FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JuneSeptember 30, 1998
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 34-0150020
ILLUMINATING COMPANY
(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
Indicate by check mark whether each of the registrants
(1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -------- ---
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date:
OUTSTANDING
CLASS AS OF AUGUST 12,NOVEMBER 13, 1998
----- --------------------------------------------
FirstEnergy Corp., $.10 par value 237,069,087
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.
This combined Form 10-Q 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.
This Form 10-Q 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 factorsfactors.
TABLE OF CONTENTS
Pages
Part I. Financial Information
Notes to Financial Statements 1-31-4
FirstEnergy Corp.
Consolidated Statements of Income 45
Consolidated Balance Sheets 5-66-7
Consolidated Statements of Cash Flows 78
Report of Independent Public Accountants 89
Management's Discussion and Analysis of
Results of Operations and Financial Condition 9-1110-14
Ohio Edison Company
Consolidated Statements of Income 1215
Consolidated Balance Sheets 13-1416-17
Consolidated Statements of Cash Flows 1518
Report of Independent Public Accountants 1619
Management's Discussion and Analysis of Results
of Operations and Financial Condition 17-1820-23
The Cleveland Electric Illuminating Company
Consolidated Statements of Income 1924
Consolidated Balance Sheets 20-2125-26
Consolidated Statements of Cash Flows 2227
Report of Independent Public Accountants 2328
Management's Discussion and Analysis of Results
of Operations and Financial Condition 24-2529-32
The Toledo Edison Company
Consolidated Statements of Income 2633
Consolidated Balance Sheets 27-2834-35
Consolidated Statements of Cash Flows 29
Report of Independent Public Accountants 30
Management's Discussion and Analysis of
Results of Operations and Financial Condition 31-32
Pennsylvania Power Company
Statements of Income 33
Balance Sheets 34-35 Statements of Cash Flows 36
Report of Independent Public Accountants 37
Management's Discussion and Analysis of Results
of Operations and Financial Condition 38-3938-41
Pennsylvania Power Company
Statements of Income 42
Balance Sheets 43-44
Statements of Cash Flows 45
Report of Independent Public Accountants 46
Management's Discussion and Analysis of Results
of Operations and Financial Condition 47-49
Part II. Other Information
PART I. FINANCIAL INFORMATION
- ------------------------------
FIRSTENERGY CORP. AND SUBSIDIARIES
OHIO EDISON COMPANY AND SUBSIDIARIES
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
THE TOLEDO EDISON COMPANY AND SUBSIDIARY
PENNSYLVANIA POWER COMPANY
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1 - FINANCIAL STATEMENTS:
FirstEnergy Corp. (FirstEnergy) became a holding company
on November 8, 1997, in connection with the merger of Ohio Edison
Company (OE) and Centerior Energy Corporation (Centerior).
FirstEnergy'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), The Toledo Edison
Company (TE) and Pennsylvania Power Company (Penn). These utility
subsidiaries are referred to throughout as "Companies." Penn is a
wholly owned subsidiary of OE. Prior to the merger in November
1997, CEI and TE were the principal operating subsidiaries of
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 CEI's and
TE's financial statements 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 of CEI and TE (separated by a heavy black line) are
presented.
The condensed financial statements of FirstEnergy and
each of the Companies reflect all normal recurring adjustments
that, in the opinion of management, are necessary to fairly
present results of operations for the interim periods. These
statements should be read in connection with the financial
statements and notes included in the combined Annual Report on
Form 10-K for the year ended December 31, 1997 for FirstEnergy and
the Companies. The reported results of operations are not
indicative of results of operations for any future period.
The sole assets of the subsidiary trust that is the
obligor on the preferred securities included in FirstEnergy's and
OE's capitalization are $123,711,350 principal amount of 9% Junior
Subordinated Debentures of OE due December 31, 2025.
