from zero to 150% of the target amount. The maximum amount in the above table is equal to 150% of the target 1997 long-term incentive opportunity and will be earned if FirstEnergy's total shareholder return is in the top 15% compared to the Index noted above. An amount equal to 100% of the target 1997 long-term incentive opportunity will be earned if FirstEnergy's total shareholder return is in the 38th percentile compared to the Index. The threshold amount is equal to 50% of the target 1997 long-term incentive opportunity and will be earned if FirstEnergy's total shareholder return is in the 60th percentile compared to the Index. Payouts for a total shareholder return ranking between the 15th percentile and 60th percentile will be interpolated. However, there will be no long-term award payouts if FirstEnergy's total shareholder return compared to the Index falls below the 60th percentile. Supplemental Executive Retirement Plan Penn participates in the FirstEnergy System Supplemental Executive Retirement Plan. Mr. Holland is the only executive officer listed above who is eligible to participate in the Plan. At normal retirement, eligible senior executives of Penn who have five or more years of service with the FirstEnergy System are provided a retirement benefit equal to the greater of 65 percent of their highest annual salary from Penn, or 55 percent of the average of their highest three consecutive years of salary plus annual incentive awards paid after January 1, 1996 and paid prior to retirement, reduced by the executive's pensions under tax-qualified pension plans of Penn or other employers, any supplementary pension under Penn's Executive Deferred Compensation Plan, and social security benefits. Subject to exceptions that might be made in specific cases, senior executives retiring prior to age 65, or with less than five years of service, or both, may receive a similar but reduced benefit. This Plan also provides for disability and surviving spouse benefits. As of the end of 1997, the estimated annual retirement benefits at age 65 from all of the above sources was $76,963 for Mr. Holland. Pension Plan The Company's trusteed noncontributory Pension Plan covers substantially all full-time employees including officers of the Company. Pension benefits are determined using a formula based on a Pension Plan participant's years of accrued service and average rate of monthly earnings for the highest 60 months of the last 120 months of accrued service immediately preceding retirement or termination of service. Compensation covered by the Pension Plan consists of basic cash wages and compensation deferred through the Savings Plan up to the maximum amount permitted under the Internal Revenue Code of 1986, as adjusted in accordance with regulations. This amount was $160,000 per year for 1997 and $160,000 per year for 1998. In addition, a supplementary pension benefit may be payable to participants in the Executive Deferred Compensation Plan. Compensation for 1997 covered by these two plans for the officers shown in the Executive Compensation Table who are not currently participants in the FirstEnergy System Supplemental Executive Retirement Plan is shown under the Salary column of the Table. The credited years of service for these same officers are as follows: J. E. Reed -31 years; and R. P. Wushinske -24 years. The following table shows the estimated annual amounts payable upon retirement as pension benefits under the Pension Plan and the supplemental pension benefit under the Executive Deferred Compensation Plan, based on specified compensation and years of credited service classifications, assuming continuation of both such present Plans and employment until age 65. Retirement prior to age 62 results in a reduction of pension benefits. The amounts shown are subject to a reduction based on an individual's covered compensation, date of birth and years of credited service as defined by the Pension Plan and its optional survivorship provision.

(b) Security Ownership of Management at December 31, 1997: OE, CEI, TE - ----------- The information required by this item for all individuals with the exception of Messrs. Lange and Edelman is incorporated herein by reference to the Company's 1998 Proxy Statement filed with the SEC pursuant to Regulation 14A. Messrs. Lange and Edelman hold 5,964 and 4,974 shares, respectively, of FirstEnergy Common Stock as of December 31, 1997. Penn - ----

(c) Changes in Control: Not applicable ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS FirstEnergy - The information required by this item is - ----------- incorporated herein by reference to the Company's 1998 Proxy Statement filed with the SEC pursuant to Regulation 14A. OE, CEI, TE and Penn - The information required by this item - -------------------- follows: None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements Included in Part II of this report and incorporated herein by reference to the respective company's 1997 Annual Report to Stockholders (Exhibit 13 below) at the pages indicated.

SCHEDULE II THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

SCHEDULE II THE TOLEDO EDISON COMPANY CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

SCHEDULE II PENNSYLVANIA POWER COMPANY VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRSTENERGY CORP. BY /s/ W. R. Holland ------------------------- W. R. Holland Chairman of the Board and Chief Executive Officer Date: March 17, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated: /s/ W. R. Holland /s/ H. P. Burg - -------------------------------- ------------------------ W. R. Holland H. P. Burg Chairman of the Board President and Chief and Chief Executive Officer Financial Officer and Director (Principal and Director (Principal Executive Officer) Financial Officer) /s/ Harvey L. Wagner /s/ Glenn H. Meadows - -------------------------------- ------------------------ Harvey L. Wagner Glenn H. Meadows Controller (Principal Director Accounting Officer) /s/ Paul J. Powers - -------------------------------- ------------------------- Robert M. Carter Paul J. Powers Director Director /s/ Carol A. Cartwright /s/ Charles W. Rainger - -------------------------------- ------------------------ Carol A. Cartwright Charles W. Rainger Director Director /s/ William F. Conway /s/ Robert C. Savage - -------------------------------- ---------------------- William F. Conway Robert C. Savage Director Director /s/ Robert L. Loughhead /s/ George M. Smart - -------------------------------- ------------------------- Robert L. Loughhead George M. Smart Director Director /s/ Russell W. Maier /s/ Jesse T. Williams, Sr. - -------------------------------- ---------------------- Russell W. Maier Jesse T. Williams, Sr. Director Director Date: March 17, 1998 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. OHIO EDISON COMPANY BY /s/ H. P. Burg ------------------- H. P. Burg President Date: March 17, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated: /s/ H. P. Burg /s/ R. H. Marsh - -------------------------- ---------------------------- H. P. Burg R. H. Marsh President and Director Vice President (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/ W. R. Holland - -------------------------- ---------------------------- Harvey L. Wagner W. R. Holland Controller Director (Principal Accounting Officer) /s/ Anthony J. Alexander - ------------------------------- Anthony J. Alexander Director Date: March 17, 1998 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE CLEVELAND ELECTRIC ILLUMINATING COMPANY BY /s/ H. P. Burg -------------------- H. P. Burg President Date: March 17, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated: /s/ H. P. Burg /s/ R. H. Marsh - ------------------------- ---------------------------- H. P. Burg R. H. Marsh President and Director Vice President (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/ W. R. Holland - ---------------------------- ---------------------------- Harvey L. Wagner W. R. Holland Controller Director (Principal Accounting Officer) /s/ Anthony J. Alexander - ------------------------------------- Anthony J. Alexander Director Date: March 17, 1998 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE TOLEDO EDISON COMPANY BY /s/ H. P. Burg -------------------------- H. P. Burg President Date: March 17, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated: /s/ H. P. Burg /s/ R. H. Marsh - --------------------------- ---------------------------- H. P. Burg R. H. Marsh President and Director Vice President (Principal Executive Officer) (Principal Financial Officer) /s/ Harvey L. Wagner /s/ W. R. Holland - --------------------------- ----------------------------- Harvey L. Wagner W. R. Holland Controller Director (Principal Accounting Officer) /s/ Anthony J. Alexander - ----------------------------------- Anthony J. Alexander Director Date: March 17, 1998 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PENNSYLVANIA POWER COMPANY BY /s/ Willard R. Holland ----------------------------- Willard R. Holland Chairman of the Board and Chief Executive Officer Date: March 25, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated: /s/ Willard R. Holland /s/ Robert P. Wushinske - ----------------------------- ---------------------------- Willard R. Holland Robert P. Wushinske Chairman of the Board Vice President and and Chief Executive Office and Treasurer (Principal Executive Officer (Principal Accounting and Principal Financial Officer) Officer) /s/ H. P. Burg /s/ Jack E. Reed - ----------------------------- -------------------------- H. P. Burg Jack E. Reed Director Director /s/ R. Joseph Hrach - ----------------------------- ---------------------------- R. Joseph Hrach Richard L. Werner Director Director - ---------------------------- Joseph J. Nowak Director Date: March 25, 1998 EX-13 2 FIRSTENERGY CORP. SELECTED FINANCIAL DATA

CLASSIFICATION OF HOLDERS OF COMMON STOCK AS OF DECEMBER 31, 1997

MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate", "potential", "expect", "believe", "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy market prices, legislative and regulatory changes (including revised environmental requirements), availability and cost of capital and other similar factors. RESULTS OF OPERATIONS FirstEnergy Corp. was formed when the merger of Ohio Edison Company (OE) and Centerior Energy Corporation (Centerior) became effective on November 8, 1997. The Federal Energy Regulatory Commission (FERC) approved our merger on October 29, 1997, and the Securities and Exchange Commission followed with their approval on November 5, 1997. The merger of the companies has been accounted for by using purchase accounting under the guidelines of Accounting Principles Board Opinion No. 16, "Business Combinations." Under purchase accounting, the results of operations for the combined entity are reported from the point of consummation forward. As a result, FirstEnergy financial statements for 1997 reflect twelve months of operations for OE and its wholly owned subsidiary, Pennsylvania Power Company (Penn), but include only seven weeks (November 8, 1997 to December 31, 1997) for the former Centerior companies, which include The Cleveland Electric Illuminating Company (CEI) and The Toledo Edison Company (TE). Results reported for prior periods are for OE and Penn only (OE companies). We continued to make significant progress in 1997 as our companies prepare for a more competitive environment in the electric utility industry. The most significant event during the year was the consummation of our merger. We expect the merger to produce a minimum of $1 billion in savings during the first ten years of joint operations through the elimination of duplicative activities, improved operating efficiencies, lower capital expenditures, accelerated debt reduction, the coordination of the Companies' work forces and enhanced purchasing opportunities. During 1997, we reviewed every facet of our operations to determine best practices and opportunities for increasing efficiency and reducing costs. On January 29, 1998, our workforce was reduced by 310 employees to eliminate duplicative activities resulting from the merger. Total merger-related staffing reductions to date are 1,336, including 582 employees who recently accepted voluntary retirement programs and 444 employees who left the Companies in 1997 and were not replaced. These reductions are expected to produce approximately $90 million in annual savings. Earnings per share of $1.94 for 1997 were adversely affected by net nonrecurring charges, primarily related to the staffing reductions discussed above, amounting to $.22 per share. Excluding these charges, 1997 earnings per share were $2.16, compared to $2.10 in 1996. The 1997 results reflect accelerated depreciation and amortization of nuclear and regulatory assets totaling approximately $211 million under OE's Rate Reduction and Economic Development Plan and Penn's Rate Stability and Economic Development Plan; results for 1996 included approximately $178 million of accelerated depreciation and amortization. The 1996 results compared favorably to earnings of $2.05 per share in 1995. Operating revenues were up $351.7 million in 1997, compared to 1996. Excluding the seven weeks of former Centerior results, we achieved record operating revenues for the third consecutive year with an increase of $3.8 million over 1996. The OE companies also achieved record retail sales for the fifth consecutive year. The following table summarizes the sources of changes in operating revenues for the OE companies for 1997 and 1996 as compared to the previous year: 1997 1996 - --------------------------------------------------------------- (In millions) Increased retail kilowatt-hour sales $ 7.8 $ 58.1 Change in average retail prices 13.3 (46.1) Sales to utilities (25.8) (4.5) Other 8.5 (3.6) - --------------------------------------------------------------- Net Increase $ 3.8 $ 3.9 =============================================================== An improving local economy helped the OE companies achieve record retail sales of 27.3 billion kilowatt-hours. Our customer base continues to grow with approximately 4,900 new retail customers added in 1997, after gaining more than 12,200 customers the previous year. Residential sales decreased 0.8% in 1997, following a 1.8% gain the previous year. Commercial sales rose 1.2% and 1.3% in 1997 and 1996, respectively. Increased demand by rubber and plastics and primary metal manufacturers contributed to a 1.0% rise in industrial sales during 1997, following a 5.5% increase the previous year. Sales to other utilities fell 26.4% in 1997 as a result of the December 31, 1996 expiration of a one-year contract with another utility to supply 250 megawatts of power. This follows a 2.7% increase the previous year. As a result of the above factors, total kilowatt-hour sales for the OE companies dropped 5.0%, compared with sales in 1996, which were up 3.0% from 1995. Fuel and purchased power expenses increased $29.6 million in 1997. Excluding the seven weeks of former Centerior results, fuel and purchased power costs were down $19.4 million. Because of lower total kilowatt-hour sales, the OE companies spent less for fuel and purchased power during 1997, compared to 1996 costs, which were also down compared to 1995. Higher nuclear expenses in 1997 reflect increased operating costs at the Beaver Valley Plant and the seven weeks of former Centerior results. Excluding the Centerior costs, 1997 nuclear expenses increased $20 million compared to 1996. Nuclear operating costs were lower in 1996, compared to 1995, due primarily to lower refueling outage cost levels. Other operating costs in 1997 were $105.6 million higher than in 1996. The seven weeks of Centerior results contributed $81 million to the increase. For the OE companies, the increase in other operating costs in 1997 reflects a fourth quarter charge of approximately $41.5 million for the voluntary retirement program mentioned above and estimated severance expenses. These cost increases were partially offset by gains on the sale of emission allowances during the year. The decrease in other operating costs in 1996, compared to 1995, reflects lower maintenance costs at our fossil-fuel generating units. The changes in depreciation and regulatory asset amortization in 1997 and 1996 reflect accelerations under the regulatory plans discussed above. The changes between 1997 and 1996 also include $31.2 million of former Centerior depreciation, $6.2 million of former Centerior regulatory asset amortization and $7.7 million of goodwill amortization. General taxes were up $40.2 million in 1997, compared to 1996. Excluding the former Centerior's results for the seven weeks ended December 31, 1997, general taxes were down $7 million, compared to last year. The decrease in 1997 was due to lower property taxes and an adjustment in the second quarter of 1997 which reduced the OE companies' liabilities for gross receipts taxes. Other income rose $20.8 million in 1997. The former Centerior's seven-week results contributed $5.6 million of the increase. For the OE companies, the increases in other income in 1997 and 1996 were principally due to higher investment income-- primarily through our PNBV Capital Trust investment, which was effective in the third quarter of 1996. Excluding the seven-week results for the former Centerior, overall interest costs continue to trend downward. For the OE companies, total interest costs were $4.2 million lower in 1997 than in 1996. Interest on long-term debt decreased due to our economic refinancings and redemption of higher-cost debt totaling approximately $282 million that had been outstanding as of December 31, 1996. Other interest expense increased compared to 1996 due mainly to higher levels of short- term borrowing. We also discontinued deferring nuclear unit interest in the second half of 1995, consistent with OE's regulatory plan. CAPITAL RESOURCES AND LIQUIDITY We have significantly improved our financial position over the past five years. For the OE companies, cash generated from operations was nearly 25% higher in 1997 than it was in 1992 due to higher revenues and aggressive cost controls. At the same time, return on common equity improved from 10.8% in 1992 to 12.1% in 1997, excluding the net nonrecurring charges discussed above. By the end of 1997, the OE companies were serving about 57,000 more customers than they were five years ago, with approximately 2,000 fewer employees. As a result, our customer/employee ratio has increased by 56% over the past five years, standing at 264 customers per employee at the end of 1997, compared with 169 at the end of 1992. In addition, capital expenditures for the OE companies have dropped substantially during that period. Expenditures in 1997 were approximately 37% lower than they were in 1992 and annual depreciation charges have exceeded property additions since the end of 1987. Over the past five years, the OE companies have aggressively taken advantage of opportunities in the financial markets to reduce our average capital costs. Through refinancing activities, we have reduced the average cost of debt from 8.53% at the end of 1992 to 7.77% at the end of 1997. Excluding the nonrecurring charges mentioned above, our fixed charge coverage ratios continue to improve. The indenture ratio, which is used to determine OE's ability to issue first mortgage bonds, improved from 4.34 at the end of 1992 to 6.21 at the end of 1997. Over the same period, the charter ratio--a measure of our ability to issue preferred stock--improved from 1.89 to 2.35. At the end of 1997, FirstEnergy's common equity as a percentage of capitalization stood at 34% compared to 40% at the end of 1992 for OE. This decrease occurred due to the addition of $4.4 billion of debt, $633.2 million of preferred stock and $1.6 billion of equity to our capital structure as a result of the merger. Our cash requirements in 1998 for operating expenses, construction expenditures and scheduled debt maturities are expected to be met without issuing additional securities. During 1997, the OE companies reduced their total debt by approximately $245 million. FirstEnergy has cash requirements of approximately $2.4 billion for the 1998-2002 period to meet scheduled maturities of long-term debt and preferred stock. Of that amount, approximately $288 million applies to 1998. We had about $98.2 million of cash and temporary investments and $302.2 million of short-term indebtedness on December 31, 1997. As of December 31, 1997, we had the capability to borrow $61 million through unused OES Fuel credit facilities. In addition, our unused borrowing capability included $162 million under revolving lines of credit and $26 million of bank facilities that provide for borrowings on a short-term basis at the banks' discretion. Our capital spending for the period 1998-2002 is expected to be about $1.5 billion (excluding nuclear fuel), of which approximately $385 million applies to 1998. These spending plans include investing approximately $300 million during the five-year period ($65 million in 1998) in nonregulated business ventures. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $518 million, of which about $85 million applies to 1998. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $380 million and $112 million, respectively, as the nuclear fuel is consumed. Also, we have operating lease commitments (net of related trust income) of approximately $1.0 billion for the 1998-2002 period, of which approximately $189 million relates to 1998. We recover the cost of nuclear fuel consumed and operating leases through our electric rates. Interest Rate Risk Our exposure to fluctuations in market interest rates is mitigated by the fact that a significant portion of our debt has fixed interest rates, as noted in the following table. As discussed in Note 3, our investments in capital trusts effectively reduce future lease obligations, also reducing interest rate risk. As discussed in Note 1, changes in the market value of our decommissioning trust funds are recognized with a corresponding change to the decommissioning liability. The table below presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio, debt obligations and preferred stock with mandatory redemption provisions:

OUTLOOK We face many competitive challenges in the years ahead as the electric utility industry undergoes significant changes, including changing regulation and the entrance of more energy suppliers into the marketplace. Retail wheeling, which would allow retail customers to purchase electricity from other energy producers, will be one of those challenges. Our regulatory plans provide the foundation to position us to meet the challenges we are facing by significantly reducing fixed costs and lowering rates to a more competitive level. OE's Rate Reduction and Economic Development Plan was approved by the Public Utilities Commission of Ohio (PUCO) in 1995; Penn's Rate Stability and Economic Development Plan was approved by the Pennsylvania Public Utility Commission (PPUC) in the second quarter of 1996 and FirstEnergy's Rate Reduction and Economic Development Plan for CEI and TE was approved in January 1997. These regulatory plans initially maintain current base electric rates for OE, CEI and TE through December 31, 2005, and Penn through June 20, 2006. The plans also revised the Companies' fuel cost recovery methods. As part of OE's regulatory plan, transition rate credits were implemented for customers, which are expected to reduce operating revenues by approximately $600 million during the regulatory plan period which is to be followed by a base rate reduction of approximately $300 million in 2006. The base rate freeze for CEI and TE is to be followed by a $310 million base rate reduction in 2006; interim reductions beginning in June 1998 of $3 per month will increase to $5 per month per residential customer by July 1, 2001. Total savings of $391 million are anticipated over the term of the plan for CEI's and TE's customers. CEI and TE have also committed $105 million for economic development and energy efficiency programs. All of the Companies' regulatory assets are being recovered under provisions of the regulatory plans. In addition, the PUCO and PPUC have authorized OE and Penn to recognize additional capital recovery related to their generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the regulatory plan periods of at least $2 billion and $358 million, respectively, more than the amounts that would have been recognized if the regulatory plans were not in effect. These additional amounts are being recovered through current rates. Based on the regulatory environment we operate in today and the regulatory plans, we believe we will continue to be able to bill and collect cost-based rates relating to CEI's and TE's nonnuclear operations and all of OE's and Penn's operations; accordingly, it is appropriate that we continue the application of Statement of Financial Accounting Standards No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). However, as discussed below, changes in the regulatory environment are on the horizon. With respect to Penn, we expect to discontinue the application of SFAS 71 for the generation portion of that business, possibly as early as 1998. We do not expect the impact of Penn discontinuing SFAS 71 to be material. As further discussed below, the Ohio legislature is in the discussion stages of restructuring the electric utility industry within the State. We do not expect any changes in regulation to be effective within the next two years and we cannot assess what the ultimate impact may be. The PUCO has authorized CEI and TE to recognize additional capital recovery related to their generating assets and additional amortization of regulatory assets during the regulatory plan period of at least $2 billion more than the amounts that would have been recognized if the regulatory plans were not in effect. For regulatory purposes, these additional charges will be reflected over the rate plan period. The FirstEnergy regulatory plan does not provide for full recovery of CEI's and TE's nuclear operations. Accordingly, regulatory assets representing customer receivables for future income taxes related to nuclear assets of $794 million were written off prior to consummation of the merger since CEI and TE ceased application of SFAS 71 for their nuclear operations when implementation of the FirstEnergy regulatory plan became probable. At the consummation of the merger in November 1997, CEI and TE recognized a fair value purchase accounting adjustment which decreased the carrying value of their nuclear assets by approximately $2.55 billion. The fair value adjustment recognized for financial reporting purposes will ultimately satisfy the $2 billion asset reduction commitment contained in the CEI and TE regulatory plan over the regulatory plan period. On September 30, 1997, Penn filed a restructuring plan with the PPUC. The plan describes how Penn will restructure its rates and provide customers with direct access to alternative electricity suppliers; customer choice is to be phased in over three years beginning in 1999, after completion of a two-year pilot program. Penn will continue to deliver power to homes and businesses through its transmission and distribution system, which remains regulated by the PPUC. Penn also plans to sell electricity and energy-related services in its own territory and throughout Pennsylvania as an alternative supplier through its nonregulated subsidiary, Penn Power Energy. Through the restructuring plan, Penn is seeking recovery of $293 million of stranded costs through a competitive transition charge starting in 1999 and ending in 2005, which is consistent with Penn's Rate Stability and Economic Development Plan currently in effect. The PPUC plans to hold public hearings on Penn's restructuring plan early in 1998. On January 6, 1998, the co-chairs of the Ohio General Assembly's Joint Select Committee on Electric Industry Deregulation released their draft report of a plan which proposes to give customers a choice from whom they buy electricity beginning January 1, 2000. No consensus has been reached by the full Committee; in the meantime, legislation consistent with the co-chairs' draft report may be introduced into the General Assembly by one or both of the co-chairs. We cannot predict when or if this legislation will be introduced and if it will be passed into law. We continue to study the potential effects that such legislation would have on our financial position and results of operations. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB reported in October 1997 that it plans to continue working on the proposal in 1998. The Clean Air Act Amendments of 1990, discussed in Note 6, require additional emission reductions by 2000. We are pursuing cost- effective compliance strategies for meeting the reduction requirements that begin in 2000. CEI and TE have been named as "potentially responsible parties" (PRPs) for three sites listed on the Superfund National Priorities List and are aware of their potential involvement in the cleanup of several other sites. Allegations that CEI and TE disposed of hazardous waste at these sites, and the amount 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. If CEI and TE were held liable for 100% of the cleanup costs of all the sites referred to above, the cost could be as high as $313 million. However, we believe that the actual cleanup costs will be substantially lower than $313 million, that CEI's and TE's share of any cleanup costs will be substantially less than 100% and that most of the other PRPs are financially able to contribute their share. CEI and TE have accrued a $5.9 million liability as of December 31, 1997, based on estimates of the costs of cleanup and their proportionate responsibility for such cost. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition, cash flows or results of operations. Impact of the Year 2000 Issue The Year 2000 Issue is the result of computer programs being written using two digits rather than four to identify the applicable year. Any of our programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the Year 2000. This could result in system failures or miscalculations. We currently believe that with modifications to existing software and conversions to new software, the Year 2000 Issue will pose no significant operational problems for our computer systems as so modified and converted. If these modifications and conversions are not made, or are not completed on a timely basis, the Year 2000 Issue could have a material impact on our operations. We have initiated formal communications with many of our major suppliers to determine the extent to which we are vulnerable to those third parties' failure to resolve their own Year 2000 problems. Our total Year 2000 project cost and estimates to complete are based on currently available information and do not include the estimated costs and time associated with the impact of a third party's Year 2000 Issue. There can be no guarantee that the failure of other companies to resolve their own Year 2000 issues will not have material adverse effect on us. We are utilizing both internal and external resources to reprogram and/or replace and test the software for Year 2000 modifications. Most of our Year 2000 problems will be resolved through system replacements. The different phases of our Year 2000 project will be completed at various dates, most of which occur in 1999. We plan to complete the entire Year 2000 project by mid-December 1999. Of the total project cost, approximately $64 million will be capitalized since those costs are attributable to the purchase of new software for total system replacements, (i.e., the year 2000 solution comprises only a portion of the benefit resulting from the system replacements). The remaining $8 million will be expensed as incurred over the next two years. To date, we have incurred and expensed approximately $1 million related to the assessment of, and preliminary efforts in connection with, our Year 2000 project and the development of a remediation plan. The costs of the project and the date on which we plan to complete the Year 2000 modifications are based on management's best estimates, which were derived from numerous assumptions of future events including the continued availability of certain resources, and other factors. However, there can be no guarantee that this project will be completed as planned and actual results could differ materially from the estimates. Specific factors that might cause material differences include, but are not limited to, the availability and cost of trained personnel, the ability to locate and correct all relevant computer code, and similar uncertainties. FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF INCOME

FIRSTENERGY CORP. CONSOLIDATED BALANCE SHEETS

FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CAPITALIZATION

FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont.)

FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont.)

FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF RETAINED EARNINGS

For the Years Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------------------------- (In thousands) Balance at beginning of year $557,642 $471,095 $389,600 Net income 305,774 302,673 294,747 -------- -------- -------- 863,416 773,768 684,347 - ------------------------------------------------------------------------------------------------- Cash dividends on common stock 216,770 216,126 215,512 Preferred stock redemption adjustments - - (2,260) -------- -------- -------- 216,770 216,126 213,252 -------- -------- -------- Balance at end of year (Note 4A) $646,646 $557,642 $471,095 - ------------------------------------------------------------------------------------------------- Preferred Stock ------------------------------------------- Not Subject to Subject to Common Stock Unallocated Mandatory Redemption Mandatory Redemption ---------------------------------- --------------------- -------------------- Other ESOP Par or Par or Number Par Paid-In Common Number Stated Number Stated of Shares Value Capital Stock of Shares Value of Shares Value --------- ------- --------- --------- ----------- -------- ---------- --------- (Dollars in thousands) Balance, January 1, 1995 152,569,437 $1,373,125 $724,848 $(170,376) 6,282,399 $328,240 400,000 $40,000 Minimum liability for unfunded retirement benefits 2,446 Allocation of ESOP Shares 1,274 7,720 Sale of 9% Preferred Stock 4,800,000 120,000 Redemptions-- 7.24% Series (720) (363,700) (36,370) 7.36% Series (609) (350,000) (35,000) 8.20% Series (932) (450,000) (45,000) - ----------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 152,569,437 1,373,125 726,307 (162,656) 5,118,699 211,870 5,200,000 160,000 Minimum liability for unfunded retirement benefits (51) Allocation of ESOP Shares 1,346 7,646 - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1996 152,569,437 1,373,125 727,602 (155,010) 5,118,699 211,870 5,200,000 160,000 Centerior acquisition 77,637,704 (1,350,104) 2,907,387 7,324,000 448,325 319,408 201,243 Minimum liability for unfunded retirement benefits 45 Allocation of ESOP Shares 1,874 8,033 Redemptions-- 8.45% Series (50,000) (5,000) - ------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1997 230,207,141 $23,021 $3,636,908 $(146,977) 12,442,699 $660,195 5,469,408 $356,243 ============================================================================================================================== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1997 1996 1995 - --------------------------------------------------------------------------------------------- (In thousands) (S) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 305,774 $ 302,673 $ 294,747 Adjustments to reconcile net income to net cash from operating activities: Provision for depreciation and amortization 431,431 355,780 256,085 Nuclear fuel and lease amortization 61,960 52,784 70,849 Other amortization, net 42,434 25,961 5,885 Deferred income taxes, net (29,642) 41,365 53,395 Investment tax credits, net (16,252) (14,041) (9,951) Allowance for equity funds used during construction (201) - - Receivables 21,846 24,326 (20,452) Materials and supplies (18,909) (736) 12,428 Accounts payable 57,807 962 3,545 Other 909 (41,317) 66,060 ---------- -------- --------- Net cash provided from operating activities 856,437 747,757 732,591 ---------- -------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Common stock 1,558,237 - - Preferred stock - - 120,000 Long-term debt 89,773 306,313 254,365 Short-term borrowings, net - 229,515 - Redemptions and Repayments- Preferred stock 5,000 1,016 117,528 Long-term debt 335,909 438,916 499,276 Short-term borrowings, net 47,251 - 54,677 Common Stock Dividend Payments 237,848 218,656 217,192 ---------- -------- --------- Net cash provided from (used for) financing activities 1,022,002 (122,760) (514,308) ---------- -------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Centerior acquisition 1,582,459 - - Property additions 203,839 148,189 198,103 Capital trust investments 8,934 487,979 - Other 62,237 13,406 13,641 ---------- -------- --------- Net cash used for investing activities 1,857,469 649,574 211,744 ---------- -------- --------- Net increase (decrease) in cash and cash equivalents 20,970 (24,577) 6,539 Cash and cash equivalents at beginning of period* 77,267 29,830 23,291 ---------- -------- --------- Cash and cash equivalents at end of year $ 98,237 $ 5,253 $ 29,830 ========== ======== ========= SUPPLEMENTAL CASH FLOWS INFORMATION: Cash Paid During the Year- Interest (net of amounts capitalized) $ 281,670 $ 224,541 $ 254,789 Income taxes $ 265,615 $ 157,477 $ 78,643 * 1997 beginning balance includes Centerior cash and cash equivalents as of the November 8, 1997 acquisition date. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
FIRSTENERGY CORP. CONSOLIDATED STATEMENTS OF TAXES
For the Years Ended December 31, 1997 1996 1995 - --------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: Real and personal property $137,816 $ 115,443 $ 118,707 State gross receipts 118,390 104,158 100,591 Social security and unemployment 16,551 14,602 15,787 Other 9,406 7,795 8,094 -------- ---------- ---------- Total general taxes $282,163 $ 241,998 $ 243,179 ======== ========== ========== PROVISION FOR INCOME TAXES: Currently payable- Federal $235,728 $ 164,132 $ 145,511 State 18,152 9,839 10,352 -------- ---------- ---------- 253,880 173,971 155,863 -------- ---------- ---------- Deferred, net- Federal (23,716) 37,277 50,631 State (5,926) 4,088 2,764 -------- ---------- ---------- (29,642) 41,365 53,395 -------- ---------- ---------- Investment tax credit amortization (16,252) (14,041) (9,951) -------- ---------- ---------- Total provision for income taxes $207,986 $ 201,295 $ 199,307 ======== ========== ========== INCOME STATEMENT CLASSIFICATION OF PROVISION FOR INCOME TAXES: Operating income $183,798 $ 189,417 $ 191,972 Other income 24,188 11,878 7,335 -------- ---------- ---------- Total provision for income taxes $207,986 $ 201,295 $ 199,307 ======== ========== ========== RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes $513,760 $ 503,968 $ 494,054 ======== ========== ========== Federal income tax expense at statutory rate $179,816 $ 176,389 $ 172,919 Increases (reductions) in taxes resulting from- Amortization of investment tax credits (16,252) (14,041) (9,951) State income taxes net of federal income tax benefit 7,947 9,053 8,525 Amortization of tax regulatory assets 30,402 26,945 19,690 Other, net 6,073 2,949 8,124 ---------- ---------- ---------- Total provision for income taxes $ 207,986 $ 201,295 $ 199,307 ========== ========== ========== ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: Property basis differences $2,091,207 $1,319,878 $1,310,852 Deferred nuclear expense 454,902 262,123 271,114 Customer receivables for future income taxes 262,428 191,537 204,978 Deferred sale and leaseback costs (121,974) 78,607 82,381 Unamortized investment tax credits (116,593) (72,663) (77,777) Unused alternative minimum tax credits (243,039) - - Other (22,626) (2,396) (19,114) ---------- ---------- ---------- Net deferred income tax liability $2,304,305 $1,777,086 $1,772,434 ========== ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include FirstEnergy Corp. (Company) and its principal electric utility operating subsidiaries, Ohio Edison Company (OE), The Cleveland Electric Illuminating Company (CEI), Pennsylvania Power Company (Penn) and The Toledo Edison Company (TE). The Company and its utility subsidiaries are referred to throughout as "Companies." The Company's 1997 results of operations include the results of CEI and TE for the period November 8, 1997 through December 31, 1997. All significant intercompany transactions have been eliminated. The Companies follow the accounting policies and practices prescribed by the Public Utilities Commission of Ohio (PUCO), the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Certain prior year amounts have been reclassified to conform with the current year presentation. REVENUES- The Companies' principal business is providing electric service to customers in central and northern Ohio and western Pennsylvania. The Companies' 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 located in the Companies' service area and sales to wholesale customers. There was no material concentration of receivables at December 31, 1997 or 1996, with respect to any particular segment of the Companies' customers. CEI and TE sell substantially all of their retail customer accounts receivable to Centerior Funding Corp. under an asset-backed securitization agreement which expires in 2001. Centerior Funding completed a public sale of $150 million of receivables-backed investor certificates in a transaction that qualified for sale accounting treatment. REGULATORY PLANS- OE's Rate Reduction and Economic Development Plan was approved by the PUCO in 1995; Penn's Rate Stability and Economic Development Plan was approved by the PPUC in the second quarter of 1996 and FirstEnergy's Rate Reduction and Economic Development Plan for CEI and TE was approved in January 1997. These regulatory plans initially maintain current base electric rates for OE, CEI and TE through December 31, 2005, and Penn through June 20, 2006. At the end of the regulatory plan periods, OE base rates will be reduced by $300 million (approximately 20 percent below current levels) and CEI and TE base rates will be reduced by a combined $310 million (approximately 15 percent below current levels). The plans also revised the Companies' fuel cost recovery methods. The Companies formerly recovered fuel-related costs not otherwise included in base rates from retail customers through separate energy rates. In accordance with the respective regulatory plans, OE's, CEI's and TE's fuel rates will be frozen through the regulatory plan period, subject to limited periodic adjustments; Penn's plan provided for the roll-in to base rates of its fuel rate. As part of OE's and FirstEnergy's regulatory plans, transition rate credits were implemented for customers, which are expected to reduce operating revenues for OE by approximately $600 million and CEI and TE by approximately $391 million during the regulatory plan period. All of the Companies' regulatory assets are being recovered under provisions of the regulatory plans. In addition, the PUCO has authorized OE to recognize additional capital recovery related to its generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the regulatory plan period of at least $2 billion, and the PPUC has authorized Penn to accelerate at least $358 million, more than the amounts that would have been recognized if the regulatory plans were not in effect. These additional amounts are being recovered through current rates. As of December 31, 1997, OE's and Penn's cumulative additional capital recovery and regulatory asset amortization amounted to $427 million. CEI and TE recognized a fair value purchase accounting adjustment of $2.55 billion in connection with the FirstEnergy merger; that fair value adjustment recognized for financial reporting purposes will ultimately satisfy the $2 billion asset reduction commitment contained in the CEI and TE regulatory plan. For regulatory purposes, CEI and TE will recognize the $2 billion of accelerated amortization over the rate plan period. UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction (except for CEI's and TE's nuclear generating units which were adjusted to fair value), including payroll and related costs such as taxes, employee benefits, administrative and general costs and financing costs (allowance for funds used during construction). The Companies provide for depreciation on a straight- line basis at various rates over the estimated lives of property included in plant in service. The annual composite rate for OE's and Penn's electric plant was approximately 3.0% in 1997, 1996, and 1995. CEI's and TE's composite rates were both approximately 3.0% in 1997. In addition to the straight-line depreciation recognized in 1997, 1996 and 1995, OE and Penn recognized additional capital recovery of $172 million, $144 million and $27 million, respectively, as additional depreciation expense in accordance with their regulatory plans. Such additional charges in the accumulated provision for depreciation were $343 million and $171 million as of December 31, 1997 and 1996, respectively. Annual depreciation expense includes approximately $30.3 million for future decommissioning costs applicable to the Companies' ownership and leasehold interests in four nuclear generating units. The Companies' share of the future obligation to decommission these units is approximately $1.2 billion in current dollars and (using a 3.5% escalation rate) approximately $2.9 billion in future dollars. The estimated obligation and the escalation rate were developed based on site specific studies. Payments for decommissioning are expected to begin in 2016, when actual decommissioning work begins. The Companies have recovered approximately $252 million for decommissioning through their electric rates from customers through December 31, 1997. If the actual costs of decommissioning the units exceed the funds accumulated from investing amounts recovered from customers, the Companies expect that additional amount to be recoverable from their customers. The Companies have approximately $301.2 million invested in external decommissioning trust funds as of December 31, 1997. Earnings on these funds are reinvested with a corresponding increase to the decommissioning liability. The Companies have also recognized an estimated liability of approximately $34.9 million related to decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy (DOE), as required by the Energy Policy Act of 1992. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB indicated in October 1997 that it plans to continue work on the proposal. COMMON OWNERSHIP OF GENERATING FACILITIES- The Companies and Duquesne Light Company constitute the Central Area Power Coordination Group (CAPCO). The CAPCO companies own and/or lease, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Companies' portions of operating expenses associated with jointly owned facilities are included in the corresponding operating expenses on the Consolidated Statements of Income. The amounts reflected on the Consolidated Balance Sheet under utility plant at December 31, 1997, include the following:
Companies' Utility Accumulated Construction Ownership/ Plant Provision for Work in Leasehold Generating Units in Service Depreciation Progress Interest - -------------------------------------------------------------------------- (In millions) W.H. Sammis #7 $ 305.5 $ 100.8 $ .8 68.80% Bruce Mansfield #1, #2 and #3 886.6 408.1 2.1 83.01% Beaver Valley #1 and #2 2,299.9 656.3 3.9 69.46% Davis-Besse 400.9 - - 100.00% Perry 2,674.6 720.3 3.1 86.26% Eastlake # 5 159.9 94.6 - 68.80% Seneca 64.9 24.3 - 80.00% - ----------------------------------------------------------------------- Total $6,792.3 $2,004.4 $ 9.9 =======================================================================
The Seneca Unit is jointly owned by CEI and a non-CAPCO company. NUCLEAR FUEL- OE's and Penn's nuclear fuel is recorded at original cost, which includes material, enrichment, fabrication and interest costs incurred prior to reactor load. CEI and TE severally lease their respective portions of nuclear fuel and pay for the fuel as it is consumed (see Note 3). The Companies amortize the cost of nuclear fuel based on the rate of consumption. The Companies' electric rates include amounts for the future disposal of spent nuclear fuel based upon the formula used to compute payments to the DOE. 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. Alternative minimum tax credits of $243 million, which may be carried forward indefinitely, are available to reduce future federal income taxes. RETIREMENT BENEFITS- The Companies' trusteed, noncontributory defined benefit pension plans cover almost all full-time employees. Upon retirement, employees receive a monthly pension based on length of service and compensation. The Companies use the projected unit credit method for funding purposes and were not required to make pension contributions during the three years ended December 31, 1997. The following sets forth the funded status of the plans and amounts recognized on the Consolidated Balance Sheets as of December 31: 1997 1996 - ----------------------------------------------------------------- (In millions) Actuarial present value of benefit obligations: Vested benefits $1,096.3 $ 562.0 Nonvested benefits 60.4 38.9 - ---------------------------------------------------------------- Accumulated benefit obligation $1,156.7 $ 600.9 ================================================================ Plan assets at fair value $1,542.5 $ 946.3 Actuarial present value of projected benefit obligation 1,327.5 688.5 - ---------------------------------------------------------------- Plan assets in excess of projected benefit obligation 215.0 257.8 Unrecognized net gain (136.5) (106.2) Unrecognized prior service cost 21.0 20.1 Unrecognized net transition asset (25.9) (33.9) - ---------------------------------------------------------------- Net pension asset $ 73.6 $ 137.8 ================================================================ The assets of the plans consist primarily of common stocks, United States government bonds and corporate bonds. Net pension costs for the three years ended December 31, 1997, were computed as follows: 1997 1996 1995 - ---------------------------------------------------------------- (In millions) Service cost-benefits earned during the period $ 15.2 $ 14.2 $ 12.8 Interest on projected benefit obligation 55.9 49.3 48.1 Return on plan assets (194.0) (141.6) (194.5) Net deferral 87.5 52.7 118.7 Voluntary early retirement program expense 54.5 12.5 - Gain on plan curtailment - (12.8) - - ---------------------------------------------------------------- Net pension cost $ 19.1 $ (25.7) $(14.9) ================================================================ The assumed discount rates used in determining the actuarial present value of the projected benefit obligation were 7.25% in 1997 and 7.5% in 1996 and 1995. The assumed rates of increase in future compensation levels used to measure this obligation were 4.0% in 1997 and 4.5% in 1996 and 1995. Expected long-term rates of return on plan assets were assumed to be 10% in 1997, 1996 and 1995. The Companies provide 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 Companies pay insurance premiums to cover a portion of these benefits in excess of set limits; all amounts up to the limits are paid by the Companies. The Companies recognize the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. In accordance with Statement of Financial Accounting Standards (SFAS) No. 88 "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," the 1996 net pension costs shown above and the 1996 postretirement benefit costs shown below included curtailment effects (significant changes in projected plan assumptions) relating to the pension and postretirement benefit plans. The employee terminations reflected in OE's and Penn's 1996 voluntary early retirement program represented a plan curtailment that significantly reduced the expected future employee service years and the related accrual of defined pension and postretirement benefits. In the pension plan, the reduction in the benefit obligation increased the net pension asset and was shown as a plan curtailment gain. In the postretirement benefit plan, the unrecognized prior service cost associated with service years no longer expected to be rendered as a result of the terminations was shown as a plan curtailment loss. The following sets forth the funded status of the plans and amounts recognized on the Consolidated Balance Sheets as of December 31: 1997 1996 - -------------------------------------------------------------- (In millions) Accumulated postretirement benefit obligation allocation: Retirees $384.8 $155.5 Fully eligible active plan participants 25.5 10.1 Other active plan participants 123.8 75.5 - -------------------------------------------------------------- Accumulated postretirement benefit obligation 534.1 241.1 Plan assets at fair value 2.8 2.0 - -------------------------------------------------------------- Accumulated postretirement benefit obligation in excess of plan assets 531.3 239.1 Unrecognized transition obligation (125.1) (133.5) Unrecognized net loss (24.0) (7.4) - ------------------------------------------------------------- Net postretirement benefit liability $382.2 $ 98.2 ============================================================== Net periodic postretirement benefit costs for the three years ended December 31, 1997, were computed as follows: 1997 1996 1995 - ----------------------------------------------------------------- (In millions) Service cost-benefits attributed to the period $ 4.6 $ 4.3 $ 4.5 Interest cost on accumulated benefit obligation 20.4 17.4 21.1 Amortization of transition obligation 8.3 8.8 10.2 Amortization of loss - .1 .1 Voluntary early retirement program expense 1.9 .5 - Loss on plan curtailment - 13.1 - - ---------------------------------------------------------------- Net periodic postretirement benefit cost $35.2 $44.2 $35.9 ================================================================ The health care trend rate assumption is 6.0% in the first year gradually decreasing to 4.0% for the year 2008 and later. The discount rates used to compute the accumulated postretirement benefit obligation were 7.25% in 1997 and 7.5% in 1996 and 1995. An increase in the health care trend rate assumption by one percentage point in all years would increase the accumulated postretirement benefit obligation by approximately $42.3 million and the aggregate annual service and interest costs by approximately $3.6 million. 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. The Companies reflect temporary cash investments at cost, which approximates their market value. Noncash financing and investing activities included capital lease transactions amounting to $3.0 million, $2.0 million and $1.0 million for the years 1997, 1996 and 1995, respectively. Commercial paper transactions of OES Fuel (a wholly owned subsidiary of OE) that have initial maturity periods of three months or less are reported net within financing activities under long-term debt and are reflected as long-term debt on the Consolidated Balance Sheets (see Note 4G). All borrowings with initial maturities of less than one year are defined as financial instruments under generally accepted accounting principles 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: 1997 1996 - ---------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value - --------------------------------------------------------------- (In millions) Long-term debt $6,980 $7,334 $2,919 $2,963 Preferred stock $ 356 $ 362 $ 160 $ 160 Investments other than cash and cash equivalents: Debt securities - Maturity (5-10 years) $ 487 $ 512 $ 364 $ 364 - Maturity (more than 10 years) 1,134 1,149 387 390 Equity securities 24 24 14 14 All other 336 337 104 102 - --------------------------------------------------------------- $1,981 $2,022 $ 869 $ 870 =============================================================== The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Companies' ratings. Long-term debt and preferred stock subject to mandatory redemption of CEI and TE 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 trust have been recognized in the trust investment with a corresponding change to the decommissioning liability. The debt and equity securities referred to above are in the held-to- maturity category. The Companies have no securities held for trading purposes. REGULATORY ASSETS- The Companies recognize, as regulatory assets, costs which the FERC, PUCO and PPUC have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are being recovered from customers under the Companies' respective regulatory plans. Based on those regulatory plans, at this time, the Companies believe they will continue to be able to bill and collect cost-based rates (with the exception of CEI's and TE's nuclear operations as discussed below); accordingly, it is appropriate that the Companies continue the application of SFAS No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). However, based on the regulatory environment in Pennsylvania, Penn is expected to discontinue its application of SFAS 71 for its generation operations, possibly as early as 1998. The impact of Penn discontinuing SFAS 71 is not expected to be material. OE and Penn recognized additional cost recovery of $39 million, $34 million and $11 million in 1997, 1996 and 1995, respectively, as additional regulatory asset amortization in accordance with their regulatory plans. FirstEnergy's regulatory plan does not provide for full recovery of CEI's and TE's nuclear operations. As a result, in October 1997 CEI and TE discontinued application of SFAS 71 for their nuclear operations and decreased their regulatory assets of customer receivables for future income taxes related to the nuclear assets by $794 million. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: 1997 1996 - ------------------------------------------------------------- (In millions) Nuclear unit expenses $1,224.2 $ 733.4 Customer receivables for future income taxes 724.2 523.0 Rate stabilization program deferrals 460.2 - Sale and leaseback costs (141.1) 220.8 Loss on reacquired debt 191.1 95.8 Employee postretirement benefit costs 25.9 29.2 Uncollectible customer accounts 18.9 29.8 Perry Unit 2 termination 36.7 40.4 DOE decommissioning and decontamination costs 39.3 18.0 Other 44.7 12.7 - ----------------------------------------------------------- Total $2,624.1 $1,703.1 =========================================================== 2. MERGER The Company was formed on November 8, 1997, by the merger of OE and Centerior Energy Corporation (Centerior). The Company holds directly all of the issued and outstanding common shares of OE and all of the issued and outstanding common shares of Centerior's former direct subsidiaries, which include, among others, CEI and TE. As a result of the merger, the former common shareholders of OE and Centerior now own all of the outstanding shares of FirstEnergy Common Stock. All other classes of capital stock of OE and its subsidiaries and of the subsidiaries of Centerior are unaffected by the Merger and remain outstanding. The merger was accounted for as a purchase of Centerior's net assets with 77,637,704 shares of FirstEnergy Common Stock through the conversion of each outstanding Centerior Common Stock share into 0.525 of a share of FirstEnergy Common Stock (fractional shares were paid in cash). Based on an imputed value of $20.125 per share, the purchase price was approximately $1.582 billion, which also included approximately $20 million of merger related costs. Goodwill of approximately $2.1 billion was recognized (to be amortized on a straight-line basis over forty years), which represented the excess of the purchase price over Centerior's net assets after fair value adjustments. Such amount may be adjusted if additional information produces changed assumptions over the twelve months following the merger as the Company continues to integrate operations and evaluate options with respect to its generation portfolio. The merger purchase accounting adjustments, which were recorded in the records of Centerior's direct subsidiaries, primarily consist of: (1) revaluation of CEI's and TE's nuclear generating units to fair value ($1.60 billion), based upon the results of an independent appraisal and estimated discounted future cash flows expected to be generated by their nuclear generating units (the estimated cash flows are based upon management's current view of the likely cost recovery associated with the nuclear units); (2) adjusting their preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (3) recognizing additional obligations related to retirement benefits; (4) recognizing estimated severance and other compensation liabilities ($80 million); and (5) adjustment of the Beaver Valley Unit 2 deferred rent liability to reflect remaining payments on a straight-line basis. The nuclear assets revaluation does not include decommissioning since that obligation is expected to be recovered with the cash flows provided by the regulated portion of the business. Other assets and liabilities were not adjusted since they remain subject to rate regulation on a historical cost basis. 3. LEASES: The Companies lease certain generating facilities, nuclear fuel, certain transmission facilities, office space and other property and equipment under cancelable and noncancelable leases. OE sold portions of its ownership interests in Perry Unit 1 and Beaver Valley Unit 2 and entered into operating leases on the portions sold for basic lease terms of approximately 29 years. CEI and TE also sold portions of their ownership interests in Beaver Valley Unit 2 and Bruce Mansfield Units 1, 2, and 3 and entered into similar operating leases for lease terms of approximately 30 years. During the terms of their respective leases OE, CEI and TE continue to be responsible, to the extent of their individual combined ownership and leasehold interests, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. They have the right, at the end of the respective basic lease terms, to renew their respective leases. They also have the right to purchase the facilities at the expiration of the basic lease term or renewal term (if elected) at a price equal to the fair market value of the facilities. The basic rental payments are adjusted when applicable federal tax law changes. OES Finance, Incorporated (OES Finance), a wholly owned subsidiary of OE, maintains deposits pledged as collateral to secure reimbursement obligations relating to certain letters of credit supporting OE's obligations to lessors under the Beaver Valley Unit 2 sale and leaseback arrangements. The deposits pledged to the financial institution providing those letters of credit are the sole property of OES Finance. In the event of liquidation, OES Finance, as a separate corporate entity, would have to satisfy its obligations to creditors before any of its assets could be made available to OE as sole owner of OES Finance common stock. Nuclear fuel is currently financed for CEI and TE through leases with a special-purpose corporation. As of December 31, 1997, $157 million of nuclear fuel was financed under a lease financing arrangement totaling $190 million ($90 million of intermediate-term notes and $100 million from bank credit arrangements). The notes mature from 1998 through 2000 and the bank credit arrangements expire in October 1998. Lease rates are based on intermediate-term note rates, bank rates and commercial paper rates. Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 1997, are summarized as follows: 1997 1996 1995 - ------------------------------------------------------------- (In millions) Operating leases Interest element $ 149.9 $107.6 $104.6 Other 45.2 18.3 13.9 Capital leases Interest element 6.1 6.5 7.0 Other 6.0 6.3 6.6 - ------------------------------------------------------------ Total rentals $207.2 $138.7 $132.1 ============================================================ The future minimum lease payments as of December 31, 1997, are: Operating Leases ------------------------------- Capital Lease Capital Trusts Leases Payments Income Net - -------------------------------------------------------------- (In millions) 1998 $ 93.0 $ 290.1 $ 101.0 $ 189.1 1999 67.6 301.6 98.0 203.6 2000 42.0 296.4 94.5 201.9 2001 24.3 307.3 90.6 216.7 2002 16.3 315.3 85.4 229.9 Years thereafter 93.6 4,263.3 607.4 3,655.9 - ----------------------------------------------------------- Total minimum lease payments 336.8 $5,774.0 $1,076.9 $4,697.1 ======== ======== ======== Executory costs 36.0 - ---------------------------- Net minimum lease payments 300.8 Interest portion 96.6 - ---------------------------- Present value of net minimum lease payments 204.2 Less current portion 74.6 - ---------------------------- Noncurrent portion $ 129.6 ============================ OE invested in the PNBV Capital Trust in the third quarter of 1996. The Trust was established to purchase a portion of the lease obligation bonds issued on behalf of lessors in OE's Perry Unit 1 and Beaver Valley Unit 2 sale and leaseback transactions. CEI and TE established the Shippingport Capital Trust in the fourth quarter of 1997 to purchase the lease obligation bonds issued on behalf of lessors in their Bruce Mansfield Units 1, 2 and 3 sale and leaseback transactions. As noted in the table on page 34, the PNBV and Shippingport Capital Trusts' income, which is included in other income in the Consolidated Statements of Income, effectively reduces lease costs related to those transactions. 4. CAPITALIZATION: (A) RETAINED EARNINGS- There are no restrictions on retained earnings for payment of cash dividends on the Company's common stock. (B) EMPLOYEE STOCK OWNERSHIP PLAN- The Companies fund the matching contribution for their 401(k) savings plan through an ESOP Trust. All full-time employees eligible for participation in the 401(k) savings plan are covered by the ESOP. The ESOP borrowed $200 million from OE and acquired 10,654,114 shares of OE's common stock through market purchases; the shares were converted into the Company's common stock in connection with the merger. Dividends on ESOP shares are used to service the debt. Shares are released from the ESOP on a pro-rata basis as debt service payments are made. In 1997, 1996 and 1995, 429,515 shares, 404,522 shares and 412,914 shares, respectively, were allocated to OE and Penn employees with the corresponding expense recognized based on the shares allocated method. The fair value of 7,829,538 shares unallocated as of December 31, 1997, was approximately $227.1 million. Total ESOP-related compensation expense was calculated as follows: - -------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------- (In millions) Base compensation $ 9.9 $ 9.0 $ 9.0 Dividends on common stock held by the ESOP and used to service debt (3.4) (2.9) (2.5) - ------------------------------------------------------------- Net expense $ 6.5 $ 6.1 $ 6.5 - ------------------------------------------------------------- (C) EQUITY COMPENSATION PLAN Under an Equity Compensation Plan adopted by Centerior in 1994, restricted common stock and common stock options were granted to management employees. Upon consummation of the merger, outstanding options became exercisable for FirstEnergy common stock with option prices and the number of shares adjusted to reflect the merger conversion ratio. A total of 222,023 options for FirstEnergy common stock were exercised and 68,592 shares of restricted stock were distributed in 1997. Unexercised options totaling 517,388 shares were outstanding as of December 31, 1997. Computing compensation costs for the options consistent with SFAS No. 123 "Accounting for Stock-Based Compensation" would not have materially affected net income in 1997 and basic and diluted earnings per common share are the same. (D) PREFERRED STOCK- Penn's 7.75% series of preferred stock has a restriction which prevents early redemption prior to July 2003. OE's 8.45% series of preferred stock has no optional redemption provision, and its 7.75% series is not redeemable before April 1998. CEI's $42.40 and $88.00 series of preferred stock are not redeemable before June 1998 and December 2001, respectively, and its $90.00 series has no optional redemption provision. All other preferred stock may be redeemed by the Companies in whole, or in part, with 30-90 days' notice. (E) PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- Annual sinking fund provisions for the Companies' preferred stock are as follows: Redemption Price Per Series Shares Share Date Beginning - -------------------------------------------------------------- OE 8.45% 50,000 $100 (i) CEI $ 7.35 C 10,000 100 (i) 88.00 E 3,000 1,000 (i) 91.50 Q 10,714 1,000 (i) 90.00 S 18,750 1,000 November 1 1999 88.00 R 50,000 1,000 December 1 2001 TE $ 9.375 16,650 100 (i) Penn 7.625% 7,500 100 October 1 2002 - ----------------------------------------------------------- (i) Sinking fund provisions are in effect. Annual sinking fund requirements for the next five years are $21 million in 1998, $40 million in 1999, $38 million in 2000, $85 million in 2001 and $19 million in 2002. A liability of $19 million was included in the net assets acquired from CEI and TE for preferred dividends declared attributable to the post-merger period. Accordingly, no accruals for CEI and TE preferred dividends are included in the Company's Statement of Consolidated Income for the period November 8, 1997 through December 31, 1997. (F) OHIO EDISON OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY OHIO EDISON SUBORDINATED DEBENTURES- Ohio Edison Financing Trust, a wholly owned subsidiary of OE, has issued $120 million of 9% Cumulative Trust Preferred Capital Securities. OE purchased all of the Trust's Common Securities and simultaneously issued to the Trust $123.7 million principal amount of 9% Junior Subordinated Debentures due 2025 in exchange for the proceeds that the Trust received from its sale of Preferred and Common Securities. The sole assets of the Trust are the Subordinated Debentures whose interest and other payment dates coincide with the distribution and other payment dates on the Trust Securities. Under certain circumstances the Subordinated Debentures could be distributed to the holders of the outstanding Trust Securities in the event the Trust is liquidated. The Subordinated Debentures may be optionally redeemed by OE beginning December 31, 2000, at a redemption price of $25 per Subordinated Debenture plus accrued interest, in which event the Trust Securities will be redeemed on a pro-rata basis at $25 per share plus accumulated distributions. OE's obligations under the Subordinated Debentures along with the related Indenture, amended and restated Trust Agreement, Guarantee Agreement and the Agreement for expenses and liabilities, constitute a full and unconditional guarantee by OE of payments due on the Preferred Securities. (G) LONG-TERM DEBT- The first mortgage indentures and their supplements, which secure all of the Companies' first mortgage bonds, serve as direct first mortgage liens on substantially all property and franchises, other than specifically excepted property, owned by the Companies. Based on the amount of bonds authenticated by the Trustee through December 31, 1997, OE's annual sinking and improvement fund requirement for all bonds issued under the mortgage amounts to $30 million. OE expects to deposit funds in 1998 that will be withdrawn upon the surrender for cancellation of a like principal amount of bonds, which are specifically authenticated for such purposes against unfunded property additions or against previously retired bonds. This method can result in minor increases in the amount of the annual sinking fund requirement. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) - --------------------------------------------------------------- 1998 $374.4 1999 866.5 2000 418.4 2001 101.6 2002 744.7 - --------------------------------------------------------------- The Companies' obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds and, in some cases, by subordinate liens on the related pollution control facilities. Certain pollution control revenue bonds are entitled to the benefit of irrevocable bank letters of credit of $419.0 million. To the extent that drawings are made under those letters of credit to pay principal of, or interest on, the pollution control revenue bonds, OE, CEI and/or TE are entitled to a credit against their obligation to repay those bonds. The Companies pay annual fees of 0.43% to 1.875% of the amounts of the letters of credit to the issuing banks and are obligated to reimburse the banks for any drawings thereunder. OE had unsecured borrowings of $215 million at December 31, 1997, which are supported by a $250 million long-term revolving credit facility agreement which expires December 30, 1999. OE must pay an annual facility fee of 0.20% on the total credit facility amount. In addition, the credit agreement provides that OE maintain unused first mortgage bond capability for the full credit agreement amount under OE's indenture as potential security for the unsecured borrowings. OE's and Penn's nuclear fuel purchases are financed through the issuance of OES Fuel commercial paper and loans, both of which are supported by a $225 million long-term bank credit agreement which expires March 31, 1999. Accordingly, the commercial paper and loans are reflected as long-term debt on the Consolidated Balance Sheets. OES Fuel must pay an annual facility fee of 0.1875% on the total line of credit and an annual commitment fee of 0.0625% on any unused amount. 5. SHORT-TERM BORROWINGS AND BANK LINES OF CREDIT: Short-term borrowings outstanding at December 31, 1997, consisted of $182.2 million of bank borrowings and $120.0 million of OES Capital, Incorporated commercial paper. OES Capital is a wholly owned subsidiary of OE whose borrowings are secured by customer accounts receivable. OES Capital can borrow up to $120 million under a receivables financing agreement at rates based on certain bank commercial paper and is required to pay an annual fee of 0.26% on the amount of the entire finance limit. The receivables financing agreement expires in 1999. The Companies have various credit facilities with domestic banks that provide for borrowings of up to $202 million under various interest rate options, including a $125 million revolving credit facility which expires in May 1998. OE's and Penn's short-term borrowings may be made under these lines of credit on their unsecured notes. To assure the availability of these lines, the Companies are required to pay annual commitment fees that vary from 0.22% to 0.625%. These lines expire at various times during 1998. The weighted average interest rates on short-term borrowings outstanding at December 31, 1997 and 1996, were 6.02% and 5.77%, respectively. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: CAPITAL EXPENDITURES- The Companies' current forecasts reflect expenditures of approximately $1.2 billion for property additions and improvements related to their regulated businesses from 1998- 2002, of which approximately $320 million is applicable to 1998. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $518 million, of which approximately $85 million applies to 1998. During the same periods, the Companies' nuclear fuel investments are expected to be reduced by approximately $380 million and $112 million, respectively, as the nuclear fuel is consumed. The Companies also expect to invest approximately $300 million during 1998-2002 ($65 million in 1998) relating to various nonregulated business ventures. NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $8.92 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on their present ownership and leasehold interests in the Beaver Valley Station, Davis-Besse Plant and the Perry Plant, the Companies' maximum potential assessment under the industry retrospective rating plan (assuming the other co-owner contributes its proportionate share of any assessments under the retrospective rating plan) would be $257.7 million per incident but not more than $32.5 million in any one year for each incident. The Companies are also insured as to their respective interests in the Beaver Valley Station, Davis-Besse Plant and the Perry Plant under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Companies have also obtained approximately $809 million of insurance coverage for replacement power costs for their respective interests in Perry, Davis-Besse and Beaver Valley. Under these policies, the Companies can be assessed a maximum of approximately $36.6 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Companies intend to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Companies' plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Companies' insurance policies, or to the extent such insurance becomes unavailable in the future, the Companies would remain at risk for such costs. GUARANTEES- The CAPCO companies have each severally guaranteed certain debt and lease obligations in connection with a coal supply contract for the Bruce Mansfield Plant. As of December 31, 1997, the Companies' shares of the guarantees (which approximate fair market value) were $66.1 million. The price under the coal supply contract, which includes certain minimum payments, has been determined to be sufficient to satisfy the debt and lease obligations. The Companies' total payments under the coal supply contract were $135.3 million, $113.8 million and $120.0 million during 1997, 1996 and 1995, respectively. The Companies' minimum annual payments are approximately $58 million under the contract, which expires December 31, 1999. ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Companies with regard to air and water quality and other environmental matters. The Companies estimate additional capital expenditures for environmental compliance of approximately $50 million, which is included in the construction forecast for their regulated businesses provided under "Capital Expenditures" for 1998 through 2002. The Companies are in compliance with the current sulfur dioxide (SO2) and nitrogen oxides (NOX) reduction requirements under the Clean Air Act Amendments of 1990. SO2 reductions through the year 1999 will be achieved by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or purchasing emission allowances. Plans for complying with reductions required for the year 2000 and thereafter have not been finalized. The Environmental Protection Agency (EPA) is conducting additional studies which could indicate the need for additional NOX reductions from the Companies' Pennsylvania facilities by the year 2003. In addition, the EPA is also considering the need for additional NOX reductions from the Companies' Ohio facilities. On November 7, 1997, the EPA proposed uniform reductions of NOX emissions across a region of twenty-two states, including Ohio and the District of Columbia (NOX Transport Rule) after determining that such NOX emissions are contributing significantly to ozone pollution in the eastern United States. In a separate but related action, eight states filed petitions with the EPA under Section 126 of the Clean Air Act seeking reductions of NOX emissions which are alleged to contribute to ozone pollution in the eight petitioning states. A December 1997 EPA Memorandum of Agreement proposes to finalize the NOX Transport Rule by September 30, 1998, and establishes a schedule for EPA action on the Section 126 petitions. The cost of NOX reductions, if required, may be substantial. The Companies continue to evaluate their compliance plans and other compliance options. The Companies are required to meet federally approved SO2 regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $25,000 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Companies cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. CEI and TE have been named as "potentially responsible parties" (PRPs) for three sites listed on the Federal Superfund National Priorities List and several other sites. Federal environmental regulations provide that PRPs for specific sites would be held liable on a joint and several basis. CEI and TE have accrued a liability of $5.9 million based on estimates of their share of potential cleanup costs. Legislative, administrative and judicial actions will continue to change the way that the Companies must operate in order to comply with environmental laws and regulations. With respect to any such changes and to the environmental matters described above, the Companies expect that any resulting additional capital costs which may be required, as well as any required increase in operating costs, would ultimately be recovered from their customers. 7. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 1997 and 1996.
March 31, June 30, September 30, December 31, Three Months Ended 1997 1997 1997 1997 - ------------------------------------------------------------------------------------ (In millions, except per share amounts) Operating Revenues $604.8 $593.3 $652.7 $970.8 Operating Expenses and Taxes 478.5 467.3 511.6 808.2 - --------------------------------------------------------------------------------- Operating Income 126.3 126.0 141.1 162.6 Other Income 13.5 14.1 12.0 18.7 Net Interest Charges 66.9 66.3 64.4 110.9 - --------------------------------------------------------------------------------- Net Income $ 72.9 $ 73.8 $ 88.7 $ 70.4 ================================================================================= Earnings per Share of Common Stock $ .51 $ .51 $ .61 $ .36 ================================================================================== March 31, June 30, September 30, December 31, Three Months Ended 1996 1996 1996 1996 - ------------------------------------------------------------------------------------ (In millions, except per share amounts) Operating Revenues $611.6 $599.3 $646.9 $611.9 Operating Expenses and Taxes 481.1 471.7 500.0 486.8 - --------------------------------------------------------------------------------- Operating Income 130.5 127.6 146.9 125.1 Other Income 7.0 10.7 7.1 12.7 Net Interest Charges 67.2 64.8 64.6 68.3 - --------------------------------------------------------------------------------- Net Income $ 70.3 $ 73.5 $ 89.4 $ 69.5 ================================================================================= Earnings per Share of Common Stock $ .49 $ .51 $ .62 $ .48 =================================================================================
Results for CEI and TE are included from the November 8, 1997 acquisition date through December 31, 1997. 8. PRO FORMA COMBINED CONDENSED FIRSTENERGY FINANCIAL STATEMENTS (UNAUDITED): The pro forma statements of income of FirstEnergy give effect to the Merger as if it had been consummated on January 1, 1996, with the purchase accounting adjustments actually recognized in the business combination. Year Ended December 31, ------------------------ 1997 1996 - -------------------------------------------------------------- (In millions, except per share amounts) Operating revenues $4,975 $5,006 Operating expenses 3,966 3,941 - ------------------------------------------------------------- Operating income 1,009 1,065 Other income 61 37 Net interest 643 634 - ------------------------------------------------------------ Net income $ 427 $ 468 ============================================================ Earnings per share of common stock $ 1.92 $ 2.11 ============================================================ Pro forma adjustments reflected above include: (1) adjusting CEI and TE nuclear generating units to fair value based upon independent appraisals and estimated discounted future cash flows based on management's current view of cost recovery; (2) goodwill recognized representing the excess of the purchase price over Centerior's adjusted net assets; (3) elimination of revenue and expense transactions between OE and Centerior; (4) amortization of the fair value adjustment of long-term debt; and (5) adjustments for estimated tax effects of the above adjustments. Report of Independent Public Accountants To the Stockholders and Board of Directors of FirstEnergy Corp.: We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of FirstEnergy Corp. (an Ohio corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, retained earnings, capital stock and other paid-in capital, cash flows and taxes for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of FirstEnergy Corp. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Cleveland, Ohio February 13, 1998 EX-21 3 EXHIBIT 21 FIRSTENERGY CORP. LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 1997 Ohio Edison Company - Incorporated in Ohio The Cleveland Electric Illuminating Company - Incorporated in Ohio The Toledo Edison Company - Incorporated in Ohio Centerior Service Company - Incorporated in Ohio Centerior Properties Company - Incorporated in Ohio Centerior Enterprises Corporation - Incorporated in Delaware FirstEnergy Trading and Power Marketing, Inc. - Incorporated in Delaware FirstEnergy Telecom Corp. - Incorporated in Ohio FirstEnergy Securities Transfer Company - Incorporated in Ohio FirstEnergy Services Corp. - Incorporated in Ohio Statement of Differences ------------------------- Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 1997, is not included in the printed document. EX-23 4 EXHIBIT 23 FIRSTENERGY CORP. CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K, into FirstEnergy Corp.'s previously filed Registration Statements, File No. 333-48587 and No. 333- 48651. ARTHUR ANDERSEN LLP Cleveland, Ohio March 30, 1998 EX-27 5
UT (AMOUNTS IN 1,000'S, EXCEPT EARNINGS PER SHARE) INCOME TAX EXPENSE INCLUDES $24,188,000 RELATED TO OTHER INCOME 0001031296 FIRSTENERGY CORP. 1,000 US DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 PER-BOOK 9,573,210 2,307,102 1,002,991 5,197,492 0 18,080,795 23,021 3,489,931 646,646 4,159,598 334,864 660,195 6,969,835 182,245 0 119,984 374,401 21,379 0 74,656 5,183,638 18,080,795 2,821,435 207,986 2,081,677 2,265,475 555,960 58,343 614,303 308,529 305,774 0 0 216,770 482,450 856,437 1.94 1.94