2 - COMMITMENTS, GUARANTEES AND CONTINGENCIES:
CAPITAL EXPENDITURES-
FirstEnergy's current forecast reflects expenditures of
approximately $1.2 billion (OE-$510 million, CEI-$430 million, TE-
$200 million and Penn-$90 million) for property additions and
improvements related to its regulated businesses from 1998-2002,
of which approximately $281$282 million (OE-$134133 million, CEI-
$87million,$89
million, TE-$4243 million and Penn-$1817 million) is applicable to
1998. Investments for additional nuclear fuel during the 1998-2002
period are estimated to be approximately $518 million (OE-$169
million, CEI-$172 million, TE-$140 million and Penn-$37 million),
of which approximately $85 million (OE-$24 million, CEI-$32
million, TE-$27 million and Penn-$2 million) applies to 1998.
FirstEnergy also expects to invest approximately $300 million
during 1998-2002 relating to various nonregulated business
ventures.
GUARANTEES-
The Companies and Duquesne Light Company have each
severally guaranteed certain debt and lease obligations in
connection with a coal supply contract for the Bruce Mansfield
Plant. As of JuneSeptember 30, 1998, the Companies' share of the
guarantees was $46.6$43.2 million (OE-$26.924.8 million, CEI-$10.09.3 million,
TE-$5.85.5 million and Penn-$3.93.6 million). The price under the coal
supply contract, which includes certain minimum payments, has
- 1 -
been determined to be sufficient to satisfy the debt and lease
obligations.
- 1 -
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 (OE-$25 million, CEI-$12 million, TE-$11 million and Penn-
$2 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. TheIn September 1998, 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 forfinalized regulations requiring additional NOx reductions
from the Companies' Ohio facilities. On
November 7, 1997, the EPA proposedand Pennsylvania facilities by May 2003.
The EPA`s NOx Transport Rule imposes uniform reductions of NOx
emissions across a region of twenty-two states including Ohio and the District of
Columbia, (NOx Transport Rule) after determiningincluding Ohio and Pennsylvania, based on a conclusion
that such NOx emissions are contributing significantly to ozone
pollution in the eastern United States. By September 1999, each of
the twenty-two states are required to submit revised State
Implementation Plans (SIP) which comply with individual state NOx
budgets established by the EPA. These state NOx budgets
contemplate an 85% reduction in utility plant NOx emissions from
1990 emissions. A proposed Federal Implementation Plan accompanied
the NOx Transport Rule and may be implemented by the EPA in states
which fail to revise their SIP. In aanother 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 1997The EPA Memorandumsuggests that the Section 126
petitions will be adequately addressed by the NOx Transport
Program, but a September 1998 proposed rulemaking established an
alternative program which would require nearly identical 85% NOx
reductions at the Companies' Ohio and Pennsylvania plants by May
2003 in the event implementation 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.is
delayed. The Companies continue to evaluate their compliance plans
and other compliance options.options and currently estimate the additional
capital expenditures for NOx reductions may reach $500 million.
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.
In July 1997, the 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.
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 of $4.8 million and $1.0 million,
respectively, as of JuneSeptember 30, 1998, 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.
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
- 2 -
required increase in operating costs, would ultimately be
recovered from their customers.
3.PENDING EXCHANGE OF ASSETS-
As discussed under "Item 5. Other Events" in the
combined Current Report on Form 8-K dated October 15, 1998,
FirstEnergy announced that it has signed an agreement in principle
with Duquesne Light Company (Duquesne) that would result in the
transfer of 1,436 megawatts owned by Duquesne at eight generating
units in exchange for 1,298 megawatts at three power plants owned
by the Companies. A definitive agreement on the exchange of
assets, which will be structured as a tax-free transaction to the
extent possible, is expected by the end of 1998. Duquesne will
fund decommissioning costs equal to its percentage interest in the
three nuclear generating units to be transferred. The asset
transfer is expected to take twelve to eighteen months to close.