EX-12.1 6 EXHIBIT 12.1 Page 1 OHIO EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, --------------------------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- (Dollars in Thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items $ 24,523 $303,531 $317,241 $315,170 $293,194 Interest and other charges, before reduction for amounts capitalized 285,169 283,849 273,719 255,572 250,920 Provision for income taxes 32,431 188,886 199,307 201,295 187,805 Interest element of rentals charged to income (a) 104,700 108,463 111,534 114,093 117,409 --------- -------- -------- -------- -------- Earnings as defined $446,823 $884,729 $901,801 $886,130 $849,328 ========= ======== ======== ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K: Interest on long-term debt $262,861 $259,554 $243,570 $211,935 $204,285 Other interest expense 16,445 18,931 22,944 28,211 31,209 Subsidiaries' preferred stock dividend requirements 5,863 5,364 7,205 15,426 15,426 Adjustment to subsidiaries' preferred stock dividends to state on a pre-income tax basis 7,659 3,294 2,956 2,910 2,918 Interest element of rentals charged to income (a) 104,700 108,463 111,534 114,093 117,409 -------- -------- -------- -------- -------- Fixed charges as defined $397,528 $395,606 $388,209 $372,575 $371,247 ======== ======== ======== ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES (b) 1.12 2.24 2.32 2.38 2.29 ==== ==== ==== ==== ==== - ------------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. (b) These ratios exclude fixed charges applicable to the guarantee of the debt of a coal supplier aggregating $8,565,000, $7,424,000, $6,315,000, $5,093,000 and $3,828,000 for each of the five years ended December 31, 1997, respectively.
EXHIBIT 12.1 Page 2 OHIO EDISON COMPANY CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED AND PREFERENCE STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, --------------------------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- (Dollars in Thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items $ 24,523 $303,531 $317,241 $315,170 $293,194 Interest and other charges, before reduction for amounts capitalized 285,169 283,849 273,719 255,572 250,920 Provision for income taxes 32,431 188,886 199,307 201,295 187,805 Interest element of rentals charged to income (a) 104,700 108,463 111,534 114,093 117,409 -------- -------- -------- -------- -------- Earnings as defined $446,823 $884,729 $901,801 $886,130 $849,328 ======== ======== ======== ======== ======== FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS PREFERRED AND PREFERENCE STOCK DIVIDEND REQUIREMENTS(PRE-INCOME TAX BASIS): Interest on long-term debt $262,861 $259,554 $243,570 $211,935 $204,285 Other interest expense 16,445 18,931 22,944 28,211 31,209 Preferred and preference stock dividend requirements 29,570 27,043 29,699 27,923 27,817 Adjustment to preferred and preference stock dividends to state on a pre-income tax basis 38,265 16,444 16,745 10,542 10,503 Interest element of rentals charged to income (a) 104,700 108,463 111,534 114,093 117,409 -------- -------- -------- -------- -------- Fixed charges as defined plus preferred and preference stock dividend requirements (pre-income tax basis) $451,841 $430,435 $424,492 $392,704 $391,223 ======== ======== ======== ======== ======== CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED AND PREFERENCE STOCK DIVIDEND REQUIREMENTS PRE-INCOME TAX BASIS) (b) 0.99(c) 2.06 2.12 2.26 $2.17 ==== ==== ==== ==== ===== - --------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. (b) These ratios exclude fixed charges applicable to the guarantee of the debt of a coal supplier aggregating $8,565,000, $7,424,000, $6,315,000, $5,093,000 and $3,828,000 for each of the five years ended December 31, 1997, respectively. (c) Earnings as defined were deficient in 1993 by $5,018,000 to cover fixed charges plus preferred stock dividend requirements (pre- income tax basis).
EX-13.1 7 OHIO EDISON COMPANY SELECTED FINANCIAL DATA
1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------- (In thousands, except per share amounts) Operating Revenues $2,473,582 $2,469,785 $2,465,846 $2,368,191 $2,369,940 ---------------------------------------------------------- Net Income $ 293,194 $ 315,170 $ 317,241 $ 303,531 $ 82,724 ---------------------------------------------------------- Earnings on Common Stock $ 280,802 $ 302,673 $ 294,747 $ 281,852 $ 59,017 ---------------------------------------------------------- Total Assets $8,977,455 $9,054,457 $8,892,088 $9,045,255 $8,964,841 ---------------------------------------------------------- Capitalization at December 31: Common Stockholders' Equity $2,724,319 $2,503,359 $2,407,871 $2,317,197 $2,243,292 Preferred Stock: Not Subject to Mandatory Redemption 211,870 211,870 211,870 328,240 328,240 Subject to Mandatory Redemption 150,000 155,000 160,000 40,000 45,500 Long-Term Debt 2,569,802 2,712,760 2,786,256 3,166,593 3,039,263 ---------------------------------------------------------- Total Capitalization $5,655,991 $5,582,989 $5,565,997 $5,852,030 $5,656,295 ---------------------------------------------------------- Capitalization Ratios: Common Stockholders' Equity 48.2% 44.8% 43.3% 39.6% 39.7% Preferred Stock: Not Subject to Mandatory Redemption 3.7 3.8 3.8 5.6 5.8 Subject to Mandatory Redemption 2.7 2.8 2.9 0.7 0.8 Long-Term Debt 45.4 48.6 50.0 54.1 53.7 ---------------------------------------------------------- Total Capitalization 100.0% 100.0% 100.0% 100.0% 100.0% ---------------------------------------------------------- Kilowatt-Hour Sales (Millions): Residential 8,631 8,704 8,546 8,201 8,237 Commercial 7,335 7,246 7,151 6,885 6,787 Industrial 11,202 11,089 10,513 9,841 9,874 Other 150 147 146 144 144 ---------------------------------------------------------- Total Retail 27,318 27,186 26,356 25,071 25,042 Total Wholesale 5,241 7,076 6,920 5,879 7,162 ---------------------------------------------------------- Total 32,559 34,262 33,276 30,950 32,204 ---------------------------------------------------------- Customers Served: Residential 995,605 988,179 978,118 968,483 957,867 Commercial 111,189 113,795 111,978 109,832 107,401 Industrial 4,568 4,590 4,268 3,786 3,685 Other 1,415 1,331 1,308 1,226 1,199 ---------------------------------------------------------- Total 1,112,777 1,107,895 1,095,672 1,083,327 1,070,152 ---------------------------------------------------------- Average Annual Residential kWh Usage 8,720 8,861 8,787 8,524 8,660 Cost of Fuel per Million Btu $1.10 $1.13 $1.18 $1.21 $1.26 Peak Load-Megawatts 6,225 6,027 6,332 5,744 5,729 Number of Employees 4,215 4,273 4,812 5,166 5,978 PRICE RANGE OF COMMON STOCK The Company's Common Stock became wholly owned by FirstEnergy Corp. effective with the November 8, 1997 merger date. Prices shown below are for the period through November 7, 1997. 1997 1996 - ---------------------------------------------------------------------------------------- First Quarter High-Low 23-7/8 20-7/8 24-7/8 21-7/8 ----------------------------------------- Second Quarter High-Low 22 19-1/4 23 20-1/4 ----------------------------------------- Third Quarter High-Low 23-5/8 21-3/4 22-1/4 19-1/4 ----------------------------------------- Fourth Quarter High-Low - - 23-1/4 19-3/8 ----------------------------------------- Yearly High-Low - - 24-7/8 19-1/4 ----------------------------------------- Prices are based on reports published in The Wall Street Journal for New York Stock Exchange Composite Transactions.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate", "potential", "expect", "believe", "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy market prices, legislative and regulatory changes (including revised environmental requirements), availability and cost of capital and other similar factors. RESULTS OF OPERATIONS We continued to make significant progress in 1997 as our companies prepare for a more competitive environment in the electric utility industry. The most significant event during the year was the approval by the Federal Energy Regulatory Commission (FERC) of our merger with Centerior Energy Corporation to form FirstEnergy Corp., which came into existence on November 8, 1997. We expect the merger to produce a minimum of $1 billion in savings for FirstEnergy Corp. during the first ten years of joint operations through the elimination of duplicative activities, improved operating efficiencies, lower capital expenditures, accelerated debt reduction, the coordination of the companies' work forces and enhanced purchasing power. Earnings on common stock of $280.8 million were adversely affected by net nonrecurring charges amounting to $26.4 million relating to a voluntary retirement program and estimated severance expenses. Excluding these charges, 1997 earnings on common stock were $307.2 million, compared to $302.7 million in 1996. The 1997 results reflect accelerated depreciation and amortization of nuclear and regulatory assets totaling approximately $211 million under our Rate Reduction and Economic Development Plan and Pennsylvania Power Company's (Penn's) Rate Stability and Economic Development Plan; results for 1996 included approximately $178 million of accelerated depreciation and amortization. The 1996 results compared favorably to earnings on common stock of $294.7 million in 1995. For the third consecutive year, we achieved record operating revenues and for the fifth consecutive year, we achieved record retail sales. The following table summarizes the sources of changes in operating revenues for 1997 and 1996 as compared to the previous year: 1997 1996 ---- ---- (In millions) Increased retail kilowatt-hour sales $ 7.8 $ 58.1 Change in average retail price 13.3 (46.1) Sales to utilities (25.8) (4.5) Other 8.5 (3.6) ------ ------ Net Increase $ 3.8 $ 3.9 ====== ====== An improving local economy helped us achieve record retail sales of 27.3 billion kilowatt-hours. Our customer base continues to grow with approximately 4,900 new retail customers added in 1997, after gaining more than 12,200 customers the previous year. Residential sales decreased 0.8% in 1997, following a 1.8% gain the previous year. Commercial sales rose 1.2% and 1.3% in 1997 and 1996, respectively. Increased demand by rubber and plastics and primary metal manufacturers contributed to a 1.0% rise in industrial sales during 1997, following a 5.5% increase the previous year. Sales to other utilities fell 26.4% in 1997 as a result of the December 31, 1996, expiration of a one-year contract with another utility to supply 250 megawatts of power. This reduction follows a 2.7% increase the previous year. As a result of the above factors, total kilowatt-hour sales dropped 5.0%, compared with sales in 1996, which were up 3.0% from 1995. Because of lower kilowatt-hour sales, the Companies spent less on fuel and purchased power during 1997, compared to 1996 costs, which were also down compared to 1995. Higher nuclear expenses in 1997 reflect increased operating costs at the Beaver Valley Plant. Nuclear operating costs were lower in 1996, compared to 1995, due primarily to lower refueling outage cost levels. The increase in other operating costs in 1997 reflects a fourth quarter charge of approximately $41.5 million for a voluntary retirement program and estimated severance expenses. These cost increases were partially offset by gains on the sale of emission allowances during the year. The decrease in other operating costs in 1996, compared to 1995, reflects lower maintenance costs at our fossil-fuel generating units. The changes in depreciation and regulatory asset amortization in 1997 and 1996 reflect accelerations under the regulatory plans discussed above. General taxes decreased in 1997, compared to 1996, due to lower property taxes and an adjustment in the second quarter of 1997 which reduced the Companies' liabilities for gross receipts taxes. The increases in other income in 1997 and 1996 were principally due to higher investment income--primarily through our PNBV Capital Trust investment, which was effective in the third quarter of 1996. Overall, interest costs continue to trend downward. Total interest costs were lower in 1997 than in 1996. Interest on long-term debt decreased due to our economic refinancings and redemption of higher-cost debt totaling approximately $282 million that had been outstanding as of December 31, 1996. Other interest expense increased compared to 1996 due mainly to higher levels of short-term borrowing. We also discontinued deferring nuclear unit interest in the second half of 1995, consistent with our regulatory plan. CAPITAL RESOURCES AND LIQUIDITY We have significantly improved our financial position over the past five years. Cash generated from operations was nearly 25% higher in 1997 than it was in 1992 due to higher revenues and aggressive cost controls. At the same time, return on common equity improved from 10.8% in 1992 to 12.0% in 1997, excluding the net nonrecurring charges discussed above. By the end of 1997, we were serving about 57,000 more customers than we were five years ago, with approximately 2,000 fewer employees. As a result, our customer/employee ratio has increased by 56% over the past five years, standing at 264 customers per employee at the end of 1997, compared with 169 at the end of 1992. In addition, capital expenditures have dropped substantially during that period. Expenditures in 1997 were approximately 37% lower than they were in 1992, and total depreciation charges have exceeded property additions since the end of 1987. Over the past five years, we have aggressively taken advantage of opportunities in the financial markets to reduce our average capital costs. Through refinancing activities, we have reduced the average cost of outstanding debt from 8.53% at the end of 1992 to 7.77% at the end of 1997. Excluding the nonrecurring charges mentioned above, our fixed charge coverage ratios continue to improve. Our indenture ratio, which is used to measure our ability to issue first mortgage bonds, improved from 4.34 at the end of 1992 to 6.21 at the end of 1997. Over the same period, our charter ratio--a measure of our ability to issue preferred stock-- improved from 1.89 to 2.35. At the end of 1997, our common equity as a percentage of capitalization stood at 48% compared to 40% at the end of 1992. Our cash requirements in 1998 for operating expenses, construction expenditures and scheduled debt maturities are expected to be met without issuing additional securities. During 1997, we reduced our total debt by approximately $245 million. We also have cash requirements of approximately $1,015 million for the 1998-2002 period to meet scheduled maturities of long-term debt and preferred stock. Of that amount, approximately $167 million applies to 1998. We had about $4.7 million of cash and temporary investments and $302.2 million of short-term indebtedness on December 31, 1997. As of December 31, 1997, we had the capability to borrow $61 million through unused OES Fuel credit facilities. In addition, our unused borrowing capability included $37 million under revolving lines of credit and $26 million of bank facilities that provide for borrowings on a short-term basis at the banks' discretion. Our capital spending for the period 1998-2002 is expected to be about $600 million (excluding nuclear fuel), of which approximately $165 million applies to 1998. This spending level is nearly $300 million lower than actual capital outlays over the past five years. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $206 million, of which about $26 million applies to 1998. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $182 million and $41 million, respectively, as the nuclear fuel is consumed. Also, we have operating lease commitments (net of PNBV Capital Trust income) of approximately $442 million for the 1998-2002 period, of which approximately $83 million relates to 1998. We recover the cost of nuclear fuel consumed and operating leases through our electric rates. INTEREST RATE RISK Our exposure to fluctuations in market interest rates is mitigated by the fact that 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. As discussed in Note 3, our investment in the PNBV Capital Trust effectively reduces future lease obligations, also reducing interest rate risk. As discussed in Note 1, changes in the market value of our decommissioning trust funds are recognized with a corresponding change to the decommissioning liability. The table below presents principal amounts and related weighted average interest rates by year of maturity for our investment portfolio, debt obligations and preferred stock with mandatory redemption provisions:
There- Fair 1998 1999 2000 2001 2002 after Total Value - ------------------------------------------------------------------------------------- (Dollars in Millions) Investments other than Cash and Cash Equivalents Fixed Income $ 7 $ 6 $ 17 $ 23 $ 26 $ 738 $ 817 $ 880 Average interest rate 5.9% 5.5% 7.3% 7.7% 7.8% 7.8% 7.8% - -------------------------------------------------------------------------------------- Liabilities - -------------------------------------------------------------------------------------- Long-term Debt Fixed rate $162 $162 $116 $ 15 $324 $1,406 $2,185 $2,297 Average interest rate 8.7% 6.9% 6.5% 8.1% 7.8% 7.4% 7.5% Variable rate $215 $ 327 $ 542 $ 538 Average interest rate 6.4% 4.1% 5.0% Short-term Borrowings $302 $ 302 $ 302 Average interest rate 6.0% 6.0% - -------------------------------------------------------------------------------------- Preferred Stock $ 5 $ 5 $ 5 $ 5 $ 1 $ 134 $ 155 $ 161 Average dividend rate 8.5% 8.5% 8.5% 8.5% 7.6% 8.9% 8.8% - --------------------------------------------------------------------------------------
OUTLOOK We face many competitive challenges in the years ahead as the electric utility industry undergoes significant changes, including changing regulation and the entrance of more energy suppliers into the marketplace. Retail wheeling, which would allow retail customers to purchase electricity from other energy producers, will be one of those challenges. Our regulatory plans provide the foundation to position us to meet the challenges we are facing by significantly reducing fixed costs and lowering rates to a more competitive level. The Company's Rate Reduction and Economic Development Plan was approved by the Public Utilities Commission of Ohio (PUCO) in 1995; Penn's Rate Stability and Economic Development Plan was approved by the Pennsylvania Public Utility Commission (PPUC) in the second quarter of 1996. These regulatory plans initially maintain the Company's current base electric rates through December 31, 2005, and Penn's through June 20, 2006. The plans also revised the Companies' fuel cost recovery methods. As part of the Company's regulatory plan, transition rate credits were implemented for customers, which are expected to reduce operating revenues by approximately $600 million during the regulatory plan period, which is to be followed by a base rate reduction of approximately $300 million in 2006. The Companies' regulatory assets are being recovered under provisions of the regulatory plans. In addition, we have been authorized by the PUCO and PPUC to recognize additional capital recovery related to our generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the regulatory plan periods of at least $2 billion for the Company and $358 million for Penn, more than the amounts that would have been recognized if the regulatory plans were not in effect. These additional amounts are being recovered through current rates. Based on the regulatory environment we operate in today and the regulatory plans, we believe we will continue to be able to bill and collect cost-based rates for all of our operations; accordingly, it is appropriate that we continue the application of Statement of Financial Accounting Standards No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). However, as discussed below, changes in the regulatory environment are on the horizon. With respect to Penn, we expect to discontinue the application of SFAS 71 for the generation portion of that business, possibly as early as 1998. We do not expect the impact of Penn discontinuing SFAS 71 to be material. As further discussed below, the Ohio legislature is in the discussion stages of restructuring the electric utility industry within the State. We do not expect any changes in Ohio regulation to be effective within the next two years and we cannot assess what the ultimate impact may be. On September 30, 1997, Penn filed a restructuring plan with the PPUC. The plan describes how Penn will restructure its rates and provide customers with direct access to alternative electricity suppliers; customer choice is to be phased in over three years beginning in 1999, after completion of a two-year pilot program. Penn will continue to deliver power to homes and businesses through its transmission and distribution system, which remains regulated by the PPUC. Penn also plans to sell electricity and energy-related services in its own territory and throughout Pennsylvania as an alternative supplier through its nonregulated subsidiary, Penn Power Energy. Through the restructuring plan, Penn is seeking recovery of $293 million of stranded costs through a competitive transition charge starting in 1999 and ending in 2005, which is consistent with Penn's Rate Stability and Economic Development Plan currently in effect. The PPUC plans to hold public hearings on Penn's restructuring plan early in 1998. On January 6, 1998, the co-chairs of the Ohio General Assembly's Joint Select Committee on Electric Industry Deregulation released their draft report of a plan which proposes to give customers a choice from whom they buy electricity beginning January 1, 2000. No consensus has been reached by the full Committee; in the meantime, legislation consistent with the co-chairs' draft report may be introduced into the General Assembly by one or both of the co-chairs. We cannot predict when or if this legislation will be introduced and if it will be passed into law. We continue to study the potential effects that such legislation would have on our financial position and results of operations. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB reported in October 1997 that it plans to continue working on the proposal in 1998. The Clean Air Act Amendments of 1990, discussed in Note 6, require additional emission reductions by 2000. We are pursuing cost-effective compliance strategies for meeting the reduction requirements that begin in 2000. IMPACT OF THE YEAR 2000 ISSUE The Year 2000 Issue is the result of computer programs being written using two digits rather than four to identify the applicable year. Any of our programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations. We currently believe that with modifications to existing software and conversions to new software, the Year 2000 Issue will pose no significant operational problems for our computer systems as so modified and converted. If these modifications and conversions are not made, or are not completed on a timely basis, the Year 2000 Issue could have a material impact on our operations. We have initiated formal communications with many of our major suppliers to determine the extent to which we are vulnerable to those third parties' failure to resolve their own Year 2000 problems. Our total Year 2000 project cost and estimates to complete are based on currently available information and do not include the estimated costs and time associated with the impact of a third party's Year 2000 issue. There can be no guarantee that the failure of other companies to resolve their own Year 2000 issues will not have a material adverse effect on us. We are utilizing both internal and external resources to reprogram and/or replace and test the software for Year 2000 modifications. Most of our Year 2000 problems will be resolved through system replacements. The different phases of our Year 2000 project will be completed at various dates, most of which occur in 1999. We plan to complete the entire Year 2000 project by mid- December 1999. Of the total project cost, approximately $30 million will be capitalized since those costs are attributable to the purchase of new software for total system replacements (i.e., the Year 2000 solution comprises only a portion of the benefit resulting from the system replacements). The remaining $4 million will be expensed as incurred over the next two years. To date, we have incurred approximately $0.5 million related to the assessment of, and preliminary efforts in connection with, our Year 2000 project and the development of a remediation plan. The costs of the project and the date on which we plan to complete the year 2000 modifications are based on management's best estimates, which were derived from numerous assumptions of future events including the continued availability of certain resources, and other factors. However, there can be no guarantee that this project will be completed as planned and actual results could differ materially from the estimates. Specific factors that might cause material differences include, but are not limited to, the availability and cost of trained personnel, the ability to locate and correct all relevant computer code, and similar uncertainties. OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------ (In thousands) OPERATING REVENUES $2,473,582 $2,469,785 $2,465,846 ---------- ---------- ---------- OPERATING EXPENSES AND TAXES: Fuel and purchased power 437,223 456,629 465,483 Nuclear operating costs 267,681 247,708 289,717 Other operating costs 446,778 420,523 446,967 ---------- ---------- ---------- Total operation and maintenance expenses 1,151,682 1,124,860 1,202,167 Provision for depreciation 392,525 355,780 256,085 Amortization of net regulatory assets 37,416 27,661 5,825 General taxes 234,964 241,998 243,179 Income taxes 168,427 189,417 191,972 ---------- ---------- ---------- Total operating expenses and taxes 1,985,014 1,939,716 1,899,228 ---------- ---------- ---------- OPERATING INCOME 488,568 530,069 566,618 OTHER INCOME 52,847 37,537 14,424 ---------- ---------- ---------- INCOME BEFORE NET INTEREST CHARGES 541,415 567,606 581,042 ---------- ---------- ---------- NET INTEREST CHARGES: Interest on long-term debt 204,285 211,935 243,570 Deferred nuclear unit interest - - (4,250) Allowance for borrowed funds used during construction and capitalized interest (2,699) (3,136) (5,668) Other interest expense 31,209 28,211 22,944 Subsidiaries' preferred stock dividend requirements 15,426 15,426 7,205 ---------- ---------- ---------- Net interest charges 248,221 252,436 263,801 ---------- ---------- ---------- NET INCOME $293,194 $315,170 $317,241 PREFERRED STOCK DIVIDEND REQUIREMENTS 12,392 12,497 22,494 -------- -------- -------- EARNINGS ON COMMON STOCK $280,802 $302,673 $294,747 ======== ======== ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
OHIO EDISON COMPANY CONSOLIDATED BALANCE SHEETS
At December 31, 1997 1996 - ----------------------------------------------------------------------------------------- (In thousands) ASSETS UTILITY PLANT: In service, at original cost $8,666,272 $8,634,030 Less--Accumulated provision for depreciation 3,546,594 3,226,259 ---------- ---------- 5,119,678 5,407,771 ---------- ---------- Construction work in progress-- Electric plant 99,158 93,413 Nuclear fuel 21,360 5,786 ---------- ---------- 120,518 99,199 ---------- ---------- 5,240,196 5,506,970 ---------- ---------- OTHER PROPERTY AND INVESTMENTS: PNBV Capital Trust (Note 3) 482,220 487,979 Letter of credit collateralization (Note 3) 277,763 277,763 Other (Note 4B) 529,408 323,316 ---------- ---------- 1,289,391 1,089,058 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents 4,680 5,253 Receivables-- Customers (less accumulated provisions of $5,618,000 and $2,306,000, respectively, for uncollectible accounts) 235,332 247,027 Associated companies 25,348 - Other 87,566 58,327 Materials and supplies, at average cost-- Owned 75,580 66,177 Under consignment 47,890 44,468 Prepayments and other 78,348 75,681 ---------- ---------- 554,744 496,933 ---------- ---------- DEFERRED CHARGES: Regulatory assets 1,601,709 1,703,111 Unamortized sale and leaseback costs 95,096 100,066 Property taxes 100,043 100,802 Other 96,276 57,517 ---------- ---------- 1,893,124 1,961,496 ---------- ---------- $8,977,455 $9,054,457 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Consolidated Statements of Capitalization): Common stockholders' equity $2,724,319 $2,503,359 Preferred stock -- Not subject to mandatory redemption 160,965 160,965 Subject to mandatory redemption 15,000 20,000 Preferred stock of consolidated subsidiary-- Not subject to mandatory redemption 50,905 50,905 Subject to mandatory redemption 15,000 15,000 Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely Company subordinated debentures 120,000 120,000 Long-term debt 2,569,802 2,712,760 ---------- ---------- 5,655,991 5,582,989 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt and preferred stock 278,492 333,667 Short-term borrowings (Note 5) 302,229 349,480 Accounts payable 115,836 93,509 Accrued taxes 157,095 142,909 Accrued interest 53,165 52,855 Other 115,256 131,275 ---------- ---------- 1,022,073 1,103,695 ---------- ---------- DEFERRED CREDITS: Accumulated deferred income taxes 1,698,354 1,777,086 Accumulated deferred investment tax credits 184,804 199,835 Pensions and other postretirement benefits 158,038 123,446 Other 258,195 267,406 ---------- ---------- 2,299,391 2,367,773 ---------- ---------- COMMITMENTS, GUARANTEES AND CONTINGENCIES (Notes 3 and 6 ) $8,977,455 $9,054,457 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION
At December 31, 1997 1996 - ---------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts) COMMON STOCKHOLDERS' EQUITY: Common stock, $9 par value, authorized 175,000,000 shares-100 shares and 152,569,437 shares outstanding, respectively $ 1 $1,373,125 Other paid-in capital 2,102,644 727,602 Retained earnings (Note 4A) 621,674 557,642 Unallocated employee stock ownership plan common stock- 8,259,053 shares (Note 4B) - (155,010) ---------- ---------- Total common stockholders' equity 2,724,319 2,503,359 ---------- ---------- Number of Shares Optional Outstanding Redemption Price ------------------ -------------------- 1997 1996 Per Share Aggregate PREFERRED STOCK (Note 4C): Cumulative, $100 par value- Authorized 6,000,000 shares Not Subject to Mandatory Redemption: 3.90% 152,510 152,510 $103.63 $15,804 15,251 15,251 4.40% 176,280 176,280 108.00 19,038 17,628 17,628 4.44% 136,560 136,560 103.50 14,134 13,656 13,656 4.56% 144,300 144,300 103.38 14,917 14,430 14,430 ---------- ---------- ------- ---------- ---------- 609,650 609,650 63,893 60,965 60,965 Cumulative, $25 par value- Authorized 8,000,000 shares Not Subject to Mandatory Redemption: 7.75% 4,000,000 4,000,000 100,000 100,000 ---------- ---------- ------- ---------- ---------- Total not subject to mandatory redemption 4,609,650 4,609,650 $63,893 160,965 160,965 ========== ========== ======= ---------- ---------- Cumulative, $100 par value- Subject to Mandatory Redemption (Note 4D): 8.45% 200,000 250,000 20,000 25,000 Redemption within one year (5,000) (5,000) ---------- ---------- --------- ---------- Total subject to mandatory redemption 200,000 250,000 15,000 20,000 ========== ========== --------- ---------- PREFERRED STOCK OF CONSOLIDATED SUBSIDIARY (Note 4C): Pennsylvania Power Company Cumulative, $100 par value- Authorized 1,200,000 shares Not Subject to Mandatory Redemption: 4.24% 40,000 40,000 $103.13 $ 4,125 4,000 4,000 4.25% 41,049 41,049 105.00 4,310 4,105 4,105 4.64% 60,000 60,000 102.98 6,179 6,000 6,000 7.64% 60,000 60,000 101.42 6,085 6,000 6,000 7.75% 250,000 250,000 - - 25,000 25,000 8.00% 58,000 58,000 102.07 5,920 5,800 5,800 ---------- ---------- ------- --------- ---------- Total not subject to mandatory redemption 509,049 509,049 $26,619 50,905 50,905 ========== ========== ======= --------- ---------- Subject to Mandatory Redemption (Note 4D): 7.625% 150,000 150,000 $107.63 $16,145 15,000 15,000 ========== ========== ======= ---------- ---------- COMPANY OBLIGATED MANDATOR- ILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES (Note 4E): Cumulative, $25 par value- Authorized 4,800,000 shares Subject to Mandatory Redemption: 9.00% 4,800,000 4,800,000 120,000 120,000 ========= ========= ---------- ----------
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont.)
At December 31, 1997 1996 1997 1996 1997 1996 - --------------------------------------------------------------------------------------------------------- (In thousands) LONG-TERM DEBT (Note 4F): First mortgage bonds: Ohio Edison Company-- Pennsylvania Power Company-- 8.750% due 1998 150,000 150,000 9.740% due 1999-2019 20,000 20,000 6.875% due 1999 150,000 150,000 7.500% due 2003 40,000 40,000 6.375% due 2000 80,000 80,000 6.375% due 2004 20,500 37,000 7.375% due 2002 120,000 120,000 6.625% due 2004 14,000 20,000 7.500% due 2002 34,265 34,265 8.500% due 2022 27,250 27,250 8.250% due 2002 125,000 125,000 7.625% due 2023 6,500 6,500 ------- ------- 8.625% due 2003 150,000 150,000 6.875% due 2005 80,000 80,000 8.750% due 2022 50,960 50,960 7.625% due 2023 75,000 75,000 7.875% due 2023 100,000 100,000 --------- --------- Total first mortgage bonds. 1,115,225 1,115,225 128,250 150,750 1,243,475 1,265,975 --------- --------- ------- ------- ---------- ---------- Secured notes: Ohio Edison Company-- Pennsylvania Power Company-- 7.930% due 2002 50,646 60,467 4.750% due 1998 850 850 7.680% due 2005 200,000 200,000 6.080% due 2000 23,000 23,000 6.750% due 2015 40,000 40,000 5.400% due 2013 1,000 1,000 7.450% due 2016 47,725 47,725 5.400% due 2017 10,600 10,600 7.100% due 2018 26,000 26,000 7.150% due 2017 17,925 17,925 7.050% due 2020 60,000 60,000 5.900% due 2018 16,800 16,800 7.000% due 2021 69,500 69,500 8.100% due 2018 - 10,300 7.150% due 2021 443 443 8.100% due 2020 5,200 5,200 7.625% due 2023 50,000 50,000 7.150% due 2021 14,482 14,482 8.100% due 2023 30,000 30,000 6.150% due 2023 12,700 12,700 7.750% due 2024 108,000 108,000 3.900% due 2027 10,300 - 5.625% due 2029 50,000 50,000 6.450% due 2027 14,500 14,500 5.950% due 2029 56,212 56,212 5.450% due 2028 6,950 6,950 5.450% due 2033 14,800 14,800 6.000% due 2028 14,250 14,250 5.950% due 2029 238 238 --------- --------- ------- ------- 803,326 813,147 148,795 148,795 952,121 961,942 --------- --------- ------- ------- ---------- ---------- OES Fuel-- 5.86% weighted average interest rate 80,755 84,000 ---------- ---------- Total secured notes 1,032,876 1,045,942 ---------- ---------- Unsecured notes: Ohio Edison Company-- 7.430% due 1997 - 100,000 8.735% due 1997 - 50,000 6.088% due 1999 - 225,000 6.338% due 1999 40,000 - 6.400% due 1999 175,000 - 4.300% due 2012 50,000 50,000 4.350% due 2014 50,000 50,000 3.950% due 2015 50,000 50,000 4.100% due 2018 57,100 57,100 4.200% due 2018 56,000 56,000 4.050% due 2032 53,400 53,400 ---------- ---------- Total unsecured notes 531,500 691,500 ---------- ---------- Capital lease obligations (Note 3) 40,614 43,775 ---------- ---------- Net unamortized discount on debt (5,171) (5,765) ---------- ---------- Long-term debt due within one year (273,492) (328,667) ---------- ---------- Total long-term debt 2,569,802 2,712,760 ---------- ---------- TOTAL CAPITALIZATION $5,655,991 $5,582,989 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
For the Years Ended December 31, 1997 1996 1995 - --------------------------------------------------------------------------------- (In thousands) Balance at beginning of year $557,642 $471,095 $389,600 Net income 293,194 315,170 317,241 -------- -------- -------- 850,836 786,265 706,841 - -------------------------------------------------------------------------------- Cash dividends on preferred stock 12,392 12,497 20,234 Cash dividends on common stock 216,770 216,126 215,512 -------- -------- -------- 229,162 228,623 235,746 -------- -------- -------- Balance at end of year (Note 4A) $621,674 $557,642 $471,095 - --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CAPITAL STOCK AND OTHER PAID-IN CAPITAL
Preferred Stock ----------------------------------------- Unallo- Not Subject to Subject to Common Stock cated Mandatory Redemption Mandatory Redemption ------------------------------ --------------------- -------------------- Other ESOP Par or Par or Number Par Paid-In Common Number Stated Number Stated of Shares Value Capital Stock of Shares Value of Shares Value ----------- ---------- -------- ---------- --------- -------- ------- -------- (Dollars in thousands) Balance, January 1, 1995 152,569,437 $1,373,125 $ 724,848 $(170,376) 6,282,399 $328,240 400,000 $40,000 Minimum liability for unfunded retirement benefits 2,446 Allocation of ESOP Shares 1,274 7,720 Sale of 9% Preferred Stock 4,800,000 120,000 Redemptions-- 7.24% Series (720) (363,700) (36,370) 7.36% Series (609) (350,000) (35,000) 8.20% Series (932) (450,000) (45,000) - -------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 152,569,437 1,373,125 726,307 (162,656) 5,118,699 211,870 5,200,000 160,000 Minimum liability for unfunded retirement benefits (51) Allocation of ESOP Shares 1,346 7,646 - -------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 152,569,437 1,373,125 727,602 (155,010) 5,118,699 211,870 5,200,000 160,000 FirstEnergy merger(152,569,337)(1,373,124) 1,373,124 146,977 Minimum liability for unfunded retirement benefits 44 Allocation of ESOP Shares 1,874 8,033 Redemptions-- 8.45% Series (50,000) (5,000) - -------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 100 $ 1 $2,102,644 $ - 5,118,699 $211,870 5,150,000 $155,000 ========================================================================================================= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1997 1996 1995 - ----------------------------------------------------------------------------------------------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $293,194 $315,170 $317,241 Adjustments to reconcile net income to net cash from operating activities: Provision for depreciation 392,525 355,780 256,085 Nuclear fuel and lease amortization 49,251 52,784 70,849 Other amortization, net 36,229 25,961 5,885 Deferred income taxes, net (40,478) 41,365 53,395 Investment tax credits, net (15,031) (14,041) (9,951) Receivables (23,887) 24,326 (20,452) Materials and supplies (10,557) (736) 12,428 Accounts payable 32,531 962 3,545 Other 22,943 (41,254) 64,189 -------- -------- -------- Net cash provided from operating activities 736,720 760,317 753,214 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Preferred stock - - 120,000 Long-term debt 89,773 306,313 254,365 Short-term borrowings, net - 229,515 - Redemptions and Repayments- Preferred stock 5,000 1,016 117,528 Long-term debt 292,409 438,916 499,276 Short-term borrowings, net 47,251 - 54,677 Dividend Payments- Common stock 237,848 218,656 217,192 Preferred stock 12,559 12,560 20,623 -------- -------- -------- Net cash used for financing activities 505,294 135,320 534,931 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Property additions 179,328 148,189 198,103 PNBV capital trust investment - 487,979 - Other 52,671 13,406 13,641 -------- -------- -------- Net cash used for investing activities 231,999 649,574 211,744 -------- -------- -------- Net increase (decrease) in cash and cash equivalents (573) (24,577) 6,539 Cash and cash equivalents at beginning of year 5,253 29,830 23,291 -------- -------- -------- Cash and cash equivalents at end of year $ 4,680 $ 5,253 $ 29,830 ======== ======== ======== SUPPLEMENTAL CASH FLOWS INFORMATION: Cash Paid During the Year- Interest (net of amounts capitalized) $212,987 $224,541 $254,789 ======== ======== ======== Income taxes $228,399 $157,477 $178,643 ======== ======== ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
OHIO EDISON COMPANY CONSOLIDATED STATEMENTS OF TAXES
For the Years Ended December 31, 1997 1996 1995 - --------------------------------------------------------------------------------------------- (In thousands) GENERAL TAXES: Real and personal property $ 114,111 $ 115,443 $ 118,707 State gross receipts 99,262 104,158 100,591 Social security and unemployment 14,113 14,602 15,787 Other 7,478 7,795 8,094 ---------- ---------- ---------- Total general taxes $ 234,964 $ 241,998 $ 243,179 ========== ========== ========== PROVISION FOR INCOME TAXES: Currently payable- Federal $ 225,529 $ 164,132 $ 145,511 State 17,784 9,839 10,352 ---------- ---------- ---------- 243,313 173,971 155,863 ---------- ---------- ---------- Deferred, net- Federal (34,429) 37,277 50,631 State (6,048) 4,088 2,764 ---------- ---------- ---------- (40,477) 41,365 53,395 ---------- ---------- ---------- Investment tax credit amortization (15,031) (14,041) (9,951) ---------- ---------- ---------- Total provision for income taxes $ 187,805 $ 201,295 $ 199,307 ========== ========== ========== INCOME STATEMENT CLASSIFICATION OF PROVISION FOR INCOME TAXES: Operating income $ 168,427 $ 189,417 $ 191,972 Other income 19,378 11,878 7,335 ---------- ---------- ---------- Total provision for income taxes $ 187,805 $ 201,295 $ 199,307 ========== ========== ========== RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes $ 480,999 $ 516,465 $ 516,548 ========== ========== ========== Federal income tax expense at statutory rate $ 168,350 $ 180,763 $ 180,792 Increases (reductions) in taxes resulting from- Amortization of investment tax credits (15,031) (14,041) (9,951) State income taxes net of federal income tax benefit 7,628 9,053 8,525 Amortization of tax regulatory assets 28,277 26,945 19,690 Other, net (1,419) (1,425) 251 ---------- ---------- ----------- Total provision for income taxes $ 187,805 $ 201,295 $ 199,307 ========== ========== ========== ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: Property basis differences $1,019,952 $1,086,533 $1,047,387 Allowance for equity funds used during construction 210,136 233,345 263,465 Deferred nuclear expense 252,946 262,123 271,114 Customer receivables for future income taxes 177,578 191,537 204,978 Deferred sale and leaseback costs 74,861 78,607 82,381 Unamortized investment tax credits (67,208) (72,663) (77,777) Other 30,089 (2,396) (19,114) ---------- ---------- ---------- Net deferred income tax liability $1,698,354 $1,777,086 $1,772,434 ========== ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include Ohio Edison Company (Company), and its wholly owned subsidiaries. Pennsylvania Power Company (Penn) is the Company's principal operating subsidiary. All significant intercompany transactions have been eliminated. The Company became a wholly owned subsidiary of FirstEnergy Corp. on November 8, 1997. The Company and Penn (Companies) follow the accounting policies and practices prescribed by the Public Utilities Commission of Ohio (PUCO), the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Certain prior year amounts have been reclassified to conform with the current year presentation. REVENUES- The Companies' principal business is providing electric service to customers in central and northeastern Ohio and western Pennsylvania. The Companies' retail customers are metered on a cycle basis. Revenue is recognized for unbilled electric service through the end of the year. Receivables from customers include sales to residential, commercial and industrial customers located in the Companies' service area and sales to wholesale customers. There was no material concentration of receivables at December 31, 1997 or 1996, with respect to any particular segment of the Companies' customers. REGULATORY PLANS- The Company's Rate Reduction and Economic Development Plan was approved by the PUCO in 1995 and Penn's Rate Stability and Economic Development Plan was approved by the PPUC in the second quarter of 1996. These regulatory plans initially maintain current base electric rates for the Company and Penn through December 31, 2005 and June 20, 2006, respectively. At the end of the regulatory plan period, the Company's base rates will be reduced by $300 million (approximately 20 percent below current levels). The plans also revised the Companies' fuel cost recovery methods. The Companies formerly recovered fuel-related costs not otherwise included in base rates from retail customers through separate energy rates. In accordance with the respective regulatory plans, the Company's fuel rate will be frozen through the regulatory plan period, subject to limited periodic adjustments; Penn's plan provided for the roll-in to base rates of its fuel rate. As part of the Company's regulatory plan, transition rate credits were implemented for customers, which are expected to reduce operating revenues for the Company by approximately $600 million during the regulatory plan period. All of the Companies' regulatory assets are being recovered under provisions of the regulatory plans. In addition, the PUCO has authorized the Company to recognize additional capital recovery related to its generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the regulatory plan period of at least $2 billion, and the PPUC has authorized Penn to accelerate at least $358 million, more than the amounts that would have been recognized if the regulatory plans were not in effect. These additional amounts are being recovered through current rates. As of December 31, 1997, the Companies' cumulative additional capital recovery and regulatory asset amortization amounted to $427 million. UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction, including payroll and related costs such as taxes, employee benefits, administrative and general costs and financing costs (allowance for funds used during construction). The Companies provide for depreciation on a straight- line basis at various rates over the estimated lives of property included in plant in service. The annual composite rate for electric plant was approximately 3.0% in 1997, 1996, and 1995. In addition to the straight-line depreciation recognized in 1997, 1996 and 1995, the Companies recognized additional capital recovery of $172 million, $144 million and $27 million, respectively, as additional depreciation expense in accordance with their regulatory plans. Such additional charges in the accumulated provision for depreciation were $343 million and $171 million as of December 31, 1997 and 1996, respectively. Annual depreciation expense includes approximately $8.8 million for future decommissioning costs applicable to the Companies' ownership and leasehold interests in three nuclear generating units. The Companies' share of the future obligation to decommission these units is approximately $481 million in current dollars and (using a 3.5% escalation rate) approximately $1.2 billion in future dollars. The estimated obligation and the escalation rate were developed based on site specific studies. Payments for decommissioning are expected to begin in 2016, when actual decommissioning work begins. The Companies have recovered approximately $72 million for decommissioning through their electric rates from customers through December 31, 1997. If the actual costs of decommissioning the units exceed the funds accumulated from investing amounts recovered from customers, the Companies expect that additional amount to be recoverable from their customers. The Companies have approximately $109.9 million invested in external decommissioning trust funds as of December 31, 1997. Earnings on these funds are reinvested with a corresponding increase to the decommissioning liability. The Companies have also recognized an estimated liability of approximately $15.2 million related to decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy (DOE), as required by the Energy Policy Act of 1992. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB indicated in October 1997 that it plans to continue work on the proposal. COMMON OWNERSHIP OF GENERATING FACILITIES- The Companies, together with the other FirstEnergy Corp. (FirstEnergy) utilities, The Cleveland Electric Illuminating Company (CEI) and The Toledo Edison Company (TE), and Duquesne Light Company constitute the Central Area Power Coordination Group (CAPCO). The CAPCO companies own and/or lease, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Companies' portions of operating expenses associated with jointly owned facilities are included in the corresponding operating expenses on the Consolidated Statements of Income. The amounts reflected on the Consolidated Balance Sheet under utility plant at December 31, 1997, include the following:
Companies' Utility Accumulated Construction Ownership/ Plant Provision for Work in Leasehold Generating Units in Service Depreciation Progress Interest - ---------------------------------------------------------------------------- (In millions) W.H. Sammis #7 $ 305.5 $ 100.8 $ .8 68.80% Bruce Mansfield #1, #2 and #3 786.3 380.3 2.1 50.68% Beaver Valley #1 and #2 1,900.0 651.7 3.9 47.11% Perry 1,837.0 720.4 3.1 35.24% - ---------------------------------------------------------------------------- Total $4,828.8 $1,853.2 $9.9 - ----------------------------------------------------------------------------
NUCLEAR FUEL- Nuclear fuel is recorded at original cost, which includes material, enrichment, fabrication and interest costs incurred prior to reactor load. The Companies amortize the cost of nuclear fuel based on the rate of consumption. The Companies' electric rates include amounts for the future disposal of spent nuclear fuel based upon the formula used to compute payments to the DOE. 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. RETIREMENT BENEFITS- The Companies' trusteed, noncontributory defined benefit pension plans cover almost all full-time employees. Upon retirement, employees receive a monthly pension based on length of service and compensation. The Companies use the projected unit credit method for funding purposes and were not required to make pension contributions during the three years ended December 31, 1997. The following sets forth the funded status of the plans and amounts recognized on the Consolidated Balance Sheets as of December 31: 1997 1996 - ----------------------------------------------------------------- (In millions) Actuarial present value of benefit obligations: Vested benefits $ 677.4 $ 562.0 Nonvested benefits 29.9 38.9 - ---------------------------------------------------------------- Accumulated benefit obligation $ 707.3 $ 600.9 ================================================================ Plan assets at fair value $1,080.6 $ 946.3 Actuarial present value of projected benefit obligation 794.1 688.5 - ---------------------------------------------------------------- Plan assets in excess of projected benefit obligation 286.5 257.8 Unrecognized net gain (139.5) (106.2) Unrecognized prior service cost 21.0 20.1 Unrecognized net transition asset (25.9) (33.9) - ---------------------------------------------------------------- Net pension asset $ 142.1 $ 137.8 ================================================================ The assets of the plans consist primarily of common stocks, United States government bonds and corporate bonds. Net pension costs for the three years ended December 31, 1997, were computed as follows: 1997 1996 1995 - ---------------------------------------------------------------- (In millions) Service cost-benefits earned during the period $ 12.9 $ 14.2 $ 12.8 Interest on projected benefit obligation 49.8 49.3 48.1 Return on plan assets (188.8) (141.6) (194.5) Net deferral 90.1 52.7 118.7 Voluntary early retirement program expense 31.5 12.5 - Gain on plan curtailment - (12.8) - - ---------------------------------------------------------------- Net pension cost $ (4.5) $ (25.7) $ (14.9) ================================================================ The assumed discount rates used in determining the actuarial present value of the projected benefit obligation were 7.25% in 1997 and 7.5% in 1996 and 1995. The assumed rates of increase in future compensation levels used to measure this obligation were 4.0% in 1997 and 4.5% in 1996 and 1995. Expected long-term rates of return on plan assets were assumed to be 10% in 1997, 1996 and 1995. The Companies provide 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 Companies pay insurance premiums to cover a portion of these benefits in excess of set limits; all amounts up to the limits are paid by the Companies. The Companies recognize the expected cost of providing other postretirement benefits to employees and their beneficiaries and covered dependents from the time employees are hired until they become eligible to receive those benefits. In accordance with Statement of Financial Accounting Standards (SFAS) No. 88 "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," the 1996 net pension costs shown above and the 1996 postretirement benefit costs shown below included curtailment effects (significant changes in projected plan assumptions) relating to the pension and postretirement benefit plans. The employee terminations reflected in the Companies' 1996 voluntary early retirement program represented a plan curtailment that significantly reduced the expected future employee service years and the related accrual of defined pension and postretirement benefits. In the pension plan, the reduction in the benefit obligation increased the net pension asset and was shown as a plan curtailment gain. In the postretirement benefit plan, the unrecognized prior service cost associated with service years no longer expected to be rendered as a result of the terminations, was shown as a plan curtailment loss. The following sets forth the funded status of the plans and amounts recognized on the Consolidated Balance Sheets as of December 31: 1997 1996 - ---------------------------------------------------------------- (In millions) Accumulated postretirement benefit obligation allocation: Retirees $174.9 $155.5 Fully eligible active plan participants 15.8 10.1 Other active plan participants 76.9 75.5 - ---------------------------------------------------------------- Accumulated postretirement benefit obligation 267.6 241.1 Plan assets at fair value 2.8 2.0 - ---------------------------------------------------------------- Accumulated postretirement benefit obligation in excess of plan assets 264.8 239.1 Unrecognized transition obligation (125.1) (133.5) Unrecognized net loss (24.0) (7.4) - ---------------------------------------------------------------- Net postretirement benefit liability $115.7 $ 98.2 ================================================================ Net periodic postretirement benefit costs for the three years ended December 31, 1997, were computed as follows: 1997 1996 1995 - ---------------------------------------------------------------- (In millions) Service cost-benefits attributed to the period $ 4.1 $ 4.3 $ 4.5 Interest cost on accumulated benefit obligation 17.6 17.4 21.1 Amortization of transition obligation 8.3 8.8 10.2 Amortization of loss - .1 .1 Voluntary early retirement program expense 1.9 .5 - Loss on plan curtailment - 13.1 - - ----------------------------------------------------------------- Net periodic postretirement benefit cost $31.9 $44.2 $35.9 ================================================================ The health care trend rate assumption is 6.0% in the first year gradually decreasing to 4.0% for the year 2008 and later. The discount rates used to compute the accumulated postretirement benefit obligation were 7.25% in 1997 and 7.5% in 1996 and 1995. An increase in the health care trend rate assumption by one percentage point in all years would increase the accumulated postretirement benefit obligation by approximately $34.6 million and the aggregate annual service and interest costs by approximately $3.1 million. TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues and operating expenses include amounts for affiliated transactions with CEI and TE since the November 8, 1997 merger date. The Company's transactions with CEI and TE from the merger date were primarily for electric sales. The amounts related to CEI and TE were $4.3 million and $0.4 million, 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. The Companies reflect temporary cash investments at cost, which approximates their market value. Noncash financing and investing activities included capital lease transactions amounting to $3.0 million, $2.0 million and $1.0 million for the years 1997, 1996 and 1995, respectively. Commercial paper transactions of OES Fuel (a wholly owned subsidiary of the Company) that have initial maturity periods of three months or less are reported net within financing activities under long-term debt and are reflected as long-term debt on the Consolidated Balance Sheets (see Note 4F). All borrowings with initial maturities of less than one year are defined as financial instruments under generally accepted accounting principles 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: 1997 1996 ---------------- --------------- Carrying Fair Carrying Fair Value Value Value Value - ---------------------------------------------------------------- (In millions) Long-term debt $2,727 $2,835 $2,919 $2,963 Preferred stock $ 155 $ 161 $ 160 $ 160 Investments other than cash and cash equivalents: Debt securities - Maturity (5-10 years) $ 486 $ 512 $ 364 $ 364 - Maturity (more than 10 years) 259 294 387 390 Equity securities 14 14 14 14 All other 145 147 104 102 --------------------------------------------------------------- $ 904 $ 967 $ 869 $ 870 ================================================================ The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Companies' ratings. The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents include decommissioning trust investments. Unrealized gains and losses applicable to the decommissioning trust have been recognized in the trust investment with a corresponding change to the decommissioning liability. The other debt and equity securities referred to above are in the held-to- maturity category. The Companies have no securities held for trading purposes. REGULATORY ASSETS- The Companies recognize, as regulatory assets, costs which the FERC, PUCO and PPUC have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are being recovered from customers under the Companies' respective regulatory plans. Based on those regulatory plans, at this time, the Companies believe they will continue to be able to bill and collect cost-based rates; accordingly, it is appropriate that the Companies continue the application of SFAS No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). However, based on the regulatory environment in Pennsylvania, Penn is expected to discontinue its application of SFAS 71 for its generation operations, possibly as early as 1998. The impact of Penn discontinuing SFAS 71 is not expected to be material. The Companies also recognized additional cost recovery of $39 million, $34 million and $11 million in 1997, 1996 and 1995, respectively, as additional regulatory asset amortization in accordance with their regulatory plans. Regulatory assets on the Consolidated Balance Sheets are comprised of the following: At December 31, 1997 1996 - --------------------------------------------------------------- (In millions) Nuclear unit expenses $ 707.7 $ 733.4 Customer receivables for future income taxes 484.7 523.0 Sale and leaseback costs 210.3 220.8 Loss on reacquired debt 89.1 95.8 Employee postretirement benefit costs 25.9 29.2 Uncollectible customer accounts 18.9 29.8 Perry Unit 2 termination 36.7 40.4 DOE decommissioning and decontamination costs 16.5 18.0 Other 11.9 12.7 - --------------------------------------------------------------- Total $1,601.7 $1,703.1 =============================================================== 2. MERGER: FirstEnergy was formed on November 8, 1997, by the merger of the Company and Centerior Energy Corporation (Centerior). FirstEnergy holds directly all of the issued and outstanding common shares of the Company and all of the issued and outstanding common shares of Centerior's former direct subsidiaries, which include, among others, CEI and TE. As a result of the merger, the former common shareholders of the Company and Centerior now own all of the outstanding shares of FirstEnergy Common Stock. All other classes of capital stock of the Company and its subsidiaries and of the subsidiaries of Centerior are unaffected by the Merger and remain outstanding. 3. LEASES: The Companies lease certain generating facilities, certain transmission facilities, office space and other property and equipment under cancelable and noncancelable leases. The Company sold portions of its ownership interests in Perry Unit 1 and Beaver Valley Unit 2 and entered into operating leases on the portions sold for basic lease terms of approximately 29 years. During the terms of the leases the Company continues to be responsible, to the extent of its individual combined ownership and leasehold interests, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. The Company has the right, at the end of the respective basic lease terms, to renew the leases for up to two years. The Company also has the right to purchase the facilities at the expiration of the basic lease term or renewal term (if elected) at a price equal to the fair market value of the facilities. The basic rental payments are adjusted when applicable federal tax law changes. OES Finance, Incorporated (OES Finance), a wholly owned subsidiary of the Company, maintains deposits pledged as collateral to secure reimbursement obligations relating to certain letters of credit supporting the Company's obligations to lessors under the Beaver Valley Unit 2 sale and leaseback arrangements. The deposits pledged to the financial institution providing those letters of credit are the sole property of OES Finance. In the event of liquidation, OES Finance, as a separate corporate entity, would have to satisfy its obligations to creditors before any of its assets could be made available to the Company as sole owner of OES Finance common stock. Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 1997, are summarized as follows: 1997 1996 1995 - ------------------------------------------------------------ (In millions) Operating leases Interest element $111.3 $107.6 $104.6 Other 23.2 18.3 13.9 Capital leases Interest element 6.1 6.5 7.0 Other 6.0 6.3 6.6 - ------------------------------------------------------------- Total rentals $146.6 $138.7 $132.1 ============================================================= The future minimum lease payments as of December 31, 1997, are:
Operating Leases -------------------------------------- Capital Lease PNBV Capital Leases Payments Trust Income Net - -------------------------------------------------------------------------------- (In millions) 1998 $ 13.8 $ 120.9 $ 38.4 $ 82.5 1999 11.7 125.8 38.0 87.8 2000 10.3 125.0 37.6 87.4 2001 9.7 127.6 36.2 91.4 2002 9.2 127.8 34.5 93.3 Years thereafter 80.0 1,979.6 249.4 1,730.2 - ------------------------------------------------------------------------------- Total minimum lease payments 134.7 $2,606.7 $ 434.1 $2,172.6 ======== ======= ======== Executory costs 36.0 - ------------------------------------- Net minimum lease payments 98.7 Interest portion 58.1 - ------------------------------------- Present value of net minimum lease payments 40.6 Less current portion 4.9 - ------------------------------------- Noncurrent portion $ 35.7 =====================================
The Company invested in the PNBV Capital Trust in the third quarter of 1996. The Trust was established to purchase a portion of the lease obligation bonds issued on behalf of lessors in the Company's Perry Unit 1 and Beaver Valley Unit 2 sale and leaseback transactions. As noted in the table above, the PNBV Capital Trust income, which is included in Other Income in the Consolidated Statements of Income, effectively reduces lease costs related to those transactions. 4. CAPITALIZATION: (A) RETAINED EARNINGS- Under the Company's first mortgage indenture, the Company's consolidated retained earnings unrestricted for payment of cash dividends on the Company's common stock were $554.9 million at December 31, 1997. (B) EMPLOYEE STOCK OWNERSHIP PLAN- The Companies fund the matching contribution for their 401(k) savings plan through an ESOP Trust. All full-time employees eligible for participation in the 401(k) savings plan are covered by the ESOP. The ESOP borrowed $200 million from the Company and acquired 10,654,114 shares of the Company's common stock through market purchases; the shares were converted into FirstEnergy's common stock in connection with the merger. The ESOP loan, which was shown as a reduction to common equity on the Consolidated Balance Sheet as of December 31, 1996, is included in Other Property and Investments on the Consolidated Balance Sheet as of December 31, 1997 as an investment with FirstEnergy related to the FirstEnergy savings plan. Dividends on ESOP shares are used to service the debt. Shares are released from the ESOP on a pro-rata basis as debt service payments are made. In 1997, 1996 and 1995, 429,515 shares, 404,522 shares and 412,914 shares, respectively, were allocated to the Companies' employees with the corresponding expense recognized based on the shares allocated method. Total ESOP-related compensation expense was calculated as follows: 1997 1996 1995 - -------------------------------------------------------------- (In millions) Base compensation $ 9.9 $ 9.0 $ 9.0 Dividends on common stock held by the ESOP and used to service debt (3.4) (2.9) (2.5) - --------------------------------------------------------------- Net expense $ 6.5 $ 6.1 $ 6.5 =============================================================== (C) PREFERRED STOCK- Penn's 7.75% series of preferred stock has a restriction which prevents early redemption prior to July 2003. The Company's 8.45% series of preferred stock has no optional redemption provision, and its 7.75% series is not redeemable before April 1998. All other preferred stock may be redeemed by the Companies in whole, or in part, with 30-60 days' notice. (D) PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- The Company's 8.45% series of preferred stock has an annual sinking fund requirement for 50,000 shares that began on September 16, 1997. Penn's 7.625% series has an annual sinking fund requirement for 7,500 shares beginning on October 1, 2002. The Companies' preferred shares are retired at $100 per share plus accrued dividends. Annual sinking fund requirements are $5 million in each year 1998-2001 and $1 million in 2002. (E) COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES- Ohio Edison Financing Trust, a wholly owned subsidiary of the Company, has issued $120 million of 9% Cumulative Trust Preferred Capital Securities. The Company purchased all of the Trust's Common Securities and simultaneously issued to the Trust $123.7 million principal amount of 9% Junior Subordinated Debentures due 2025 in exchange for the proceeds that the Trust received from its sale of Preferred and Common Securities. The sole assets of the Trust are the Subordinated Debentures whose interest and other payment dates coincide with the distribution and other payment dates on the Trust Securities. Under certain circumstances the Subordinated Debentures could be distributed to the holders of the outstanding Trust Securities in the event the Trust is liquidated. The Subordinated Debentures may be optionally redeemed by the Company beginning December 31, 2000, at a redemption price of $25 per Subordinated Debenture plus accrued interest, in which event the Trust Securities will be redeemed on a pro-rata basis at $25 per share plus accumulated distributions. The Company's obligations under the Subordinated Debentures along with the related Indenture, amended and restated Trust Agreement, Guarantee Agreement and the Agreement for expenses and liabilities, constitute a full and unconditional guarantee by the Company of payments due on the Preferred Securities. (F) LONG-TERM DEBT- The first mortgage indentures and their supplements, which secure all of the Companies' first mortgage bonds, serve as direct first mortgage liens on substantially all property and franchises, other than specifically excepted property, owned by the Companies. Based on the amount of bonds authenticated by the Trustee through December 31, 1997, the Company's annual sinking and improvement fund requirement for all bonds issued under the mortgage amounts to $30 million. The Company expects to deposit funds in 1998 that will be withdrawn upon the surrender for cancellation of a like principal amount of bonds, which are specifically authenticated for such purposes against unfunded property additions or against previously retired bonds. This method can result in minor increases in the amount of the annual sinking fund requirement. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) - ------------------------------------------------------- 1998 $268.6 1999 617.2 2000 166.5 2001 14.5 2002 324.4 - -------------------------------------------------------- The Companies' obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds and, in some cases, by subordinate liens on the related pollution control facilities. Certain pollution control revenue bonds are entitled to the benefit of irrevocable bank letters of credit of $338.8 million. To the extent that drawings are made under those letters of credit to pay principal of, or interest on, the pollution control revenue bonds, the Company is entitled to a credit against their obligation to repay those bonds. The Company pays annual fees of 0.43% to 0.625% of the amounts of the letters of credit to the issuing banks and are obligated to reimburse the banks for any drawings thereunder. The Company had unsecured borrowings of $215 million at December 31, 1997, which are supported by a $250 million long- term revolving credit facility agreement which expires December 30, 1999. The Company must pay an annual facility fee of 0.20% on the total credit facility amount. In addition, the credit agreement provides that the Company maintain unused first mortgage bond capability for the full credit agreement amount under the Company's indenture as potential security for the unsecured borrowings. Nuclear fuel purchases are financed through the issuance of OES Fuel commercial paper and loans, both of which are supported by a $225 million long-term bank credit agreement which expires March 31, 1999. Accordingly, the commercial paper and loans are reflected as long-term debt on the Consolidated Balance Sheets. OES Fuel must pay an annual facility fee of 0.1875% on the total line of credit and an annual commitment fee of 0.0625% on any unused amount. 5. SHORT-TERM BORROWINGS AND BANK LINES OF CREDIT: Short-term borrowings outstanding at December 31, 1997, consisted of $182.2 million of bank borrowings and $120.0 million of OES Capital, Incorporated commercial paper. OES Capital is a wholly owned subsidiary of the Company whose borrowings are secured by customer accounts receivable. OES Capital can borrow up to $120 million under a receivables financing agreement at rates based on certain bank commercial paper and is required to pay an annual fee of 0.26% on the amount of the entire finance limit. The receivables financing agreement expires in 1999. The Companies have lines of credit with domestic banks that provide for borrowings of up to $77 million under various interest rate options. Short-term borrowings may be made under these lines of credit on their unsecured notes. To assure the availability of these lines, the Companies are required to pay annual commitment fees that vary from 0.22% to 0.50%. These lines expire at various times during 1998. The weighted average interest rates on short-term borrowings outstanding at December 31, 1997 and 1996, were 6.02% and 5.77%, respectively. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: CAPITAL EXPENDITURES- The Companies' current forecasts reflect expenditures of approximately $600 million for property additions and improvements from 1998-2002, of which approximately $165 million is applicable to 1998. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $206 million, of which approximately $26 million applies to 1998. During the same periods, the Companies' nuclear fuel investments are expected to be reduced by approximately $182 million and $41 million, respectively, as the nuclear fuel is consumed. NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $8.92 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on their present ownership and leasehold interests in the Beaver Valley Station and the Perry Plant, the Companies' maximum potential assessment under the industry retrospective rating plan (assuming the other co-owners contribute their proportionate shares of any assessments under the retrospective rating plan) would be $102.8 million per incident but not more than $13 million in any one year for each incident. The Companies are also insured as to their respective interests in the Beaver Valley Station and the Perry Plant under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Companies have also obtained approximately $232 million of insurance coverage for replacement power costs for their respective interests in Perry and Beaver Valley. Under these policies, the Companies can be assessed a maximum of approximately $13 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Companies intend to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Companies' plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Companies' insurance policies, or to the extent such insurance becomes unavailable in the future, the Companies would remain at risk for such costs. GUARANTEES- The CAPCO companies have each severally guaranteed certain debt and lease obligations in connection with a coal supply contract for the Bruce Mansfield Plant. As of December 31, 1997, the Companies' shares of the guarantees (which approximate fair market value) were $43.4 million. The price under the coal supply contract, which includes certain minimum payments, has been determined to be sufficient to satisfy the debt and lease obligations. The Companies' total payments under the coal supply contract were $119.5 million, $113.8 million and $120.0 million during 1997, 1996 and 1995, respectively. The Companies' minimum annual payments are approximately $35 million under the contract, which expires December 31, 1999. ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Companies with regard to air and water quality and other environmental matters. The Companies estimate additional capital expenditures for environmental compliance of approximately $27 million, which is included in the construction forecast provided under "Capital Expenditures" for 1998 through 2002. The Companies are in compliance with the current sulfur dioxide (SO2) and nitrogen oxides (NOX) reduction requirements under the Clean Air Act Amendments of 1990. SO2 reductions through the year 1999 will be achieved by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or purchasing emission allowances. Plans for complying with reductions required for the year 2000 and thereafter have not been finalized. The Environmental Protection Agency (EPA) is conducting additional studies which could indicate the need for additional NOX reductions from the Companies' Pennsylvania facilities by the year 2003. In addition, the EPA is also considering the need for additional NOX reductions from the Companies' Ohio facilities. On November 7, 1997, the EPA proposed uniform reductions of NOX emissions across a region of twenty-two states, including Ohio and the District of Columbia (NOX Transport Rule) after determining that such NOX emissions are contributing significantly to ozone pollution in the eastern United States. In a separate but related action, eight states filed petitions with the EPA under Section 126 of the Clean Air Act seeking reductions of NOX emissions which are alleged to contribute to ozone pollution in the eight petitioning states. A December 1997 EPA Memorandum of Agreement proposes to finalize the NOX Transport Rule by September 30, 1998, and establishes a schedule for EPA action on the Section 126 petitions. The cost of NOX reductions, if required, may be substantial. The Companies continue to evaluate their compliance plans and other compliance options. The Companies are required to meet federally approved SO2 regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $25,000 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Companies cannot predict what action the EPA may take in the future with respect to the interim enforcement policy. Legislative, administrative and judicial actions will continue to change the way that the Companies must operate in order to comply with environmental laws and regulations. With respect to any such changes and to the environmental matters described above, the Companies expect that any resulting additional capital costs which may be required, as well as any required increase in operating costs, would ultimately be recovered from their customers. 7. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 1997 and 1996.
March 31, June 30, September 30, December 31, Three Months Ended 1997 1997 1997 1997 - ---------------------------------------------------------------------------------------------- (In millions) Operating Revenues $604.8 $593.3 $652.7 $622.9 Operating Expenses and Taxes 478.5 467.3 511.6 527.7 - -------------------------------------------------------------------------------------------- Operating Income 126.3 126.0 141.1 95.2 Other Income 13.5 14.1 12.0 13.3 Net Interest Charges 63.8 63.2 61.3 60.0 - -------------------------------------------------------------------------------------------- Net Income $ 76.0 $ 76.9 $ 91.8 $ 48.5 - -------------------------------------------------------------------------------------------- Earnings on Common Stock $ 72.9 $ 73.8 $ 88.7 $ 45.4 - --------------------------------------------------------------------------------------------