3 - REGULATORY ACCOUNTING-
OnACCOUNTING:
In June 18, 1998, the Pennsylvania Public Utility Commission
(PPUC) authorized a rate restructuring plan for Penn, which
essentially resulted in the deregulation of Penn's generation
business. Accordingly, Penn discontinued the application of
Statement of Financial Accounting Standards (SFAS) No. 71,
"Accounting for the Effects of Certain Types of RegulationRegulation" (SFAS
71), for its generation business as of June 30, 1998. In
- 2 -
accordance with SFAS 101, "Regulated Enterprises - Accounting for
the Discontinuation of Application of SFAS 71," Penn was required
to remove from its balance sheet all regulatory assets and
liabilities related to its generation business for which SFAS 71
was discontinued and assess all other assets for impairment.
The Securities and Exchange Commission (SEC) recently
issued interpretive guidance regarding asset impairment
measurement when a regulated enterprise such as an electric
utility discontinues SFAS 71 for separable portions of its
operations and assets. That guidance concludes that any
supplemental regulated cash flows such as a competitive transition
charge (CTC) should be excluded from the cash flows of assets in a
portion of the business not subject to regulatory accounting
practices. If such assets are impaired, a regulatory asset should
be established if such costs are recoverable through regulatory
cash flows. Consistent with the SEC guidance, Penn reduced its
nuclear generating unit investments by approximately $305 million,
of which approximately $227 million was recognized as a regulatory
asset to be recovered through a CTC over a seven-year transition
period. The charge of $51.7 million ($30.5 million after income
taxes) for discontinuing the application of SFAS 71 to Penn's
generation business was recorded as an extraordinary item on
theFirstEnergy's and OE's respective Consolidated StatementStatements of
Income and Penn's Statements of Income.
Based on the current regulatory environment and the
Companies' respective regulatory plans, the Companies believe they
will continue to be able to bill and collect cost-based rates
relating to all of OE's operations, CEI's and TE's nonnuclear
operations, and Penn's nongeneration operations; accordingly, it
is appropriate that the Companies continue the application of SFAS
71 to those respective operations.
4.4 - PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME:
The following pro forma statements of income for
FirstEnergy, CEI and TE for the three months and sixnine months
ended JuneSeptember 30, 1997, give effect to the OE-Centerior merger
as if it had been consummated on January 1, 1997, with the
purchase accounting adjustments actually recognized in the
business combination.
- 3 -
FE CEI TE
-- --- --
(In millions, except per share amounts)
Three Months Ended JuneSeptember 30, 1997
--------------------------------------------------------------------
Operating Revenues $1,200 $428 $222$1,350 $ 499 $241
Operating Expenses and Taxes 955 348 1831,022 365 188
------ ---------- ----
Operating Income 245 80 39328 134 53
Other Income (Expense) 13 (3) 221 10 6
Net Interest Charges 155 55 22170 68 26
------ ---------- ----
Net Income $ 103179 $ 2276 $ 1933
====== ========== ====
Earnings per Share of Common Stock $ .47.81
======
SixNine Months Ended JuneSeptember 30, 1997
------------------------------------------------------------------
Operating Revenues $2,410 $860 $439$3,760 $1,359 $680
Operating Expenses and Taxes 1,920 698 3642,942 1,063 552
------ ---------- ----
Operating Income 490 162 75818 296 128
Other Income (Expense) 26 (3) 347 8 9
Net Interest Charges 308 108 44478 177 69
------ ---------- ----
Net Income $ 208387 $ 51127 $ 3468
====== ========== ====
Earnings per Share of Common Stock $ .94
======
1.74
======
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) the effect of discontinuing SFAS 71 for
CEI's and TE's nuclear operations; (3) amortization of the fair value adjustment for long-term debt;
(4) goodwill recognized representing the excess of CEI's and TE's portion of the purchase price over
the respective company's adjusted net assets; (5) the elimination of merger costs; and (6)
adjustments for estimated tax effects of the above adjustments.