March 31, June 30, September 30, December 31, Three Months Ended 1996 1996 1996 1996 - ---------------------------------------------------------------------------------------------- (In millions) Operating Revenues $611.6 $599.3 $646.9 $611.9 Operating Expenses and Taxes 481.1 471.7 500.0 486.8 - ------------------------------------------------------------------------------------------- Operating Income 130.5 127.6 146.9 125.1 Other Income 7.0 10.7 7.1 12.7 Net Interest Charges 64.1 61.7 61.5 65.1 - ------------------------------------------------------------------------------------------- Net Income $ 73.4 $ 76.6 $ 92.5 $ 72.7 - ------------------------------------------------------------------------------------------- Earnings on Common Stock $ 70.3 $ 73.5 $ 89.4 $ 69.5 - -------------------------------------------------------------------------------------------
Report of Independent Public Accountants To the Stockholders and Board of Directors of Ohio Edison Company: We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of Ohio Edison Company (an Ohio corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, retained earnings, capital stock and other paid-in capital, cash flows and taxes for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Ohio Edison Company and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Cleveland, Ohio February 13, 1998 EX-21.1 8 EXHIBIT 21.1 OHIO EDISON COMPANY LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 1997 Pennsylvania Power Company - Incorporated in Pennsylvania OES Fuel, Incorporated - Incorporated in Ohio OES Ventures, Incorporated - Incorporated in Ohio OES Capital, Incorporated - Incorporated in Ohio OES Finance, Incorporated - Incorporated in Ohio OES Nuclear, Incorporated - Incorporated in Ohio Ohio Edison Financing Trust - Incorporated in Delaware Ohio Edison Financing Trust II - Incorporated in Delaware Statement of Differences ------------------------ Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 1997, is not included in the printed document. EX-23.1 9 EXHIBIT 23.1 OHIO EDISON COMPANY CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K, into Ohio Edison Company's previously filed Registration Statements, File No. 33-49135, No. 33-49259, No. 33-49413, No. 33-51139, No. 333-01489 and No. 333- 05277. ARTHUR ANDERSEN LLP Cleveland, Ohio March 30, 1998 EX-27.1 10
UT (AMOUNTS IN 1,000'S, EXCEPT PER SHARE) INCOME TAX EXPENSE INCLUDES $19,378,000 RELATED TO OTHER INCOME 0000073960 OHIO EDISON COMPANY 1,000 US DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 PER-BOOK 5,240,196 1,289,391 554,744 1,893,124 0 8,977,455 1 2,102,644 621,674 2,724,319 150,000 211,870 2,569,802 182,245 0 119,984 268,621 5,000 0 4,871 2,740,743 8,977,455 2,473,582 187,805 1,816,587 1,985,014 488,568 52,847 541,415 248,221 293,194 12,392 280,802 216,770 204,285 736,720 0 0