- 34 -
FIRSTENERGY CORP.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended SixNine Months Ended
JuneSeptember 30, JuneSeptember 30,
----------------------------------------- ----------------------
1998 1997 1998 1997
---------- ------------------ ---------- ----------
(In thousands, except per share amounts)
OPERATING REVENUES $1,277,061 $ 593,250 $2,477,054 $1,198,024
---------- --------- ---------- ----------$1,416,741 $652,660 $3,893,795 $1,850,684
OPERATING EXPENSES AND TAXES:
Fuel and purchased power 323,399 100,689 533,092 209,790291,228 111,724 833,412 321,514
Nuclear operating costs 117,050 67,320 247,112 135,843124,508 66,990 365,858 202,833
Other operating costs 229,872 107,079 441,692 195,069225,809 101,937 664,171 297,006
---------- ----------------- ---------- ----------
Total operation and maintenance expenses 670,321 275,088 1,221,896 540,702641,545 280,651 1,863,441 821,353
Provision for depreciation and amortization 166,324 86,615 333,897 186,573162,478 106,402 496,375 292,975
Amortization of net regulatory assets 22,520 7,421 44,377 14,84128,702 11,288 73,079 26,129
General taxes 135,108 55,436 271,482 116,973138,471 58,986 409,953 175,959
Income taxes 61,892 42,736 138,783 86,632125,080 54,277 263,863 140,909
---------- ----------------- ---------- ----------
Total operating expenses and taxes 1,056,165 467,296 2,010,435 945,7211,096,276 511,604 3,106,711 1,457,325
---------- ----------------- ---------- ----------
OPERATING INCOME 220,896 125,954 466,619 252,303320,465 141,056 787,084 393,359
OTHER INCOME (EXPENSE) (6,327) 14,075 15,236 27,570(5,275) 12,035 9,961 39,605
---------- ----------------- ---------- ----------
INCOME BEFORE NET INTEREST CHARGES 214,569 140,029 481,855 279,873315,190 153,091 797,045 432,964
---------- ----------------- ---------- ----------
NET INTEREST CHARGES:
Interest on long-term debt 132,717 51,713 262,331 104,338128,479 50,799 390,810 155,137
Allowance for borrowed funds used during
construction and capitalized interest (1,187) (381) (2,668) (761)(2,461) (1,056) (5,129) (1,817)
Other interest expense 4,622 7,955 10,795 15,6736,513 7,669 17,308 23,342
Subsidiaries' preferred stock dividend requirements 18,46319,568 6,981 27,791 13,96247,359 20,943
---------- ----------------- ---------- ----------
Net interest charges 154,615 66,268 298,249 133,212152,099 64,393 450,348 197,605
---------- ----------------- ---------- ----------
INCOME BEFORE EXTRAORDINARY ITEM 59,954 73,761 183,606 146,661163,091 88,698 346,697 235,359
EXTRAORDINARY ITEM (NET OF INCOME TAXES) (Note 3) (30,522)- - (30,522) -
---------- ----------------- ---------- ----------
NET INCOME $ 29,432163,091 $ 73,76188,698 $ 153,084316,175 $ 146,661235,359
========== ================= ========== ==========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING 223,987 144,468 223,197 144,406
======= ======= ======= =======229,482 144,586 225,292 144,466
========== ======== ========== ==========
BASIC AND DILUTED EARNINGS PER SHARE OF
COMMON STOCK:
BeforeIncome before extraordinary item $ .27.71 $ .51.61 $ .83 $1.021.54 $ 1.63
Extraordinary item (Net of income taxes) (Note 3) (.14)- - (.14) -
----- ----- ------ ------
------ -----
BASIC AND DILUTED EARNINGS PER SHARE OF
COMMON STOCKNet income $ .13.71 $ .51.61 $ .69 $1.021.40 $ 1.63
===== ===== ====== ====== ====== =====
DIVIDENDS DECLARED PER SHARE OF COMMON STOCK $ .375 $ .375 $ .75 $ .75$.375 $.375 $1.125 $1.125
===== ===== ====== ====== ====== =====
The preceding Notes to Financial Statements as they relate to FirstEnergy Corp. are an integral part
of these statements.
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FIRSTENERGY CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
1998 1997
----------- -------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service $14,441,698 $15,008,448
Less--Accumulated provision for depreciation 5,549,051 5,635,900
----------- -----------
8,892,647 9,372,548
----------- -----------
Construction work in progress-
Electric plant 210,275 165,837
Nuclear fuel 31,712 34,825
----------- -----------
241,987 200,662
----------- -----------
9,134,634 9,573,210
----------- -----------
OTHER PROPERTY AND INVESTMENTS:
Capital trust investments 1,332,604 1,370,177
Nuclear plant decommissioning trusts 327,481 301,173
Letter of credit collateralization 277,763 277,763
Other. 594,995 357,989
----------- -----------
2,532,843 2,307,102
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents 70,965 98,237
Receivables-
Customers (less accumulated provisions of
$6,227,000 and $5,618,000, respectively,
for uncollectible accounts) 248,243 284,162
Other (less accumulated provisions of $36,932,000
and $4,026,000,respectively, for uncollectible
accounts) 378,723 219,106
Materials and supplies, at average cost-
Owned 139,558 154,961
Under consignment 112,386 82,839
Prepayments and other 201,418 163,686
----------- ----------
1,151,293 1,002,991
----------- ----------
DEFERRED CHARGES:
Regulatory assets 2,783,213 2,624,144
Goodwill 2,256,883 2,107,795
Property taxes 270,647 270,585
Other 206,176 194,968
----------- -----------
5,516,919 5,197,492
----------- -----------
$18,335,689 $18,080,795
=========== ===========
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FIRSTENERGY CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
------------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service $14,528,550 $15,008,448
Less--Accumulated provision for depreciation 5,738,191 5,635,900
----------- -----------
8,790,359 9,372,548
----------- -----------
Construction work in progress-
Electric plant 254,835 165,837
Nuclear fuel 32,358 34,825
----------- -----------
287,193 200,662
----------- -----------
9,077,552 9,573,210
----------- -----------
OTHER PROPERTY AND INVESTMENTS:
Capital trust investments 1,331,843 1,370,177
Nuclear plant decommissioning trusts 323,252 301,173
Letter of credit collateralization 277,763 277,763
Other 634,662 357,989
----------- -----------
2,567,520 2,307,102
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents 117,671 98,237
Receivables-
Customers (less accumulated provisions of
$6,273,000 and $5,618,000, respectively,
for uncollectible accounts) 266,487 284,162
Other (less accumulated provisions of $49,204,000
and $4,026,000,respectively, for
uncollectible accounts) 407,389 219,106
Materials and supplies, at average cost-
Owned 125,840 154,961
Under consignment 104,811 82,839
Prepayments and other 152,705 163,686
----------- -----------
1,174,903 1,002,991
----------- -----------
DEFERRED CHARGES:
Regulatory assets 2,736,580 2,624,144
Goodwill 2,194,940 2,107,795
Property taxes 270,888 270,585
Other 200,668 194,968
----------- -----------
5,403,076 5,197,492
----------- -----------
$18,223,051 $18,080,795
=========== ===========
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FIRSTENERGY CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
1998 1997
------------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholders' equity-
Common stock, $.10 par value, authorized
300,000,000 shares - 237,069,087 and
230,207,141 shares outstanding, respectively $ 23,707 $ 23,021
Other paid-in capital 3,838,8663,843,946 3,636,908
Retained earnings 632,753709,804 646,646
Unallocated employee stock ownership plan common
stock - 7,663,7457,533,164 and 7,829,538 shares,
respectively (143,864)(141,413) (146,977)
----------- --------------------- ----------
Total common stockholders' equity 4,351,4624,436,044 4,159,598
Preferred stock of consolidated subsidiaries-
Not subject to mandatory redemption 660,195 660,195
Subject to mandatory redemption 199,460193,460 214,864
OE obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely OE
subordinated debentures 120,000 120,000
Long-term debt 6,996,7966,606,324 6,969,835
----------- -----------
12,327,91312,016,023 12,124,492
----------- -----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock 407,184602,926 470,436
Short-term borrowings 202,738348,450 302,229
Accounts payable 506,476262,197 312,690
Accrued taxes 386,295460,008 381,937
Accrued interest 144,767148,336 147,694
Other 197,420258,186 193,850
----------- -----------
1,844,8802,080,103 1,808,836
----------- -----------
DEFERRED CREDITS:
Accumulated deferred income taxes 2,286,3852,265,548 2,304,305
Accumulated deferred investment tax credits 296,886291,044 324,200
Pensions and other postretirement benefits 509,850518,588 492,425
Other 1,069,7751,051,745 1,026,537
----------- -----------
4,162,8964,126,925 4,147,467
----------- -----------
COMMITMENTS, GUARANTEES AND
CONTINGENCIES (Note 2) ----------- -----------
$18,335,689$18,223,051 $18,080,795
=========== ===========
The preceding Notes to Financial Statements as they relate to FirstEnergy Corp. are an integral part
of these balance sheets.