EX-13.2 11 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED FINANCIAL AND OPERATING STATISTICS
Nov. 8 - | Jan. 1 - Dec. 31, 1997 | Nov. 7, 1997 1996 1995 1994 1993 | (Dollars in thousands) GENERAL FINANCIAL INFORMATION: | | Operating Revenues $ 253,963 | $1,529,014 $1,789,961 $1,768,737 $1,698,021 $1,751,330 ========== | ========== ========== ========== ========== ========== Operating Income $ 49,502 | $ 307,332 $ 358,620 $ 397,899 $ 396,009 $ 222,941 ========== | ========== ========== ========== ========== ========== Income (Loss) Before | Extraordinary Item $ 19,290 | $ 95,191 $ 116,553 $ 183,719 $ 185,431 $ (587,147) ========== | ========== ========== ========== ========== ========== Net Income (Loss) $ 19,290 | $ (229,247) $ 116,553 $ 183,719 $ 185,431 $ (587,147) ========== | ========== ========== ========== ========== ========== Earnings (Loss) on Common | Stock $ 19,290 | $ (274,276) $ 77,810 $ 141,275 $ 139,994 $ (631,797) ========== | ========== ========== ========== ========== ========== Net Utility Plant $3,156,659 | $4,983,219 $5,090,315 $5,191,628 $5,257,080 ========== | ========== ========== ========== ========== Total Assets $6,440,284 | $6,962,297 $7,222,416 $7,204,045 $7,199,763 ========== | ========== ========== ========== ========== | CAPITALIZATION: | Common Stockholder's Equity $ 950,904 | $1,044,283 $1,126,762 $1,058,190 $1,039,947 Preferred Stock-- | Not Subject to Mandatory | Redemption 238,325 | 238,325 240,871 240,871 240,871 Subject to Mandatory | Redemption 183,174 | 186,118 215,420 245,971 285,225 Long-Term Debt 3,189,590 | 2,523,030 2,759,492 2,683,207 2,951,981 ---------- | ---------- ---------- ---------- ---------- Total Capitalization $4,561,993 | $3,991,756 $4,342,545 $4,228,239 $4,518,024 ========== | ========== ========== ========== ========== | CAPITALIZATION RATIOS: | Common Stockholder's Equity 20.9% | 26.2% 25.9% 25.0% 23.0% Preferred Stock-- | Not Subject to Mandatory | Redemption 5.2 | 6.0 5.6 5.7 5.3 Subject to Mandatory | Redemption 4.0 | 4.6 5.0 5.8 6.3 Long-Term Debt 69.9 | 63.2 63.5 63.5 65.4 ----- | ----- ----- ----- ----- Total Capitalization 100.0% | 100.0% 100.0% 100.0% 100.0% ===== | ===== ===== ===== ===== | KILOWATT-HOUR SALES (Millions): | Residential 790 | 4,062 4,958 5,063 4,924 4,934 Commercial 893 | 4,990 5,908 5,946 5,770 5,634 Industrial 1,285 | 6,710 7,977 7,994 7,970 7,911 Other 89 | 476 522 550 575 532 ---------- | ---------- ---------- ---------- ---------- ---------- Total Retail 3,057 | 16,238 19,365 19,553 19,239 19,011 Total Wholesale 575 | 2,408 2,155 1,694 1,073 2,290 ---------- | ---------- ---------- ---------- ---------- ---------- Total 3,632 | 18,646 21,520 21,247 20,312 21,301 ========== | ========== ========== ========== ========== ========== | CUSTOMERS SERVED (Year-End): | Residential 671,265 | 663,130 669,725 668,346 669,118 Commercial 74,597 | 70,886 72,259 71,609 70,442 Industrial 6,515 | 6,545 6,649 6,993 7,852 Other 432 | 446 442 417 297 ---------- | ---------- ---------- ---------- ---------- Total 752,809 | 741,007 749,075 747,365 747,709 ========== | ========== ========== ========== ========== | Average Annual Residential | kWh Usage 7,235 | 7,451 7,570 7,370 7,373 Peak Load-Megawatts 3,955 | 3,938 4,049 3,740 3,862 Number of Employees (Year-End) 3,162 | 3,282 3,636 3,547 3,606
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate", "potential", "expect", "believe", "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy market prices, legislative and regulatory changes (including revised environmental requirements), availability and cost of capital and other similar factors. RESULTS OF OPERATIONS We continued to make significant progress in 1997 as we prepare for a more competitive environment in the electric utility industry. The most significant event during the year was the approval by the Federal Energy Regulatory Commission (FERC) of the merger of our former parent company, Centerior Energy Corporation, with Ohio Edison Company to form FirstEnergy Corp., which came into existence on November 8, 1997. We expect the merger to produce a minimum of $1 billion in savings for FirstEnergy Corp. during the first ten years of joint operations through the elimination of duplicative activities, improved operating efficiencies, lower capital expenditures, accelerated debt reduction, the coordination of the companies' work forces and enhanced purchasing power. The merger was accounted for using the purchase method of accounting in accordance with generally accepted accounting principles (see Note 2), and the applicable effects were "pushed down," or reflected on the separate financial statements of Centerior's direct subsidiaries as of the merger date. As a result, we recorded purchase accounting fair value adjustments to: (1) revalue our nuclear generating units to fair value, (2) adjust preferred stock and long-term debt to fair value, (3) recognize additional retirement and severance benefit liabilities, and (4) record goodwill. Accordingly, the post-merger financial statements reflect a new basis of accounting, and separate financial statements are presented for the pre-merger and post-merger periods. For the remainder of this discussion, for categories substantially unaffected by the merger and with no significant pre- merger or post-merger accounting events, we have combined the 1997 pre-merger and post-merger periods and have compared the total to 1996. Earnings on common stock in the 1997 pre-merger period were adversely affected by an extraordinary item resulting from the October 1997 write-off of certain regulatory assets discussed below. Excluding this write-off, pre-merger 1997 earnings on common stock were $50.2 million. Earnings on common stock for the 1997 post-merger period were $19.3 million. In 1996, earnings on common stock were $77.8 million which was lower than 1995 due primarily to the delay in implementing our 1996 rate increase and the end of certain regulatory accounting deferrals in November 1995. Operating revenues were down $7.0 million in 1997 from 1996 levels following a $21.2 million increase in 1996 compared to 1995. A significant factor contributing to lower operating revenues was the cancellation of a generating plant lease agreement for which revenues were recorded in 1996; a related refund was recognized in the 1997 first quarter which reduced other operating revenue. The following table summarizes the sources of changes in operating revenues for 1997 and 1996 as compared to the previous year: 1997 1996 ---- ---- (In millions) Reduced retail kilowatt-hour sales $ (9.8) $(40.7) Change in average retail price (4.8) 42.2 Sales to utilities 18.6 14.6 Other (11.0) 5.1 ------ ------ Net Change $ (7.0) $ 21.2 ====== ====== Total kilowatt-hour sales were at a new high for the second consecutive year with 22.3 billion kilowatt-hours sold. Sales to other utilities increased 38.4% in 1997. This followed a 27.2% increase from the previous year resulting from greater availability of our generating units and an aggressive bulk power marketing effort. Retail sales totaled 19.3 billion kilowatt-hours in 1997, a decline of 0.4% from the prior year level. Residential sales decreased 2.2% in 1997 following a 2.1% decline the previous year. Commercial sales were down 0.4% and 0.6% in 1997 and 1996, respectively. Industrial sales increased slightly in 1997, following a small decline the previous year. Overall, there was a 3.5% increase in total kilowatt-hour sales following a 1.3% increase in 1996 based on the strength of wholesale sales. We spent more on fuel and purchased power during 1997, as higher purchased power expense was partially offset by lower fuel expense. An increase in the mix of nuclear generation to coal-fired generation contributed to the lower fuel costs. Lower nuclear expenses in 1997 resulted from lower operating costs at the Perry and Davis-Besse plants offset in part by increased operating costs at the Beaver Valley Plant. The decrease in other operating costs in 1997 resulted from ongoing cost cutting and the effect of work force reductions. Also, other operation and maintenance expenses in 1996 included an $11.9 million charge for the disposal of obsolete materials and supplies. The 1997 decrease in other operating costs was offset in part by a fourth quarter, pre-merger charge for estimated severance expenses totaling $9.9 million. Depreciation and amortization increased in the 1997 pre- merger period and in 1996 principally due to changes in depreciation rates approved in the April 1996 Public Utilities Commission of Ohio (PUCO) rate order. In the post-merger period depreciation and amortization was lower due to a fair value adjustment which was recorded in connection with accounting for the merger. Amortization of regulatory assets remained nearly unchanged in 1997 after a large increase in 1996 following cessation of the Rate Stabilization Program deferrals and initiation of their amortization. Income taxes increased in 1997, compared to 1996, as a function of taxable income. Income taxes decreased in 1996 from the prior year due to lower pretax operating income. Other income decreased in the 1997 pre-merger period and in 1996 principally due to merger-related expenses and costs associated with the accounts receivable securitization. In the post-merger period, other income increased primarily because of interest income on trust notes acquired in connection with the Bruce Mansfield Plant lease refinancing. Interest costs were higher overall in 1997 because new secured notes and short-term borrowings for the Bruce Mansfield Plant lease refinancing exceeded the expense reduction from the redemption and refinancing of debt securities in 1997 and 1996. CAPITAL RESOURCES AND LIQUIDITY Our financial position has improved over the past five years. Cash generated from operations was 24% higher in 1997 than it was in 1992 due to higher revenues and aggressive cost controls. At the end of 1997 we had 1,300 fewer employees than five years ago as a result of our focus on becoming more competitive. The availability of additional cash generated from operations increased the Company's ability to redeem higher cost debt and preferred stock. We have also actively pursued refinancing activities which replace higher cost debt and preferred stock with lower cost issues. The merger has resulted in improved credit ratings which has lowered the cost of new issues. The following table summarizes changes in credit ratings resulting from the merger. Pre-Merger Post-Merger --------------------- -------------------- Standard Moody's Standard Moody's & Poor's Investors & Poor's Investors Corporation Service, Inc. Corporation Service, Inc. ----------- ------------- ----------- ------------ First mortgage bonds BB Ba2 BB+ Ba1 Subordinated debt B+ Ba3 BB- Ba3 Preferred Stock B b2 BB- b1 Excluding the effect of the Bruce Mansfield Plant lease refinancing described below, interest costs and preferred dividends have been reduced by approximately $22 million from 1996 levels. Through economic refinancings and redemption of higher cost debt we have reduced the average cost of outstanding debt from 8.90% in 1992 to 8.15% in 1997. The Bruce Mansfield Plant lease refinancing is expected to provide an annual after tax savings of about $13 million resulting from an increase in interest income and a decrease in rent expense offset in part by increased interest expense on secured notes issued as part of the transaction. Our cash requirements in 1998 for operating expenses, construction expenditures and scheduled debt maturities are expected to be met without issuing additional securities. We have cash requirements of approximately $856.1 million for the 1998-2002 period to meet scheduled maturities of long-term debt and preferred stock. Of that amount, approximately $81.5 million applies to 1998. We had about $33.8 million of cash and temporary investments and $56.8 million of short-term indebtedness to an associated company on December 31, 1997. Upon completion of the merger, application of purchase accounting reduced bondable property such that we are not currently able to issue additional first mortgage bonds, except in connection with refinancings. Together with Toledo Edison Company as of December 31, 1997, we had unused borrowing capability of $125 million under a revolving line of credit. Our capital spending for the period 1998-2002 is expected to be about $430 million (excluding nuclear fuel), of which approximately $105 million applies to 1998. This spending level is over $300 million lower than actual capital outlays over the past five years. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $172 million, of which about $32 million applies to 1998. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $113 million and $42 million, respectively, as the nuclear fuel is consumed. Also, we have operating lease commitments net of trust income of approximately $167 million for the 1998-2002 period, of which approximately $25 million relates to 1998. We recover the cost of nuclear fuel consumed and operating leases through our electric rates. OUTLOOK We face many competitive challenges in the years ahead as the electric utility industry undergoes significant changes, including changing regulation and the entrance of more energy suppliers into the marketplace. Retail wheeling, which would allow retail customers to purchase electricity from other energy producers, will be one of those challenges. The FirstEnergy Rate Reduction and Economic Development Plan provides the foundation to position us to meet the challenges we are facing by significantly reducing fixed costs and lowering rates to a more competitive level. The plan was approved by the PUCO in January 1997, and initially maintains current base electric rates through December 31, 2005. The plan also revised our fuel recovery methods. As part of the regulatory plan, interim reductions beginning in June 1998 of $3 per month will increase to $5 per month per residential customer by July 1, 2001 followed by a $217 million base rate reduction in 2006. Total savings of $280 million are anticipated over the term of the plan for our customers. We have also committed $70 million for economic development and energy efficiency programs. We have been authorized by the PUCO to recognize additional depreciation related to our generating assets and additional amortization of regulatory assets during the regulatory plan period of at least $1.4 billion more than the amounts that would have been recognized if the regulatory plan was not in effect. For regulatory purposes these additional charges will be reflected over the rate plan period. Our regulatory plan does not provide for full recovery of nuclear operations. Accordingly, regulatory assets representing customer receivables for future income taxes related to nuclear assets of $499 million were written off ($324 net of tax impact) prior to consummation of the merger since we ceased application of Statement of Financial Accounting Standards No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71) for our nuclear operations when implementation of the FirstEnergy regulatory plan became probable. Based on the regulatory environment we operate in today and our regulatory plan, we believe we will continue to be able to bill and collect cost-based rates relating to our nonnuclear operations; accordingly, it is appropriate that we continue the application of SFAS 71 for those operations. However, as discussed below, changes in the regulatory environment are on the horizon. The Ohio legislature is in the discussion stages of restructuring the electric utility industry within the State. We do not expect any changes in regulation to be effective within the next two years and we cannot assess what the ultimate impact may be. At the consummation of the merger in November 1997, we recognized a fair value purchase accounting adjustment which decreased the carrying value of our nuclear assets by approximately $1.7 billion based upon cash flow models. The fair value adjustment to nuclear plant recognized for financial reporting purposes will ultimately satisfy the asset reduction commitment contained in our regulatory plan over the regulatory plan period. On January 6, 1998, the co-chairs of the Ohio General Assembly's Joint Select Committee on Electric Industry Deregulation released their draft report of a plan which proposes to give customers a choice from whom they buy electricity beginning January 1, 2000. No consensus has been reached by the full Committee; in the meantime, legislation consistent with the co-chairs' draft report may be introduced into the General Assembly by one or both of the co-chairs. We cannot predict when or if this legislation will be introduced and if it will be passed into law. We continue to study the potential effects that such legislation would have on our financial position and results of operations. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB reported in October 1997 that it plans to continue working on the proposal in 1998. The Clean Air Act Amendments of 1990, discussed in Note 6, require additional emission reductions by 2000. We are pursuing cost-effective compliance strategies for meeting the reduction requirements that begin in 2000. We have been named as a "potentially responsible party" (PRP) for three sites listed on the Superfund National Priorities List and are aware of our potential involvement in the cleanup of several other sites. Allegations that we disposed of hazardous waste at these sites, and the amount 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. If we were held liable for 100% of the cleanup costs of all the sites referred to above, the cost could be as high as $212 million. However, we believe that the actual cleanup costs will be substantially lower than $212 million, that our share of any cleanup costs will be substantially less than 100% and that most of the other PRPs are financially able to contribute their share. We have accrued a $4.8 million liability as of December 31, 1997, based on estimates of the costs of cleanup and our proportionate responsibility for such cost. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition, cash flows or results of operations. IMPACT OF THE YEAR 2000 ISSUE The Year 2000 Issue is the result of computer programs being written using two digits rather than four to identify the applicable year. Any of our programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations. We currently believe that with modifications to existing software and conversions to new software, the Year 2000 Issue will pose no significant operational problems for our computer systems as so modified and converted. If these modifications and conversions are not made, or are not completed on a timely basis, the Year 2000 Issue could have a material impact on our operations. We have initiated formal communications with many of our major suppliers to determine the extent to which we are vulnerable to those third parties' failure to resolve their own Year 2000 problems. Our total Year 2000 project cost and estimates to complete are based on currently available information and do not include the estimated costs and time associated with the impact of a third party's Year 2000 issue. There can be no guarantee that the failure of other companies to resolve their own Year 2000 issues will not have material adverse effect on us. We are utilizing both internal and external resources to reprogram and/or replace and test the software for Year 2000 modifications. Most of our Year 2000 problems will be resolved through system replacements. The different phases of our Year 2000 project will be completed at various dates, most of which occur in 1999. We plan to complete the entire Year 2000 project by mid- December 1999. Of the total project cost, approximately $22 million will be capitalized since those costs are attributable to the purchase of new software for total system replacements (i.e., the Year 2000 solution comprises only a portion of the benefit resulting from the system replacements). The remaining $3 million will be expensed as incurred over the next two years. To date, we have incurred approximately $350,000 related to the assessment of, and preliminary efforts in connection with, our Year 2000 project and the development of a remediation plan. The costs of the project and the date on which we plan to complete the year 2000 modifications are based on management's best estimates, which were derived from numerous assumptions of future events including the continued availability of certain resources, and other factors. However, there can be no guarantee that this project will be completed as planned and actual results could differ materially from the estimates. Specific factors that might cause material differences include, but are not limited to, the availability and cost of trained personnel, the ability to locate and correct all relevant computer code, and similar uncertainties. THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF INCOME
Nov. 8 - | Jan. 1 - For the Years Ended December 31, | -------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - -----------------------------------------------------|---------------------------------------------- | (In thousands) | OPERATING REVENUES $253,963 | $1,529,014 $1,789,961 $1,768,737 -------- | ---------- ---------- ---------- OPERATING EXPENSES AND TAXES: | Fuel and purchased power 51,381 | 359,048 407,632 413,391 Nuclear operating costs 15,465 | 77,228 96,150 95,791 Other operating costs 61,036 | 303,558 385,853 377,720 -------- | ---------- ---------- ---------- Total operation and maintenance | expenses 127,882 | 739,834 889,635 886,902 Provision for depreciation and | amortization 28,111 | 189,937 218,539 208,812 Amortization (deferral) of net | regulatory assets 3,867 | 21,890 26,076 (36,148) General taxes 33,912 | 194,400 229,856 229,962 Income taxes 10,689 | 75,621 67,235 81,310 -------- | ---------- ---------- ---------- Total operating expenses and taxes 204,461 | 1,221,682 1,431,341 1,370,838 -------- | ---------- ---------- ---------- | OPERATING INCOME 49,502 | 307,332 358,620 397,899 | OTHER INCOME (LOSS) 4,572 | (2,476) (2,089) 31,298 -------- | ---------- ---------- ---------- | INCOME BEFORE NET INTEREST CHARGES 54,074 | 304,856 356,531 429,197 -------- | ---------- ---------- ---------- | NET INTEREST CHARGES: | Interest on long-term debt 35,300 | 197,323 229,491 238,684 Allowance for borrowed funds used | during construction (631) | (1,928) (2,110) (2,701) Other interest expense 115 | 14,270 12,597 9,495 -------- | ---------- ---------- ---------- Net interest 34,784 | 209,665 239,978 245,478 -------- | ---------- ---------- ---------- INCOME BEFORE EXTRAORDINARY ITEM 19,290 | 95,191 116,553 183,719 | EXTRAORDINARY ITEM (NET OF INCOME | TAXES) (Note 1) - | (324,438) - - -------- | ---------- ---------- ---------- | NET INCOME (LOSS) 19,290 | (229,247) 116,553 183,719 | PREFERRED STOCK DIVIDEND | REQUIREMENTS - | 45,029 38,743 42,444 -------- | ---------- ---------- ---------- | EARNINGS (LOSS) ON COMMON STOCK $ 19,290 | $ (274,276) $ 77,810 $ 141,275 ======== | ========== ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED BALANCE SHEETS
At December 31, 1997 1996 - -------------------------------------------------------------------------------------------- (In thousands) ASSETS | UTILITY PLANT: | In service $4,578,649 | $7,330,963 Less--Accumulated provision for depreciation 1,470,084 | 2,415,226 ---------- | ---------- 3,108,565 | 4,915,737 ---------- | ---------- | Construction work in progress-- | Electric plant 41,261 | 56,853 Nuclear fuel 6,833 | 10,629 ---------- | ---------- 48,094 | 67,482 ---------- | ---------- 3,156,659 | 4,983,219 ---------- | ---------- | OTHER PROPERTY AND INVESTMENTS: | Shippingport Capital Trust (Note 3) 575,084 | - Nuclear plant decommissioning trusts 105,334 | 75,573 Other 21,482 | 20,805 ---------- | ---------- 701,900 | 96,378 ---------- | ---------- | CURRENT ASSETS: | Cash and cash equivalents 33,775 | 30,273 Receivables-- | Customers 29,759 | 4,339 Associated companies 8,695 | 5,634 Other 98,077 | 170,736 Materials and supplies, at average cost-- | Owned 47,489 | 51,686 Under consignment 25,411 | 23,655 Prepayments and other 57,763 | 58,235 ---------- | ---------- 300,969 | 344,558 ---------- | ---------- DEFERRED CHARGES: | Regulatory assets 579,711 | 1,349,694 Goodwill 1,552,483 | - Property taxes 125,204 | 129,048 Other 23,358 | 59,400 ---------- | ---------- 2,280,756 | 1,538,142 ---------- | ---------- $6,440,284 | $6,962,297 ========== | ========== CAPITALIZATION AND LIABILITIES | | CAPITALIZATION (See Consolidated Statements of Capitalization): | Common stockholder's equity $ 950,904 | $1,044,283 Preferred stock-- | Not subject to mandatory redemption 238,325 | 238,325 Subject to mandatory redemption 183,174 | 186,118 Long-term debt 3,189,590 | 2,523,030 ---------- | ---------- 4,561,993 | 3,991,756 ---------- | ---------- | CURRENT LIABILITIES: | Currently payable long-term debt and preferred stock 121,965 | 196,260 Accounts payable-- | Associated companies 56,109 | 59,815 Other 90,737 | 82,693 Notes payable to associated companies 56,802 | 111,618 Accrued taxes 194,394 | 183,998 Accrued interest 67,896 | 52,487 Other 52,297 | 58,900 ---------- | ---------- 640,200 | 745,771 ---------- | ---------- DEFERRED CREDITS: | Accumulated deferred income taxes 496,437 | 1,305,601 Accumulated deferred investment tax credits 96,131 | 183,026 Pensions and other postretirement benefits 198,642 | 72,843 Other 446,881 | 663,300 ---------- | ---------- 1,238,091 | 2,224,770 ---------- | ---------- COMMITMENTS, GUARANTEES AND CONTINGENCIES | (Notes 3 and 6 ) ---------- | ---------- $6,440,284 | $6,962,297 ========== | ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION
At December 31, 1997 | 1996 - ---------------------------------------------------------------------------------------- |---------- - - (Dollars in thousands, except per share amounts) | | COMMON STOCKHOLDER'S EQUITY: | Common stock, without par value, authorized 105,000,000 shares-- | 79,590,689 shares outstanding $ 931,614 |$1,241,287 Other paid-in capital - | 79,454 Retained earnings (deficit) (Note 4A) 19,290 | (276,458) ---------- |---------- Total common stockholder's equity 950,904 | 1,044,283 ---------- |---------- | | Number of Shares Optional | Outstanding Redemption Price | ---------------- --------------------- | 1997 1996 Per Share Aggregate | ---- ---- --------- --------- | | PREFERRED STOCK (Note 4B): | Without par value, authorized | 4,000,000 shares | Not Subject to Mandatory | Redemption: | $ 7.40 Series A 500,000 500,000 $ 101.00 $ 50,500 50,000 | 50,000 $ 7.56 Series B 450,000 450,000 102.26 46,017 45,071 | 45,071 Adjustable Series L 474,000 474,000 100.00 47,400 46,404 | 46,404 $42.40 Series T 200,000 200,000 500.00 100,000 96,850 | 96,850 --------- --------- --------- --------- |---------- 1,624,000 1,624,000 $ 243,917 238,325 | 238,325 ========= ========= ========= --------- |---------- Subject to Mandatory | Redemption (Note 4C): | $ 7.35 Series C. 110,000 120,000 $ 101.00 $ 11,110 11,110 | 12,000 $88.00 Series E 9,000 12,000 1,007.65 9,069 9,000 | 12,000 $ 9.125 Series N - 150,000 - - - | 14,794 $91.50 Series Q 42,858 53,572 1,000.00 42,858 42,858 | 53,572 $88.00 Series R 50,000 50,000 - - 55,000 | 50,000 $90.00 Series S 74,000 74,000 - - 79,920 | 73,260 Redemption within one year (14,714)| (29,508) --------- --------- -------- --------- |---------- 285,858 459,572 $ 63,037 183,174 | 186,118 ========= ========= ======== --------- |---------- LONG-TERM DEBT (Note 4D): | First mortgage bonds: | 7.625% due 2002 195,000 | 195,000 7.375% due 2003 100,000 | 100,000 8.750% due 2005 75,000 | 75,000 9.500% due 2005 300,000 | 300,000 9.250% due 2009 - | 50,000 8.375% due 2011 125,000 | 125,000 8.375% due 2012 75,000 | 75,000 9.375% due 2017 - | 300,000 10.000% due 2020 - | 100,000 9.000% due 2023 150,000 | 150,000 ---------- |---------- Total first mortgage bonds 1,020,000 | 1,470,000 ---------- |---------- | Unsecured notes: | 5.500% due 1997 - | 110 6.700% due 2006 19,500 | 20,000 5.700% due 2008 7,300 | 7,600 6.700% due 2011 5,500 | 5,500 5.875% due 2012 14,300 | 14,300 ---------- |---------- Total unsecured notes 46,600 | 47,510 ---------- |----------
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont.)
At December 31, 1997 1996 - --------------------------------------------------------------------------------------------------- (In thousands) LONG-TERM DEBT: (Cont.) Secured notes: 9.450% due 1997 - | 43,000 8.150% due 1998 7,500 | 7,500 8.160% due 1998 5,000 | 5,000 8.170% due 1998 11,000 | 11,000 8.260% due 1998 2,500 | 2,500 8.330% due 1998 25,000 | 25,000 8.870% due 1998 10,000 | 10,000 9.000% due 1998 5,000 | 5,000 7.250% due 1999 12,000 | 12,000 7.670% due 1999 3,000 | 3,000 7.770% due 1999 17,000 | 17,000 7.850% due 1999 25,000 | 25,000 8.290% due 1999 10,000 | 10,000 9.250% due 1999 52,500 | 52,500 9.300% due 1999 25,000 | 25,000 7.190% due 2000 175,000 | - 7.420% due 2001 10,000 | 10,000 8.540% due 2001 3,000 | 3,000 8.550% due 2001 5,000 | 5,000 8.560% due 2001 3,500 | 3,500 8.680% due 2001 15,000 | 15,000 9.050% due 2001 5,000 | 5,000 9.200% due 2001 15,000 | 15,000 7.850% due 2002 5,000 | 5,000 8.130% due 2002 28,000 | 28,000 7.750% due 2003 15,000 | 15,000 7.670% due 2004 280,000 | - 7.000% due 2006-2009 1,910 | 64,500 7.130% due 2007 120,000 | - 7.430% due 2009 150,000 | - 6.000% due 2011* 5,650 | 5,650 6.000% due 2011* 1,700 | 1,700 6.200% due 2013 - | 47,500 8.000% due 2013 78,700 | 78,700 3.786% due 2015* 39,835 | 39,835 6.000% due 2017* 1,285 | 1,285 7.880% due 2017 300,000 | - 3.771% due 2018* 72,795 | 72,795 3.800% due 2020* 47,500 | - 6.000% due 2020* 40,900 | 40,900 6.000% due 2020* 9,100 | 9,100 6.000% due 2020 62,560 | - 6.100% due 2020 70,500 | - 9.520% due 2021 7,500 | 7,500 9.750% due 2022 - | 70,500 6.850% due 2023 30,000 | 30,000 8.000% due 2023 73,800 | 73,800 7.625% due 2025 53,900 | 53,900 7.700% due 2025 43,800 | 43,800 7.750% due 2025 45,150 | 45,150 ---------- |---------- Total secured notes 2,026,585 | 1,044,615 ---------- |---------- | Capital lease obligations (Note 3) 98,504 | 133,407 ---------- |---------- Net unamortized premium (discount) on debt 105,152 | (5,750) ---------- |---------- Long-term debt due within one year (107,251)| (166,752) ---------- |---------- Total long-term debt 3,189,590 | 2,523,030 ---------- |---------- TOTAL CAPITALIZATION $4,561,993 |$3,991,756 ========== |========== *Denotes variable rate issue with December 31, 1997 interest rate shown. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
Nov. 8 - | Jan. 1 - For the Years Ended December 31, | -------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - -----------------------------------------------------|---------------------------------------------- | (In thousands) | Balance at beginning of period $ - | $(276,458) $(193,146) $(261,521) Net income (loss) 19,290 | (229,247) 116,553 183,719 ------- | --------- --------- --------- 19,290 | (505,705) (76,593) (77,802) - -----------------------------------------------------|-------------------------------------------- Cash dividends on preferred stock - | 35,848 38,734 40,694 Cash dividends on common stock - | 123,602 160,816 74,213 Purchase accounting fair value | adjustment - | (665,387) - - Other, primarily preferred stock | redemption expenses - | 232 315 437 ------- | --------- --------- --------- - | (505,705) 199,865 115,344 ------- | --------- --------- --------- Balance at end of period (Note 4A) $19,290 | $ - $(276,458) $(193,146) ================================================================================================= CONSOLIDATED STATEMENTS OF CAPITAL STOCK AND OTHER PAID-IN CAPITAL Preferred Stock ------------------------------------------ Not Subject to Subject to Common Stock Mandatory Redemption Mandatory Redemption ------------------------------ -------------------- --------------------- Other Number Carrying Paid-In Number Carrying Number Carrying of Shares Value Capital of Shares Value of Shares Value --------- -------- ------- --------- -------- --------- -------- (Dollars in thousands) Balance, January 1, 1995 79,590,689 $1,241,087 $78,624 1,650,000 $240,871 868,766 $281,562 Redemptions-- $ 7.35 Series C (10,000) (1,000) $ 88.00 Series E (3,000) (3,000) Adjustable Series M (100,000) (9,800) $ 9.125 Series N 35 (110,766) (10,924) $ 91.50 Series Q 51 (10,714) (10,714) $ 90.00 Series S 111 (1,000) (990) - --------------------------------------------------------------------------------------------------- Balance, December 31, 1995 79,590,689 1,241,284 78,624 1,650,000 240,871 633,286 245,134 Reclassification of $90.00 Series S Gain (111) 111 Unrealized loss on securities (6) Redemptions-- Adjustable Series L 7 725 (26,000) (2,546) $ 7.35 Series C (10,000) (1,000) $ 88.00 Series E (3,000) (3,000) $ 9.125 Series N 25 (150,000) (14,794) $ 91.50 Series Q 82 (10,714) (10,714) Balance, December 31, 1996 79,590,689 1,241,287 79,454 1,624,000 238,325 459,572 215,626 Equity contributions from parent 4,500 Redemptions-- $ 7.35 Series C (10,000) (1,000) $ 88.00 Series E (3,000) (3,000) $ 9.125 Series N 25 (150,000) (14,794) $ 91.50 Series Q (10,714) (10,714) ____________________________________________________________________________________________________ Purchase accounting fair value adjustments-- Common Stock (309,698) (83,954) $ 7.35 Series C 110 $ 88.00 Series R 5,000 $ 90.00 Series S 6,660 - --------------------------------------------------------------------------------------------------- Balance, December 31, 1997 79,590,689 $ 931,614 $ - 1,624,000 $238,325 285,858 $197,888 =================================================================================================== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 8 - | Jan. 1 - For the Years Ended December 31, | -------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - -----------------------------------------------------|---------------------------------------------- | (In thousands) | CASH FLOWS FROM OPERATING ACTIVITIES: | Net Income (Loss) $ 19,290 | $(229,247) $116,553 $183,719 Adjustments to reconcile net income to net | cash from operating activities: | Provision for depreciation and | amortization 28,111 | 189,937 218,539 208,812 Nuclear fuel and lease amortization 7,393 | 42,577 45,987 70,745 Other amortization, net 3,867 | 21,890 26,076 (64,641) Deferred income taxes, net 7,723 | (126,693) 24,973 56,063 Investment tax credits, net (822)| (6,670) (7,992) (12,566) Allowance for equity funds used | during construction (140)| (1,647) (2,014) (2,173) Extraordinary loss - | 499,135 - - Receivables 51,213 | (3,974) 586 (12,927) Net proceeds from accounts | receivable securitization - | - 64,891 - Materials and supplies (3,922)| 6,363 25,589 9,818 Accounts payable (777)| (7,938) (6,344) 1,084 Other 18,839 | (2,566) 10,992 (7,996) -------- | -------- -------- -------- Net cash provided from operating | activities 130,775 | 381,167 517,836 429,938 -------- | -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: | New Financing-- | Long-term debt - | 1,176,781 (307) 432,052 Short-term borrowings, net 703 | - 106,618 - Redemptions and Repayments-- | Preferred stock - | 29,714 31,528 36,670 Long-term debt 43,500 | 701,843 310,177 481,426 Short-term borrowings, net - | 55,519 - 53,100 Dividend Payments-- | Common stock 34,785 | 88,816 160,816 74,213 Preferred stock 7,191 | 29,311 39,325 42,951 -------- | --------- -------- -------- Net cash provided from (used for) financing activities (84,773)| 271,578 (435,535) (256,308) -------- | --------- -------- -------- | CASH FLOWS FROM INVESTING ACTIVITIES: | Property additions 17,943 | 104,230 105,588 151,038 Capital trust investments 16,248 | 558,836 - - Other (4,288)| 2,276 16,210 18,465 -------- | --------- -------- -------- Net cash used for investing activities 29,903 | 665,342 121,798 169,503 -------- | --------- -------- -------- Net increase (decrease) in cash and cash | equivalents 16,099 | (12,597) (39,497) 4,127 Cash and cash equivalents at beginning | of period 17,676 | 30,273 69,770 65,643 -------- | --------- -------- -------- Cash and cash equivalents at end of | period $ 33,775 | $ 17,676 $ 30,273 $ 69,770 ======== | ========= ======== ======== | SUPPLEMENTAL CASH FLOWS INFORMATION: | Cash Paid During the Period-- | Interest (net of amounts capitalized) $ 36,000 | $ 188,000 $237,000 $214,000 ======== | ========= ======== ======== Income taxes $ 9,000 | $ 26,300 $ 29,732 $ 65,900 ======== | ========= ======== ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSOLIDATED STATEMENTS OF TAXES
Nov. 8 - | Jan. 1 - For the Years Ended December 31, | -------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - -----------------------------------------------------|---------------------------------------------- | (In thousands) | GENERAL TAXES: | Real and personal property $ 17,707 | $ 114,393 $ 132,582 $ 134,346 State gross receipts 13,302 | 65,966 78,109 76,806 Social security and unemployment 1,548 | 6,296 9,127 9,145 Other 1,355 | 7,745 10,038 9,665 -------- | --------- ---------- ---------- Total general taxes $ 33,912 | $ 194,400 $ 229,856 $ 229,962 ======== | ========= ========== ========== PROVISION FOR INCOME TAXES: | Currently payable- | Federal $ 6,969 | $ 37,605 $ 44,147 $ 39,499 State (1) 159 | - - - -------- | --------- ---------- ---------- 7,128 | 37,605 44,147 39,499 -------- | --------- ---------- ---------- Deferred, net- | Federal 7,617 | (126,693) 24,973 56,063 State (1) 106 | - - - -------- | --------- ---------- ---------- 7,723 | (126,693) 24,973 56,063 -------- | --------- ---------- ---------- Investment tax credit amortization (822) | (6,670) (7,992) (12,566) -------- | --------- ---------- ---------- Total provision for income taxes $ 14,029 | $ (95,758) $ 61,128 $ 82,996 ======== | ========= ========== ========== INCOME STATEMENT CLASSIFICATION | OF PROVISION FOR INCOME TAXES: | Operating income $ 10,689 | $ 75,621 $ 67,235 $ 81,310 Other income 3,340 | 3,318 (6,107) 1,686 Extraordinary item - | (174,697) - - --------- | --------- ---------- ---------- Total provision for income taxes $ 14,029 | $ (95,758) $ 61,128 $ 82,996 ========= | ========= ========== ========== | RECONCILIATION OF FEDERAL INCOME TAX | EXPENSE AT STATUTORY RATE TO TOTAL | PROVISION FOR INCOME TAXES: | Book income before provision for | income taxes $ 33,319 | $(325,005) $ 177,681 $ 266,715 ========= | ========= ========== ========== Federal income tax expense at | statutory rate $ 11,662 | $(113,752) $ 62,188 $ 93,350 Increases (reductions) in taxes | resulting from- | Amortization of investment tax credits (822) | (6,670) (7,992) (12,566) Depreciation - | 14,780 7,853 7,915 Other, net 3,189 | 9,884 (921) (5,703) --------- | --------- ---------- ---------- Total provision for income taxes $ 14,029 | $ (95,758) $ 61,128 $ 82,996 ========= | ========= ========== ========== ACCUMULATED DEFERRED INCOME TAXES AT | DECEMBER 31: | Property basis differences $ 676,853 | $1,482,000 $1,468,000 Deferred nuclear expense 133,281 | 134,000 139,000 Deferred sale and leaseback costs (118,611) | (121,000) (123,000) Unamortized investment tax credits (42,743) | (95,000) (99,000) Unused alternative minimum tax credits (133,442) | (173,733) (132,647) Other (18,901) | 79,334 45,907 --------- | ---------- ---------- Net deferred income tax liability $ 496,437 | $1,305,601 $1,298,260 ========= | ========== ========== | (1) For periods prior to November 8, 1997, state income taxes are included in the General Taxes section above. These amounts are not material and no restatement was made. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include The Cleveland Electric Illuminating Company (Company) and its wholly owned subsidiary, Centerior Funding Corporation (Centerior Funding). The subsidiary was formed in 1995 to serve as the transferor in connection with an accounts receivable securitization completed in 1996. All significant intercompany transactions have been eliminated. The Company is a wholly owned subsidiary of FirstEnergy Corp. (FirstEnergy). Prior to the merger in November 1997 (see Note 2), the Company and The Toledo Edison Company (TE) were the principal operating subsidiaries of Centerior Energy Corporation (Centerior). The merger was accounted for using the purchase method of accounting in accordance with generally accepted accounting principles, and the applicable effects were reflected on the separate financial statements of Centerior's direct subsidiaries as of the merger date. Accordingly, the post-merger financial statements reflect a new basis of accounting, and pre-merger period and post-merger period financial results (separated by a heavy black line) are presented. The Company follows the accounting policies and practices prescribed by The Public Utilities Commission of Ohio (PUCO) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. 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 northeastern Ohio. 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 located in the Company's service area and sales to wholesale customers. There was no material concentration of receivables at December 31, 1997 or 1996, with respect to any particular segment of the Company's customers. In May 1996, the Company and TE began to sell on a daily basis substantially all of their retail customer accounts receivable to Centerior Funding under an asset-backed securitization agreement which expires in 2001. In July 1996, Centerior Funding completed a public sale of $150 million of receivables-backed investor certificates in a transaction that qualified for sale accounting treatment. REGULATORY PLAN- FirstEnergy's Rate Reduction and Economic Development Plan for the Company was approved in January 1997, to become effective upon consummation of the merger. The regulatory plan initially maintains current base electric rates for the Company through December 31, 2005. At the end of the regulatory plan period, the Company's base rates will be reduced by $217 million (approximately 15 percent below current levels). The regulatory plan also revised the Company's fuel cost recovery method. The Company formerly recovered fuel-related costs not otherwise included in base rates from retail customers through a separate energy rate. In accordance with the regulatory plan, the Company's fuel rate will be frozen through the regulatory plan period, subject to limited periodic adjustments. As part of the regulatory plan, transition rate credits were implemented for customers, which are expected to reduce operating revenues for the Company by approximately $280 million during the regulatory plan period. All of the Company's regulatory assets related to its nonnuclear operations are being recovered under provisions of the regulatory plan (see Regulatory Assets). The Company recognized a fair value purchase accounting adjustment to reduce nuclear plant by $1.71 billion in connection with the FirstEnergy merger (see Note 2); that fair value adjustment recognized for financial reporting purposes will ultimately satisfy the $1.4 billion asset reduction commitment contained in the regulatory plan. For regulatory purposes, the Company will recognize the $1.4 billion of accelerated amortization over the rate plan period. UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction (except for the Company's nuclear generating units which were adjusted to fair value in 1997), including payroll and related costs such as taxes, employee benefits, administrative and general costs and financing costs (including allowance for funds used during construction). The Company provides for depreciation on a straight- line basis at various rates over the estimated lives of property included in plant in service. In its April 1996 rate order, the PUCO approved depreciation rates for the Company of 2.88% for nuclear property and 3.23 % for nonnuclear property. The annualized composite rate was approximately 2.8% for the post- merger period. Annual depreciation expense includes approximately $11.7 million for future decommissioning costs applicable to the Company's ownership interests in three nuclear generating units. The Company's share of the future obligation to decommission these units is approximately $406 million in current dollars and (using a 3.5% escalation rate) approximately $985 million in future dollars. The estimated obligation and the escalation rate were developed based on site-specific studies. Payments for decommissioning are expected to begin in 2016, when actual decommissioning work begins. The Company has recovered approximately $99 million for decommissioning through its electric rates from customers through December 31, 1997. If the actual costs of decommissioning the units exceed the funds accumulated from investing amounts recovered from customers, the Company expects that additional amount to be recoverable from its customers. The Company has approximately $105.3 million invested in external decommissioning trust funds as of December 31, 1997. Earnings on these funds are reinvested with a corresponding increase to the decommissioning liability. The Company has also recognized an estimated liability of approximately $11.2 million at December 31, 1997 related to decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy (DOE), as required by the Energy Policy Act of 1992. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning trusts in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB indicated in October 1997 that it plans to continue work on the proposal in 1998. COMMON OWNERSHIP OF GENERATING FACILITIES- The Company, TE, Duquesne Light Company, Ohio Edison Company (OE) and its wholly owned subsidiary, Pennsylvania Power Company (Penn), constitute the Central Area Power Coordination Group (CAPCO). The CAPCO Companies own and/or lease, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Company's portion of operating expenses associated with jointly owned facilities is included in the corresponding operating expenses on the Consolidated Statements of Income. The amounts reflected on the Consolidated Balance Sheet under utility plant at December 31, 1997 include the following: Utility Accumulated Construction Ownership/ Plant Provision for Work in Leasehold Generating Units in Service Depreciation Progress Interest - ----------------------------------------------------------------- (In millions) Bruce Mansfield Units 1, 2, and 3 $ 62.0 $ 18.1 $ .6 19.92% Beaver Valley Unit 2 342.4 3.5 1.2 24.47% Davis-Besse 200.1 - 3.6 51.38% Perry 521.6 - 3.3 31.11% Eastlake Unit 5 159.9 94.6 .3 68.80% Seneca 64.9 24.3 .1 80.00% - ---------------------------------------------------------------- Total $1,350.9 $140.5 9.1 ================================================================ The Bruce Mansfield Plant is being leased through a sale and leaseback transaction (see Note 3) and the above related amounts represent construction expenditures subsequent to the transaction. The Seneca Unit is jointly owned by the Company and a non-CAPCO company. NUCLEAR FUEL- The Company leases its nuclear fuel and pays for the fuel as it is consumed (see Note 3). The Company amortizes the cost of nuclear fuel based on the rate of consumption. The Company's electric rates include amounts for the future disposal of spent nuclear fuel based upon the payments to the DOE. 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. Alternative minimum tax credits of $133 million, which may be carried forward indefinitely, are available to reduce future federal income taxes. RETIREMENT BENEFITS- Centerior had sponsored jointly with the Company, TE and Centerior Service Company (Service Company) a noncontributing pension plan (Centerior Pension Plan) which covered all employee groups. Upon retirement, employees receive a monthly pension generally based on the length of service. Under certain circumstances, benefits can begin as early as age 55. The funding policy was to comply with the Employee Retirement Income Security Act of 1974 guidelines. In December 1997, the Centerior Pension Plan was merged into the FirstEnergy pension plans. In connection with the merger, the Company recorded fair value purchase accounting adjustments to recognize the net gain, prior service cost, and net transition asset (obligation) associated with the pension and post retirement benefit plans. The following sets forth the funded status of the former Centerior Pension Plan. The Company's share of the former Centerior Pension Plan's total projected benefit obligation approximates 70% at December 31, 1997. At December 31, 1997 1996 - --------------------------------------------------------------- (In millions) Actuarial present value of benefit | obligations: | Vested benefits $418.9 | $325.8 Nonvested benefits 30.5 | 15.8 - -----------------------------------------------------|-------- Accumulated benefit obligation $449.4 | $341.6 =====================================================|======== Plan assets at fair value $461.9 | $420.8 Actuarial present value of | projected benefit obligation 533.4 | 395.0 - -----------------------------------------------------|-------- Projected benefit obligation in excess of | plan assets 71.5 | (25.8) Unrecognized net gain (loss) (3.0)| 55.0 Unrecognized prior service cost - | (14.2) Unrecognized net transition asset - | 32.3 - -----------------------------------------------------|-------- Net pension liability $ 68.5 | $ 47.3 ============================================================== The assets of the Centerior Pension Plan consisted primarily of investments in common stock, bonds, guaranteed investment contracts, cash equivalent securities and real estate. Net pension costs for the three years ended December 31, 1997 were computed as follows:
Nov. 8 - | Jan. 1 - Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - ----------------------------------------------------|----------------------------------- | (In millions) | Service cost-benefits earned | during the period $ 2.3 | $ 11.1 $ 12.6 $ 9.8 Interest on projected benefit | obligation 6.1 | 25.4 27.9 25.8 Return on plan assets (7.7) | (38.0) (49.7) (52.8) Net deferral (amortization) - | (2.4) 1.8 9.2 Voluntary early retirement | program expense 23.0 | 4.8 - - - ----------------------------------------------------|---------------------------------- Net pension cost $ 23.7 | $ 0.9 $ (7.4) $ (8.0) ====================================================|================================== Company's share, including pro | rata share of the Service | Company's costs $ 16.5 | $ (2.5) $ (5.0) $ (5.2) - ---------------------------------------------------------------------------------------
A September 30 measurement date was used for 1996 reporting. The assumed discount rates used in determining the actuarial present value of the projected benefit obligation were 7.25% in 1997, 7.75% in 1996 and 8.0% in 1995. The assumed rate of increase in future compensation levels used to measure this obligation was 4.0% in 1997. The rate of annual compensation increase assumption in 1996 was 3.5% for 1997 and 4.0% thereafter. The rate of annual compensation increase assumption in 1995 was 3.5% for 1996 and 1997 and 4.0% thereafter. Expected long-term rates of return on plan assets were assumed to be 10% in 1997 and 11% in 1996 and 1995. At December 31, 1997, the Company's net pension liability included in Pensions and Other Postretirement Benefits on the Consolidated Balance Sheet was $49.2 million. At December 31, 1996, the Company's net prepaid pension cost included in Deferred Charges -- Other on the Consolidated Balance Sheet was $15.4 million (see Note 2). Centerior had sponsored jointly with its former subsidiaries a postretirement benefit plan which provided all employee groups certain health care, death and other postretirement benefits other than pensions. The plan was contributory, with retiree contributions adjusted annually. The plan was not funded. The accumulated postretirement benefit obligation and accrued postretirement benefit cost for the Centerior postretirement benefit plan are as follows: At December 31, 1997 1996 - -------------------------------------------------------------- (In millions) | Accumulated postretirement benefit | obligation allocation: | Retirees $209.8 | $ 177.1 Fully eligible active plan participants 9.8 | 3.9 Other active plan participants 46.9 | 30.9 - ----------------------------------------------------|--------- Accumulated postretirement benefit | obligation 266.5 | 211.9 Unrecognized transition obligation - | (120.1) Unrecognized net gain - | 44.4 - ----------------------------------------------------|--------- Net postretirement benefit liability $266.5 | $ 136.2 Net periodic postretirement benefit costs for the three years ended December 31, 1997 were computed as follows:
Nov. 8 - | Jan. 1 - Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - ---------------------------------------------------------|----------------------------------- | (In millions) | Service cost-benefits | attributed to the period $0.5 | $ 1.8 $ 2.1 $ 1.7 Interest cost on accumulated | benefit obligation 2.8 | 13.5 17.8 17.9 Amortization of transition obligation - | 6.4 7.5 7.5 Amortization of gain - | (0.9) - (0.6) - ---------------------------------------------------------|---------------------------------- Net periodic postretirement | benefit cost $3.3 | $20.8 $27.4 $26.5 =========================================================|================================== Company's share, including pro rata | share of the Service Company's costs $2.6 | $11.4 $18.4 $16.0 - ---------------------------------------------------------------------------------------------
The Consolidated Balance Sheet classification of Pensions and Other Postretirement Benefits at December 31, 1997 and 1996 includes the Company's share of the accrued postretirement benefit liability of $149.5 million and $72.8 million, respectively (see Note 2). The health care trend rate assumption is approximately 6.0% in the first year gradually decreasing to approximately 4.0% for the year 2008 and later. The discount rates used to compute the accumulated postretirement benefit obligation were 7.25% in 1997, 7.75% in 1996 and 8.0% in 1995. An increase in the health care trend rate assumption by one percentage point in all years would increase the accumulated postretirement benefit obligation by approximately $7.7 million and the aggregate annual service and interest costs by approximately $0.5 million. A September 30 measurement date was used for 1996 reporting. TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and interest charges include amounts for transactions with affiliated companies in the ordinary course of business operations. The Company's transactions with TE and the other FirstEnergy operating subsidiaries (OE and Penn) from the November 8, 1997 merger date are primarily for firm power, interchange power, transmission line rentals and jointly owned power plant operations and construction. (See Note 2.) Beginning in May 1996, Centerior Funding began serving as the transferor in connection with the accounts receivable securitization for the Company and TE. The Service Company (formerly a wholly owned subsidiary of Centerior and now a wholly owned subsidiary of FirstEnergy) provides support services at cost to the Company and other affiliated companies. The Service Company billed the Company $34.1 million, $130.8 million, $148.6 million and $141.1 million in the November 8-December 31, 1997, the January 1-November 7, 1997 period, 1996 and 1995, respectively, for such services. Fuel and purchased power expenses on the Consolidated Statements of Income include the cost of power purchased from TE of $17.7 million, $98.5 million, $105.0 million and $102.1 million in the November 8-December 31, 1997 period, the January 1-November 7, 1997 period, 1996 and 1995, 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. The Company reflects temporary cash investments at cost, which approximates their market value. Noncash financing and investing activities included capital lease transactions amounting to $16 million, $37 million and $19 million for the years 1997, 1996 and 1995, respectively. All borrowings with initial maturities of less than one year are defined as financial instruments under generally accepted accounting principles 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: 1997 1996 -------------- --------------- Carrying Fair Carrying Fair Value Value Value Value - -------------------------------------------------------------- (In Millions) Long-term debt $3,198 $3,238|$2,562 $2,630 Preferred stock $ 198 $ 198|$ 216 $ 220 Investments other than cash | and cash equivalents: | Debt securities | - (Maturing in more than | 10 years) $ 547 $ 553|$ - $ - All other 105 104| 75 75 - ----------------------------------------------|-------------- $ 652 $ 657|$ 75 $ 75 ============================================================= The carrying values of long-term debt and preferred stock subject to mandatory redemption were adjusted to fair value in connection with the merger and reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Company's ratings. 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 trusts investments. Unrealized gains and losses applicable to the decommissioning trusts have been recognized in the trust investments with a corresponding change to the decommissioning liability. In 1996, the Company and TE transferred most of their investment assets in existing trusts into Centerior pooled trust funds for the two companies. The amounts in the table represent the Company's pro rata share of the fair value of such noncash investments. The debt securities referred to above are in the held-to-maturity category. The Company has no securities held for trading purposes. REGULATORY ASSETS- The Company recognizes, as regulatory assets, costs which the FERC and PUCO have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets related to nonnuclear operations are being recovered from customers under the Company's regulatory plan. Based on the regulatory plan, at this time, the Company believes it will continue to be able to bill and collect cost-based rates (with the exception of the Company's nuclear operations as discussed below); accordingly, it is appropriate that the Company continue the application of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71), in the foreseeable future for its nonnuclear operations. The Company discontinued the application of SFAS 71 for its nuclear operations in October 1997 when implementation of the regulatory plan became probable. The regulatory plan does not provide for full recovery of the Company's nuclear operations. In accordance with SFAS No. 101, "Regulated Enterprises -- Accounting for the Discontinuation of Application of SFAS 71," the Company was required to remove from its balance sheet all regulatory assets and liabilities related to the portion of its business for which SFAS 71 was discontinued and to assess all other assets for impairment. Regulatory assets attributable to nuclear operations of $499.1 million ($324.4 million after taxes) were written off as an extraordinary item in October 1997. The regulatory assets attributable to nuclear operations written off represent the net amounts due from customers for future federal income taxes when the taxes become payable, which, under the regulatory plan, are no longer recoverable from customers. The remainder of the Company's business continues to comply with the provisions of SFAS 71. All remaining regulatory assets of the Company will continue to be recovered through rates set for the nonnuclear portion of its business. For financial reporting purposes, the net book value of the nuclear generating units was not impaired as a result of the regulatory plan. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: At December 31, 1997 1996 - -------------------------------------------------------------- (In millions) Nuclear unit expenses $ 309.0 $ 320.0 Customer receivables for future income taxes 143.0 633.6 Rate stabilization program deferrals 288.1 300.3 Gain from Bruce Mansfield Plant sale* (274.4) - Loss on reacquired debt 80.9 57.8 Other 33.1 38.0 - -------------------------------------------------------------- Total $ 579.7 $1,349.7 =============================================================== * The Gain from the Bruce Mansfield Plant sale was reclassified as a regulatory liability in connection with the purchase accounting adjustments, consistent with the ratemaking treatment. 2. OHIO EDISON-CENTERIOR MERGER: FirstEnergy was formed on November 8, 1997 by the merger of OE and Centerior. FirstEnergy holds directly all of the issued and outstanding common shares of OE and all of the issued and outstanding common shares of Centerior's former direct subsidiaries, which include, among others, the Company and TE. As a result of the merger, the former common shareholders of OE and Centerior now own all of the outstanding shares of FirstEnergy Common Stock. All other classes of capital stock of OE and its subsidiaries and of the subsidiaries of Centerior are unaffected by the Merger and remain outstanding. The merger was accounted for as a purchase of Centerior's net assets with 77,637,704 shares of FirstEnergy Common Stock through the conversion of each outstanding Centerior Common Stock share into 0.525 of a share of FirstEnergy Common Stock (fractional shares were paid in cash). Based on an imputed value of $20.125 per share, the purchase price was approximately $1.582 billion which also included approximately $20 million of merger related costs. Goodwill of approximately $2.1 billion was recognized by FirstEnergy (to be amortized on a straight-line basis over forty years), which represented the excess of the purchase price over Centerior's net assets after fair value adjustments. Such amount may be adjusted if additional information produces changed assumptions over the twelve months following the merger as FirstEnergy continues to integrate operations and evaluate options with respect to its generation portfolio. The Company's merger purchase accounting adjustments, which were recorded in the records of Centerior's direct subsidiaries, primarily consist of (1) revaluation of the Company's nuclear generating units to fair value ($1.0 billion), based upon the results of an independent appraisal and estimated discounted future cash flows expected to be generated by its nuclear generating units (the estimated cash flows are based upon management's current view of the likely cost recovery associated with the nuclear units); (2) adjusting by $119 million its preferred stock subject to mandatory redemption and long-term debt to estimated fair value; (3) recognizing additional obligations related to retirement benefits (pension liability - $50 million and postretirement obligation - $71 million); (4) recognizing the Company's estimated severance and other compensation liabilities ($56 million); and (5) adjusting the Company's common equity by $272 million. The nuclear assets revaluation does not include decommissioning since that obligation is expected to be recovered with the cash flows provided by the regulated portion of the business. Other assets and liabilities were not adjusted since they remain subject to rate regulation on a historical cost basis. See Note 8. 3. LEASES: The Company leases certain generating facilities, nuclear fuel, certain transmission facilities, office space and other property and equipment under cancelable and noncancelable leases. The Company and TE sold their ownership interests in Bruce Mansfield Units 1, 2 and 3 and TE sold a portion of its ownership interest in Beaver Valley Unit 2. In connection with these sales, which were completed in 1987, the Company and TE entered into operating leases for lease terms of approximately 30 years as co-lessees. During the terms of the leases, the Company and TE continue to be responsible, to the extent of their combined ownership and leasehold interest, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. The Company and TE have the right, at the end of the respective basic lease terms, to renew the leases. The Company and TE also have the right to purchase the facilities at the expiration of the basic lease term or renewal term (if elected) at a price equal to the fair market value of the facilities. As co-lessee with TE, the Company is also obligated for TE's lease payments. If TE is unable to make its payments under the Beaver Valley Unit 2 and Bruce Mansfield Plant leases, the Company would be obligated to make such payments. No such payments have been made on behalf of TE. (TE's minimum lease payments as of December 31, 1997 were $1.7 billion). The Company is buying 150 megawatts of TE's Beaver Valley Unit 2 leased capacity entitlement. Purchased power expense for this transaction was $16.8 million, $87.4 million, $99.4 million and $97.6 million in the November 8-December 31, 1997, the January 1-November 7, 1997 period, 1996 and 1995, respectively. This purchase is expected to continue through the end of the lease period. The future minimum lease payments through 2017 associated with Beaver Valley Unit 2 are approximately $1.2 billion. Nuclear fuel is currently financed for the Company and TE through leases with a special-purpose corporation. As of December 31, 1997, $157 million of nuclear fuel ($93 million for the Company) was financed under a lease financing arrangement totaling $190 million ($90 million of intermediate-term notes and $100 million from bank credit arrangements). The notes mature from 1998 through 2000 and the bank credit arrangements expire in October 1998. Lease rates are based on intermediate-term note rates, bank rates and commercial paper rates. Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 1997 are summarized as follows:
Nov. 8 - | Jan. 1 - Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - ----------------------------------------------------|------------------------------------ | (In millions) | Operating leases | Interest element $10.6 | $ 56.0 $ 58.1 $ 58.1 Other 8.4 | 18.3 4.8 4.8 Capital leases | Interest element 1.5 | 8.5 10.1 10.7 Other 7.5 | 43.4 51.7 58.4 - ----------------------------------------------------|------------------------------------ Total rentals $28.0 | $126.2 $124.7 $132.0 ========================================================================================= The future minimum lease payments as of December 31, 1997 are: Capital Capital Operating Trust Leases Leases Income Net - -------------------------------------------------------------------------------- (In millions) 1998 $ 47.0 $ 65.3 $ 40.1 $ 25.2 1999 33.4 69.3 38.2 31.1 2000 18.9 66.6 36.3 30.3 2001 8.5 71.7 35.0 36.7 2002 4.1 76.4 32.9 43.5 Years thereafter 10.8 853.7 227.7 626.0 - --------------------------------------------------------------------------------- Total minimum lease payments 122.7 $1,203.0 $410.2 $792.8 ======== ====== ====== Interest portion 24.2 - ---------------------------------------------- Present value of net minimum lease payments 98.5 Less current portion 40.4 - ---------------------------------------------- Noncurrent portion $ 58.1 - -----------------------------------------------
The Company and TE refinanced high-cost fixed obligations related to their 1987 sale and leaseback transaction for the Bruce Mansfield Plant through a lower cost transaction in June and July 1997. In a June 1997 offering (Offering), the two companies pledged $720 million aggregate principal amount ($575 million for the Company and $145 million for TE) of first mortgage bonds due in 2000, 2004 and 2007 to a trust as security for the issuance of a like principal amount of secured notes due in 2000, 2004 and 2007. The obligations of the two companies under these secured notes are joint and several. Using available cash, short-term borrowings and the net proceeds from the Offering, the two companies invested $906.5 million ($569.4 million for the Company and $337.1 million for TE) in a business trust, in June 1997. The trust used these funds in July 1997 to purchase lease notes and redeem all $873.2 million aggregate principal amount of 10-1/4% and 11-1/8% secured lease obligation bonds (SLOBs) due 2003 and 2016. The SLOBs were issued by a special-purpose funding corporation in 1988 on behalf of lessors in the two companies' 1987 sale and leaseback transaction. As noted in the table above, the trust income, which is included in Other Income in the Consolidated Statements of Income, effectively reduce lease costs related to that transaction. 4. CAPITALIZATION: (A) RETAINED EARNINGS- There are no restrictions on retained earnings for payment of cash dividends on the Company's common stock. The merger purchase accounting adjustments included resetting the retained earnings balance at zero at the November 8, 1997 merger date. (B) PREFERRED AND PREFERENCE STOCK- The Company's $42.40 Series T and $88.00 Series R preferred stock are not redeemable before June 1998 and December 2001, respectively, and its $90.00 Series S has no optional redemption provision. All other preferred stock may be redeemed by the Company in whole, or in part, with 30-90 days' notice. The preferred dividend rate on the Company's Series L fluctuates based on prevailing interest rates and market conditions. The dividend rate for this issue was 7% in 1997. Preference stock authorized for the Company is 3,000,000 shares without par value. No preference shares are currently outstanding. A liability of $14 million was included in the Company's net assets as of the merger date for preferred dividends declared attributable to the post-merger period. Accordingly, no accrual for preferred stock dividend requirements is included on the Company's November 8, 1997 to December 31, 1997 Consolidated Statement of Income. (C) PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- Annual sinking fund provisions for preferred stock are as follows: Redemption Price Per Series Shares Share Date Beginning - ----------------------------------------------- $ 7.35 C 10,000 $ 100 (i) 88.00 E 3,000 1,000 (i) 91.50 Q 10,714 1,000 (i) 90.00 S 18,750 1,000 November 1 1999 88.00 R 50,000 1,000 December 1 2001 - ----------------------------------------------- i) Sinking fund provisions are in effect. Annual sinking fund requirements for the next five years are $14.7 million in 1998, $33.5 million in each year 1999 and 2000, $80.5 million in 2001 and $18.8 million in 2002. (D) LONG-TERM DEBT- The first mortgage indenture and its supplements, which secure all of the Company's first mortgage bonds, serve as direct first mortgage liens on substantially all property and franchises, other than specifically excepted property, owned by the Company. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) - -------------------------------------------------------------- 1998 $ 66.8 1999 145.5 2000 176.0 2001 57.5 2002 229.3 - -------------------------------------------------------------- The Company's obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds. One pollution control revenue bond issue is entitled to the benefit of an irrevocable bank letter of credit of $48.1 million. To the extent that drawings are made under this letter of credit to pay principal of, or interest on, the pollution control revenue bonds, the Company is entitled to a credit against its obligation to repay those bonds. The Company pays an annual fee of 1.1% of the amount of the letter of credit to the issuing bank and is obligated to reimburse the bank for any drawings thereunder. The Company and TE have letters of credit of approximately $225 million in connection with the sale and leaseback of Beaver Valley Unit 2 that expire in June 1999. The letters of credit are secured by first mortgage bonds of the Company and TE in the proportion of 40% and 60%, respectively (see Note 3). 5. SHORT-TERM BORROWINGS: FirstEnergy has a $125 million revolving credit facility that expires in May 1998. FirstEnergy and the Service Company may borrow under the facility, with all borrowings jointly and severally guaranteed by the Company and TE. FirstEnergy plans to transfer any of its borrowed funds to the Company and TE. The credit agreement is secured with first mortgage bonds of the Company and TE in the proportion of 40% and 60%, respectively. The credit agreement also provides the participating banks with a subordinate mortgage security interest on the properties of the Company and TE. The banks' fee is 0.625% per annum payable quarterly in addition to interest on any borrowings. There were no borrowings under the facility at December 31, 1997. Also, the Company may borrow from its affiliates on a short-term basis. At December 31, 1997, the Company had total short-term borrowings of $56.8 million from its affiliates with a weighted average interest rate of approximately 6%. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $430 million for property additions and improvements from 1998-2002, of which approximately $105 million is applicable to 1998. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $172 million, of which approximately $32 million applies to 1998. During the same periods, the Company's nuclear fuel investments are expected to be reduced by approximately $113 million and $42 million, respectively, as the nuclear fuel is consumed. NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $8.92 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its present ownership and leasehold interests in Beaver Valley Unit 2, the Davis-Besse Nuclear Power Station (Davis-Besse) and the Perry Nuclear Power Plant (Perry), the Company's maximum potential assessment under the industry retrospective rating plan (assuming the other CAPCO companies were to contribute their proportionate share of any assessments under the retrospective rating plan) would be $84 million per incident but not more than $10.7 million in any one year for each incident. The Company is also insured as to its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Company has also obtained approximately $316 million of insurance coverage for replacement power costs for its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry. Under these policies, the Company can be assessed a maximum of approximately $13 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Company's plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. GUARANTEE- The Company, together with the other CAPCO companies, has severally guaranteed certain debt and lease obligations in connection with a coal supply contract for the Bruce Mansfield Plant. As of December 31, 1997, the Company's share of the guarantee (which approximates fair market value) was $14.3 million. The price under the coal supply contract, which includes certain minimum payments, has been determined to be sufficient to satisfy the debt and lease obligations. The Company's total payments under the coal supply contract were $51.2 million, $47.0 million and $38.6 million during 1997, 1996 and 1995, respectively. The Company's minimum annual payments are approximately $14 million under the contract, which expires December 31, 1999. ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Company with regard to air and water quality and other environmental matters. The Company has estimated additional capital expenditures for environmental compliance of approximately $12 million, which is included in the construction forecast provided under "Capital Expenditures" for 1998 through 2002. The Company is in compliance with the current sulfur dioxide (SO2) and nitrogen oxides (NOX) reduction requirements under the Clean Air Act Amendments of 1990. SO2 reductions through the year 1999 will be achieved by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or purchasing emission allowances. Plans for complying with reductions required for the year 2000 and thereafter have not been finalized. The Environmental Protection Agency (EPA) is conducting additional studies which could indicate the need for additional NOX reductions from the Bruce Mansfield Plant by the year 2003. In addition, the EPA is also considering the need for additional NOX reductions from the Company's Ohio facilities. On November 7, 1997, the EPA proposed uniform reductions of NOX emissions across a region of twenty-two states, including Ohio and the District of Columbia (NOX Transport Rule) after determining that such NOX emissions are contributing significantly to ozone pollution in the eastern United States. In a separate but related action, eight states filed petitions with the EPA under Section 126 of the Clean Air Act seeking reductions of NOX emissions which are alleged to contribute to ozone pollution in the eight petitioning states. A December 1997 EPA Memorandum of Agreement proposes to finalize the NOX Transport Rule by September 30, 1998 and establishes a schedule for EPA action on the Section 126 petitions. The cost of NOX reductions, if required, may be substantial. The Company continues to evaluate its compliance plans and other compliance options. The Company is required to meet federally approved SO2 regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $25,000 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Company cannot predict what action the EPA may take in the future with respect to proposed regulations or the interim enforcement policy. The Company is aware of its potential involvement in the cleanup of three hazardous waste disposal sites listed on the Superfund National Priorities List and several other sites. The Company has accrued a liability totaling $4.8 million at December 31, 1997 based on estimates of the costs of cleanup and its proportionate responsibility for such costs. The Company believes that the ultimate outcome of these matters will not have a material adverse effect on the its financial condition, cash flows or results of operations. Legislative, administrative and judicial actions will continue to change the way that the Company must operate in order to comply with environmental laws and regulations. With respect to any such changes and to the environmental matters described above, the Company expects that any resulting additional capital costs which may be required, as well as any required increase in operating costs, would ultimately be recovered from its customers. 7. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 1997 and 1996.
Three Months Ended -------------------------------- Mar. 31, June 30, Sept. 30, Oct. 1 - | Nov. 8 - 1997 1997 1997 Nov. 7, 1997 | Dec. 31, 1997 - ----------------------------------------------------------------------------------|--------------- (In millions) | | Operating Revenues $431.6 $428.2 $499.5 $169.7 | $254.0 Operating Expenses and Taxes 351.6 350.8 368.0 151.3 | 204.5 - ----------------------------------------------------------------------------------|------------ Operating Income 80.0 77.4 131.5 18.4 | 49.5 Other Income (Loss) (3.7) (5.2) 7.5 (1.2) | 4.6 Net Interest Charges 56.1 58.2 71.3 24.0 | 34.8 - ----------------------------------------------------------------------------------|------------ Income (Loss) Before | Extraordinary Item 20.2 14.0 67.7 (6.8) | 19.3 Extraordinary Item (Net | of Income Taxes) (Note 1) - - - (324.4) | - - ----------------------------------------------------------------------------------|------------ Net Income (Loss) $ 20.2 $ 14.0 $ 67.7 $(331.2) | $ 19.3 - ----------------------------------------------------------------------------------|------------ Earnings (Loss) on Common Stock $ 10.9 $ 4.9 $ 58.9 $(348.9) | $ 19.3 - ----------------------------------------------------------------------------------|------------ March 31, June 30, September 30, December 31, Three Months Ended 1996 1996 1996 1996 - ------------------------------------------------------------------------------- (In millions) Operating Revenues $427.5 $434.0 $506.5 $421.9 Operating Expenses and Taxes 351.7 348.1 385.8 345.7 - ---------------------------------------------------------------------------- Operating Income 75.8 85.9 120.7 76.2 Other Income (Loss) 1.3 .7 (2.7) (1.4) Net Interest Charges 60.3 61.4 59.3 59.0 - ---------------------------------------------------------------------------- Net Income $ 16.8 $ 25.2 $ 58.7 $ 15.8 - ---------------------------------------------------------------------------- Earnings on Common Stock $ 6.8 $ 15.3 $ 49.2 $ 6.5 - ----------------------------------------------------------------------------
Earnings for the quarter ended September 30, 1996 were decreased by $10.8 million as a result of a $16.6 million charge for the disposition of materials and supplies inventory as part of the reengineering of the supply chain process. 8. PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME UNAUDITED): The following pro forma statements of income for the Company give effect to the OE-Centerior merger as if it had been consummated on January 1, 1996, with the purchase accounting adjustments actually recognized in the business combination. Year Ended December 31, ---------------------- 1997 1996 - ---------------------------------------------------------------- (In millions) Operating Revenues $1,783 $1,790 Operating Expenses and Taxes 1,418 1,423 ------ ------ Operating Income 365 367 Other Income 15 2 Net Interest Charges 232 227 ------ ------ Net Income $ 148 $ 142 ============================================================= Pro forma adjustments reflected above include: (1) adjusting the Company's nuclear generating units to fair value based upon independent appraisals and estimated discounted future cash flows based on management's current view of cost recovery; (2) the effect of discontinuing SFAS 71 for the Company's nuclear operations; (3) amortization of the fair value adjustment for long-term debt; (4) goodwill recognized representing the excess of the Company's portion of the purchase price over the Company's adjusted net assets; (4) the elimination of merger costs; and (5) adjustments for estimated tax effects of the above adjustments. See Note 2. 9. PENDING MERGER OF TE INTO THE COMPANY: In March 1994, Centerior announced a plan to merge TE into the Company. All necessary regulatory approvals have been obtained, except the approval of the Nuclear Regulatory Commission (NRC). This application was withdrawn at the NRC's request pending the decision whether to complete this merger. No final decision regarding the proposed merger has been reached. In June 1995, TE's preferred stockholders approved the merger and the Company's preferred stockholders approved the authorization of additional shares of preferred stock. If and when the merger becomes effective, TE's preferred stockholders will exchange their shares for preferred stock shares of the Company having substantially the same terms. Debt holders of the merging companies will become debt holders of the Company. For the merging companies, the combined pro forma operating revenues were $2.527 billion, $2.554 billion and $2.516 billion and the combined pro forma net income was $220 million (excluding the extraordinary item discussed in Note 1 and a similar item for TE), $218 million and $281 million for the years 1997, 1996 and 1995, respectively. The pro forma data is based on accounting for the merger of the Company and TE on a method similar to a pooling of interests and for 1997 and 1996 includes pro forma adjustments to reflect the effect of the OE and Centerior merger (see Note 8). The pro forma data is not necessarily indicative of the results of operations which would have been reported had the merger been in effect during those years or which may be reported in the future. The pro forma data should be read in conjunction with the audited financial statements of both the Company and TE. Report of Independent Public Accountants To the Stockholders and Board of Directors of The Cleveland Electric Illuminating Company: We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of The Cleveland Electric Illuminating Company (an Ohio corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiary as of December 31, 1997 (post-merger) and 1996 (pre-merger), and the related consolidated statements of income, retained earnings, capital stock and other paid-in capital, cash flows and taxes for the years ended December 31, 1996 and 1995 and the period from January 1, 1997 to November 7, 1997 (pre-merger), and the period from November 8, 1997 to December 31, 1997 (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 audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Cleveland Electric Illuminating Company and subsidiary as of December 31, 1997 (post-merger) and 1996 (pre-merger), and the results of their operations and their cash flows for the years ended December 31, 1996 and 1995 and the period from January 1, 1997 to November 7, 1997 (pre-merger), and the period from November 8, 1997 to December 31, 1997 (post-merger), in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Cleveland, Ohio February 13, 1998 EX-21.2 12 EXHIBIT 21.2 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 1997 Centerior Funding Corporation - Incorporated in Ohio Statement of Differences ------------------------ Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 1997, is not included in the printed document. EX-23.2 13 EXHIBIT 23.2 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K, into The Cleveland Electric Illuminating Company's previously filed Registration Statements, File No. 33-55513 and No. 333-47651. ARTHUR ANDERSEN LLP Cleveland, Ohio March 30, 1998 EX-27.2 14
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE RELATED FORM 10-K FINANCIAL STATEMENTS FOR THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000020947 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY 1,000 US DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 PER-BOOK 3,156,659 701,900 300,969 2,280,756 0 6,440,284 931,614 0 19,290 950,904 183,174 238,325 3,189,590 56,802 0 0 66,830 14,714 0 40,421 1,699,425 6,440,284 1,782,977 86,310 1,339,833 1,426,143 356,834 2,096 358,930 244,449 (209,957) 45,029 (254,986) 123,602 235,288 511,942 0 0