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FIRSTENERGY CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended SixNine Months Ended
JuneSeptember 30, JuneSeptember 30,
-------------------- --------------------------------------- ----------------------
1998 1997 1998 1997
---------- -------- -------- -------- ------------------ ----------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 29,432163,091 $ 73,76188,698 $ 153,084 $146,661316,175 $ 235,359
Adjustments to reconcile net income to net
cash from operating activities-
Provision for depreciation and amortization 166,324 86,615 333,897 186,573162,478 106,402 496,375 292,975
Nuclear fuel and lease amortization 16,319 14,297 40,632 28,64221,974 12,040 62,606 40,682
Other amortization, net 12,838 7,119 34,423 14,22928,214 10,996 62,637 25,225
Deferred income taxes, net (24,953) (8,255) (15,251) (16,696)8,395 (14,796) (6,856) (31,492)
Investment tax credits, net (5,568) (3,338) (11,339) (7,164)(5,841) (4,058) (17,180) (11,222)
Extraordinary item 51,730- - 51,730 -
Receivables 48,421 6,612 88,486 23,964(192,236) (3,405) (103,750) 20,559
Materials and supplies 197 (10,613) (9,797) (9,561)21,275 (135) 11,478 (9,696)
Accounts payable 1,526 9,176 (35,149) 5,312(97,985) (9,219) (133,134) (3,907)
Accrued liabilities 171,765 25,702 82,871 75,731
Other (17,520) (16,075) (98,458) 1,134(15,648) 20,132 (25,212) (28,763)
--------- ----------------- --------- --------
Net cash provided from operating activities 278,746 159,299 532,258 373,094265,482 232,357 797,740 605,451
--------- ----------------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Common stock 203,855- - 203,855 -
Long-term debt 114,286 41,318 262,405 70,52310,151 9,694 272,556 80,217
Ohio Schools Council Prepayment Program - - 116,598 -
116,598Short-term borrowings, net 145,612 - 37,169 -
Redemptions and Repayments-
Preferred stock 15,379 - 15,379 -6,000 5,000 21,379 5,000
Long-term debt 189,930 104,056 349,911 216,543209,963 121,163 559,874 337,706
Short-term borrowings, net 87,599 13,996 108,443 43,503- 10,303 - 53,806
Common stock dividend payments 83,586 56,419 166,977 109,96086,040 53,109 253,017 163,069
--------- ----------------- --------- --------
Net cash provided from (used for)used for financing activities 58,245 (133,153) (57,852) (299,483)146,240 179,881 204,092 479,364
--------- ----------------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions 307,120 29,196 371,224 63,57776,614 52,147 447,838 115,724
Cash investments 66(205) - 111,610111,405 -
Other 7,685 1,748 18,844 4,798(3,873) 2,374 14,971 7,172
--------- -------- --------- --------- --------
Net cash used for investing activities 314,871 30,944 501,678 68,37572,536 54,521 574,214 122,896
--------- -------- --------- --------- --------
Net increase (decrease) in cash and cash equivalents 22,120 (4,798) (27,272) 5,23646,706 (2,045) 19,434 3,191
Cash and cash equivalents at beginning of period 48,845 15,28770,965 10,489 98,237 5,253
--------- ----------------- --------- --------
Cash and cash equivalents at end of period $ 70,965117,671 $ 10,4898,444 $ 70,965117,671 $ 10,4898,444
========= ================= ========= ========
The preceding Notes to Financial Statements as they relate to FirstEnergy Corp. are an integral part
of these statements.