EX-13.3 15 THE TOLEDO EDISON COMPANY CONSOLIDATED FINANCIAL AND OPERATING STATISTICS
Nov. 8 - Jan. 1 - Dec. 31, 1997| Nov. 7, 1997 1996 1995 1994 1993 - ----------------------------------------|------------------------------------------------------------ | (Dollars in thousands) | | GENERAL FINANCIAL INFORMATION | | Operating Revenues $ 122,669 | $ 772,707 $ 897,259 $ 873,657 $ 864,647 $ 870,841 ========== | ========== ========== ========== ========== ========== Operating Income $ 19,055 | $ 123,282 $ 156,815 $ 188,068 $ 179,499 $ 88,502 ========== | ========== ========== ========== ========== ========== Income (Loss) Before | Extraordinary Item $ 7,616 | $ 41,769 $ 57,289 $ 96,762 $ 82,531 $ (289,275) ========== | ========== ========== ========== ========== ========== Net Income (Loss) $ 7,616 | $ (150,132) $ 57,289 $ 96,762 $ 82,531 $ (289,275) ========== | ========== ========== ========== ========== ========== Earnings (Loss) on Common | Stock $ 7,616 | $ (169,567) $ 40,363 $ 78,510 $ 62,311 $ (311,757) ========== | ========== ========== ========== ========== ========== Net Utility Plant $1,170,806 | $2,079,742 $2,122,266 $2,204,717 $2,262,407 ========== | ========== ========== ========== ========== Total Assets $2,758,152 | $3,428,175 $3,532,714 $3,546,628 $3,543,520 ========== | ========== ========== ========== ========== CAPITALIZATION: | Common Stockholder's Equity $ 531,650 | $ 803,237 $ 762,877 $ 684,568 $ 622,375 Preferred Stock - | Not Subject to Mandatory | Redemption 210,000 | 210,000 210,000 210,000 210,000 Subject to Mandatory | Redemption 1,690 | 3,355 5,020 6,685 28,350 Long-Term Debt 1,210,190 | 1,051,517 1,119,294 1,241,331 1,328,283 ---------- | ---------- ---------- ---------- ---------- Total Capitalization $1,953,530 | $2,068,109 $2,097,191 $2,142,584 $2,189,008 ========== | ========== ========== ========== ========== CAPITALIZATION RATIOS: | Common Stockholder's Equity 27.2%| 38.8% 36.4% 32.0% 28.4% Preferred Stock - | Not Subject to Mandatory | Redemption 10.8 | 10.2 10.0 9.8 9.6 Subject to Mandatory | Redemption .1 | .2 .2 .3 1.3 Long-Term Debt 61.9 | 50.8 53.4 57.9 60.7 ----- | ----- ----- ----- ----- Total Capitalization 100.0%| 100.0% 100.0% 100.0% 100.0% ===== | ===== ===== ===== ===== KILOWATT-HOUR SALES (Millions): | Residential 355 | 1,718 2,145 2,164 2,056 2,039 Commercial 284 | 1,498 1,790 1,748 1,711 1,672 Industrial 847 | 4,003 4,301 4,174 4,099 3,776 Other 79 | 413 488 500 499 490 ---------- | ---------- ---------- ---------- --------- ---------- Total Retail 1,565 | 7,632 8,724 8,586 8,365 7,977 Total Wholesale 435 | 2,218 2,330 2,563 2,548 2,146 ---------- | ---------- ---------- ---------- --------- ---------- Total 2,000 | 9,850 11,054 11,149 10,913 10,123 ========== | ========== ========== ========== ========= ========== CUSTOMERS SERVED (Year-End): | Residential 262,501 | 261,541 260,007 256,998 255,109 Commercial 27,562 | 27,411 26,508 25,921 26,049 Industrial 1,835 | 1,839 1,846 1,839 1,761 Other 2,152 | 2,136 2,119 1,858 2,315 ---------- | ---------- ---------- --------- ---------- Total 294,050 | 292,927 290,480 286,616 285,234 ========== | ========== ========== ========= ========== Average Annual Residential | kWh Usage 7,937 | 8,284 8,384 8,044 7,997 Peak Load-Megawatts 1,813 | 1,758 1,738 1,620 1,568 Number of Employees (Year-End) 1,532 | 1,643 1,809 1,887 1,909
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate", "potential", "expect", "believe", "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy market prices, legislative and regulatory changes (including revised environmental requirements), availability and cost of capital and other similar factors. RESULTS OF OPERATIONS We continued to make significant progress in 1997 as we prepare for a more competitive environment in the electric utility industry. The most significant event during the year was the approval by the Federal Energy Regulatory Commission (FERC) of the merger of our former parent company, Centerior Energy Corporation, with Ohio Edison Company to form FirstEnergy Corp., which came into existence on November 8, 1997. We expect the merger to produce a minimum of $1 billion in savings for FirstEnergy Corp. during the first ten years of joint operations through the elimination of duplicative activities, improved operating efficiencies, lower capital expenditures, accelerated debt reduction, the coordination of the companies' work forces and enhanced purchasing power. The merger was accounted for using the purchase method of accounting in accordance with generally accepted accounting principles (see Note 2), and the applicable effects were "pushed down," or reflected on the separate financial statements of Centerior's direct subsidiaries as of the merger date. As a result, we recorded purchase accounting fair value adjustments to: (1) revalue our nuclear generating units to fair value, (2) adjust long-term debt to fair value, (3) adjust our retirement and severance benefit liabilities, and (4) record goodwill. Accordingly, the post-merger financial statements reflect a new basis of accounting, and separate financial statements are presented for the pre-merger and post-merger periods. For the remainder of this discussion, for categories substantially unaffected by the merger and with no significant pre-merger or post-merger accounting events, we have combined the 1997 pre-merger and post-merger periods and have compared the total to 1996. Earnings on common stock in the 1997 pre-merger period were adversely affected by an extraordinary item resulting from the October 1997 write-off of certain regulatory assets discussed below. Excluding this write-off, pre-merger 1997 earnings on common stock were $22.3 million. Earnings on common stock for the 1997 post-merger period were $7.6 million. In 1996, earnings on common stock were $40.4 million which was lower than 1995 due primarily to the delay in implementing our 1996 rate increase and the end of certain regulatory accounting deferrals in November 1995. Operating revenues were down $1.9 million in 1997 from 1996 levels following a $23.6 million increase in 1996 compared to 1995. A factor contributing to the lower operating revenues in 1997 was a reduction in average retail prices due in part to contract renegotiations with certain large industrial customers. The following table summarizes the sources of changes in operating revenues for 1997 and 1996 as compared to the previous year: 1997 1996 ---- ---- (In millions) Increased retail kilowatt-hour sales $ 14.4 $19.2 Change in average retail price (23.4) 3.4 Sales to utilities 7.8 3.2 Other (0.7) (2.2) ------ ----- Net Change $ (1.9) $23.6 ====== ===== Total kilowatt-hour sales were at a new high with 11.9 billion kilowatt-hours sold. Retail sales totaled 9.2 billion kilowatt-hours, a 5.4% increase from the prior year level. Residential sales decreased 3.3% in 1997 following a 0.9% decline the previous year. Commercial sales were down 0.5% after a 2.4% increase in 1996. Industrial sales increased 12.8% in the current year following a 3.0% increase in 1996. Excluding sales to the North Star BHP Steel facility which began operations in late 1996, industrial sales increased 4.6% in 1997. Sales to other utilities increased 11.6%, compared to an 8.5% decrease in 1996. Overall, there was a 7.2% increase in 1997 total kilowatt-hour sales based on the strength of industrial sales following a 0.9% decrease in 1996 compared to 1995. We spent more for fuel and purchased power during 1997 and 1996 compared to 1996 and 1995, respectively, due to higher purchased power costs. In 1997, the increase was partially offset by lower fuel expense. An increase in the mix of nuclear generation to coal-fired generation contributed to the lower fuel costs. Nuclear expenses in 1997 were relatively unchanged from 1996 as increased operating costs at the Beaver Valley Plant were substantially offset by lower operating costs at the Perry and Davis-Besse Plants. Nuclear expenses in 1996 increased from 1995 due principally to higher operating costs at Davis-Besse resulting from its refueling outage. Other operating costs in the pre-merger period of 1997 included a $9.3 million charge for severance and early retirement benefits. In 1996, other operating costs decreased compared to 1995 reflecting the Company's cost reduction program. Depreciation and amortization increased in the 1997 pre- merger period and in 1996 principally due to changes in depreciation rates approved in the April 1996 Public Utilities Commission of Ohio (PUCO) rate order. In the post-merger period depreciation and amortization was lower due to a fair value adjustment which was recorded in connection with accounting for the merger, which was partially offset by amortization of goodwill. Amortization of regulatory assets remained nearly unchanged in 1997 after a large increase in 1996 following cessation of the Rate Stabilization Program deferrals and initiation of their amortization. Income taxes increased in 1997, compared to 1996, as a function of taxable income, following a decrease in 1996 from the prior year due to lower pretax operating income. Other income increased in the 1997 pre-merger and post- merger periods reflecting interest income on trust notes acquired in connection with the Bruce Mansfield Plant lease refinancing (see Note 3). The increase in income in the pre-merger period was offset in part by merger-related expenses. A write-down of two inactive production facilities totaling $11 million and our share of merger- related expenses were the primary causes of the decrease in other income in 1996, compared to 1995. Interest costs were higher overall in 1997 because new secured notes and short-term borrowings for the Bruce Mansfield Plant lease refinancing exceeded the expense reduction from the redemption and refinancing of debt securities in 1997 and 1996. CAPITAL RESOURCES AND LIQUIDITY Our financial position has improved over the past five years. Cash generated from operations was 27% higher in 1997 than it was in 1992 due to higher revenues and aggressive cost controls. At the end of 1997 we had 890 fewer employees than five years ago as a result of our focus on becoming more competitive. The availability of additional cash generated from operations increased the Company's ability to redeem higher cost debt and preferred stock. We have also actively pursued refinancing activities which replace higher cost debt and preferred stock with lower cost issues. The merger has resulted in improved credit ratings which have lowered the cost of new issues. The following table summarizes changes in credit ratings resulting from the merger.
Pre-Merger Post-Merger --------------------------- -------------------------- Standard Moody's Standard Moody's & Poor's Investors & Poor's Investors Corporation Service, Inc. Corporation Service, Inc. ----------- ------------- ----------- ------------- First mortgage bonds BB Ba2 BB+ Ba1 Subordinated debt B+ B1 BB- Ba3 Preferred Stock B b2 BB- b1
Excluding the effect of the Bruce Mansfield Plant lease refinancing described below, interest costs and preferred dividends have been reduced by approximately $2.8 million from 1996 levels. Through economic refinancings and redemption of higher cost debt we have reduced the average cost of outstanding debt from 9.4% in 1992 to 8.25% in 1997. The Bruce Mansfield Plant lease refinancing is expected to provide an average annual after tax savings of about $10 million resulting from an increase in interest income and a decrease in rent expense offset in part by increased interest expense on secured notes issued as part of the transaction. Our cash requirements in 1998 for operating expenses, construction expenditures and scheduled debt maturities are expected to be met without issuing additional securities. We have cash requirements of approximately $442.6 million for the 1998-2002 period to meet scheduled maturities of long-term debt and preferred stock. Of that amount, approximately $40.6 million applies to 1998. We had about $22.2 million of cash and temporary investments and no short-term indebtedness on December 31, 1997. Upon completion of the merger, application of purchase accounting reduced bondable property such that we are not currently able to issue additional first mortgage bonds, except in connection with refinancings. Together with CEI, as of December 31, 1997, we had unused borrowing capability of $125 million under a revolving line of credit. Our capital spending for the period 1998-2002 is expected to be about $200 million (excluding nuclear fuel), of which approximately $50 million applies to 1998. This spending level is about $30 million lower than actual capital outlays over the past five years. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $140 million, of which about $27 million applies to 1998. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $85 million and $30 million, respectively, as the nuclear fuel is consumed. Also, we have operating lease commitments net of trust income of approximately $432 million for the 1998-2002 period, of which approximately $81 million relates to 1998. We recover the cost of nuclear fuel consumed and operating leases through our electric rates. OUTLOOK We face many competitive challenges in the years ahead as the electric utility industry undergoes significant changes, including changing regulation and the entrance of more energy suppliers into the marketplace. Retail wheeling, which would allow retail customers to purchase electricity from other energy producers, will be one of those challenges. The FirstEnergy Rate Reduction and Economic Development Plan provides the foundation to position us to meet the challenges we are facing by significantly reducing fixed costs and lowering rates to a more competitive level. The plan was approved by the PUCO in January 1997, and initially maintains current base electric rates through December 31, 2005. The plan also revised our fuel recovery methods. As part of the regulatory plan, interim reductions beginning in June 1998 of $3 per month will increase to $5 per month per residential customer by July 1, 2001 followed by a $93 million base rate reduction in 2006. Total savings of $111 million are anticipated over the term of the plan for our customers. We have also committed $35 million for economic development and energy efficiency programs. We have been authorized by the PUCO to recognize additional depreciation related to our generating assets and additional amortization of regulatory assets during the regulatory plan period of at least $647 million more than the amounts that would have been recognized if the regulatory plans were not in effect. For regulatory purposes these additional charges will be reflected over the rate plan period. Our regulatory plan does not provide for full recovery of nuclear operations. Accordingly, regulatory assets representing customer receivables for future income taxes related to nuclear assets of $295 million were written off ($192 million net of tax impact) prior to consummation of the merger since we ceased application of Statement of Financial Accounting Standards No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71) for our nuclear operations when implementation of the FirstEnergy regulatory plan became probable. Based on the regulatory environment we operate in today and our regulatory plan, we believe we will continue to be able to bill and collect cost-based rates relating to our nonnuclear operations; accordingly, it is appropriate that we continue the application of SFAS 71 for those operations. However, as discussed below, changes in the regulatory environment are on the horizon. The Ohio legislature is in the discussion stages of restructuring the electric utility industry within the State. We do not expect any changes in regulation to be effective within the next two years and we cannot assess what the ultimate impact may be. At the consummation of the merger in November 1997, we recognized a fair value purchase accounting adjustment which decreased the carrying value of our nuclear assets by approximately $842 million based upon cash flow models. The fair value adjustment to nuclear plant recognized for financial reporting purposes will ultimately satisfy the asset reduction commitment contained in our regulatory plan over the regulatory plan period. On January 6, 1998, the co-chairs of the Ohio General Assembly's Joint Select Committee on Electric Industry Deregulation released their draft report of a plan which proposes to give customers a choice from whom they buy electricity beginning January 1, 2000. No consensus has been reached by the full Committee; in the meantime, legislation consistent with the co-chairs' draft report may be introduced into the General Assembly by one or both of the co-chairs. We cannot predict when or if this legislation will be introduced and if it will be passed into law. We continue to study the potential effects that such legislation would have on our financial position and results of operations. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB reported in October 1997 that it plans to continue working on the proposal in 1998. The Clean Air Act Amendments of 1990, discussed in Note 6, require additional emission reductions by 2000. We are pursuing cost-effective compliance strategies for meeting the reduction requirements that begin in 2000. We are aware of our potential involvement in the cleanup of several sites containing hazardous waste. Although these sites are not on the Superfund National Priorities List, they are generally being administered by various governmental entities in the same manner as they would be administered if they were on such list. Allegations that we disposed of hazardous waste at these sites, and the amount involved are often unsubstantiated and subject to dispute. Federal law provides that all "potentially responsible parties" for a particular site be held liable on a joint and several basis. If we were held liable for 100% of the cleanup costs of all the sites referred to above, the cost could be as high as $100 million. However, we believe that the actual cleanup costs will be substantially lower than $100 million, that our share of any cleanup costs will be substantially less than 100% and that most of the other parties involved are financially able to contribute their share. We have accrued a $1.1 million liability as of December 31, 1997, based on estimates of the costs of cleanup and our proportionate responsibility for such cost. We believe that the ultimate outcome of these matters will not have a material adverse effect on our financial condition, cash flows or results of operations. IMPACT OF THE YEAR 2000 ISSUE The Year 2000 Issue is the result of computer programs being written using two digits rather than four to identify the applicable year. Any of our programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations. We currently believe that with modifications to existing software and conversions to new software, the Year 2000 Issue will pose no significant operational problems for our computer systems as so modified and converted. If these modifications and conversions are not made, or are not completed on a timely basis, the Year 2000 Issue could have a material impact on our operations. We have initiated formal communications with many of our major suppliers to determine the extent to which we are vulnerable to those third parties' failure to resolve their own Year 2000 problems. Our total Year 2000 project cost and estimates to complete are based on currently available information and do not include the estimated costs and time associated with the impact of a third party's Year 2000 issue. There can be no guarantee that the failure of other companies to resolve their own Year 2000 issues will not have a material adverse effect on us. We are utilizing both internal and external resources to reprogram and/or replace and test the software for Year 2000 modifications. Most of our Year 2000 problems will be resolved through system replacements. The different phases of our Year 2000 project will be completed at various dates, most of which occur in 1999. We plan to complete the entire Year 2000 project by mid- December 1999. Of the total project cost, approximately $10 million will be capitalized since those costs are attributable to the purchase of new software for total system replacements (i.e., the Year 2000 solution comprises only a portion of the benefit resulting from the system replacements). The remaining $1 million will be expensed as incurred over the next two years. To date, we have incurred approximately $150,000 related to the assessment of, and preliminary efforts in connection with, our Year 2000 project and the development of a remediation plan. The costs of the project and the date on which we plan to complete the year 2000 modifications are based on management's best estimates, which were derived from numerous assumptions of future events including the continued availability of certain resources, and other factors. However, there can be no guarantee that this project will be completed as planned and actual results could differ materially from the estimates. Specific factors that might cause material differences include, but are not limited to, the availability and cost of trained personnel, the ability to locate and correct all relevant computer code, and similar uncertainties. THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF INCOME
Nov. 8 - | Jan. 1 - For the Years Ended December 31, | -------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - ----------------------------------------------------|------------------------------------------------- | (In thousands) | OPERATING REVENUES (1) $122,669 | $ 772,707 $897,259 $873,657 -------- | --------- -------- -------- OPERATING EXPENSES AND TAXES: | Fuel and purchased power 21,261 | 149,890 168,909 156,874 Nuclear operating costs 28,977 | 132,931 161,321 145,836 Other operating costs 22,668 | 158,939 173,530 182,838 -------- | --------- -------- --------- Total operation and | maintenance expenses 72,906 | 441,760 503,760 485,548 Provision for depreciation | and amortization 10,795 | 84,682 98,042 92,911 Amortization (deferral) of net | regulatory assets 2,338 | 14,304 17,041 (16,799) General taxes 13,126 | 77,426 89,647 91,042 Income taxes 4,449 | 31,253 31,954 32,887 -------- | --------- -------- -------- Total operating expenses and taxes 103,614 | 649,425 740,444 685,589 -------- | --------- -------- -------- | OPERATING INCOME 19,055 | 123,282 156,815 188,068 | OTHER INCOME (LOSS) 2,153 | 2,153 (4,585) 18,835 -------- | --------- -------- -------- | INCOME BEFORE NET INTEREST CHARGES 21,208 | 125,435 152,230 206,903 -------- | --------- -------- -------- NET INTEREST CHARGES: | Interest on long-term debt 13,689 | 74,264 85,535 98,550 Allowance for borrowed funds | used during construction (138) | (259) (827) (674) Other interest expense 41 | 9,661 10,233 12,265 -------- | --------- -------- -------- Net interest 13,592 | 83,666 94,941 110,141 -------- | --------- -------- -------- INCOME BEFORE EXTRAORDINARY ITEM 7,616 | 41,769 57,289 96,762 | EXTRAORDINARY ITEM (NET OF INCOME | TAXES) (Note 1) - | (191,901) - - -------- | --------- -------- -------- | NET INCOME (LOSS) 7,616 | (150,132) 57,289 96,762 | PREFERRED STOCK DIVIDEND | REQUIREMENTS - | 19,435 16,926 18,252 -------- | --------- -------- -------- EARNINGS (LOSS) ON COMMON STOCK $ 7,616 | $(169,567) $ 40,363 $ 78,510 ======== | ========= ======== ======== (1) Includes electric sales to The Cleveland Electric Illuminating Company of $17.7 million, $98.5 million, $105.0 million and $102.1 million in the November 8-December 31, 1997 period, the January 1- November 7, 1997 period, 1996 and 1995, respectively. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE TOLEDO EDISON COMPANY CONSOLIDATED BALANCE SHEETS
At December 31, 1997 1996 - --------------------------------------------------------------------------------------------- (In thousands) ASSETS | | UTILITY PLANT: | In service $1,763,495 | $3,138,344 Less--Accumulated provision for depreciation 619,222 | 1,084,933 ---------- | ---------- 1,144,273 | 2,053,411 ---------- | ---------- Construction work in progress-- | Electric plant 19,901 | 21,479 Nuclear fuel 6,632 | 4,852 ---------- | ---------- 26,533 | 26,331 ---------- | ---------- 1,170,806 | 2,079,742 ---------- | ---------- OTHER PROPERTY AND INVESTMENTS: | Shippingport Capital Trust (Note 3) 312,873 | - Nuclear plant decommissioning trusts 85,956 | 64,093 Other 3,164 | 6,281 ---------- | ---------- 401,993 | 70,374 ---------- | ---------- CURRENT ASSETS: | Cash and cash equivalents 22,170 | 81,454 Receivables-- | Customers 19,071 | 18,337 Associated companies 15,199 | 13,519 Other 2,593 | 5,567 Notes receivable from associated companies 40,802 | 81,817 Materials and supplies, at average cost-- | Owned 31,892 | 33,160 Under consignment 9,538 | 10,383 Prepayments and other 26,437 | 26,206 ---------- | ---------- 167,702 | 270,443 ---------- | ---------- DEFERRED CHARGES: | Regulatory assets 442,724 | 927,629 Goodwill 514,462 | - Property taxes 45,338 | 45,625 Other 15,127 | 34,362 ---------- | ---------- 1,017,651 | 1,007,616 ---------- | ---------- $2,758,152 | $3,428,175 ========== | ========== CAPITALIZATION AND LIABILITIES | | CAPITALIZATION (See Consolidated Statements of Capitalization): | Common stockholder's equity $ 531,650 | $ 803,237 Preferred stock-- | Not subject to mandatory redemption 210,000 | 210,000 Subject to mandatory redemption 1,690 | 3,355 Long-term debt 1,210,190 | 1,051,517 ---------- | ---------- 1,953,530 | 2,068,109 ---------- | ---------- CURRENT LIABILITIES: | Currently payable long-term debt and preferred stock 69,979 | 87,609 Accounts payable-- | Associated companies 21,173 | 30,016 Other 60,756 | 46,496 Accrued taxes 34,441 | 24,829 Accrued interest 26,633 | 22,348 Other 22,603 | 18,722 ---------- | ---------- 235,585 | 230,020 ---------- | ---------- DEFERRED CREDITS: | Accumulated deferred income taxes 104,543 | 565,600 Accumulated deferred investment tax credits 43,265 | 80,884 Pensions and postretirement benefits 113,254 | 102,214 Other 307,975 | 381,348 ---------- | ---------- 569,037 | 1,130,046 ---------- | ---------- COMMITMENTS, GUARANTEES AND CONTINGENCIES | (Notes 3 and 6) | ---------- | ---------- $2,758,152 | $3,428,175 ========== | ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION
At December 31, 1997 | 1996 - --------------------------------------------------------------------------------------------|----------- (Dollars in thousands, except per share amounts) | | COMMON STOCKHOLDER'S EQUITY: | Common stock, $5 par value, authorized 60,000,000 shares - | 39,133,887 shares outstanding $ 195,670 | $ 195,687 Premium on capital stock 328,364 | 481,057 Other paid-in capital - | 121,056 Retained earnings (Note 4A) 7,616 | 5,437 ---------- | ---------- Total common stockholder's equity 531,650 | 803,237 ---------- | ---------- Number of Shares Optional | Outstanding Redemption Price | ----------------- -------------------- | 1997 1996 Per Share Aggregate | ---- ---- --------- --------- | | PREFERRED STOCK (Note 4B): | $100 par value, authorized | 3,000,000 shares;$25 par value, | authorized 12,000,000 shares | Not Subject to Mandatory | Redemption: | $ 100 par $ 4.25 160,000 160,000 $104.63 $ 16,740 16,000 | 16,000 $ 4.56 50,000 50,000 101.00 5,050 5,000 | 5,000 $ 4.25 100,000 100,000 102.00 10,200 10,000 | 10,000 $ 8.32 100,000 100,000 102.46 10,246 10,000 | 10,000 $ 7.76 150,000 150,000 102.44 15,366 15,000 | 15,000 $ 7.80 150,000 150,000 101.65 15,248 15,000 | 15,000 $10.00 190,000 190,000 101.00 19,190 19,000 | 19,000 $ 25 par $ 2.21 1,000,000 1,000,000 25.25 25,250 25,000 | 25,000 $ 2.365 1,400,000 1,400,000 27.75 38,850 35,000 | 35,000 Series A Adjustable 1,200,000 1,200,000 25.00 30,000 30,000 | 30,000 Series B Adjustable 1,200,000 1,200,000 25.00 30,000 30,000 | 30,000 --------- --------- -------- ---------- | ---------- 5,700,000 5,700,000 $216,140 210,000 | 210,000 ========= ========= ======== ---------- | ---------- Subject to Mandatory Redemption | (Note 4C): | $ 100 par $ 9.375 33,550 50,200 $100.49 $ 3,371 3,355 | 5,020 Redemption within one year (1,665)| (1,665) --------- --------- -------- ----------- | --------- 33,550 50,200 $ 3,371 1,690 | 3,355 ========= ========= ======== ----------- | --------- LONG-TERM DEBT (Note 4D): | First mortgage bonds: | 6.125% due 1997 - | 31,400 7.250% due 1999 85,000 | 85,000 7.500% due 2002 26,000 | 26,000 8.000% due 2003 35,725 | 35,725 7.875% due 2004 145,000 | 145,000 ----------- | ---------- Total first | mortgage bonds 291,725 | 323,125 ----------- | --------- - - Unsecured notes: | 5.750% due 2003 3,900 | 4,100 10.000% due 2010 1,000 | 1,000 ----------- | --------- Total unsecured notes 4,900 | 5,100 ----------- | --------- Notes secured by subordinate mortgage: | 8.750% due 1997 - | 8,000 ----------- | ---------
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Cont.)
At December 31, 1997 1996 - ------------------------------------------------------------------------------------------------------- (In thousands) | LONG-TERM DEBT (Cont.): | Secured notes: | 7.940% due 1998 5,000 | 5,000 8.000% due 1998 7,000 | 7,000 9.300% due 1998 26,000 | 26,000 10.000% due 1998 650 | 650 7.720% due 1999 15,000 | 15,000 8.470% due 1999 3,500 | 3,500 7.190% due 2000 45,000 | - 7.380% due 2000 14,000 | 14,000 7.460% due 2000 16,500 | 16,500 7.500% due 2000 100 | 100 8.500% due 2001 8,000 | 8,000 9.500% due 2001 21,000 | 21,000 8.180% due 2002 17,000 | 17,000 8.620% due 2002 7,000 | 7,000 8.650% due 2002 5,000 | 5,000 7.760% due 2003 5,000 | 5,000 7.780% due 2003 1,000 | 1,000 7.820% due 2003 38,400 | 38,400 7.850% due 2003 15,000 | 15,000 7.910% due 2003 3,000 | 3,000 7.670% due 2004 70,000 | - 7.130% due 2007 30,000 | - 3.800% due 2011* 31,250 | 31,250 8.000% due 2019 67,300 | 67,300 7.625% due 2020 45,000 | 45,000 7.750% due 2020 54,000 | 54,000 9.220% due 2021 15,000 | 15,000 10.000% due 2021 15,000 | 15,000 7.400% due 2022 30,900 | 30,900 9.875% due 2022 - | 10,100 6.875% due 2023 20,200 | 20,200 7.550% due 2023 37,300 | 37,300 8.000% due 2023 49,300 | 49,300 6.100% due 2027 10,100 | - ---------- | --------- Total secured notes 728,500 | 583,500 ---------- | --------- Debentures: | 8.700% due 2002 135,000 | 135,000 ---------- | --------- Nuclear fuel lease obligations (Note 3) 64,843 | 84,735 ---------- | --------- Net unamortized premium (discount) on debt (Note 2) 53,536 | (1,999) ---------- | --------- Long-term debt due within one year (68,314)| (85,944) ---------- | --------- Total long-term debt 1,210,190 | 1,051,517 ---------- |---------- TOTAL CAPITALIZATION $1,953,530 |$2,068,109 ========== |========== *Denotes variable rate issue with December 31, 1997 interest rate shown. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
Nov. 8 - | Jan. 1 - For the Years Ended December 31, | ------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - --------------------------------------------------|------------------------------------------------------ | (In thousands) | Balance at beginning of period $ - | $ 5,437 $(34,926) $(113,235) Net income (loss) 7,616 | (150,132) 57,289 96,762 ------ | -------- -------- --------- 7,616 | (144,695) 22,363 (16,473) - --------------------------------------------------|---------------------------------------------------- Cash dividends on preferred | stock - | 20,973 16,926 18,454 Purchase accounting fair | value adjustment - | (165,668) - - Other - | - - (1) ------ | -------- -------- --------- - | (144,695) 16,926 18,453 ------ | -------- -------- --------- Balance at end of period (Note 4A) $7,616 | $ - $ 5,437 $ (34,926) ======================================================================================================
CONSOLIDATED STATEMENTS OF CAPITAL STOCK AND OTHER PAID-IN CAPITAL
Preferred Stock ------------------------------------------ Not Subject to Subject to Common Stock Mandatory Redemption Mandatory Redemption ------------------------------------------- -------------------- -------------------- Premium Other Number Par on Capital Paid-In Number Par Number Par of Shares Value Stock Capital of Shares Value of Shares Value --------- --------- ---------- -------- ---------- -------- --------- ------- (Dollars in thousands) Balance, January 1, 1995 39,133,887 $195,687 $481,057 $121,059 5,700,000 $210,000 483,500 $18,350 Redemptions-- $100 par $9.375 (16,650) (1,665) $ 25 par $2.81 (400,000) (10,000) - ---------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 39,133,887 195,687 481,057 121,059 5,700,000 210,000 66,850 6,685 Unrealized loss on securities (3) Redemptions-- $100 par $9.375 (16,650) (1,665) - ---------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 39,133,887 195,687 481,057 121,056 5,700,000 210,000 50,200 5,020 Redemptions-- $100 par $9.375 (16,650) (1,665) - ---------------------------------------------------------------------------------------------------------------------- Purchase accounting fair value adjustment (17) (152,693) (121,056) - ---------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 39,133,887 $195,670 $328,364 $ - 5,700,000 $210,000 33,550 $ 3,355 ======================================================================================================================= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 8 - Jan. 1 - For the Years Ended December 31, | -------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - ------------------------------------------------------|------------------------------------------------ | (In thousands) | CASH FLOWS FROM OPERATING ACTIVITIES: | Net Income (Loss) $ 7,616 | $ (150,132) $ 57,289 $ 96,762 Adjustments to reconcile net income | to net cash from operating activities: | Provision for depreciation | and amortization 10,795 | 84,682 98,042 92,911 Nuclear fuel and lease amortization 5,316 | 30,354 33,294 54,099 Other amortization, net 2,338 | 14,304 17,041 (30,817) Deferred income taxes, net 3,113 | (121,002) 17,919 16,316 Investment tax credits, net (400) | (3,601) (4,321) (8,641) Allowance for equity funds used | during construction (61) | (776) (1,045) (874) Extraordinary item - | 295,233 - - Receivables 1,923 | 317 (9,610) (6,283) Net proceeds from accounts | receivable securitization - | - 78,461 - Materials and supplies (4,430) | 6,543 5,697 7,988 Accounts payable (12,989) | 18,679 (9,737) 8,043 Other (29,443) | 55,233 (1,509) 9,419 -------- | -------- -------- -------- Net cash provided from (used for) | operating activities (16,222) | 229,834 281,521 238,923 -------- | -------- -------- -------- | CASH FLOWS FROM FINANCING ACTIVITIES: | New Financing-- | Long-term debt - | 149,804 (260) 92,439 Short-term borrowings, net - | - - 20,950 Redemptions and Repayments-- | Preferred stock - | 1,665 1,665 11,665 Long-term debt - | 85,419 110,108 246,714 Short-term borrowings, net - | - 20,950 - Dividend Payments-- | Preferred stock 4,156 | 12,589 16,926 18,454 ------- | --------- -------- -------- Net cash provided from (used for) | financing activities (4,156) | 50,131 (149,909) (163,444) ------- | --------- -------- -------- | CASH FLOWS FROM INVESTING ACTIVITIES: | Property additions 6,568 | 36,680 47,961 53,492 Loans to associated companies - | - 81,817 - Loan payments from associated companies (15,297) | (25,718) - - Capital trust investments (7,314) | 320,187 - - Other (6,585) | 10,350 14,049 16,118 ------- | --------- --------- --------- Net cash used for (provided from) | investing activities (22,628) | 341,499 143,827 69,610 ------- | --------- --------- --------- Net increase (decrease) in cash and | cash equivalents 2,250 | (61,534) (12,215) 5,869 Cash and cash equivalents at beginning | of period 19,920 | 81,454 93,669 87,800 ------- | --------- --------- --------- Cash and cash equivalents at end | of period $22,170 | $ 19,920 $ 81,454 $ 93,669 ======= | ========= ========= ========= SUPPLEMENTAL CASH FLOWS INFORMATION: | Cash Paid During the Period-- | Interest (net of amounts capitalized) $16,000 | $ 73,000 $ 92,000 $ 93,000 ======= | ========= ========= ========= Income taxes $28,000 | $ 25,300 $ 15,950 $ 22,500 ======= | ========= ========= ========= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
THE TOLEDO EDISON COMPANY CONSOLIDATED STATEMENTS OF TAXES
Nov. 8- Jan. 1 - For the Years Ended December 31, | ------------------------------- Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - --------------------------------------------------|----------------------------------------------------- | (In thousands) | GENERAL TAXES: | Real and personal property $ 5,998 | $ 40,495 $ 45,446 $ 47,100 State gross receipts 5,826 | 28,590 33,793 33,149 Social security and unemployment 818 | 4,444 5,689 5,684 Other 484 | 3,897 4,719 5,109 -------- | --------- --------- --------- Total general taxes $ 13,126 | $ 77,426 $ 89,647 $ 91,042 ======== | ========= ========= ========= | PROVISION FOR INCOME TAXES: | Currently payable-- | Federal $ 2,859 | $ 55,192 $ 13,582 $ 27,512 State (1) 209 | - - - -------- | --------- --------- --------- 3,068 | 55,192 13,582 27,512 -------- | --------- --------- --------- Deferred, net-- | Federal 3,096 | (121,002) 17,919 16,316 State (1) 17 | - - - -------- | --------- --------- --------- 3,113 | (121,002) 17,919 16,316 -------- | --------- --------- --------- Investment tax credit amortization (400) | (3,601) (4,321) (8,641) -------- | --------- --------- --------- Total provision for income taxes $ 5,781 | $ (69,411) $ 27,180 $ 35,187 ======== | ========= ========= ========= INCOME STATEMENT CLASSIFICATION | OF PROVISION FOR INCOME TAXES: | Operating income $ 4,449 | $ 31,253 $ 31,954 $ 32,887 Other income 1,332 | 2,667 (4,774) 2,300 Extraordinary item - | (103,331) - - -------- | --------- --------- --------- Total provision for income taxes $ 5,781 | $ (69,411) $ 27,180 $ 35,187 ======== | ========= ========= ========= RECONCILIATION OF FEDERAL INCOME | TAX EXPENSE AT STATUTORY RATE TO | TOTAL PROVISION FOR INCOME TAXES: | Book income before provision for | income taxes $ 13,397 | $(219,543) $ 84,469 $ 131,949 ======== | ========= ========= ========= Federal income tax expense at | statutory rate $ 4,689 | $ (76,840) $ 29,564 $ 46,182 Increases (reductions) in taxes | resulting from-- | Amortization of investment tax | credits (400) | (3,601) (4,321) (8,641) Depreciation - | 3,428 (3,742) (1,259) Other, net 1,492 | 7,602 5,679 (1,095) -------- | --------- --------- --------- Total provision for income | taxes $ 5,781 | $ (69,411) $ 27,180 $ 35,187 ======== | ========= ========= ========= ACCUMULATED DEFERRED INCOME TAXES | AT DECEMBER 31: | Property basis differences $190,636 | $ 612,000 $ 627,000 Deferred nuclear expense 83,052 | 84,000 85,000 Deferred sale and leaseback costs (17,431) | - (4,000) Unamortized investment tax credits (20,960) | (44,000) (46,000) Unused alternative minimum tax | credits (108,156) | (99,837) (80,396) Other (22,598) | 13,437 (8,569) -------- | --------- --------- Net deferred income tax liability $104,543 | $ 565,600 $ 573,035 ======== | ========= ========= (1) For periods prior to November 8, 1997, state income taxes are included in the General Taxes section above. These amounts are not material and no restatement was made. The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The consolidated financial statements include The Toledo Edison Company (Company) and its 90% owned subsidiary, The Toledo Edison Capital Corporation (TECC). The subsidiary was formed in 1997 to make equity investments in a business trust in connection with the financing transactions related to the Bruce Mansfield Plant sale and leaseback (see Note 3). The Cleveland Electric Illuminating Company (CEI), an affiliate, has a 10% interest in TECC. All significant intercompany transactions have been eliminated. The Company is a wholly owned subsidiary of FirstEnergy Corp. (FirstEnergy). Prior to the merger in November 1997 (see Note 2), the Company and CEI were the principal operating subsidiaries of Centerior Energy Corporation (Centerior). The merger was accounted for using the purchase method of accounting in accordance with generally accepted accounting principles, and the applicable effects were reflected on the separate financial statements of Centerior's direct subsidiaries as of the merger date. Accordingly, the post-merger financial statements reflect a new basis of accounting, and pre- merger period and post-merger period financial results (separated by a heavy black line) are presented. The Company follows the accounting policies and practices prescribed by The Public Utilities Commission of Ohio (PUCO) and the Federal Energy Regulatory Commission (FERC). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. 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 northwestern Ohio. 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 located in the Company's service area and sales to wholesale customers. There was no material concentration of receivables at December 31, 1997 or 1996, with respect to any particular segment of the Company's customers. In May 1996, the Company and CEI began to sell on a daily basis substantially all of their retail customer accounts receivable to Centerior Funding Corporation (Centerior Funding), a wholly owned subsidiary of CEI, under an asset-backed securitization agreement which expires in 2001. In July 1996, Centerior Funding completed a public sale of $150 million of receivables-backed investor certificates in a transaction that qualified for sale accounting treatment. REGULATORY PLAN- FirstEnergy's Rate Reduction and Economic Development Plan for the Company was approved in January 1997, to be effective upon consummation of the merger. The regulatory plan initially maintains current base electric rates for the Company through December 31, 2005. At the end of the regulatory plan period, the Company's base rates will be reduced by $93 million (approximately 15 percent below current levels). The regulatory plan also revised the Company's fuel cost recovery method. The Company formerly recovered fuel-related costs not otherwise included in base rates from retail customers through a separate energy rate. In accordance with the regulatory plan, the Company's fuel rate will be frozen through the regulatory plan period, subject to limited periodic adjustments. As part of the regulatory plan, transition rate credits were implemented for customers, which are expected to reduce operating revenues for the Company by approximately $111 million during the regulatory plan period. All of the Company's regulatory assets related to its nonnuclear operations are being recovered under provisions of the regulatory plan (see Regulatory Assets). The Company recognized a fair value purchase accounting adjustment to reduce nuclear plant by $842 million in connection with the FirstEnergy merger (see Note 2); that fair value adjustment recognized for financial reporting purposes will ultimately satisfy the $647 million asset reduction commitment contained in the regulatory plan. For regulatory purposes, the Company will recognize the $647 million of accelerated amortization over the regulatory plan period. UTILITY PLANT AND DEPRECIATION- Utility plant reflects the original cost of construction (except for the Company's nuclear generating units which were adjusted to fair value in 1997), including payroll and related costs such as taxes, employee benefits, administrative and general costs and financing costs (allowance for funds used during construction). The Company provides for depreciation on a straight- line basis at various rates over the estimated lives of property included in plant in service. In its April 1996 rate order, the PUCO approved depreciation rates for the Company of 2.95% for nuclear property and 3.13% for nonnuclear property. The annualized composite rate was approximately 2.6% for the post- merger period. Annual depreciation expense includes approximately $9.8 million for future decommissioning costs applicable to the Company's ownership interests in three nuclear generating units. The Company's share of the future obligation to decommission these units is approximately $327 million in current dollars and (using a 3.5% escalation rate) approximately $774 million in future dollars. The estimated obligation and the escalation rate were developed based on site-specific studies. Payments for decommissioning are expected to begin in 2016, when actual decommissioning work begins. The Company has recovered approximately $81 million for decommissioning through its electric rates from customers through December 31, 1997. If the actual costs of decommissioning the units exceed the funds accumulated from investing amounts recovered from customers, the Company expects that additional amount to be recoverable from its customers. The Company has approximately $86.0 million invested in external decommissioning trust funds as of December 31, 1997. Earnings on these funds are reinvested with a corresponding increase to the decommissioning liability. The Company has also recognized an estimated liability of approximately $9.6 million at December 31, 1997 related to decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy (DOE), as required by the Energy Policy Act of 1992. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB indicated in October 1997 that it plans to continue work on the proposal in 1998. COMMON OWNERSHIP OF GENERATING FACILITIES- The Company, CEI, Duquesne Light Company, Ohio Edison Company (OE) and its wholly owned subsidiary, Pennsylvania Power Company (Penn), constitute the Central Area Power Coordination Group (CAPCO). The CAPCO companies own and/or lease, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Company's portion of operating expenses associated with jointly owned facilities is included in the corresponding operating expenses on the Consolidated Statements of Income. The amounts reflected on the Consolidated Balance Sheet under utility plant at December 31, 1997 include the following:
Utility Accumulated Construction Ownership/ Plant Provision for Work in Leasehold Generating Units in Service Depreciation Progress Interest - ---------------------------------------------------------------------------------- (In millions) Bruce Mansfield Units 2 and 3 $ 38.3 $ 9.7 $ .4 18.61% Beaver Valley Unit 2 57.5 1.0 3.1 19.91% Davis-Besse 200.8 - 2.2 48.62% Perry 315.9 - .7 19.91% - -------------------------------------------------------------------------------- Total $612.5 $10.7 $6.4 =================================================================================
The Bruce Mansfield Plant and Beaver Valley Unit 2 are being leased through sale and leaseback transactions (see Note 3) and the above related amounts represent construction expenditures subsequent to the transaction. NUCLEAR FUEL- The Company leases its nuclear fuel and pays for the fuel as it is consumed (see Note 3). The Company amortizes the cost of nuclear fuel based on the rate of consumption. The Company's electric rates include amounts for the future disposal of spent nuclear fuel based upon the payments to the DOE. 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. Alternative minimum tax credits of $108 million, which may be carried forward indefinitely, are available to reduce future federal income taxes. RETIREMENT BENEFITS- Centerior had sponsored jointly with the Company, CEI and Centerior Service Company (Service Company) a noncontributing pension plan (Centerior Pension Plan) which covered all employee groups. Upon retirement, employees receive a monthly pension generally based on the length of service. Under certain circumstances, benefits can begin as early as age 55. The funding policy was to comply with the Employee Retirement Income Security Act of 1974 guidelines. In December 1997, the Centerior Pension Plan was merged into the FirstEnergy pension plans. In connection with the Ohio Edison-Centerior merger, the Company recorded fair value purchase accounting adjustments to recognize the net gain, prior service cost and net transition asset (obligation) associated with the pension and postretirement benefit plans (see Note 2). The following sets forth the funded status of the former Centerior Pension Plan. The Company's share of the former Centerior Pension Plan's total projected benefit obligation approximates 30% at December 31, 1997. At December 31, 1997 1996 - ---------------------------------------------------------------- (In millions) Actuarial present value | of benefit obligations: | Vested benefits $418.9 | $325.8 Nonvested benefits 30.5 | 15.8 - --------------------------------------------------------|-------- Accumulated benefit obligation $449.4 | $341.6 ========================================================|======== Plan assets at fair value $461.9 | $420.8 Actuarial present value of | projected benefit obligation 533.4 | 395.0 - --------------------------------------------------------|-------- Projected benefit obligation in | excess of plan assets 71.5 | (25.8) Unrecognized net gain (loss) (3.0)| 55.0 Unrecognized prior service cost - | (14.2) Unrecognized net transition asset - | 32.3 - --------------------------------------------------------|-------- Net pension liability $ 68.5 | $ 47.3 ================================================================= The assets of the Centerior Pension Plan consisted primarily of investments in common stocks, bonds, guaranteed investment contracts, cash equivalent securities and real estate. Net pension costs for the three years ended December 31, 1997 were computed as follows:
Nov. 8 - Jan. 1 - Dec. 31, 1997 Nov. 7, 1997 1996 1995 - --------------------------------------------------------------------------------- (In millions) | Service cost-benefits earned | during the period $ 2.3 | $ 11.1 $ 12.6 $ 9.8 Interest on projected benefit | obligation 6.1 | 25.4 27.9 25.8 Return on plan assets (7.7) | (38.0) (49.7) (52.8) Net deferral (amortization) - | (2.4) 1.8 9.2 Voluntary early retirement | program expense 23.0 | 4.8 - - - ----------------------------------------------|------------------------------------ Net pension cost $ 23.7 | $ 0.9 $ (7.4) $ (8.0) ==============================================|==================================== Company's share, including | pro rata share of the Service | Company's costs $ 5.7 | $ 3.5 $ (2.4) $ (2.7) - -----------------------------------------------------------------------------------
A September 30 measurement date was used for 1996 reporting. The assumed discount rates used in determining the actuarial present value of the projected benefit obligation were 7.25% in 1997, 7.75% in 1996 and 8.0% in 1995. The assumed rate of increase in future compensation levels used to measure this obligation was 4.0% in 1997. The rate of annual compensation increase assumption in 1996 was 3.5% for 1997 and 4.0% thereafter. The rate of annual compensation increase assumption in 1995 was 3.5% for 1996 and 1997 and 4.0% thereafter. Expected long-term rates of return on plan assets were assumed to be 10% in 1997 and 11% in 1996 and 1995. At December 31, 1997 and 1996, the Company's net pension liability included in Pensions and Other Postretirement Benefits on the Consolidated Balance Sheets was $18.1 million and $61.9 million, respectively. Centerior had sponsored jointly with its former subsidiaries a postretirement benefit plan which provided all employee groups certain health care, death and other postretirement benefits other than pensions. The plan was contributory, with retiree contributions adjusted annually. The plan was not funded. The accumulated postretirement benefit obligation and accrued postretirement benefit cost for the Centerior postretirement benefit plan are as follows: At December 31, 1997 1996 - ----------------------------------------------------------------- (In millions) Accumulated postretirement benefit | obligation allocation: | Retirees $209.8 | $ 177.1 Fully eligible active plan | participants 9.8 | 3.9 Other active plan participants 46.9 | 30.9 - ------------------------------------------------------|--------- Accumulated postretirement benefit | obligation 266.5 | 211.9 Unrecognized transition obligation - | (120.1) Unrecognized net gain - | 44.4 - ------------------------------------------------------|--------- Net postretirement benefit liability $266.5 | $ 136.2 ================================================================ Net periodic postretirement benefit costs for the three years ended December 31, 1997 were computed as follows:
Nov. 8 - Jan. 1 - Dec. 31, 1997 Nov. 7, 1997 1996 1995 - ----------------------------------------------------------------------------------------------------- | (In millions) | Service cost-benefits attributed | to the period $0.5 | $ 1.8 $ 2.1 $ 1.7 Interest cost on accumulated | benefit obligation 2.8 | 13.5 17.8 17.9 Amortization of transition obligation - | 6.4 7.5 7.5 Amortization of gain - | (0.9) - (0.6) - ---------------------------------------------------------|-------------------------------------------- Net periodic postretirement benefit cost $3.3 | $20.8 $27.4 $26.5 =========================================================|=========================================== Company's share, including pro rata | share of the Service Company's costs $1.5 | $ 8.9 $ 9.0 $ 9.6 - -----------------------------------------------------------------------------------------------------
The Consolidated Balance Sheet classification of Pensions and Other Postretirement Benefits at December 31, 1997 and 1996 includes the Company's share of the accrued postretirement benefit liability of $95.2 million and $40.3 million, respectively. The health care trend rate assumption is approximately 6.0% in the first year gradually decreasing to approximately 4.0% for the year 2008 and later. The discount rates used to compute the accumulated postretirement benefit obligation were 7.25% in 1997, 7.75% in 1996 and 8.0% in 1995. An increase in the health care trend rate assumption by one percentage point in all years would increase the accumulated postretirement benefit obligation by approximately $7.7 million and the aggregate annual service and interest costs by approximately $0.5 million. A September 30 measurement date was used for 1996 reporting. TRANSACTIONS WITH AFFILIATED COMPANIES- Operating revenues, operating expenses and interest charges include amounts for transactions with affiliated companies in the ordinary course of business operations. The Company's transactions with CEI and the other FirstEnergy operating subsidiaries (OE and Penn) from the November 8, 1997 merger date are primarily for firm power, interchange power, transmission line rentals and jointly owned power plant operations and construction (see Note 3). Beginning in May 1996, Centerior Funding began serving as the transferor in connection with the accounts receivable securitization for the Company and CEI. The Service Company (formerly a wholly owned subsidiary of Centerior and now a wholly owned subsidiary of FirstEnergy) provides support services at cost to the Company and other affiliated companies. The Service Company billed the Company $13.9 million, $51.5 million, $59.8 million and $66.7 million in the November 8-December 31, 1997 period, the January 1- November 7, 1997 period, 1996 and 1995, respectively, for such services. 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. The Company reflects temporary cash investments at cost, which approximates their fair market value. Noncash financing and investing activities included capital lease transactions amounting to $2 million, $12 million, $32 million and $12 million in the November 8-December 31, 1997 period, the January 1-November 7, 1997 period, 1996 and 1995, respectively. All borrowings with initial maturities of less than one year are defined as financial instruments under generally accepted accounting principles 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: 1997 1996 ---------------- --------------- Carrying Fair Carrying Fair Value Value Value Value - ---------------------------------------------------------------- (In millions) Long-term debt $1,214 $1,218 | $1,054 $1,086 Preferred stock $ 3 $ 3 | $ 5 $ 5 Investments other | than cash and cash | equivalents: | Debt securities | - (Maturing in more | than 10 years) $ 295 $ 303 | $ - $ - Equity securities 3 3 | - - All other 86 85 | 52 52 - ----------------------------------------------|----------------- $ 384 $ 391 | $ 52 $ 52 ================================================================ The carrying value of long-term debt was adjusted to fair value in connection with the merger and reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Company's ratings. 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 trusts investments. Unrealized gains and losses applicable to the decommissioning trusts have been recognized in the trust investments with a corresponding change to the decommissioning liability. In 1996, the Company and CEI transferred most of their investment assets in existing trusts into Centerior pooled trust funds for the two companies. The amounts in the table represent the Company's pro rata share of the fair value of such noncash investments. The other debt and equity securities referred to above are in the held-to-maturity category. The Company has no securities held for trading purposes. REGULATORY ASSETS- The Company recognizes, as regulatory assets, costs which the FERC and PUCO have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets related to nonnuclear operations are being recovered from customers under the Company's regulatory plan. Based on the regulatory plan, at this time, the Company believes it will continue to be able to bill and collect cost-based rates (with the exception of the Company's nuclear operations as discussed below); accordingly, it is appropriate that the Company continue the application of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71), in the foreseeable future for its nonnuclear operations. The Company discontinued the application of SFAS 71 for its nuclear operations in October 1997 when implementation of the regulatory plan became probable. The regulatory plan does not provide for full recovery of the Company's nuclear operations. In accordance with SFAS No. 101, "Regulated Enterprises -- Accounting for the Discontinuation of Application of SFAS 71," the Company was required to remove from its balance sheet all regulatory assets and liabilities related to the portion of its business for which SFAS 71 was discontinued and to assess all other assets for impairment. Regulatory assets attributable to nuclear operations of $295.2 million ($191.9 million after taxes) were written off as an extraordinary item in October 1997. The regulatory assets attributable to nuclear operations written off represent the net amounts due from customers for future federal income taxes when the taxes become payable, which, under the regulatory plan, are no longer recoverable from customers. The remainder of the Company's business continues to comply with the provisions of SFAS 71. All remaining regulatory assets of the Company will continue to be recovered through rates set for the nonnuclear portion of its business. For financial reporting purposes, the net book value of the nuclear generating units was not impaired as a result of the regulatory plan. Net regulatory assets on the Consolidated Balance Sheets are comprised of the following: At December 31, 1997 1996 - ---------------------------------------------------------------- (In millions) Nuclear unit expenses $207.4 | $214.8 Customer receivables for future income | taxes 96.5 | 391.4 Rate stabilization program deferrals 172.0 | 179.8 Sale and leaseback costs * (76.9) | 91.7 Loss on reacquired debt 21.1 | 24.2 Other 22.6 | 25.7 - -------------------------------------------------------|--------- Total $442.7 | $927.6 ================================================================ * Includes the gain from the Bruce Mansfield Plant sale which was reclassified as a regulatory liability in connection with the purchase accounting adjustments, consistent with the ratemaking treatment. 2. OHIO EDISON-CENTERIOR MERGER: FirstEnergy was formed on November 8, 1997 by the merger of OE and Centerior. FirstEnergy holds directly all of the issued and outstanding common shares of OE and all of the issued and outstanding common shares of Centerior's former direct subsidiaries, which include, among others, the Company and CEI. As a result of the merger, the former common shareholders of OE and Centerior now own all of the outstanding shares of FirstEnergy Common Stock. All other classes of capital stock of OE and its subsidiaries and of the subsidiaries of Centerior are unaffected by the Merger and remain outstanding. The merger was accounted for as a purchase of Centerior's net assets with 77,637,704 shares of FirstEnergy Common Stock through the conversion of each outstanding Centerior Common Stock share into 0.525 of a share of FirstEnergy Common Stock (fractional shares were paid in cash). Based on an imputed value of $20.125 per share, the purchase price was approximately $1.582 billion which also included approximately $20 million of merger related costs. Goodwill of approximately $2.1 billion was recognized by FirstEnergy (to be amortized on a straight-line basis over forty years), which represented the excess of the purchase price over Centerior's net assets after fair value adjustments. Such amount may be adjusted if additional information produces changed assumptions over the twelve months following the merger as FirstEnergy continues to integrate operations and evaluate options with respect to its generation portfolio. The Company's merger purchase accounting adjustments, which were recognized in its accounting records, primarily consist of (1) revaluation of the Company's nuclear generating units to fair value ($561 million), based upon the results of independent appraisals and estimated discounted future cash flows expected to be generated by its nuclear generating units (the estimated cash flows are based upon management's current view of the likely cost recovery associated with the nuclear units); (2) adjusting by $55 million its long-term debt to estimated fair value; (3) adjusting its obligations related to retirement benefits (pension liability - $53 million and postretirement obligation - $51 million); (4) recognizing the Company's estimated severance and other compensation liabilities ($24 million); (5) adjustment of the Beaver Valley Unit 2 deferred rent liability by $57 million to reflect remaining payments on a straight-line basis; and (6) adjusting the Company's common equity by $108 million. The nuclear assets revaluation does not include decommissioning since that obligation is expected to be recovered with the cash flows provided by the regulated portion of the business. Other assets and liabilities were not adjusted since they remain subject to rate regulation on a historical cost basis. See Note 8. 3. LEASES: The Company leases certain generating facilities, nuclear fuel, certain transmission facilities, office space and other property and equipment under cancelable and noncancelable leases. The Company and CEI sold their ownership interests in Bruce Mansfield Units 1, 2 and 3 and the Company sold a portion of its ownership interest in Beaver Valley Unit 2. In connection with these sales, which were completed in 1987, the Company and CEI entered into operating leases for lease terms of approximately 30 years as co-lessees. During the terms of the leases, the Company and CEI continue to be responsible, to the extent of their combined ownership and leasehold interest, for costs associated with the units including construction expenditures, operation and maintenance expenses, insurance, nuclear fuel, property taxes and decommissioning. The Company and CEI have the right, at the end of the respective basic lease terms, to renew the leases. The Company and CEI also have the right to purchase the facilities at the expiration of the basic lease term or renewal term (if elected) at a price equal to the fair market value of the facilities. As co-lessee with CEI, the Company is also obligated for CEI's lease payments. If CEI is unable to make its payments under the Bruce Mansfield Plant lease, the Company would be obligated to make such payments. No such payments have been made on behalf of CEI. (CEI's minimum lease payments as of December 31, 1997 were $793 million.) The Company is selling 150 megawatts of its Beaver Valley Unit 2 leased capacity entitlement to CEI. Operating revenues for this transaction were $16.8 million, $87.4 million, $99.4 million and $97.6 million in the November 8-December 31, 1997 period, the January 1-November 7, 1997 period, 1996 and 1995, respectively. This sale is expected to continue through the end of the lease period. The future minimum lease payments through 2017 associated with Beaver Valley Unit 2 are approximately $1.2 billion. Nuclear fuel is currently financed for the Company and CEI through leases with a special-purpose corporation. As of December 31, 1997, $157 million of nuclear fuel ($64 million for the Company) was financed under a lease financing arrangement totaling $190 million ($90 million of intermediate-term notes and $100 million from bank credit arrangements). The notes mature from 1998 through 2000 and the bank credit arrangements expire in October 1998. Lease rates are based on intermediate-term note rates, bank rates and commercial paper rates. Consistent with the regulatory treatment, the rentals for capital and operating leases are charged to operating expenses on the Consolidated Statements of Income. Such costs for the three years ended December 31, 1997 are summarized as follows: Nov. 8 - Jan. 1 - Dec. 31, 1997 | Nov. 7, 1997 1996 1995 - ---------------------------------|------------------------------ | (In millions) Operating leases | Interest element $28.0 | $ 57.4 $ 82.5 $ 85.0 Other 13.5 | 23.1 42.6 17.8 Capital leases | Interest element 1.0 | 6.0 7.5 8.2 Other 5.3 | 30.4 38.6 43.6 - ---------------------------------|----------------------------- Total rentals $47.8 | $116.9 $171.2 $154.6 ============================================================== The future minimum lease payments as of December 31, 1997 are: Capital Operating Capital Trust Leases Leases Income Net - -------------------------------------------------------------- (In millions) 1998 $32.1 $ 103.9 $ 22.5 $ 81.4 1999 22.5 106.5 21.8 84.7 2000 12.8 104.8 20.6 84.2 2001 6.1 108.0 19.4 88.6 2002 3.0 111.1 18.0 93.1 Years thereafter 2.7 1,430.1 130.3 1,299.8 - -------------------------------------------------------------- Total minimum lease payments 79.2 $1,964.4 $232.6 $1,731.8 ======== ====== ======== Interest portion 14.4 - ------------------------------ Present value of net minimum lease payments 64.8 Less current portion 29.4 - ------------------------------ Noncurrent portion $35.4 ============================== The Company and CEI refinanced high-cost fixed obligations related to their 1987 sale and leaseback transaction for the Bruce Mansfield Plant through a lower cost transaction in June and July 1997. In a June 1997 offering (Offering), the two companies pledged $720 million aggregate principal amount ($145 million for the Company and $575 million for CEI) of first mortgage bonds due in 2000, 2004 and 2007 to a trust as security for the issuance of a like principal amount of secured notes due in 2000, 2004 and 2007. The obligations of the two companies under these secured notes are joint and several. Using available cash, short-term borrowings and the net proceeds from the Offering, the two companies invested $906.5 million ($337.1 million for the Company and $569.4 million for CEI) in a business trust, in June 1997. The trust used these funds in July 1997 to purchase lease notes and redeem all $873.2 million aggregate principal amount of 10-1/4% and 11-1/8% secured lease obligation bonds (SLOBs) due 2003 and 2016. The SLOBs were issued by a special-purpose funding corporation in 1988 on behalf of lessors in the two companies' 1987 sale and leaseback transaction. As noted in the table above, the trust income, which is included in Other Income in the Consolidated Statements of Income, effectively reduces lease costs related to that transaction. 4. CAPITALIZATION: (A) RETAINED EARNINGS- The Company has a provision in its mortgage applicable to approximately $62 million of outstanding first mortgage bonds that requires common stock dividends to be paid out of its total balance of retained earnings. The merger purchase accounting adjustments included resetting the retained earnings balance to zero at the November 8, 1997 merger date. (B) PREFERRED AND PREFERENCE STOCK- Preferred stock may be redeemed by the Company in whole, or in part, with 30-90 days' notice. The preferred dividend rates on the Company's Series A and Series B fluctuate based on prevailing interest rates and market conditions. The dividend rates for these issues averaged 7.03% and 7.71%, respectively, in 1997. Preference stock authorized for the Company is 5,000,000 shares with a $25 par value. No preference shares are currently outstanding. A liability of $5 million was included in the Company's net assets as of the merger date for preferred dividends declared attributable to the post-merger period. Accordingly, no accrual for preferred stock dividend requirements is included on the Company's November 8, 1997 to December 31, 1997 Consolidated Statement of Income. (C) PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION- Annual sinking fund requirements for the next five years are $1.7 million in each year 1998 and 1999. (D) LONG-TERM DEBT- The first mortgage indenture and its supplements, which secure all of the Company's first mortgage bonds, serve as direct first mortgage liens on substantially all property and franchises, other than specifically excepted property, owned by the Company. Sinking fund requirements for first mortgage bonds and maturing long-term debt (excluding capital leases) for the next five years are: (In millions) - -------------------------------------------------------- 1998 $ 39.0 1999 103.8 2000 75.9 2001 29.5 2002 191.0 - --------------------------------------------------------- The Company's obligations to repay certain pollution control revenue bonds are secured by several series of first mortgage bonds. One pollution control revenue bond issue is entitled to the benefit of an irrevocable bank letter of credit of $31.3 million. To the extent that drawings are made under this letter of credit to pay principal of, or interest on, the pollution control revenue bonds, the Company is entitled to a credit against its obligation to repay those bonds. The Company pays an annual fee of 1.875% of the amount of the letter of credit to the issuing bank and is obligated to reimburse the bank for any drawings thereunder. The Company and CEI have letters of credit of approximately $225 million in connection with the sale and leaseback of Beaver Valley Unit 2 that expire in June 1999. The letters of credit are secured by first mortgage bonds of the Company and CEI in the proportion of 60% and 40%, respectively (see Note 3). 5. SHORT-TERM BORROWINGS: FirstEnergy has a $125 million revolving credit facility that expires in May 1998. FirstEnergy and the Service Company may borrow under the facility, with all borrowings jointly and severally guaranteed by the Company and CEI. FirstEnergy plans to transfer any of its borrowed funds to the Company and CEI. The credit agreement is secured with first mortgage bonds of the Company and CEI in the proportion of 60% and 40%, respectively. The credit agreement also provides the participating banks with a subordinate mortgage security interest in the properties of the Company and CEI. The banks' fee is 0.625% per annum payable quarterly in addition to interest on any borrowings. There were no borrowings under the facility at December 31, 1997. Also, the Company may borrow from its affiliates on a short-term basis. 6. COMMITMENTS, GUARANTEES AND CONTINGENCIES: CAPITAL EXPENDITURES- The Company's current forecast reflects expenditures of approximately $200 million for property additions and improvements from 1998-2002, of which approximately $50 million is applicable to 1998. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $140 million, of which approximately $27 million applies to 1998. During the same periods, the Company's nuclear fuel investments are expected to be reduced by approximately $85 million and $30 million, respectively, as the nuclear fuel is consumed. NUCLEAR INSURANCE- The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $8.92 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its present ownership and leasehold interests in Beaver Valley Unit 2, the Davis-Besse Nuclear Power Station (Davis-Besse) and the Perry Nuclear Power Plant (Perry), the Company's maximum potential assessment under the industry retrospective rating plan (assuming the other CAPCO companies were to contribute their proportionate share of any assessments under the retrospective rating plan) would be $70 million per incident but not more than $8.8 million in any one year for each incident. The Company is also insured as to its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Company has also obtained approximately $260 million of insurance coverage for replacement power costs for its respective interests in Beaver Valley Unit 2, Davis-Besse and Perry. Under these policies, the Company can be assessed a maximum of approximately $11 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above as long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Company's plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. GUARANTEE- The Company, together with the other CAPCO companies, has severally guaranteed certain debt and lease obligations in connection with a coal supply contract for the Bruce Mansfield Plant. As of December 31, 1997, the Company's share of the guarantee (which approximates fair market value) was $8.3 million. The price under the coal supply contract, which includes certain minimum payments, has been determined to be sufficient to satisfy the debt and lease obligations. The Company's total payments under the coal supply contract were $29.9 million, $31.4 million and $24.5 million during 1997, 1996 and 1995, respectively. The Company's minimum annual payments are approximately $9 million under the contract, which expires December 31, 1999. ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Company with regard to air and water quality and other environmental matters. The Company has estimated additional capital expenditures for environmental compliance of approximately $11 million, which is included in the construction forecast provided under "Capital Expenditures" for 1998 through 2002. The Company is in compliance with the current sulfur dioxide (SO2) and nitrogen oxides (NOX) reduction requirements under the Clean Air Act Amendments of 1990. SO2 reductions through the year 1999 will be achieved by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or purchasing emission allowances. Plans for complying with reductions required for the year 2000 and thereafter have not been finalized. The Environmental Protection Agency (EPA) is conducting additional studies which could indicate the need for additional NOX reductions from the Bruce Mansfield Plant by the year 2003. In addition, the EPA is also considering the need for additional NOX reductions from the Company's Ohio facilities. On November 7, 1997, the EPA proposed uniform reductions of NOX emissions across a region of twenty-two states, including Ohio and the District of Columbia (NOX Transport Rule) after determining that such NOX emissions are contributing significantly to ozone pollution in the eastern United States. In a separate but related action, eight states filed petitions with the EPA under Section 126 of the Clean Air Act seeking reductions of NOX emissions which are alleged to contribute to ozone pollution in the eight petitioning states. A December 1997 EPA Memorandum of Agreement proposes to finalize the NOX Transport Rule by September 30, 1998 and establishes a schedule for EPA action on the Section 126 petitions. The cost of NOX reductions, if required, may be substantial. The Company continues to evaluate its compliance plans and other compliance options. The Company is required to meet federally approved SO2 regulations. Violations of such regulations can result in shutdown of the generating unit involved and/or civil or criminal penalties of up to $25,000 for each day the unit is in violation. The EPA has an interim enforcement policy for SO2 regulations in Ohio that allows for compliance based on a 30-day averaging period. The Company cannot predict what action the EPA may take in the future with respect to proposed regulations or the interim enforcement policy. The Company is aware of its potential involvement in the cleanup of several hazardous waste disposal sites. The Company has accrued a liability totaling $1.1 million at December 31, 1997 based on estimates of the costs of cleanup and its proportionate responsibility for such costs. The Company believes that the ultimate outcome of these matters will not have a material adverse effect on its financial condition, cash flows or results of operations. Legislative, administrative and judicial actions will continue to change the way that the Company must operate in order to comply with environmental laws and regulations. With respect to any such changes and to the environmental matters described above, the Company expects that any resulting additional capital costs which may be required, as well as any required increase in operating costs, would ultimately be recovered from its customers. 7. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain consolidated operating results by quarter for 1997 and 1996.
Three Months Ended ---------------------------- Mar. 31, June 30, Sept. 30, Oct. 1 - Nov. 8 - 1997 1997 1997 Nov. 7, 1997 | Dec. 31, 1997 - ---------------------------------------------------------------------------|--------------- (In millions) | | Operating Revenues $217.1 $222.1 $241.3 $ 92.2 | $122.7 Operating Expenses | and Taxes 184.7 186.1 191.9 86.7 | 103.6 - ---------------------------------------------------------------------------|------------ Operating Income 32.4 36.0 49.4 5.5 | 19.1 Other Income (Loss) (.4) .4 5.0 (2.9) | 2.1 Net Interest Charges 23.2 23.3 27.2 10.0 | 13.6 - ---------------------------------------------------------------------------|----------- Income (Loss) Before | Extraordinary Item 8.8 13.1 27.2 (7.4) | 7.6 Extraordinary Item | (Net of Income Taxes) | (Note 1) - - - (191.9) | - - ---------------------------------------------------------------------------|----------- Net Income (Loss) $ 8.8 $ 13.1 $ 27.2 $(199.3) | $ 7.6 - ---------------------------------------------------------------------------|----------- Earnings (Loss) on Common | Stock $ 4.6 $ 8.9 $ 23.0 $(206.2) | $ 7.6 - --------------------------------------------------------------------------------------