- 78 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To FirstEnergy Corp.:
We have reviewed the accompanying consolidated balance sheet of
FirstEnergy Corp. (an Ohio corporation) and subsidiaries as of
JuneSeptember 30, 1998, and the related consolidated statements of
income and cash flows for the three-month and six-monthnine-month periods
ended JuneSeptember 30, 1998 and 1997. These financial statements are
the responsibility of the company's management.
We conducted our review in accordance with standards established
by the American Institute of Certified Public Accountants. A
review of interim financial information consists principally of
applying analytical procedures to financial data and making
inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the financial statements
referred to above for them to be in conformity with generally
accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of FirstEnergy
Corp. and subsidiaries as of December 31, 1997 (not presented
herein), and, in our report dated February 13, 1998, we expressed
an unqualified opinion on that statement. In our opinion, the
information set forth in the accompanying consolidated balance
sheet as of December 31, 1997, is fairly stated, in all material
respects, in relation to the balance sheet from which it has been
derived.
ARTHUR ANDERSEN LLP
Cleveland, Ohio
August 12,November 13, 1998
- 89 -
FIRSTENERGY CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The Company, as a producer and trader of electricity,
has certain financial risks inherent in its business activities.
With respect to its trading operations, the Company uses
principally over-the-counter contracts for the purchase and sale
of electricity. These contracts expose the Company to commodity
price fluctuations. Market risk represents the risk of loss that
may impact financial position, results of operations or cash flow
due to either changes in the commodity market prices for
electricity or the failure of contract counterparties to perform.
Various policies and procedures have been established to manage
market risk exposure based on measures of historical market
volatility. However, electricity is subject to unpredictable
price fluctuations due to changing economic and weather
conditions.conditions and constraints which arise from time to time in
availability of supply. Financial results in the secondthird quarter
and year-to-date periods of 1998 were adversely affected by a
combination of these factors as described below.
Expenses in the third quarter of 1998 are expected to be
adversely affected, to a lesser extent, from trading losses due to the
continuing price volatility in the regional power market.
Results of Operations
Basic and diluted earnings onper share of common stock
decreased to $.69 per share$1.40 for the six-monthnine-month period ended JuneSeptember 30,
1998, compared to $1.02$1.63 per share for the same period last year.
For the secondthird quarter of 1998, earnings decreasednet income increased to $.13$.71 per
share, compared to $.51$.61 per share for the secondthird quarter of 1997.
Financial results reflect several factors including the merger of
OE and Centerior, which was effective November 8, 1997. The
former Centerior companies, which include CEI and TE, have been
included in the secondthird quarter and year-to-date 1998 results. The
1997 secondthird quarter and six-monthnine-month results are for OE and Penn
only (OE companies). Also, 1998 second quarter
and six-monthnine-month results include an
extraordinary charge of $30.5 million after taxes, or $.14 per
common share, resulting from Penn's discontinued application of
SFAS 71 to its generation business (see Note 3). Sharp increases
in the spot market price for electricity occasioned by
constrained power supply conditions and heavy customer demand in
the latter part of June 1998, combined with unscheduled outages
at certain FirstEnergy generating units, resulted in spot market
purchases of power at prices which substantially exceeded amounts
recovered from retail customers. The recovery shortfall reduced
year-to-date net income by approximately $50 million or $.22 per
common share. Finally, the unprecedented market prices for
electricity in June 1998 contributed to a credit loss of $25losses totaling
$28 million after taxes or $.11$.12 per common share. OneFour power
marketermarketers with which the Company's FirstEnergy Trading and Power
Marketing Corp. subsidiary had transactions under contract
defaulted and others
may be unable to perform as a result of June's price movements.