March 31, June 30, September 30, December 31, 1996 1996 1996 1996 - ------------------------------------------------------------------------------------------ (In millions) Operating Revenues $210.8 $210.9 $252.2 $223.3 Operating Expenses and Taxes 177.9 180.3 200.5 181.7 - ------------------------------------------------------------------------------ Operating Income 32.9 30.6 51.7 41.6 Other Income (Loss) (5.5) .7 .3 - Net Interest Charges 24.1 23.7 24.0 23.2 - ------------------------------------------------------------------------------ Net Income $ 3.3 $ 7.6 $ 28.0 $ 18.4 - ------------------------------------------------------------------------------ Earnings (Loss) on Common Stock $ (.9) $ 3.4 $ 23.7 $ 14.2 - ------------------------------------------------------------------------------
8. PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME (UNAUDITED): The following pro forma statements of income for the Company give effect to the OE-Centerior merger as if it had been consummated on January 1, 1996, with the purchase accounting adjustments actually recognized in the business combination. Year Ended December 31, ----------------------- 1997 1996 - -------------------------------------------------------- (In millions) Operating Revenues $895 $897 Operating Expenses and Taxes 742 728 ---- ---- Operating Income 153 169 Other Income (Loss) 10 (3) Net Interest Charges 91 89 ---- ---- Net Income $ 72 $ 77 =================================================== Pro forma adjustments reflected above include: (1) adjusting the Company's nuclear generating units to fair value based upon independent appraisals and estimated discounted future cash flows based on management's current view of cost recovery; (2) the effect of discontinuing SFAS 71 for the Company's nuclear operations; (3) amortization of the fair value adjustment for long-term debt; (4) goodwill recognized representing the excess of the Company's portion of the purchase price over the Company's adjusted net assets; (4) the elimination of merger costs; and (5) adjustments for estimated tax effects of the above adjustments. See Note 2. 9. PENDING MERGER OF THE COMPANY INTO CEI: In March 1994, Centerior announced a plan to merge the Company into CEI. All necessary regulatory approvals have been obtained, except the approval of the Nuclear Regulatory Commission (NRC). This application was withdrawn at the NRC's request pending the decision whether to complete this merger. No final decision regarding the proposed merger has been reached. In June 1995, the Company's preferred stockholders approved the merger and CEI's preferred stockholders approved the authorization of additional shares of preferred stock. If and when the merger becomes effective, the Company's preferred stockholders will exchange their shares for preferred stock shares of CEI having substantially the same terms. Debt holders of the merging companies will become debt holders of CEI. For the merging companies, the combined pro forma operating revenues were $2.527 billion, $2.554 billion and $2.516 billion and the combined pro forma net income was $220 million (excluding the extraordinary item discussed in Note 1 and a similar item for CEI), $218 million and $281 million for the years 1997, 1996 and 1995, respectively. The pro forma data is based on accounting for the merger of the Company and CEI on a method similar to a pooling of interests and for 1997 and 1996 includes pro forma adjustments to reflect the effect of the OE and Centerior merger (see Note 8). The pro forma data is not necessarily indicative of the results of operations which would have been reported had the merger been in effect during those years or which may be reported in the future. The pro forma data should be read in conjunction with the audited financial statements of both the Company and CEI. Report of Independent Public Accountants To the Stockholders and Board of Directors of The Toledo Edison Company: We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of The Toledo Edison Company (an Ohio corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiary as of December 31, 1997 (post-merger) and 1996 (pre-merger), and the related consolidated statements of income, retained earnings, capital stock and other paid-in capital, cash flows and taxes for the years ended December 31, 1996 and 1995 and the period from January 1, 1997 to November 7, 1997 (pre-merger), and the period from November 8, 1997 to December 31, 1997 (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 audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Toledo Edison Company and subsidiary as of December 31, 1997 (post-merger) and 1996 (pre- merger), and the results of their operations and their cash flows for the years ended December 31, 1996 and 1995 and the period from January 1, 1997 to November 7, 1997 (pre-merger), and the period from November 8, 1997 to December 31, 1997 (post-merger), in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Cleveland, Ohio February 13, 1998 EX-21.3 16 EXHIBIT 21.3 THE TOLEDO EDISON COMPANY LIST OF SUBSIDIARIES OF THE REGISTRANT AT DECEMBER 31, 1997 The Toledo Edison Capital Corporation Statement of Differences ------------------------ Exhibit Number 21, List of Subsidiaries of the Registrant at December 31, 1997, is not included in the printed document. EX-27.3 17
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE RELATED FORM 10-K FINANCIAL STATEMENTS FOR THE TOLEDO EDISON COMPANY AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000352049 THE TOLEDO EDISON COMPANY 1,000 US DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 PER-BOOK 1,170,806 401,993 167,702 1,017,651 0 2,758,152 195,670 328,364 7,616 531,650 1,690 210,000 1,210,190 0 0 0 38,950 1,665 0 29,364 734,643 2,758,152 895,376 35,702 717,337 753,039 142,337 4,306 146,643 97,258 (142,516) 19,435 (161,951) 0 78,406 213,612 0 0

EX-4 18 FORTY-FIFTH SUPPLEMENTAL INDENTURE, dated as of June 1, 1997, made and entered into by and between PENNSYLVANIA POWER COMPANY, a corporation organized and existing under the laws of the Commonwealth of Pennsylvania, with its principal place of business in New Castle, Lawrence County, Pennsylvania (hereinafter sometimes referred to as the "Company") and CITIBANK, N.A., a national banking association incorporated and existing under the laws of the United States of America, with its principal office in the Borough of Manhattan, The City, County and State of New York (hereinafter sometimes referred to as the "Trustee"), as trustee under the Indenture dated as of November 1, 1945 between the Company and CITIBANK, N.A. (successor to The First National Bank of The City of New York), as trustee, as supplemented and amended by Supplemental Indentures between the Company and the Trustee, dated as of May 1, 1948, as of March 1, 1950, as of February 1, 1952, as of October 1, 1957, as of September 1, 1962, as of June 1, 1963, as of June 1, 1969, as of May 1, 1970, as of April 1, 1971, as of October 1, 1971, as of May 1, 1972, as of December 1, 1974, as of October 1, 1975, as of September 1, 1976, as of April 15, 1978, as of June 28, 1979, as of January 1, 1980, as of June 1, 1981, as of January 14, 1982, as of August 1, 1982, as of December 15, 1982, as of December 1, 1983, as of September 6, 1984, as of December 1, 1984, as of May 30, 1985, as of October 29, 1985, as of August 1, 1987, as of May 1, 1988, as of November 1, 1989, as of December 1, 1990, as of September 1, 1991, as of May 1, 1992, as of July 15, 1992, as of August 1, 1992, as of May 1, 1993, as of July 1, 1993, as of August 31, 1993, as of September 1, 1993, as of September 15, 1993, as of October 1, 1993, as of November 1, 1993, as of August 1, 1994, and as of September 1, 1995 (said Indenture as so supplemented and amended, and as hereby supplemented and amended, being hereinafter sometimes referred to as the "Indenture"); WHEREAS, the Company and the Trustee have executed and delivered the Indenture for the purpose of securing an issue of bonds of the First Series described therein and such additional bonds as may from time to time be issued under and in accordance with the terms of the Indenture, the aggregate principal amount of bonds to be secured thereby being not limited, and the Indenture fully describes and sets forth the property conveyed thereby and is filed with the Secretary of the Commonwealth of Pennsylvania and the Secretary of State of the State of Ohio and will be of record in the office of the recorder of deeds of each county in the Commonwealth of Pennsylvania and the State of Ohio in which this Forty-fifth Supplemental Indenture is to be recorded and is on file at the corporate trust office of the Trustee, above referred to; and WHEREAS the Indenture provides for the issuance of bonds thereunder in one or more series and the Company, by appropriate corporate action in conformity with the terms of the Indenture, has duly determined to create two such series of bonds under the Indenture to be designated as "First Mortgage Bonds, Guarantee Series A of 1997 due 2027" (hereinafter sometimes referred to as the "bonds of the Guarantee Series A") and "First Mortgage Bonds, Guarantee Series B of 1997 due 2027" (hereinafter sometimes referred to as the "bonds of the Guarantee Series B") (bonds of the Guarantee Series A and B collectively hereinafter sometimes referred to as "bonds of the Guarantee Series"), the bonds of which are to bear interest at the same rates as those of the State of Ohio Pollution Control Revenue Refunding Bonds, Series 1997 (Pennsylvania Power Company Project) referred to herein, and are to mature on June 1, 2027; AND WHEREAS each of the bonds of the Guarantee Series and the Trustee's Authentication Certificate thereon are to be substantially in the following form, to wit: [FORM OF BOND OF THE GUARANTEE SERIES A] [FACE] This Bond is not transferable except (i) to a successor trustee under the Trust Indenture, dated as of June 1, 1997, between the Ohio Water Development Authority and PNC Bank, National Association, as Trustee, (ii) to a Credit Facility Issuer (the "Credit Facility Issuer") as provided in the Pledge Agreement, dated as of June 1, 1997, between the Pennsylvania Power Company and said Trustee, or (iii) in connection with the exercise of the rights and remedies of the holder hereof consequent upon a "default" as defined in the Indenture referred to herein. PENNSYLVANIA POWER COMPANY First Mortgage Bond, Guarantee Series A of 1997 due 2027 $5,800,000 No. R-1 Pennsylvania Power Company, a Pennsylvania corporation (hereinafter called the "Company"), for value received, hereby promises to pay to , or registered assigns, the principal sum of $5,800,000 on June 1, 2027, and to pay the registered holder hereof interest on said sum from the Initial Interest Accrual Date (hereinbelow defined) at the same rates as those of the $5,800,000 State of Ohio Pollution Control Revenue Refunding Bonds, Series 1997 (Pennsylvania Power Company Project). The principal of and interest on this bond shall be payable at the office or agency of the Company in the Borough of Manhattan, The City, County and State of New York, designated for that purpose, in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not be valid or become obligatory for any purpose unless and until it shall have been authenticated by the execution by the Trustee or its successor in trust under the Indenture of the certificate hereon. IN WITNESS WHEREOF, PENNSYLVANIA POWER COMPANY has caused this bond to be executed in its name by its President or one of its Vice Presidents by his or her signature or a facsimile thereof, and its corporate seal or a facsimile thereof to be affixed hereto or imprinted hereon and attested by its Secretary or one of its Assistant Secretaries by his or her signature or a facsimile thereof. Dated: PENNSYLVANIA POWER COMPANY By ---------------------- Vice President Attest: - --------------------------- Assistant Secretary [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds, of the series designated therein, described in the within-mentioned Indenture. CITIBANK, N.A. AS TRUSTEE, By ----------------------- Authorized Officer [FORM OF BOND OF THE GUARANTEE SERIES A] [REVERSE] PENNSYLVANIA POWER COMPANY First Mortgage Bond, Guarantee Series A of 1997 due 2027 This bond is one of the bonds issued and to be issued from time to time under and in accordance with and all secured by an indenture of mortgage or deed of trust dated as of November 1, 1945, and indentures supplemental thereto, given by the Company to Citibank, N.A. (successor to The First National Bank of The City of New York), as trustee (hereinafter referred to as the "Trustee"), to which indenture and indentures supplemental thereto (hereinafter referred to collectively as the "Indenture") reference is hereby made for a description of the property mortgaged and pledged, the nature and extent of the security and the rights, duties and immunities thereunder of the Trustee and the rights of the holders of the bonds and coupons and of the Trustee and of the Company in respect of such security, and the limitations on such rights. By the terms of the Indenture, the bonds to be secured thereby are issuable in series which may vary as to date, amount, date of maturity, rate of interest, terms of redemption and in other respects as in the Indenture provided. The Indenture contains provisions permitting the Company and the Trustee, with the consent of the holders of not less than seventy-five per centum in principal amount of the bonds (exclusive of bonds disqualified by reason of the Company's interest therein) at the time outstanding, including, if more than one series of bonds shall be at the time outstanding, not less than sixty per centum in principal amount of each series affected, to effect, by an indenture supplemental to the Indenture, modifications or alterations of the Indenture and of the rights and obligations of the Company and the rights of the holders of the bonds and coupons; provided, however, that no such modification or alteration shall be made without the written approval or consent of the holder hereof which will (a) extend the maturity of this bond or reduce the rate or extend the time of payment of interest hereon or reduce the amount of the principal hereof or reduce any premium payable on the redemption hereof, or (b) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Indenture, or (c) reduce the percentage of the principal amount of the bonds upon the approval or consent of the holders of which modifications or alterations may be made as aforesaid. The bonds of this series shall be redeemed in whole, by payment of the principal amount thereof plus accrued interest thereon, if any, to the date fixed for redemption, upon receipt by the Trustee of a written advice from the trustee under the Trust Indenture (the "Revenue Bond Indenture") dated as of June 1, 1997, between the Ohio Water Development Authority and PNC Bank, National Association, as trustee (such trustee and any successor trustee being hereinafter referred to as the "Revenue Bond Trustee"), securing $5,800,000 of State of Ohio Pollution Control Revenue Refunding Bonds, Series 1997 (Pennsylvania Power Company Project), or the Credit Facility Issuer, if any, as assignee, stating that the principal amount of all the pollution control revenue refunding bonds then outstanding under the Revenue Bond Indenture has been declared due and payable pursuant to the provisions of Section 11.02 of the Revenue Bond Indenture, specifying the date of the accelerated maturity of such pollution control revenue refunding bonds and the date from which interest on the pollution control revenue refunding bonds issued under the Revenue Bond Indenture has then accrued, stating such declaration of maturity has not been annulled and demanding payment of the principal amount hereof plus accrued interest hereon to the date fixed for such redemption. As provided in the Supplemental Indenture establishing the terms and provisions of the bonds of this series, the date fixed for such redemption shall be not earlier than the date specified in the aforesaid written advice as the date of the accelerated maturity of the pollution control revenue refunding bonds then outstanding under the Revenue Bond Indenture and not later than the 45th day after the receipt by the Trustee of such advice, unless such 45th day is earlier than such date of accelerated maturity. The date fixed for such redemption shall be specified in a notice of redemption to be given not less than 30 days prior to the date so fixed for such redemption. Upon mailing of such notice of redemption, the date from which unpaid interest on the aforesaid pollution control revenue refunding bonds has then accrued (as specified by the Revenue Bond Trustee) shall become the initial interest accrual date (the "Initial Interest Accrual Date") with respect to the bonds of this series, and the date which is six months after the Initial Interest Accrual Date shall be the first interest payment date for the bonds of this series, provided, however, on any demand for payment of the principal amount hereof at maturity as a result of the principal of the aforesaid pollution control revenue refunding bonds becoming due and payable on the maturity date of the bonds of this series, the date from which unpaid interest on the aforesaid pollution control revenue refunding bonds has then accrued shall become the Initial Interest Accrual Date with respect to the bonds of this series, such date to be as stated in a written notice from the Revenue Bond Trustee to the Trustee. As provided in said Supplemental Indenture, the aforementioned notice of redemption shall become null and void for all purposes under the Indenture (including the fixing of the Initial Interest Accrual Date with respect to the bonds of this series) upon receipt by the Trustee of written notice from the Revenue Bond Trustee of the annulment of the acceleration of the maturity of the pollution control revenue refunding bonds then outstanding under the Revenue Bond Indenture and of the rescission of the aforesaid written advice prior to the redemption date specified in such notice of redemption, and thereupon no redemption of the bonds of this series and no payment in respect thereof as specified in such notice of redemption shall be effected or required. But no such rescission shall extend to any subsequent written advice from the Revenue Bond Trustee or impair any right consequent on such subsequent written notice. Bonds of this series are not otherwise redeemable prior to their maturity. In case of certain defaults as specified in the Indenture, the principal of this bond may be declared or may become due and payable on the conditions, at the time, in the manner and with the effect provided in the Indenture. No recourse shall be had for the payment of the principal of or interest on this bond, or for any claim based hereon, or otherwise in respect hereof or of the Indenture, to or against any incorporator, stockholder, director or officer, past, present or future, as such, of the Company, or of any predecessor or successor company, either directly or through the Company, or such predecessor or successor company, or otherwise, under any constitution or statute or rule of law, or by the enforcement of any assessment or penalty, or otherwise, all such liability of incorporators, stockholders, directors and officers, as such, being waived and released by the holder and owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000 and authorized multiples thereof. Except as may be stated in any legend written on the face of this bond, this bond is transferable by the registered holder hereof, in person or by attorney duly authorized, at the corporate trust office of the Trustee, in the Borough of Manhattan, The City, County and State of New York, or at such other place or places as the Company may designate by resolution of the Board of Directors, but only in the manner and upon the conditions prescribed in the Indenture, upon the surrender and cancellation of this bond and the payment of charges for transfer, and upon any such transfer a new registered bond or bonds, without coupons, of the same series and maturity date and for the same aggregate principal amount, in authorized denominations, will be issued to the transferee in exchange herefor. The Company, the Trustee and any agent designated to make transfers or exchanges of bonds of this series may deem and treat the person in whose name this bond is registered as the absolute owner for all purposes including the purpose of the receipt of payment. Registered bonds of this series shall be exchangeable at said corporate trust office of the Trustee, or at such other place or places as the Company may designate by resolution of the Board of Directors, for registered bonds of other authorized denominations having the same aggregate principal amount, in the manner and upon the conditions prescribed in the Indenture. Neither the Company nor the Trustee nor any other agent designated for such purpose shall be required to make transfers or exchanges of bonds of this series during the period between any interest payment date for such series and the record date next preceding such interest payment date. Notwithstanding any provisions of the Indenture, no charge shall be made upon any transfer or exchange of bonds of this series other than for any tax or taxes or other governmental charge required to be paid by the Company. [END OF FORM OF BOND OF THE GUARANTEE SERIES A] [FORM OF BOND OF THE GUARANTEE SERIES B] [FACE] This Bond is not transferable except (i) to a successor trustee under the Trust Indenture, dated as of June 1, 1997, between the Ohio Air Quality Development Authority and PNC Bank, National Association, as Trustee, (ii) to a Credit Facility Issuer (the "Credit Facility Issuer") as provided in the Pledge Agreement, dated as of June 1, 1997, between the Pennsylvania Power Company and said Trustee, or (iii) in connection with the exercise of the rights and remedies of the holder hereof consequent upon a "default" as defined in the Indenture referred to herein. PENNSYLVANIA POWER COMPANY First Mortgage Bond, Guarantee Series B of 1997 due 2027 $4,500,000 No. R-1 Pennsylvania Power Company, a Pennsylvania corporation (hereinafter called the "Company"), for value received, hereby promises to pay to , or registered assigns, the principal sum of $4,500,000 on June 1, 2027, and to pay the registered holder hereof interest on said sum from the Initial Interest Accrual Date (hereinbelow defined) at the same rates as those of the $4,500,000 State of Ohio Pollution Control Revenue Refunding Bonds, Series 1997 (Pennsylvania Power Company Project). The principal of and interest on this bond shall be payable at the office or agency of the Company in the Borough of Manhattan, The City, County and State of New York, designated for that purpose, in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts. The provisions of this bond are continued on the reverse hereof and such continued provisions shall for all purposes have the same effect as though fully set forth at this place. This bond shall not be valid or become obligatory for any purpose unless and until it shall have been authenticated by the execution by the Trustee or its successor in trust under the Indenture of the certificate hereon. IN WITNESS WHEREOF, PENNSYLVANIA POWER COMPANY has caused this bond to be executed in its name by its President or one of its Vice Presidents by his or her signature or a facsimile thereof, and its corporate seal or a facsimile thereof to be affixed hereto or imprinted hereon and attested by its Secretary or one of its Assistant Secretaries by his or her signature or a facsimile thereof. Dated: PENNSYLVANIA POWER COMPANY By --------------------- Vice President Attest: - ------------------------ Assistant Secretary [FORM OF TRUSTEE'S AUTHENTICATION CERTIFICATE] TRUSTEE'S AUTHENTICATION CERTIFICATE This bond is one of the bonds, of the series designated therein, described in the within-mentioned Indenture. CITIBANK, N.A. AS TRUSTEE, By -------------------------- Authorized Officer [FORM OF BOND OF THE GUARANTEE SERIES B] [REVERSE] PENNSYLVANIA POWER COMPANY First Mortgage Bond, Guarantee Series B of 1997 due 2027 This bond is one of the bonds issued and to be issued from time to time under and in accordance with and all secured by an indenture of mortgage or deed of trust dated as of November 1, 1945, and indentures supplemental thereto, given by the Company to Citibank, N.A. (successor to The First National Bank of The City of New York), as trustee (hereinafter referred to as the "Trustee"), to which indenture and indentures supplemental thereto (hereinafter referred to collectively as the "Indenture") reference is hereby made for a description of the property mortgaged and pledged, the nature and extent of the security and the rights, duties and immunities thereunder of the Trustee and the rights of the holders of the bonds and coupons and of the Trustee and of the Company in respect of such security, and the limitations on such rights. By the terms of the Indenture, the bonds to be secured thereby are issuable in series which may vary as to date, amount, date of maturity, rate of interest, terms of redemption and in other respects as in the Indenture provided. The Indenture contains provisions permitting the Company and the Trustee, with the consent of the holders of not less than seventy-five per centum in principal amount of the bonds (exclusive of bonds disqualified by reason of the Company's interest therein) at the time outstanding, including, if more than one series of bonds shall be at the time outstanding, not less than sixty per centum in principal amount of each series affected, to effect, by an indenture supplemental to the Indenture, modifications or alterations of the Indenture and of the rights and obligations of the Company and the rights of the holders of the bonds and coupons; provided, however, that no such modification or alteration shall be made without the written approval or consent of the holder hereof which will (a) extend the maturity of this bond or reduce the rate or extend the time of payment of interest hereon or reduce the amount of the principal hereof or reduce any premium payable on the redemption hereof, or (b) permit the creation of any lien, not otherwise permitted, prior to or on a parity with the lien of the Indenture, or (c) reduce the percentage of the principal amount of the bonds upon the approval or consent of the holders of which modifications or alterations may be made as aforesaid. The bonds of this series shall be redeemed in whole, by payment of the principal amount thereof plus accrued interest thereon, if any, to the date fixed for redemption, upon receipt by the Trustee of a written advice from the trustee under the Trust Indenture (the "Revenue Bond Indenture") dated as of June 1, 1997, between the Ohio Air Quality Development Authority and PNC Bank, National Association, as trustee (such trustee and any successor trustee being hereinafter referred to as the "Revenue Bond Trustee"), securing $4,500,000 of State of Ohio Pollution Control Revenue Refunding Bonds, Series 1997 (Pennsylvania Power Company Project), or the Credit Facility Issuer, if any, as assignee, stating that the principal amount of all the pollution control revenue refunding bonds then outstanding under the Revenue Bond Indenture has been declared due and payable pursuant to the provisions of Section 11.02 of the Revenue Bond Indenture, specifying the date of the accelerated maturity of such pollution control revenue refunding bonds and the date from which interest on the pollution control revenue refunding bonds issued under the Revenue Bond Indenture has then accrued, stating such declaration of maturity has not been annulled and demanding payment of the principal amount hereof plus accrued interest hereon to the date fixed for such redemption. As provided in the Supplemental Indenture establishing the terms and provisions of the bonds of this series, the date fixed for such redemption shall be not earlier than the date specified in the aforesaid written advice as the date of the accelerated maturity of the pollution control revenue refunding bonds then outstanding under the Revenue Bond Indenture and not later than the 45th day after the receipt by the Trustee of such advice, unless such 45th day is earlier than such date of accelerated maturity. The date fixed for such redemption shall be specified in a notice of redemption to be given not less than 30 days prior to the date so fixed for such redemption. Upon mailing of such notice of redemption, the date from which unpaid interest on the aforesaid pollution control revenue refunding bonds has then accrued (as specified by the Revenue Bond Trustee) shall become the initial interest accrual date (the "Initial Interest Accrual Date") with respect to the bonds of this series, and the date which is six months after the Initial Interest Accrual Date shall be the first interest payment date for the bonds of this series, provided, however, on any demand for payment of the principal amount hereof at maturity as a result of the principal of the aforesaid pollution control revenue refunding bonds becoming due and payable on the maturity date of the bonds of this series, the date from which unpaid interest on the aforesaid pollution control revenue refunding bonds has then accrued shall become the Initial Interest Accrual Date with respect to the bonds of this series, such date to be as stated in a written notice from the Revenue Bond Trustee to the Trustee. As provided in said Supplemental Indenture, the aforementioned notice of redemption shall become null and void for all purposes under the Indenture (including the fixing of the Initial Interest Accrual Date with respect to the bonds of this series) upon receipt by the Trustee of written notice from the Revenue Bond Trustee of the annulment of the acceleration of the maturity of the pollution control revenue refunding bonds then outstanding under the Revenue Bond Indenture and of the rescission of the aforesaid written advice prior to the redemption date specified in such notice of redemption, and thereupon no redemption of the bonds of this series and no payment in respect thereof as specified in such notice of redemption shall be effected or required. But no such rescission shall extend to any subsequent written advice from the Revenue Bond Trustee or impair any right consequent on such subsequent written notice. Bonds of this series are not otherwise redeemable prior to their maturity. In case of certain defaults as specified in the Indenture, the principal of this bond may be declared or may become due and payable on the conditions, at the time, in the manner and with the effect provided in the Indenture. No recourse shall be had for the payment of the principal of or interest on this bond, or for any claim based hereon, or otherwise in respect hereof or of the Indenture, to or against any incorporator, stockholder, director or officer, past, present or future, as such, of the Company, or of any predecessor or successor company, either directly or through the Company, or such predecessor or successor company, or otherwise, under any constitution or statute or rule of law, or by the enforcement of any assessment or penalty, or otherwise, all such liability of incorporators, stockholders, directors and officers, as such, being waived and released by the holder and owner hereof by the acceptance of this bond and being likewise waived and released by the terms of the Indenture. The bonds of this series are issuable only as registered bonds without coupons in denominations of $1,000 and authorized multiples thereof. Except as may be stated in any legend written on the face of this bond, this bond is transferable by the registered holder hereof, in person or by attorney duly authorized, at the corporate trust office of the Trustee, in the Borough of Manhattan, The City, County and State of New York, or at such other place or places as the Company may designate by resolution of the Board of Directors, but only in the manner and upon the conditions prescribed in the Indenture, upon the surrender and cancellation of this bond and the payment of charges for transfer, and upon any such transfer a new registered bond or bonds, without coupons, of the same series and maturity date and for the same aggregate principal amount, in authorized denominations, will be issued to the transferee in exchange herefor. The Company, the Trustee and any agent designated to make transfers or exchanges of bonds of this series may deem and treat the person in whose name this bond is registered as the absolute owner for all purposes including the purpose of the receipt of payment. Registered bonds of this series shall be exchangeable at said corporate trust office of the Trustee, or at such other place or places as the Company may designate by resolution of the Board of Directors, for registered bonds of other authorized denominations having the same aggregate principal amount, in the manner and upon the conditions prescribed in the Indenture. Neither the Company nor the Trustee nor any other agent designated for such purpose shall be required to make transfers or exchanges of bonds of this series during the period between any interest payment date for such series and the record date next preceding such interest payment date. Notwithstanding any provisions of the Indenture, no charge shall be made upon any transfer or exchange of bonds of this series other than for any tax or taxes or other governmental charge required to be paid by the Company. [END OF FORM OF BOND OF THE GUARANTEE SERIES B] AND WHEREAS all acts and things necessary to make the bonds of the Guarantee Series, when authenticated by the Trustee and issued as in the Indenture provided, the valid, binding and legal obligations of the Company, and to constitute the Indenture a valid, binding and legal instrument for the security thereof, have been done and performed, and the creation, execution and delivery of the Indenture and the creation, execution and issue of the bonds of the Guarantee Series subject to the terms hereof and of the Indenture, have in all respects been duly authorized; NOW THEREFORE, in consideration of the premises, and of the acceptance and purchase by holders thereof of the bonds issued and to be issued under the Indenture, and of the issuance of the Letter of Credit under the Letter of Credit and Reimbursement Agreement, dated as of June 1, 1997 (the "Reimbursement Agreement"), among Pennsylvania Power Company, The First National Bank of Chicago, as Credit Facility Issuer, and the various Banks named therein, and the sum of One Dollar duly paid by the Trustee to the Company, and of other good and valuable considerations, the receipt of which is hereby acknowledged, and for the purpose of securing the due and punctual payment of the principal of and premium, if any, and interest on all bonds now outstanding under the Indenture and the $5,800,000 principal amount of bonds of the Guarantee Series A and the $4,500,000 principal amount of bonds of the Guarantee Series B proposed presently to be issued and all other bonds which shall be issued under the Indenture, and for the purpose of securing the faithful performance and observance of all covenants and conditions therein and in any supplemental indenture set forth, and for the purpose of securing the obligations owed to the Credit Facility Issuer under the Reimbursement Agreement, the Company has given, granted, bargained, sold, released, transferred, assigned, hypothecated, pledged, mortgaged, confirmed, created a security interest in, set over, warranted, aliened and conveyed and by these presents does give, grant, bargain, sell, release, transfer, assign, hypothecate, pledge, mortgage, confirm, create a security interest in, set over, warrant, alien and convey unto Citibank, N.A., as Trustee as provided in the Indenture, and its successor or successors in the trust thereby and hereby created and to its or their assigns forever, all the right, title and interest of the Company in and to the property described in Schedule A (which is identified by the signature of an officer of each party hereto at the end thereof) hereto annexed and made a part hereof, together (subject to the provisions of Article X of the Indenture) with the tolls, rents, revenues, issues, earnings, income, products and profits thereof, and does hereby confirm that the Company will not cause or consent to a partition, whether voluntary or through legal proceedings, of property, whether herein described or heretofore or hereafter acquired, in which its ownership shall be as a tenant in common except as permitted by and in conformity with the provisions of the Indenture and particularly of said Article X thereof. TOGETHER WITH all and singular the tenements, hereditaments and appurtenances belonging or in any wise appertaining to the premises, property, franchises and rights, or any thereof, referred to in the Indenture (and not therein expressly excepted) with the reversion and reversions, remainder and remainders and (subject to the provisions of Article X of the Indenture) the tolls, rents, revenues, issues, earnings, income, products and profits thereof, and all the estate, right, title and interest and claim whatsoever, at law as well as in equity, which the Company now has or may hereafter acquire in and to such premises, property, franchises and rights and every part and parcel thereof described in the aforesaid Schedule A, subject to "excepted encumbrances" of the original Indenture. TO HAVE AND TO HOLD all said premises, property, franchises and rights hereby conveyed, assigned, pledged, or mortgaged, or intended so to be, unto the Trustee, its successor or successors in trust, and their assigns forever. BUT IN TRUST, NEVERTHELESS, with power of sale, for the equal and proportionate benefit and security of the holders of all bonds now or hereafter authenticated and delivered under the Indenture, and interest coupons appurtenant thereto, pursuant to the provisions thereof, and for the enforcement of the payment of said bonds and coupons when payable and the performance of and compliance with the covenants and conditions of the Indenture, without any preference, distinction or priority as to lien or otherwise of any bond or bonds over others by reason of the difference in time of the actual authentication, delivery, issue, sale or negotiation thereof or for any other reason whatsoever, except as otherwise expressly provided in the Indenture; and so that each and every bond now or hereafter authenticated and delivered thereunder shall have the same lien, and so that the principal of and premium, if any, and interest on every such bond, shall, subject to the terms of the Indenture, be equally and proportionately secured thereby and hereby, as if it had been made, executed, authenticated, delivered, sold and negotiated simultaneously with the execution and delivery of the Indenture. AND IT IS EXPRESSLY DECLARED that all bonds authenticated and delivered and secured thereunder and hereunder are to be issued, authenticated and delivered, and all said premises, property, franchises and rights hereby and by the Indenture conveyed, assigned, pledged or mortgaged, or intended so to be (including all the right, title and interest of the Company in and to any and all premises, property, franchises and rights of every kind and description, real, personal and mixed, tangible and intangible, thereafter acquired by the Company and whether or not specifically described in the Indenture, except any therein expressly excepted), are to be dealt with and disposed of, under, upon and subject to the terms, conditions, stipulations, covenants, agreements, trusts, uses and purposes in the Indenture expressed, and it is hereby agreed as follows: Section 1. There is hereby created two series of bonds designated Guarantee Series A of 1997 due 2027 and Guarantee Series B of 1997 due 2027, each of which shall also bear the descriptive title "First Mortgage Bond" (said bonds being sometimes herein referred to, respectively, as the "bonds of the Guarantee Series A" and the "bonds of the Guarantee Series B" and, collectively, as the "bonds of the Guarantee Series") and the form of each such series shall be substantially as hereinbefore set forth. Bonds of the Guarantee Series shall mature on June 1, 2027. The bonds of the Guarantee Series may be issued only as registered bonds without coupons in denominations of $1,000 or such multiples thereof as the Board of Directors shall approve, and delivery to the Trustee for authentication shall be conclusive evidence of such approval. The serial numbers of bonds of the Guarantee Series shall be such as may be approved by any officer of the Company, the execution thereof by any such officer, by facsimile signature or otherwise, to be conclusive evidence of such approval. Bonds of the Guarantee Series shall bear interest from their respective Initial Interest Accrual Dates (as defined in the respective forms of the bonds of the Guarantee Series A and the Guarantee Series B hereinabove set forth) at the same rates as those of the State of Ohio Pollution Control Revenue Refunding Bonds, Series 1997 (Pennsylvania Power Company Project) referred to in the respective forms of the bonds of the Guarantee Series A and the Guarantee Series B hereinabove set forth. Principal or redemption price of and interest on said bonds shall be payable in any coin or currency of the United States of America which at the time of payment is legal tender for public and private debts at the office or agency of the Company in the Borough of Manhattan, The City, County and State of New York, designated for that purpose. Bonds of the Guarantee Series shall be redeemable, exchangeable and transferable as and to the extent set forth in their respective forms thereof hereinbefore set forth. The bonds of the Guarantee Series shall be redeemable as set forth in their respective forms thereof hereinbefore set forth in whole, prior to maturity, upon notice given by mailing the same, postage pre-paid, at least thirty days and not more than forty-five days prior to the date fixed for redemption to each registered holder of a bond to be redeemed at the last address of such holder appearing on the registry books. The Trustee shall within five business days of receiving the written advice specified in the form of bond of the Guarantee Series A with respect to the bonds of the Guarantee Series A, or in the form of bond of the Guarantee Series B with respect to the bonds of the Guarantee Series B, provided for herein mail a copy thereof to the Company stamped or otherwise marked to indicate the date of receipt by the Trustee. The Company shall fix a redemption date for the redemption so demanded and shall mail to the Trustee notice of such date at least thirty-five days prior thereto. Subject to the foregoing sentence, the redemption date so fixed may be any day not earlier than the date specified in the aforesaid written advice as the date of the accelerated maturity of the pollution control revenue refunding bonds then outstanding under the applicable Revenue Bond Indenture and not later than the forty-fifth day after receipt by the Trustee of such advice, unless such forty-fifth day is earlier than such date of accelerated maturity. If the Trustee does not receive such notice from the Company within thirteen days after receipt by the Trustee of the aforesaid written advice, the redemption date shall be deemed fixed as the forty-fifth day after such receipt. The Trustee shall mail notice of the redemption date to the applicable Revenue Bond Trustee not less than thirty days prior to such redemption date, provided, however, that the Trustee shall mail no such notice (and no redemption shall be made) if prior to the mailing of such notice the Trustee shall have received written notice from the applicable Revenue Bond Trustee of the annulment of the acceleration of the maturity of the pollution control revenue refunding bonds then outstanding under the applicable Revenue Bond Indenture and of the rescission of the aforesaid written advice. The terms "Revenue Bond Trustee" and "Revenue Bond Indenture" as they relate to the bonds of the Guarantee Series A and Guarantee Series B shall have the meanings specified in the respective forms thereof hereinabove set forth. Redemption of the bonds of the Guarantee Series shall be at the principal amount thereof, plus accrued interest thereon to the date fixed for redemption and such amount shall become due and payable on the date fixed for such redemption. Anything in this paragraph contained to the contrary notwithstanding, if, after mailing notice of the date fixed for redemption but prior to such date, the Trustee shall have been advised in writing by the applicable Revenue Bond Trustee that the acceleration of the maturity of the pollution control revenue refunding bonds then outstanding under the applicable Revenue Bond Indenture has been annulled and that the aforesaid written advice has been rescinded, the aforesaid written advice shall thereupon, without further act of the Trustee or the Company, be rescinded and become null and void for all purposes hereunder (including the fixing of the applicable Initial Interest Accrual Date as provided in the respective forms of the bonds of the Guarantee Series A and Guarantee Series B, as the case may be, provided for herein) and no redemption of the bonds of the Guarantee Series A or Guarantee Series B and no payments in respect thereof as specified in the aforesaid written notice shall be effected or required. But no such rescission shall extend to any subsequent written advice from the applicable Revenue Bond Trustee or impair any right consequent on such subsequent written advice. SECTION 2. Bonds of the Guarantee Series shall be deemed to be paid and no longer outstanding under the Indenture to the extent that (i) pollution control revenue refunding bonds which are outstanding from time to time under the applicable Revenue Bond Indenture are paid or deemed to be paid and are no longer outstanding and the Trustee has been notified to such effect by the Company and (ii) all obligations secured by the bonds of the Guarantee Series payable to the Credit Facility Issuer under or in connection with the Reimbursement Agreement are no longer outstanding and the Trustee has been notified to such effect by the Company. SECTION 3. The Company covenants and agrees that the provisions of Section 3 of the Fifth Supplemental Indenture dated as of September 1, 1962, which are to remain in effect so long as any bonds of the Sixth Series shall be outstanding under the Indenture, shall remain in full force and effect so long as any bonds of the Guarantee Series shall be outstanding under the Indenture. SECTION 4. As supplemented and amended by this Supplemental Indenture, the Indenture is in all respects ratified and confirmed, and the Indenture and this Supplemental Indenture shall be read, taken and construed as one and the same instrument. SECTION 5. Nothing in this Supplemental Indenture contained shall, or shall be construed to, confer upon any person other than a holder of bonds issued under the Indenture, the Company and the Trustee any right or interest to avail himself of any benefit under any provision of the Indenture or of this Supplemental Indenture. SECTION 6. The Trustee assumes no responsibility for or in respect of the validity or sufficiency of this Supplemental Indenture or the due execution hereof by the Company or for or in respect of the recitals and statements contained herein, all of which recitals and statements are made solely by the Company. SECTION 7. This Supplemental Indenture may be executed in several counterparts and all such counterparts executed and delivered, each as an original, shall constitute but one and the same instrument. PENNSYLVANIA POWER COMPANY hereby constitutes and appoints Robert P. Wushinske to be its attorney for it and in its name as and for its corporate act and deed to acknowledge this Supplemental Indenture before any person having authority to take such acknowledgment, to the intent that the same may be duly recorded. CITIBANK, N.A. hereby constitutes and appoints P. DeFelice to be its attorney for it and in its name as and for its corporate act and deed to acknowledge this Supplemental Indenture before any person having authority to take such acknowledgment, to the intent that the same may be duly recorded. IN WITNESS WHEREOF, PENNSYLVANIA POWER COMPANY has caused its corporate name to be hereunto affixed, and this instrument to be signed and sealed by its President or a Vice President, and its corporate seal to be attested by its Secretary or an Assistant Secretary for and on its behalf, in the city of New Castle, County of Lawrence and Commonwealth of Pennsylvania and CITIBANK, N.A., in token of its acceptance of the trust, has caused its corporate name to be hereunto affixed, and this instrument to be signed by a Vice President and its corporate seal to be affixed and attested by one of its Vice Presidents in the City of New York, County of New York and State of New York, all as of the day and year first above written. PENNSYLVANIA POWER COMPANY By: Robert P. Wushinske ------------------------- Robert P. Wushinske Vice President ATTEST: By: Randy Scilla --------------------------- Randy Scilla Assistant Secretary [Seal] Signed, sealed and delivered by PENNSYLVANIA POWER COMPANY in the presence of: Donna S. Mathieson - ----------------------------- Donna S. Mathieson R. Terry Conlin - ----------------------------- R. Terry Conlin CITIBANK, N.A. as Trustee as aforesaid, By: P. DeFelice --------------------- P. DeFelice Vice President ATTEST: By: Arthur W. Aslanian --------------------------- Arthur W. Aslanian Vice President [Seal] Signed, sealed and delivered by CITIBANK, N.A. in the presence of: Rosemary Melendez - ------------------------------ Rosemary Melendez Kristine Prall - ------------------------------ Kristine Prall COMMONWEALTH OF PENNSYLVANIA ) : ss.: COUNTY OF LAWRENCE ) BE IT REMEMBERED that, on the 26th day of June, 1997, before me, the undersigned, a Notary Public in said County of Lawrence, Commonwealth of Pennsylvania, personally appeared Randy Scilla, who being duly sworn according to law, doth depose and say that he was personally present and did see the common or corporate seal of the above named PENNSYLVANIA POWER COMPANY affixed to the foregoing Supplemental Indenture; that the seal so affixed is the common or corporate seal of the said Pennsylvania Power Company and was so affixed by the authority of the said corporation as the act and deed thereof; that the above named Robert P. Wushinske is a Vice President of said corporation and did sign the said Supplemental Indenture as such in the presence of this deponent; that this deponent is an Assistant Secretary of Pennsylvania Power Company, and that the name of this deponent above signed in attestation of the due execution of the said Supplemental Indenture is in this deponent's own proper handwriting. Sworn to and subscribed before me this 26th day of June, 1997. Randy Scilla ----------------------- [SEAL] Sylvia M. Rashid ------------------------ NOTARIAL SEAL SYLVIA M. RASHID, Notary Public New Castle, Lawrence Co., PA My Commission Expires March 11, 2001 COMMONWEALTH OF PENNSYLVANIA ) : ss.: COUNTY OF LAWRENCE ) I HEREBY CERTIFY that, on this 26th day of June, 1997, before me, the subscriber, a Notary Public in and for the State and County aforesaid, personally appeared Robert P. Wushinske, the attorney for PENNSYLVANIA POWER COMPANY, and the attorney named in the foregoing Supplemental Indenture and, by virtue and in pursuance of the authority therein conferred upon him, acknowledged the said Supplemental Indenture to be the act and deed of said Pennsylvania Power Company. WITNESS my hand and notarial seal the day and year aforesaid. [SEAL] Sylvia M. Rashid ------------------------ NOTARIAL SEAL SYLVIA M. RASHID, Notary Public New Castle, Lawrence Co., PA My Commission Expires March 11, 2001 COMMONWEALTH OF PENNSYLVANIA ) : ss.: COUNTY OF LAWRENCE ) On the 26th day of June, 1997, before me, personally came Robert P. Wushinske, to me known, who, being by me duly sworn, did depose and say that he resides at R.D. 2, Means Road, New Wilmington, Pennsylvania 16142; that he is a Vice President of PENNSYLVANIA POWER COMPANY, one of the corporations described in and which executed the above instrument; that he knows the seal of said corporation; that the seal affixed to said instrument is such corporate seal; that it was affixed by order of the Board of Directors of said corporation, and that he signed his name thereto by like authority. WITNESS my hand and notarial seal the day and year aforesaid. [SEAL] Sylvia M. Rashid ----------------------- NOTARIAL SEAL SYLVIA M. RASHID, Notary Public New Castle, Lawrence Co., PA My Commission Expires March 11, 2001 STATE OF NEW YORK ) : ss.: COUNTY OF NEW YORK ) BE IT REMEMBERED that, on the 30th day of June, 1997, before me, the undersigned, a Notary Public in said County of New York, State of New York, personally appeared Arthur W. Aslanian, who being duly sworn according to law, doth depose and say that he was personally present and did see the common or corporate seal of the above named CITIBANK, N.A. affixed to the foregoing Supplemental Indenture; that the seal so affixed is the common or corporate seal of the said CITIBANK, N.A. and was so affixed by the authority of the said association as the act and deed thereof; that the above named P. DeFelice is one of the Vice Presidents of said association and did sign the said Supplemental Indenture as such in the presence of this deponent; that this deponent is a Vice President of said CITIBANK, N.A., and that the name of this deponent above signed in attestation of the due execution of the said Supplemental Indenture is in this deponent's own proper handwriting. Sworn to and subscribed before me this 30th day of June, 1997. Arthur W. Aslanian ------------------------- [SEAL] Jeffry Berger ------------------------- JEFFRY BERGER Notary Public, State of New York No. 01BE5015814 Qualified in Kings County Commission Expires July 26, 1997 STATE OF NEW YORK ) ) ss.: COUNTY OF NEW YORK ) I HEREBY CERTIFY that, on this 30th day of June, 1997, before me, the subscriber, a Notary Public in and for the State and County aforesaid, personally appeared P. DeFelice, the attorney for CITIBANK, N.A., and the attorney named in the foregoing Supplemental Indenture and, by virtue and in pursuance of the authority therein conferred upon him, acknowledged the execution of said Supplemental Indenture to be the act and deed of said CITIBANK, N.A. WITNESS my hand and notarial seal the day and year aforesaid. Jeffry Berger ------------------------- [SEAL] JEFFRY BERGER Notary Public, State of New York No. 01BE5015814 Qualified in Kings County Commission Expires July 26, 1997 STATE OF NEW YORK ) ) ss.: COUNTY OF NEW YORK ) On the 30th day of June, 1997, before me, personally came P. DeFelice, to me known, who being by me duly sworn, did depose and say that he resides at 47-09 169th Street, Flushing, New York; that he is a Vice President of CITIBANK, N.A., one of the parties described in and which executed the above instrument; that he knows the seal of said association; that the seal affixed to said instrument is such corporate seal; that it was so affixed by authority of the Board of Directors of said association, and that he signed his name thereto by like authority. WITNESS my hand and notarial seal the day and year aforesaid. Jeffry Berger ----------------------- [SEAL] JEFFRY BERGER Notary Public, State of New York No. 01BE5015814 Qualified in Kings County Commission Expires July 26, 1997 Citibank, N.A. hereby certifies that its precise name and address as Trustee hereunder are: CITIBANK, N.A. 111 Wall Street Borough of Manhattan City, County and State of New York 10043 CITIBANK, N.A. By P. DeFelice ------------------------ P. DeFelice Vice President SCHEDULE A Detailed Description of Additional Properties STEAM PRODUCTION Bruce Mansfield Generating Station - Unit No. 2 - Pennsylvania Power Company's portion (6.8%) of low nox burners. NUCLEAR PRODUCTION Perry Nuclear Power Plant - Common Facility - Pennsylvania Power Company's portion (5.24%) of shoreline revetment. TRANSMISSION LINES Y-196 Tap to Grant Street Substation - 69,000 volts - .38 mile. DISTRIBUTION SUBSTATION Grant Street Substation - A 69,000/12,470 volt circuit exit and associated equipment located in the City of New Castle, Lawrence County, Pennsylvania. OTHER REAL PROPERTY An undivided 5.76% interest as tenant in common in a parcel of land containing 97.821 acres, located in Greene Township, Beaver County, Pennsylvania recorded in Beaver County Deed Book 1658, Page 398, on July 12, 1995. An undivided 5.76% interest as tenant in common in a parcel of land containing 1.33 acres, located in Greene Township, Beaver County, Pennsylvania, recorded in Beaver County Deed Book 1683, Page 842, on December 28, 1995. Parcel of land containing 1.033 acres, located in Springfield Township, Mercer County, Pennsylvania, recorded in Mercer County Deed Book 96DR, Page 433, on January 3, 1996. Parcel of land containing 1.5 acres, located in Marshall Township, Allegheny County, Pennsylvania, recorded in Allegheny County Deed Book 9639, Page 380, on May 8, 1995. Parcel of land containing 1.43 acres, located in Delaware Township, Mercer County, Pennsylvania, recorded in Mercer County Deed Book 96DR, Page 1685, on August 28, 1996. An undivided 5.76% interest as tenant in common in a parcel of land containing .07 acres, located in Shippingport Borough, Beaver County, Pennsylvania, recorded in Beaver County Deed Book 1741, Page 622, on December 4, 1996. An undivided 5.76% interest as tenant in common in a parcel of land containing 64.698 acres, located in Greene Township, Beaver County, Pennsylvania, recorded in Beaver County Deed Book 1743, Page 97, on December 5, 1996. An undivided 5.76% interest as tenant in common in a parcel of land containing 147.98 acres, located in Greene Township, Beaver County, Pennsylvania, recorded in Beaver County Deed Book 1751, Page 626, on February 4, 1997. An undivided 5.76% interest as tenant in common in a parcel of land containing 0.43 acres, located in Shippingport Borough, Beaver County, Pennsylvania, recorded in Beaver County Deed Book 1757, Page 673, on March 31, 1997. Signed for identification Randy Scilla -------------------------- Randy Scilla Assistant Secretary PENNSYLVANIA POWER COMPANY P. DeFelice --------------------------- P. DeFelice Vice President CITIBANK, N.A. [CONFORMED WITH RECORDATION DATA] PENNSYLVANIA POWER COMPANY to CITIBANK, N.A., As Trustee Forty-fifth Supplemental Indenture Providing among other things for FIRST MORTGAGE BONDS Guarantee Series A 1997 due 2027 Guarantee Series B 1997 due 2027 Dated as of June 1, 1997 RECORDING AND FILING DATA Forty-fifth Supplemental Indenture Recorded in the Offices of the Recorders of Deeds as follows: Mortgage Book ---------------------------- Name of County Date Volume No. Page No. -------------- ---- ---------- -------- PENNSYLVANIA Allegheny July 7, 1997 16752 199 Beaver July 7, 1997 1495 837 Butler July 7, 1997 2755 715 Crawford July 7, 1997 348 1158 Lawrence July 7, 1997 1360 406 Mercer July 7, 1997 97 MR 09134 Venango July 7, 1997 80 611 OHIO Belmont July 10, 1997 677 719 Clark July 10, 1997 868 251 Jefferson July 11, 1997 237 666 Lake July 10, 1997 Instrument No. 970023744 Lorain July 10, 1997 Instrument No. 477631 Film No.1231 Monroe July 10, 1997 33 242 Trumbull July 10, 1997 1133 930 Filed with the Secretary of the Commonwealth of Pennsylvania on July 3, 1997, as part of amendment to Financing Statement--File No. 00900172. Filed with the Secretary of the State of Ohio on July 10, 1997, as part of Financing Statement No. AN80555. Filed in Belmont County, Ohio, on July 10, 1997, as part of Financing Statement No. 9700096046. Filed in Clark County, Ohio, on July 10, 1997, as part of Financing Statement No. 9700002554. Filed in Jefferson County, Ohio, on July 10, 1997, as part of Financing Statement No. 83092. Filed in Lake County, Ohio, on July 10, 1997, as part of Financing Statement No. 97195196. Filed in Lorain County, Ohio, on July 10, 1997, as part of Financing Statement No. 477630. Filed in Trumbull County, Ohio, on July 10, 1997, as part of Financing Statement No. 970020409. EX-12.2 19 EXHIBIT 12.2 Page 1 PENNSYLVANIA POWER COMPANY RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, --------------------------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- (Dollars in Thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items $15,664 $31,260 $ 38,930 $40,587 $31,472 Interest before reduction for amounts capitalized 35,262 34,947 31,350 27,889 22,438 Provision for income taxes 12,865 24,333 32,591 33,421 26,658 Interest element of rentals charged to income (a) 1,662 1,652 1,865 1,868 1,750 ------- ------- -------- -------- ------- Earnings as defined $65,453 $92,192 $104,736 $103,765 $82,318 ======= ======= ======== ======== ======= FIXED CHARGES AS DEFINED IN REGULATION S-K: Interest on long-term debt $33,208 $32,130 $ 28,937 $25,715 $20,458 Interest on nuclear fuel obligations 401 519 407 219 276 Other interest expense 1,653 2,298 2,006 1,955 1,704 Interest element of rentals charged to income (a) 1,662 1,652 1,865 1,868 1,750 ------- ------- -------- ------- ------- Fixed charges as defined $36,924 $36,599 $ 33,215 $29,757 $24,188 ======= ======= ======== ======= ======= CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES (b) 1.77 2.52 3.15 3.49 3.40 ==== ==== ==== ==== ==== - ----------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. (b) These ratios exclude fixed charges applicable to the guarantee of the debt of a coal supplier aggregating $1,078,000, $935,000, $795,000, $642,000 and $483,00 for each of the five years ended December 31, 1997, respectively.
EXHIBIT 12.2 Page 2 PENNSYLVANIA POWER COMPANY RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS)
Year Ended December 31, --------------------------------------------- 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- (Dollars in Thousands) EARNINGS AS DEFINED IN REGULATION S-K: Income before extraordinary items $15,664 $31,260 $ 38,930 $ 40,587 $31,472 Interest before reduction for amounts capitalized 35,262 34,947 31,350 27,889 22,438 Provision for income taxes 12,865 24,333 32,591 33,421 26,658 Interest element of rentals charged to income (a) 1,662 1,652 1,865 1,868 1,750 ------- ------- -------- -------- ------- Earnings as defined $65,453 $92,192 $104,736 $103,765 $82,318 ======= ======= ======== ======== ======= FIXED CHARGES AS DEFINED IN REGULATION S-K PLUS STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS): Interest on long-term debt $33,208 $32,130 $ 28,937 $ 25,715 $20,458 Interest on nuclear fuel obligations 401 519 407 219 276 Other interest expense 1,653 2,298 2,006 1,955 1,704 Preferred stock dividend requirements 5,863 5,364 4,775 4,626 4,626 Adjustment to preferred stock dividends to state on a pre-income tax basis 4,757 4,121 3,939 3,751 3,859 Interest element of rentals charged to income (a) 1,662 1,652 1,865 1,868 1,750 ------- ------- -------- -------- ------- Fixed charges as defined plus preferred stock dividend requirements(pre-income tax basis) $47,544 $46,084 $ 41,929 $ 38,134 $32,673 ======= ======= ======== ======== ======= RATIO OF EARNINGS TO FIXED CHARGES PLUS PREFERRED AND PREFERENCE STOCK DIVIDEND REQUIREMENTS (PRE-INCOME TAX BASIS) (b) 1.38 2.00 2.50 2.72 $2.52 ==== ==== ==== ==== ===== - --------------- (a) Includes the interest element of rentals where determinable plus 1/3 of rental expense where no readily defined interest element can be determined. (b) These ratios exclude fixed charges applicable to the guarantee of the debt of a coal supplier aggregating $1,078,000, $935,000, $795,000, $642,000 and $483,000 for each of the five years ended December 31, 1997, respectively.
EX-13.4 20 SELECTED FINANCIAL DATA Pennsylvania Power Company - -------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (Dollars in thousands) Operating Revenues $ 323,381 $ 322,625 $ 314,642 $ 301,965 $ 292,084 ========== ========== ========= ========== ========== Net Income $ 31,472 $ 40,587 $ 38,930 $ 31,260 $ 21,317 ========== ========== ========= ========== ========== Earnings on Common Stock $ 26,846 $ 35,961 $ 34,155 $ 25,896 $ 15,454 ========== ========== ========= ========== ========== Return on Average Common Equity 9.3% 12.8% 12.9% 10.0% 5.9% === ==== ==== ==== === Cash Dividends on Common Stock $ 21,386 $ 21,386 $ 21,386 $ 21,386 $ 21,386 ========== ========== ========== ========== ========== Total Assets $1,034,457 $1,074,578 $1,151,990 $1,197,302 $1,184,606 ========== ========== ========== ========== ========== CAPITALIZATION: Common Stockholder's Equity $ 291,977 $ 286,504 $ 271,920 $ 258,973 $ 254,782 Preferred Stock- Not Subject to Mandatory Redemption 50,905 50,905 50,905 50,905 50,905 Subject to Mandatory Redemption 15,000 15,000 15,000 15,000 20,500 Long-Term Debt 289,305 310,996 338,670 424,457 440,555 ---------- ---------- ---------- ---------- ---------- Total Capitalization $ 647,187 $ 663,405 $ 676,495 $ 749,335 $ 766,742 ========== ========== ========== ========== ========== CAPITALIZATION RATIOS: Common Stockholder's Equity 45.1% 43.2% 40.2% 34.6% 33.2% Preferred Stock- Not Subject to Mandatory Redemption 7.9 7.7 7.5 6.8 6.6 Subject to Mandatory Redemption 2.3 2.2 2.2 2.0 2.7 Long-Term Debt 44.7 46.9 50.1 56.6 57.5 ----- ----- ----- ----- ----- Total Capitalization 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== ===== KILOWATT-HOUR SALES (Millions): Residential 1,238 1,254 1,195 1,178 1,105 Commercial 1,013 996 938 891 831 Industrial 1,659 1,693 1,558 1,293 1,212 Other 123 126 151 148 139 ------- ------- ------- ------- ------- Subtotal 4,033 4,069 3,842 3,510 3,287 Parent Company 311 221 250 468 469 Other Utilities 473 765 685 466 748 ------- ------- ------- ------- ------- Total 4,817 5,055 4,777 4,444 4,504 ======= ======= ======= ======= ======= CUSTOMERS SERVED: Residential 129,316 127,936 126,480 124,951 123,316 Commercial 16,738 16,531 16,317 15,966 15,593 Industrial 241 225 223 219 221 Other 97 99 97 98 97 ------- ------- ------- ------- ------- Total 146,392 144,791 143,117 141,234 139,227 ======= ======= ======= ======= ======= Average Annual Residential Kilowatt-Hours Used 9,634 9,866 9,505 9,501 9,017 Cost of Fuel per Million Btu $1.10 $1.09 $1.12 $1.20 $1.28 Peak Load (Megawatts) 836 792 836 710 690 Generating Capability: Coal 72.1% 72.1% 72.1% 72.1% 74.6% Oil 3.0 3.0 3.0 3.0 2.8 Nuclear 24.9 24.9 24.9 24.9 22.6 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== ===== SOURCES OF ELECTRIC GENERATION: Coal 73.8% 67.6% 65.6% 69.6% 76.8% Nuclear 26.2 32.4 34.4 30.4 23.2 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== ===== NUMBER OF EMPLOYEES 997 1,015 1,220 1,255 1,355 ===== ===== ===== ===== =====
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion includes forward looking statements based on information currently available to management. Such statements are subject to certain risks and uncertainties. These statements typically contain, but are not limited to, the terms "anticipate," "potential," "expect," "believe," "estimate" and similar words. Actual results may differ materially due to the speed and nature of increased competition and deregulation in the electric utility industry, economic or weather conditions affecting future sales and margins, changes in markets for energy services, changing energy market prices, legislative and regulatory changes (including revised environmental requirements), availability and cost of capital and other similar factors. RESULTS OF OPERATIONS--We continued to make significant progress in 1997 as we prepare for a more competitive environment in the electric utility industry. The most significant event during the year was the approval by the Federal Energy Regulatory Commission (FERC) of the merger of our parent company, Ohio Edison Company, with Centerior Energy Corporation to form FirstEnergy Corp., which came into existence on November 8, 1997. We expect the merger to produce a minimum of $1 billion in savings for FirstEnergy Corp. during the first ten years of joint operations through the elimination of duplicative activities, improved operating efficiencies, lower capital expenditures, accelerated debt reduction, the coordination of the companies' work forces and enhanced purchasing power. Earnings on common stock of $26.8 million in 1997 declined from $36.0 million in 1996. Current year results were adversely affected by charges for uncollectible customer accounts and a voluntary retirement program discussed below. The 1997 results also reflect accelerated depreciation and amortization of nuclear and regulatory assets totaling approximately $38 million under our Rate Stability and Economic Development Plan; results for 1996 included approximately $29 million of accelerated depreciation and amortization. The 1996 results compared favorably to earnings on common stock of $34.2 million in 1995. For the second consecutive year, we achieved record operating revenues. The following table summarizes the sources of changes in operating revenues for 1997 and 1996 as compared to the previous year: 1997 1996 ---- ---- (In millions) Change in retail kilowatt-hour sales $(1.7) $16.5 Change in average retail price 3.7 0.3 Sales to utilities (2.4) (0.2) Other 1.2 (8.6) ----- ----- Net Increase $ 0.8 $ 8.0 ===== ===== Our customer base continues to grow with approximately 1,600 new retail customers added in 1997, after gaining more than 1,600 customers the previous year. Residential sales decreased 1.3% in 1997, following a 4.9% gain the previous year. Commercial sales rose 1.8% and 6.1% in 1997 and 1996, respectively. Closure of electric arc facilities by Caparo Steel Company in August 1997 contributed to a 2.0% decrease in industrial sales for the year, following an 8.7% increase the previous year. Sales to other utilities fell 20.5% in 1997 as a result of the December 31 1996, expiration of a one-year contract with another utility to supply 33 megawatts of power. This follows a 5.5% increase the previous year. As a result of the above factors, total kilowatt-hour sales dropped 4.7% in 1997, compared with sales in 1996, which were up 5.8% from 1995. Because of lower kilowatt-hour sales, we spent less on fuel and purchased power during 1997, compared to 1996 costs. More was spent in 1996, compared to 1995 costs, due to higher kilowatt-hour sales. Higher nuclear expenses in 1997 reflect increased operating costs at the Beaver Valley Plant. Nuclear operating costs were lower in 1996, compared to 1995, due primarily to lower refueling outage cost levels. The increase in other operating costs in 1997 reflects a $3 million second quarter charge for uncollectible customer accounts and a fourth quarter charge of approximately $5.4 million for a voluntary retirement program. The changes in depreciation and regulatory asset amortization in 1997 and 1996 reflect accelerations under the regulatory plan discussed above. General taxes decreased in 1997, due principally to a 1997 adjustment which reduced our liability for gross receipts tax. The decrease in other income was due primarily to last year's adjustment to recoverable costs related to Perry Unit 2 since recovery began sooner than originally anticipated; that adjustment increased other income in 1996. Overall, interest costs continue to trend downward. Total interest costs were lower in 1997 than in 1996. Interest on long-term debt decreased due to our economic refinancings and redemption of higher-cost debt totaling approximately $39.4 million that had been outstanding as of December 31, 1996. CAPITAL RESOURCES AND LIQUIDITY--We have significantly improved our financial position over the past five years as evidenced by our enhanced fixed charge coverage ratios and percentage of common equity to total capitalization. Our SEC ratio of earnings to fixed charges improved to 3.54 at the end of 1997 from 2.33 at the end of 1992. The Company's indenture ratio, which is used to determine our ability to issue first mortgage bonds, increased from 3.12 at the end of 1992 to 4.24 at the end of 1997. Over the same period, the charter ratio-a measure of our ability to issue preferred stock-improved from 1.59 to 2.01 and our common equity percentage of capitalization rose from approximately 36% at the end of 1992 to over 45% at the end of 1997. Our improving financial position reflects ongoing efforts to increase competitiveness. At year end 1997, we were serving about 8,800 more customers than we were five years ago, with 435 fewer employees. As a result, our customer/employee ratio has increased by 53% over the past five years, standing at 147 customers per employee at the end of 1997, compared with 96 at the end of 1992. All cash requirements for the year, including debt repayments, were met with internally generated funds. Our cash requirements in 1998 for operating expenses, construction expenditures and scheduled debt maturities are expected to be met without issuing additional securities. Cash requirements of approximately $28 million for the 1998-2002 period to meet scheduled maturities of long term debt and preferred stock are also expected to be funded internally. We had about $18.2 million of cash and temporary investments and no short-term indebtedness on December 31, 1997. We also had $2 million of unused short-term bank lines of credit, and $12 million of bank facilities that provide for borrowings on a short-term basis at the banks' discretion. During 1997, our capital spending (excluding nuclear fuel) totaled approximately $15 million. Our capital spending for the period 1998-2002 is expected to be about $90 million (excluding nuclear fuel), of which approximately $18 million applies to 1998. This is about $30 million lower than actual capital outlays over the past five years. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $37 million, of which about $2 million applies to 1998. During the same periods, our nuclear fuel investments are expected to be reduced by approximately $32 million and $7 million, respectively, as the nuclear fuel is consumed. OUTLOOK--On September 30, 1997, we filed a restructuring plan with the Pennsylvania Public Utility Commission (PPUC). The plan describes how we will restructure our rates and provide customers with direct access to alternative electricity suppliers; customer choice is to be phased in over three years beginning in 1999, after completion of a two-year pilot program. We will continue to deliver power to homes and businesses through our transmission and distribution system, which remains regulated by the PPUC. We also plan to sell electricity and energy-related services in our own territory and throughout Pennsylvania as an alternative supplier through our nonregulated subsidiary, Penn Power Energy. Through the restructuring plan, we are seeking recovery of $293 million of stranded costs through a competitive transition charge starting in 1999 and ending in 2005, which is consistent with our Rate Stability and Economic Development Plan currently in effect. The PPUC plans to hold public hearings on our restructuring plan early in 1998. Our Rate Stability and Economic Development Plan was approved by the PPUC in the second quarter of 1996. This regulatory plan initially maintains our current base electric rates through June 20, 2006. The plan also revised our fuel cost recovery methods. All regulatory assets are being recovered under provisions of the regulatory plan. In addition, we have been authorized by the PPUC to recognize additional capital recovery related to our generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the regulatory plan period of at least $358 million more than the amount that would have been recognized if the regulatory plan was not in effect. This additional amount is being recovered through current rates. Based on the regulatory environment we operate in today and our regulatory plan, we believe we will continue to be able to bill and collect cost-based rates for all of our operations; accordingly, it is appropriate that we continue the application of Statement of Financial Accounting Standards No. 71 "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). However, as discussed above, changes in the regulatory environment are taking place in Pennsylvania. We expect to discontinue the application of SFAS 71 for the generation portion of our business, possibly as early as 1998. We do not expect the impact of discontinuing SFAS 71 to have a material adverse effect. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability, and (3) income from the external decommissioning trusts could be reported as investment income. The FASB reported in October 1997 that it plans to continue working on the proposal in 1998. The Clean Air Act Amendments of 1990, discussed in Note 6, require additional emission reductions by 2000. We are pursuing cost- effective compliance strategies for meeting the reduction requirements that begin in 2000. IMPACT OF THE YEAR 2000 ISSUE--The Year 2000 Issue is the result of computer programs being written using two digits rather than four to identify the applicable year. Any of our programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations. We currently believe that with modifications to existing software and conversions to new software, the Year 2000 Issue will pose no significant operational problems for our computer systems as so modified and converted. If these modifications and conversions are not made, or are not completed on a timely basis, the Year 2000 Issue could have a material impact on our operations. We have initiated formal communications with many of our major suppliers to determine the extent to which we are vulnerable to those third parties' failure to resolve their own Year 2000 problems. Our total Year 2000 project cost and estimates to complete are based on currently available information and do not include the estimated costs and time associated with the impact of a third party's Year 2000 issue. There can be no guarantee that the failure of other companies to resolve their own Year 2000 issues will not have material adverse effect on us. We are utilizing both internal and external resources to reprogram and/or replace and test the software for Year 2000 modifications. Most of our Year 2000 problems will be resolved through system replacements. The different phases of our Year 2000 project will be completed at various dates, most of which occur in 1999. We plan to complete the entire Year 2000 project by mid-December 1999. Of the total project cost, approximately $4 million will be capitalized since those costs are attributable to the purchase of new software for total system replacements (i.e., the Year 2000 solution comprises only a portion of the benefit resulting from the system replacements). The remaining $0.5 million will be expensed as incurred over the next two years. To date, we have incurred approximately $70,000 related to the assessment of, and preliminary efforts in connection with, our Year 2000 project and the development of a remediation plan. The costs of the project and the date on which we plan to complete the year 2000 modifications are based on management's best estimates, which were derived from numerous assumptions of future events including the continued availability of certain resources, and other factors. However, there can be no guarantee that this project will be completed as planned and actual results could differ materially from the estimates. Specific factors that might cause material differences include, but are not limited to, the availability and cost of trained personnel, the ability to locate and correct all relevant computer code, and similar uncertainties. STATEMENTS OF INCOME Pennsylvania Power Company - --------------------------------------------------------------------------------------------------
For the Years Ended December 31, 1997 1996 1995 ---------- ---------- ---------- (In thousands, except per share amounts) OPERATING REVENUES $323,381 $322,625 $314,642 -------- -------- -------- OPERATING EXPENSES AND TAXES: Fuel and purchased power 67,345 67,443 63,059 Nuclear operating costs 26,220 22,064 32,759 Other operating costs 66,518 59,753 58,959 -------- -------- -------- Total operation and maintenance expenses 160,083 149,260 154,777 Provision for depreciation 57,248 51,579 33,152 Amortization of net regulatory assets 7,380 5,535 - General taxes 22,379 24,015 28,278 Income taxes 25,555 29,907 31,118 -------- -------- -------- Total operating expenses and taxes 272,645 260,296 247,325 -------- -------- -------- OPERATING INCOME 50,736 62,329 67,317 OTHER INCOME 2,760 5,760 2,213 -------- -------- -------- INCOME BEFORE NET INTEREST CHARGES 53,496 68,089 69,530 -------- -------- -------- NET INTEREST CHARGES: Interest on long-term debt 20,458 25,715 28,937 Interest on nuclear fuel obligations 276 219 407 Allowance for borrowed funds used during construction (414) (387) (750) Other interest expense 1,704 1,955 2,006 -------- -------- -------- Net interest charges 22,024 27,502 30,600 -------- -------- -------- NET INCOME 31,472 40,587 38,930 PREFERRED STOCK DIVIDEND REQUIREMENTS 4,626 4,626 4,775 --------- --------- --------- EARNINGS ON COMMON STOCK $ 26,846 $ 35,961 $ 34,155 ========= ========= ======== The accompanying Notes to Financial Statements are an integral part of these statements.
BALANCE SHEETS Pennsylvania Power Company - -------------------------------------------------------------------------------------------------
At December 31, 1997 1996 -------- -------- (In thousands) ASSETS UTILITY PLANT: In service, at original cost $1,237,562 $1,228,618 Less-Accumulated provision for depreciation 508,981 456,320 ---------- ---------- 728,581 772,298 ---------- ---------- Construction work in progress- Electric plant 7,427 7,645 Nuclear fuel 6,788 1,803 ---------- ---------- 14,215 9,448 ---------- ---------- 742,796 781,746 ---------- ---------- OTHER PROPERTY AND INVESTMENTS 26,157 21,131 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents 660 1,387 Notes receivable from parent company (Note 4) 17,500 2,500 Accounts receivable- Customers (less accumulated provisions of $3,609,000 and $569,000, respectively, for uncollectible accounts) 33,934 38,054 Parent company 12,599 14,450 Other 14,426 14,970 Materials and supplies, at average cost 14,973 14,269 Prepayments 1,707 1,576 ---------- ---------- 95,799 87,206 ---------- ---------- DEFERRED CHARGES: Regulatory assets 162,966 177,283 Other 6,739 7,212 ---------- ---------- 169,705 184,495 ---------- ---------- $1,034,457 $1,074,578 ========== ========== CAPITALIZATION AND LIABILITIES CAPITALIZATION (See Statements of Capitalization): Common stockholder's equity $ 291,977 $ 286,504 Preferred stock- Not subject to mandatory redemption 50,905 50,905 Subject to mandatory redemption 15,000 15,000 Long-term debt- Associated companies 9,231 7,245 Other 280,074 303,751 ---------- ---------- 647,187 663,405 ---------- ---------- CURRENT LIABILITIES: Currently payable long-term debt- Associated companies 6,958 6,784 Other 1,443 712 Accounts payable- Associated companies 6,788 8,084 Other 22,751 25,686 Accrued taxes 12,332 14,823 Accrued interest 6,588 7,382 Other 14,746 21,199 ---------- --------- 71,606 84,670 ---------- --------- DEFERRED CREDITS: Accumulated deferred income taxes 239,952 253,776 Accumulated deferred investment tax credits 26,052 28,383 Other 49,660 44,344 ---------- ---------- 315,664 326,503 COMMITMENTS, GUARANTEES AND CONTINGENCIES (Notes 2 & 5) ---------- ---------- $1,034,457 $1,074,578 ========== ========== The accompanying Notes to Financial Statements are an integral part of these balance sheets.
STATEMENTS OF CAPITALIZATION Pennsylvania Power Company - --------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share amounts)
At December 31, 1997 1996 -------- -------- COMMON STOCKHOLDER'S EQUITY: Common stock, $30 par value, 6,500,000 shares authorized, 6,290,000 shares outstanding $188,700 $188,700 Other paid-in capital (400) (413) Retained earnings (Note 3a) 103,677 98,217 -------- -------- Total common stockholder's equity 291,977 286,504 -------- -------- Number of Shares Optional Outstanding Redemption Price 1997 1996 Per Share Aggregate -------- -------- ---------- --------- PREFERRED STOCK (Note 3b): Cumulative, $100 par value- Authorized 1,200,000 shares Not subject to mandatory redemption: 4.24% 40,000 40,000 $ 103.13 $ 4,125 4,000 4,000 4.25% 41,049 41,049 105.00 4,310 4,105 4,105 4.64% 60,000 60,000 102.98 6,179 6,000 6,000 7.64% 60,000 60,000 101.42 6,085 6,000 6,000 7.75% 250,000 250,000 - - 25,000 25,000 8.00% 58,000 58,000 102.07 5,920 5,800 5,800 ------- ------- ------- -------- -------- Total not subject to mandatory redemption 509,049 509,049 $26,619 50,905 50,905 ======= ======= ======= ======== ======== Subject to mandatory redemption (Note 3c): 7.625% 150,000 150,000 107.63 $16,145 15,000 15,000 ======= ======= ======= ======== ======== LONG-TERM DEBT (Note 3d): First mortgage bonds- 9.740% due 1999-2019 20,000 20,000 7.500% due 2003 40,000 40,000 6.375% due 2004 20,500 37,000 6.625% due 2004 14,000 20,000 8.500% due 2022 27,250 27,250 7.625% due 2023 6,500 6,500 -------- -------- Total first mortgage bonds 128,250 150,750 -------- -------- Secured notes- 4.750% due 1998 850 850 6.080% due 2000 23,000 23,000 5.400% due 2013 1,000 1,000 5.400% due 2017 10,600 10,600 7.150% due 2017 17,925 17,925 5.900% due 2018 16,800 16,800 8.100% due 2018 - 10,300 8.100% due 2020 5,200 5,200 7.150% due 2021 14,482 14,482 6.150% due 2023 12,700 12,700 3.900% due 2027 10,300 - 6.450% due 2027 14,500 14,500 5.450% due 2028 6,950 6,950 6.000% due 2028 14,250 14,250 5.950% due 2029 238 238 -------- -------- Total secured notes 148,795 148,795 -------- -------- Other obligations- Nuclear fuel 16,189 14,029 Capital leases (Note 2) 5,022 5,651 -------- -------- Total other obligations 21,211 19,680 -------- -------- Net unamortized discount on debt (550) (733) -------- -------- Long-term debt due within one year (8,401) (7,496) -------- -------- Total long-term debt 289,305 310,996 -------- -------- TOTAL CAPITALIZATION $647,187 $663,405 ======== ======== The accompanying Notes to Financial Statements are an integral part of these statements.
STATEMENTS OF RETAINED EARNINGS Pennsylvania Power Company - ----------------------------------------------------------------------------------------------------
For the Years Ended December 31, 1997 1996 1995 -------- -------- -------- (In thousands) Balance at beginning of year $ 98,217 $ 83,642 $ 70,873 Net income 31,472 40,587 38,930 --------- --------- --------- 129,689 124,229 109,803 --------- --------- --------- Cash dividends on common stock 21,386 21,386 21,386 Cash dividends on preferred stock 4,626 4,626 4,775 -------- --------- --------- 26,012 26,012 26,161 -------- --------- --------- Balance at end of year (Note 3a) $103,677 $ 98,217 $ 83,642 ======== ========= =========
STATEMENTS OF CAPITAL STOCK AND OTHER PAID-IN CAPITAL - ---------------------------------------------------------------------------------------------------
Preferred Stock --------------------------------------------- Not Subject to Subject to Common Stock Mandatory Redemption Mandatory Redemption ------------------------------ -------------------- -------------------- Other Number Par Paid-In Number Par Number Par of Shares Value Capital of Shares Value of Shares Value ----------- ---------- -------- --------- --------- -------- ------- (Dollars in thousands) Balance, January 1, 1995 6,290,000 $188,700 $(600) 509,049 $50,905 150,000 $15,000 Minimum liability for unfunded re- tirement benefits 178 ---------- -------- ----- -------- ------- ------- ------- Balance, December 31, 1995 6,290,000 188,700 (422) 509,049 50,905 150,000 15,000 Minimum liability for unfunded retirement benefits 9 ---------- -------- ---- -------- ------- ------- ------- Balance, December 31, 1996 6,290,000 188,700 (413) 509,049 50,905 150,000 15,000 Minimum liability for unfunded retirement benefits 13 --------- -------- ---- -------- ------- ------- ------- Balance, December 31, 1997 6,290,000 $188,700 $(400) 509,049 $50,905 150,000 $15,000 ========= ======== ===== ======= ======= ======= ======= The accompanying Notes to Financial Statements are an integral part of these statements.
STATEMENTS OF CASH FLOWS Pennsylvania Power Company - ------------------------------------------------------------------------------------------------
For the Years Ended December 31, 1997 1996 1995 ------ ------ ------ (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 31,472 $ 40,587 $ 38,930 Adjustments to reconcile net income to net cash from operating activities: Provision for depreciation 57,248 51,579 33,152 Nuclear fuel and lease amortization 7,172 8,693 11,337 Amortization of net regulatory assets 6,193 5,535 - Deferred income taxes, net (6,631) 396 8,144 Investment tax credits, net (2,331) (2,138) (1,688) Deferred fuel costs, net - 3,220 155 Receivables 6,515 (1,193) 64 Materials and supplies (704) 1,319 1,451 Accounts payable (4,476) (2,472) 1,848 Other (5,707) (13,787) 11,003 -------- ------- -------- Net cash provided from operating activities 88,751 91,739 104,396 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: New Financing- Long-term debt 9,942 - 13,528 Redemptions and Repayments- Long-term debt 39,464 84,347 67,337 Dividend Payments- Common stock 21,386 21,386 21,386 Preferred stock 4,626 4,626 4,775 -------- ------- -------- Net cash used for financing activities 55,534 110,359 79,970 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Property additions 14,513 20,361 29,705 Loan to parent 15,000 - - Loan payment from parent - (19,500) (3,000) Sale of utility property to parent - - (4,249) Other 4,431 116 (1,814) --------- -------- -------- Net cash used for investing activities 33,944 977 20,642 --------- -------- -------- Net increase (decrease) in cash and cash equivalents (727) (19,597) 3,784 Cash and cash equivalents at beginning of year 1,387 20,984 17,200 --------- -------- -------- Cash and cash equivalents at end of year $ 660 $ 1,387 $ 20,984 ========= ======== ======== SUPPLEMENTAL CASH FLOWS INFORMATION: Cash paid during the year- Interest (net of amounts capitalized) $ 21,137 $ 26,653 $ 30,215 Income taxes $ 38,324 $ 36,815 $ 26,605 The accompanying Notes to Financial Statements are an integral part of these statements.
STATEMENTS OF TAXES Pennsylvania Power Company - -------------------------------------------------------------------------------------------------------
For the Years Ended December 31, 1997 1996 1995 -------- -------- -------- (In thousands) GENERAL TAXES: State gross receipts $ 11,267 $ 12,305 $ 11,680 Real and personal property 6,060 6,178 11,222 State capital stock 2,566 2,820 2,499 Social security and unemployment 2,224 2,064 2,440 Other 261 648 437 -------- -------- -------- Total general taxes $ 22,378 $ 24,015 $ 28,278 ======== ======== ======== PROVISION FOR INCOME TAXES: Currently payable- Federal $ 27,560 $ 27,282 $ 20,352 State 8,061 7,881 5,783 -------- -------- -------- 35,621 35,163 26,135 -------- -------- -------- Deferred, net- Federal (5,096) 272 6,222 State (1,535) 124 1,922 -------- -------- -------- (6,631) 396 8,144 -------- -------- -------- Investment tax credit amortization (2,331) (2,138) (1,688) -------- -------- -------- Total provision for income taxes $ 26,659 $ 33,421 $ 32,591 ======== ======== ======== INCOME STATEMENT CLASSIFICATION OF PROVISION FOR INCOME TAXES: Operating expenses $ 25,555 $ 29,907 $ 31,118 Other income 1,104 3,514 1,473 -------- -------- -------- Total provision for income taxes $ 26,659 $ 33,421 $ 32,591 ======== ======== ======== RECONCILIATION OF FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE TO TOTAL PROVISION FOR INCOME TAXES: Book income before provision for income taxes $ 58,131 $ 74,008 $ 71,521 ======== ======== ======== Federal income tax expense at statutory rate $ 20,346 $ 25,903 $ 25,032 Increases (reductions) in taxes resulting from: State income taxes, net of federal income tax benefit 4,242 5,203 5,008 Amortization of investment tax credits (2,331) (2,138) (1,688) Amortization of tax regulatory assets 4,554 4,423 4,398 Other, net (152) 30 (159) -------- -------- -------- Total provision for income taxes $ 26,659 $ 33,421 $ 32,591 ======== ======== ======== ACCUMULATED DEFERRED INCOME TAXES AT DECEMBER 31: Property basis differences $172,094 $178,886 $178,589 Allowance for equity funds used during construction 29,875 33,677 38,894 Deferred nuclear expense 7,163 8,031 8,681 Customer receivables for future income taxes 37,954 40,901 43,801 Unamortized investment tax credits (10,681) (11,635) (12,510) Other 3,547 3,916 3,003 -------- -------- -------- Net deferred income tax liability $239,952 $253,776 $260,458 ======== ======== ======== The accompanying Notes to Financial Statements are an integral part of these statements.
NOTES TO FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The Company, a wholly owned subsidiary of Ohio Edison Company (Edison), 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 generally accepted accounting principles requires management to make periodic estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. 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 western 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 located in the Company's service area and sales to wholesale customers. There was no material concentration of receivables at December 31, 1997 or 1996, with respect to any particular segment of the Company's customers. REGULATORY PLAN- The Company's Rate Stability and Economic Development Plan was approved by the PPUC in the second quarter of 1996. The regulatory plan initially maintains current base electric rates for the Company through June 20, 2006, and revised the Company's fuel cost recovery method. All of the Company's regulatory assets are being recovered under provisions of the regulatory plan. In addition, the PPUC has authorized the Company to recognize additional capital recovery related to its generating assets (which is reflected as additional depreciation expense) and additional amortization of regulatory assets during the regulatory plan period of at least $358 million more than the amounts that would have been recognized if the regulatory plan was not in effect. These additional amounts are being recovered through current rates. In December 1996, Pennsylvania enacted "The Electricity Generation Customer Choice and Competition Act," which permitted customers, including the Company's customers, to choose their electric generation supplier, while transmission and distribution services will continue to be supplied by their current providers. On September 30, 1997, the Company filed a restructuring plan with the PPUC. The plan describes how the Company will restructure its rates and provide customers with direct access to alternative electricity suppliers; customer choice is to be phased in over three years beginning in 1999, after completion of a two-year pilot program. The Company also plans to sell electricity and energy-related services in its own territory and throughout Pennsylvania as an alternative supplier through its nonregulated subsidiary, Penn Power Energy. Through the restructuring plan, the Company is seeking recovery of $293 million of stranded costs through a competitive transition charge starting in 1999 and ending in 2005, which is consistent with the regulatory plan. The PPUC plans to hold public hearings on the Company's restructuring plan early in 1998. UTILITY PLANT AND DEPRECIATION--Utility plant reflects the original cost of construction, including payroll and related costs such as taxes, employee benefits, administrative and general costs and financing costs (allowance for funds used during construction). The Company provides for depreciation on a straight- line basis at various rates over the estimated lives of property included in plant in service. The annual composite rate for electric plant was approximately 2.7% in 1997, 1996 and 1995. In addition to the straight-line depreciation recognized in 1977 and 1996, the Company also recognized additional capital recovery of $27 million and $20 million, respectively, as additional depreciation expense in accordance with the regulatory plan. Annual depreciation expense includes approximately $3.0 million for future decommissioning costs applicable to the Company's ownership interest in two nuclear generating units. The Company's share of the future obligation to decommission these units is approximately $83 million in current dollars and (using a 3.5% escalation rate) approximately $181 million in future dollars. The estimated obligation and the escalation rate were developed based on site specific studies. Payments for decommissioning are expected to begin in 2016, when actual decommissioning work begins. The Company has recovered approximately $8 million for decommissioning through its electric rates from customers through December 31, 1997. If the actual costs of decommissioning the units exceed the funds accumulated from investing amounts recovered from customers, the Company expects that additional amount to be recoverable from its customers. The Company has approximately $10.3 million invested in external decommissioning trust funds as of December 31, 1997. Earnings on these funds are reinvested with a corresponding increase to the decommissioning liability. The Company has also recognized an estimated liability of approximately $3.3 million related to decontamination and decommissioning of nuclear enrichment facilities operated by the United States Department of Energy (DOE), as required by the Energy Policy Act of 1992. The Financial Accounting Standards Board (FASB) issued a proposed accounting standard for nuclear decommissioning costs in February 1996. If the standard is adopted as proposed: (1) annual provisions for decommissioning could increase; (2) the net present value of estimated decommissioning costs could be recorded as a liability; and (3) income from the external decommissioning trusts could be reported as investment income. The FASB indicated in October 1997 that it plans to continue work on the proposal. COMMON OWNERSHIP OF GENERATING FACILITIES--The Company and other Central Area Power Coordination Group (CAPCO) companies own, as tenants in common, various power generating facilities. Each of the companies is obligated to pay a share of the costs associated with any jointly owned facility in the same proportion as its interest. The Company's portion of operating expenses associated with jointly owned facilities is included in the corresponding operating expenses on the Statements of Income. The amounts reflected on the Balance Sheet under utility plant at December 31, 1997, include the following: Utility Accumulated Construc- Company's Plant Provision tion Owner- Generating in for Work in ship Units Service Depreciation Progress Interest - ----------------------------------------------------------------- (In millions) W. H. Sammis #7 $ 57.6 $ 20.7 $ .2 20.80% Bruce Mansfield #1, #2 and #3 93.7 45.9 .5 5.76% Beaver Valley #1 227.2 102.0 1.0 17.50% Perry #1 341.4 124.8 - 5.24% - --------------------------------------------------------------- Total $719.9 $293.4 $1.7 - --------------------------------------------------------------- NUCLEAR FUEL--OES Fuel, Incorporated (OES Fuel), a wholly owned subsidiary of Edison, is the sole lessor for the Company's nuclear fuel requirements. Minimum lease payments during the next five years are estimated to be as follows: (In millions) - ------------------------------------------------------------ 1998 $7.0 1999 4.0 2000 3.0 2001 1.4 2002 0.5 - ------------------------------------------------------------ The Company amortizes the cost of nuclear fuel based on the rate of consumption. The Company's electric rates include amounts for the future disposal of spent nuclear fuel based upon the formula used to compute payments to the DOE. INCOME TAXES--Details of the total provision for income taxes are shown on the 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. The Company is included in Edison's consolidated federal income tax return. The consolidated tax liability is allocated on a "stand-alone" company basis, with the Company recognizing any tax losses or credits it contributed to the consolidated return. RETIREMENT BENEFITS--The Company's trusteed, noncontributory defined benefit pension plan covers almost all full-time employees. Upon retirement, employees receive a monthly pension based on length of service and compensation. The Company uses the projected unit credit method for funding purposes and was not required to make pension contributions during the three years ended December 31, 1997. The following sets forth the funded status of the plan and amounts recognized on the Balance Sheets as of December 31: 1997 1996 - --------------------------------------------------------------- (In millions) Actuarial present value of benefit obligations: Vested benefits $115.2 $ 94.7 Nonvested benefits 6.8 8.2 - --------------------------------------------------------------- Accumulated benefit obligation $122.0 $102.9 =============================================================== Plan assets at fair value $172.1 $150.5 Actuarial present value of projected benefit obligation 142.4 122.8 - --------------------------------------------------------------- Plan assets in excess of projected benefit obligation 29.7 27.7 Unrecognized net gain (25.7) (21.8) Unrecognized prior service cost 4.2 4.1 Unrecognized net transition asset (5.3) (6.3) - --------------------------------------------------------------- Net pension asset $ 2.9 $ 3.7 =============================================================== The assets of the plan consist primarily of common stocks, United States government bonds and corporate bonds. Net pension costs for the three years ended December 31, 1997, were computed as follows: 1997 1996 1995 - -------------------------------------------------------------- (In millions) Service cost-benefits earned during the period $ 2.7 $ 3.2 $ 2.9 Interest on projected benefit obligation 8.9 9.5 8.8 Return on plan assets (30.0) (22.5) (31.0) Net deferral 14.3 9.6 19.1 Voluntary early retirement program expense 5.8 - - Gain on plan curtailment - (4.3) - - ------------------------------------------------------------- Net pension cost $ 1.7 $ (4.5) $ (.2) ============================================================= The assumed discount rates used in determining the actuarial present value of the projected benefit obligation were 7.25% in 1997 and 7.5% in 1996 and 1995. The assumed rates of increase in future compensation levels used to measure this obligation were 4.0% in 1997 and 4.5% in 1996 and 1995. Expected long-term rates of return on plan assets were assumed to be 10% in 1997, 1996 and 1995. 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. In accordance with Statement of Financial Accounting Standards (SFAS) No. 88 "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," the 1996 net pension costs shown above and the 1996 postretirement benefit costs shown below included curtailment effects (significant changes in projected plan assumptions) relating to the pension and postretirement benefit plans. The employee terminations in connection with the Company's 1996 restructuring activities represented a plan curtailment that significantly reduced the expected future employee service years and the related accrual of defined pension and postretirement benefits. In the pension plan, the reduction in the benefit obligation increased the net pension asset and was shown as a plan curtailment gain. In the postretirement benefit plan, the unrecognized prior service cost associated with service years no longer expected to be rendered as a result of the terminations, was shown as a plan curtailment loss. The following sets forth the funded status of the plan and amounts recognized on the Balance Sheets as of December 31: 1997 1996 - ------------------------------------------------------------ (In millions) Accumulated postretirement benefit obligation allocation: Retirees $26.0 $24.4 Fully eligible active plan participants 3.8 2.2 Other active plan participants 17.5 17.1 - ------------------------------------------------------------ Accumulated postretirement benefit obligation 47.3 43.7 Plan assets at fair value .3 .2 - ------------------------------------------------------------ Accumulated postretirement benefit obligation in excess of plan assets 47.0 43.5 Unrecognized transition obligation (17.4) (18.5) Unrecognized net loss (4.3) (3.0) - ------------------------------------------------------------ Net postretirement benefit liability $25.3 $22.0 ============================================================ Net periodic postretirement benefit costs for the three years ended December 31, 1997 were computed as follows: 1997 1996 1995 - ---------------------------------------------------------------- (In millions) Service cost-benefits attributed to the period $0.9 $1.1 $1.1 Interest cost on accumulated benefit obligation 3.2 3.2 4.0 Amortization of transition obligation 1.2 1.3 1.7 Amortization of loss - .1 .1 Voluntary early retirement program expense 0.3 - - Loss on plan curtailment - 3.5 - - ---------------------------------------------------------------- Net periodic postretirement benefit cost $5.6 $9.2 $6.9 ================================================================ The health care trend rate assumption is 6.0% in the first year gradually decreasing to 4.0% for the year 2008 and later. The discount rates used to compute the accumulated postretirement benefit obligation were 7.25% in 1997 and 7.5% in 1996 and 1995. An increase in the health care trend rate assumption by one percentage point in all years would increase the accumulated postretirement benefit obligation by approximately $7.0 million and the aggregate annual service and interest costs by approximately $0.7 million. TRANSACTIONS WITH AFFILIATED COMPANIES- Transactions with affiliated companies are included on the Statements of Income as follows: 1997 1996 1995 - -------------------------------------------------------------- (In millions) Operating revenues: Electric sales $ 6.1 $ 3.6 $ 4.4 Bruce Mansfield Plant administrative and general charges to affiliates .9 - 6.1 Other transactions .4 .4 .3 - -------------------------------------------------------------- $7.4 $ 4.0 $10.8 ============================================================== Fuel and purchased power: Purchased power $12.7 $13.2 $15.1 Nuclear fuel leased from OES Fuel 7.5 9.6 12.0 - -------------------------------------------------------------- $20.2 $22.8 $27.1 ============================================================== Other operating costs: Rental of transmission lines $1.0 $ 1.0 $ 1.0 Data processing services from OE 2.9 2.5 2.6 Other transactions 4.4 3.9 4.0 - -------------------------------------------------------------- $ 8.3 $ 7.4 $ 7.6 ============================================================== 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 Balance Sheets. The Company reflects temporary cash investments at cost, which approximates their market value. Noncash financing and investing activities included capital lease transactions amounting to $8.5 million, $4.1 million and $3.7 million for the years 1997, 1996 and 1995, respectively. All borrowings with initial maturities of less than one year are defined as financial instruments under generally accepted accounting principles and are reported on the Balance Sheets at cost, which approximates their fair market value. The following sets forth the approximate fair value and related carrying amounts of all other long-term debt, preferred stock subject to mandatory redemption and investments other than cash and cash equivalents as of December 31: 1997 1996 - ------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value -------- ----- -------- ----- (In millions) Long-term debt $277 $291 $300 $302 - ------------------------------------------------------------ Preferred stock $ 15 $ 15 $ 15 $ 14 - ------------------------------------------------------------ Investments other than cash and cash equivalents $ 14 $ 15 $ 8 $ 9 - ------------------------------------------------------------ The fair values of long-term debt and preferred stock reflect the present value of the cash outflows relating to those securities based on the current call price, the yield to maturity or the yield to call, as deemed appropriate at the end of each respective year. The yields assumed were based on securities with similar characteristics offered by a corporation with credit ratings similar to the Company's ratings. The fair value of investments other than cash and cash equivalents represent cost (which approximates fair value) or the present value of the cash inflows based on the yield to maturity. The yields assumed were based on financial instruments with similar characteristics and terms. Investments other than cash and cash equivalents consist primarily of decommissioning trust investments. Unrealized gains and losses applicable to the decommissioning trust have been recognized in the trust investment with a corresponding change to the decommissioning liability. The Company has no securities held for trading purposes. REGULATORY ASSETS--The Company recognizes, as regulatory assets, costs which the FERC and PPUC have authorized for recovery from customers in future periods. Without such authorization, the costs would have been charged to income as incurred. All regulatory assets are being recovered from customers under the Company's regulatory plan. Based on the regulatory plan, at this time, the Company believes it will continue to be able to bill and collect cost- based rates; accordingly, it is appropriate that the Company continues application of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). However, based on the regulatory environment in Pennsylvania, the Company is expected to discontinue its application of SFAS 71 for its generation operations, possibly as early as 1998. The impact of the Company discontinuing SFAS 71 is not expected to be material. The Company recognized additional cost recovery of $11 million and $8 million in 1997 and 1996, respectively, as additional regulatory asset amortization in accordance with its regulatory plan. Regulatory assets on the Balance Sheets are comprised of the following: 1997 1996 - ------------------------------------------------------------- (In millions) Customer receivables for future income taxes $ 92.6 $ 99.8 Nuclear unit expenses 17.5 19.6 Perry Unit 2 termination 36.7 40.4 Loss on reacquired debt 9.2 9.8 DOE decommissioning and decontamination costs 3.6 3.9 Deferred fuel costs 3.4 3.8 - ----------------------------------------------------------- Total $163.0 $177.3 =========================================================== 2. LEASES: The Company leases certain transmission facilities, office space and other property and equipment under cancelable and noncancelable leases. Consistent with the regulatory treatment, the rental payments for capital and operating leases are charged to operating expenses on the Statements of Income. Such costs for the three years ended December 31, 1997, are summarized as follows: 1997 1996 1995 - ----------------------------------------------------------- (In millions) Operating leases Interest element $ .5 $ .5 $ .3 Other 1.5 1.3 1.0 Capital leases Interest element .7 .7 .8 Other .8 .9 1.3 - ----------------------------------------------------------- Total rental payments $3.5 $3.4 $3.4 =========================================================== The future minimum lease payments as of December 31, 1997, are: Capital Operating Leases Leases - ------------------------------------------------------------ (In millions) 1998 $ 1.5 $ .2 1999 1.2 .2 2000 1.1 .2 2001 1.0 .2 2002 1.0 .2 Years thereafter 10.6 3.2 - ---------------------------------------------------------- Total minimum lease payments 16.4 $4.2 ==== Executory costs 3.5 - ------------------------------------------------ Net minimum lease payments 12.9 Interest portion 7.9 - ------------------------------------------------ Present value of net minimum lease payments 5.0 Less current portion .6 - ------------------------------------------------ Noncurrent portion $ 4.4 ================================================ 3. CAPITALIZATION: a. RETAINED EARNINGS--Under the Company's Charter, the Company's retained earnings unrestricted for payment of cash dividends on the Company's common stock were $92.1 million at December 31, 1997. b. PREFERRED STOCK--The Company's 7.75% series of preferred stock has restrictions which prevent early redemption prior to July 2003. All other preferred stock may be redeemed by the Company in whole, or in part, with 30-60 days' notice. c. PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION--The Company's 7.625% series has an annual sinking fund requirement for 7,500 shares beginning on October 1, 2002. d. LONG-TERM DEBT--The first mortgage indenture and its supplements, which secure all of the Company's first mortgage bonds, serves as a direct first mortgage lien on substantially all property and franchises, other than specifically excepted property, owned by the Company. Long-term debt maturities (excluding capital leases) during the next five years are $0.9 million in 1998, $0.5 million in 1999, $24.0 million in 2000, $1.0 million in 2001 and $1.0 million in 2002. The Company's obligations to repay certain pollution control revenue bonds are secured by series of first mortgage bonds and, in some cases, by subordinate liens on the related pollution control facilities. 4. SHORT-TERM FINANCING ARRANGEMENTS: The Company has lines of credit with banks that provide for borrowings of up to $2 million under various interest rate options. Short-term borrowings may be made under these lines of credit on the Company's unsecured notes. To assure the availability of these lines, the Company is required to pay annual commitment fees of 0.50%. These lines expire at various times during 1998. The Company also has a credit agreement with Edison whereby either company can borrow funds from the other by issuing unsecured notes at the prevailing prime or similar interest rate. Under the terms of this agreement the maximum borrowing is limited only by the availability of funds; however, the Company's borrowing under this agreement is currently limited by the PPUC to a total of $50 million. Either company can terminate the agreement with six months' notice. 5. COMMITMENTS, GUARANTEES AND CONTINGENCIES: CAPITAL EXPENDITURES--The Company's current forecast reflects expenditures of approximately $90 million for property additions and improvements from 1998 through 2002, of which approximately $18 million is applicable to 1998. Investments for additional nuclear fuel during the 1998-2002 period are estimated to be approximately $37 million, of which approximately $2 million applies to 1998. During the same periods, the Company's nuclear fuel investments are expected to be reduced by approximately $32 million and $7 million, respectively, as the nuclear fuel is consumed. NUCLEAR INSURANCE--The Price-Anderson Act limits the public liability relative to a single incident at a nuclear power plant to $8.92 billion. The amount is covered by a combination of private insurance and an industry retrospective rating plan. Based on its present ownership interests in Beaver Valley Unit 1 and the Perry Plant, the Company's maximum potential assessment under the industry retrospective rating plan (assuming the other CAPCO companies were to contribute their proportionate share of any assessments under the retrospective rating plan) would be $18 million per incident but not more than $2.3 million in any one year for each incident. The Company is also insured as to its interest in Beaver Valley Unit 1 and the Perry Plant under policies issued to the operating company for each plant. Under these policies, up to $2.75 billion is provided for property damage and decontamination and decommissioning costs. The Company has also obtained approximately $53 million of insurance coverage for replacement power costs for its interests in Perry and Beaver Valley Unit 1. Under these policies, the Company can be assessed a maximum of approximately $2.3 million for incidents at any covered nuclear facility occurring during a policy year which are in excess of accumulated funds available to the insurer for paying losses. The Company intends to maintain insurance against nuclear risks as described above so long as it is available. To the extent that replacement power, property damage, decontamination, decommissioning, repair and replacement costs and other such costs arising from a nuclear incident at any of the Company's plants exceed the policy limits of the insurance in effect with respect to that plant, to the extent a nuclear incident is determined not to be covered by the Company's insurance policies, or to the extent such insurance becomes unavailable in the future, the Company would remain at risk for such costs. GUARANTEES--The Company, together with the other CAPCO companies, has severally guaranteed certain debt and lease obligations in connection with a coal supply contract for the Bruce Mansfield Plant. As of December 31, 1997, the Company's share of the guarantee (which approximates fair market value) was $5.5 million. The price under the coal supply contract, which includes certain minimum payments, has been determined to be sufficient to satisfy the debt and lease obligations. The Company's total payments under the coal supply contract amounted to $13.3 million, $11.1 million and $9.8 million during 1997, 1996, and 1995, respectively. The Company's minimum annual payments are approximately $4 million under the contract, which expires December 31, 1999. ENVIRONMENTAL MATTERS- Various federal, state and local authorities regulate the Company with regard to air and water quality and other environmental matters. The Company has estimated additional capital expenditures for environmental compliance of approximately $2 million, which is included in the construction forecast under "Construction Program" for 1998 through 2002. The Company is in compliance with the current sulfur dioxide (SO2) and nitrogen oxides (NOX) reduction requirements under the Clean Air Act Amendments of 1990. SO2 reductions through the year 1999 will be achieved by burning lower-sulfur fuel, generating more electricity from lower-emitting plants, and/or purchasing emission allowances. Plans for complying with the reductions required for the year 2000 and thereafter have not been finalized. The Environmental Protection Agency is conducting additional studies which could indicate the need for additional NOX reductions from the Company's Pennsylvania facilities by the year 2003. In addition, the EPA is also considering the need for additional NOX reductions from the Company's Ohio facilities. On November 7, 1997, the EPA proposed uniform reductions of NOX emissions across a region of twenty-two states, including Ohio and the District of Columbia (NOX Transport Rule) after determining that such NOX emissions are contributing significantly to ozone pollution in the eastern United States. In a separate but related action, eight states filed petitions with the EPA under Section 126 of the Clear Air Act seeking reductions of NOX emissions which are alleged to contribute to ozone pollution in the eight petitioning states. A December 1997 EPA Memorandum of Agreement proposes to finalize the NOX Transport Rule by September 30, 1998 and establishes a schedule for EPA action on the Section 126 petitions. The cost of NOX reductions, if required, may be substantial. The Company continues to evaluate its compliance plan and other compliance options. Legislative, administrative and judicial actions will continue to change the way that the Company must operate in order to comply with environmental laws and regulations. With respect to any such changes and to the environmental matters described above, the Company expects that any resulting additional capital costs which may be required, as well as any required increase in operating costs, would ultimately be recovered from its customers. 6. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED): The following summarizes certain operating results by quarter for 1997 and 1996. March 31, June 30, Sept. 30, Dec. 31, Three Months Ended 1997 1997 1997 1997 - ----------------------------------------------------------------- (In millions) Operating Revenues $79.0 $79.2 $85.2 $79.9 Operating Expenses and Taxes 65.4 66.2 69.6 71.4 - ----------------------------------------------------------------- Operating Income 13.6 13.0 15.6 8.5 Other Income .7 .3 .8 .9 Net Interest 5.7 5.5 5.5 5.2 - ----------------------------------------------------------------- Net Income $8.6 $7.8 $10.9 $ 4.2 ================================================================= Earnings on Common Stock $7.4 $6.6 $ 9.7 $ 3.1 ================================================================= March 31, June 30, Sept. 30, Dec. 31, Three Months Ended 1996 1996 1996 1996 - ----------------------------------------------------------------- (In millions) Operating Revenues $80.3 $81.3 $80.5 $80.5 Operating Expenses and Taxes 60.4 66.3 66.4 67.2 - ----------------------------------------------------------------- Operating Income 19.9 15.0 14.1 13.3 Other Income .3 3.9 .9 .6 Net Interest 7.2 6.9 6.9 6.5 - ----------------------------------------------------------------- Net Income $13.0 $12.0 $ 8.1 $ 7.4 ================================================================= Earnings on Common Stock $11.9 $10.9 $ 7.0 $ 6.2 ================================================================= REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Pennsylvania Power Company: We have audited the accompanying balance sheets and statements of capitalization of Pennsylvania Power Company (a Pennsylvania corporation and wholly owned subsidiary of Ohio Edison Company) as of December 31, 1997 and 1996, and the related statements of income, retained earnings, capital stock and other paid-in capital, cash flows and taxes for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pennsylvania Power Company as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Arthur Andersen LLP Cleveland, Ohio February 13, 1998 EX-23.3 21 EXHIBIT 23.3 PENNSYLVANIA POWER COMPANY CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K, into Pennsylvania Power Company's previously filed Registration Statements, File No. 33-47372, No. 33-62450 and No. 33-65156. ARTHUR ANDERSEN LLP Cleveland, Ohio March 30, 1998 EX-27.4 22
UT (AMOUNTS IN 1,000'S, EXCEPT EARNINGS PER SHARE) INCOME TAX EXPENSE INCLUDES $1,104,000 RELATED TO OTHER INCOME. 0000077278 PENNSYLVANIA POWER COMPANY 1,000 US DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 PER-BOOK 742,796 26,157 95,799 169,705 0 1,034,457 188,700 (400) 103,677 291,977 15,000 50,905 289,305 0 0 0 850 0 0 7,551 378,869 1,034,457 323,381 26,659 247,090 272,645 50,736 2,760 53,496 22,024 31,472 4,626 26,846 21,386 20,458 88,751 0 0

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