Operating revenues increased $1.279$2.043 billion during the
six-monthnine-month period ending JuneSeptember 30, 1998, compared to the same
period of 1997, and increased $684$764 million in the secondthird quarter
of 1998 compared to the secondthird quarter of 1997. Excluding the
contribution of the former Centerior companies, operating
revenues were 4.3%6.7% higher during the quarter and 1.5%3.4% higher in
the year-to-date period compared to the corresponding periods of
1997. For the OE companies, year-to-date retail kilowatt-hour
sales decreased 0.2%increased 1.7%, with a 3.2%4.1% increase in residential sales
and a 4.7% increase in commercial sales offset, in part, by a
2.1% decrease in industrial sales. Industrial sales for 1998 were
affected by the August 1997 closure of a major customer's
electric arc furnace in the Penn service area. Excluding sales to
that facility,customer, industrial sales increased 0.2%0.1% and retail sales
were 0.8%2.6% higher. Residential sales were down
slightly in the year-to-date period ending June 30, 1998, with a
0.4% decrease from last year. Sales to wholesale customers increased 7.8%
compared to the first halfnine months of 1997. This increase
contributed to the 1.1%2.7% increase in total kilowatt-hour sales
during the period.
Retail kilowatt-hour sales in the secondthird quarter of 1998
for the OE companies increased 2.4%5.4% with residential and
commercial sales being 4.0%13.1% and 8.5%7.5% higher, respectively.
Residential sales benefited from higher air-conditioning loads
due to hotter weather and commercial sales benefited from
continued growth in the service sector of the area economy during
the period. Industrial sales decreased 2.4%2.0% during the secondthird
quarter of 1998 compared to the same period of 1997. However,1997; removing the
impact of the electric arc furnace closure, industrial sales were
slightly higher.relatively flat. A general decline in electricity demand by
primary metal manufacturers and the General Motors strike also
dampened industrial sales in the third quarter of 1998. Sales to
- 10 -
FIRSTENERGY CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
wholesale customers increased 16.4%7.8% in the secondthird quarter compared
to the same period last year, contributing to the increase in
total kilowatt-hour sales of 4.6%5.8%.
- 9 -
All operation and maintenance expense categories
increased substantially infor the first halfnine months of 1998,
compared to the same period of last year, due principally to the
inclusion of the former Centerior companies. Excluding the 1998
costs of the former Centerior companies, operation and
maintenance expenses increased $67.5$116.6 million infor the first halfnine
months of 1998 compared to the first sixnine months of 1997. Most of
the increase for the OE companies resulted from purchased power
expenses which were up $57.7$82.1 million in the first halfnine months of
1998 from the same period in 1997. ThatMost of the increase wasoccurred
in the result ofsecond quarter and resulted from a combination of
factors. In late June 1998, the midwestern and southern regions
of the United States experienced electricity shortages caused
mainly by record temperatures and humidity and unscheduled
generating unit outages. During thisthat period, the Beaver Valley
Plant remainedwas out of service and the Company's Davis-Besse Nuclear Power StationPlant was removed
from service as a result of damage to transmission facilities
caused by a tornado. Also, Avon Lake Unit 9 experienced an
unscheduled outage during the period due to lightning-related
transformer damage. As a result, the Companies purchased
significant amounts of power on the spot market at unusually high
prices (as discussed above), causing thean increase in purchased
power costs. ExcludingTemperatures continued above last year's credits fromlevels
throughout the third quarter as well and the Beaver Valley Plant
remained out of service for most of that period.
Nuclear operating costs were higher in the first nine
months of 1998 than the same period last year for the OE
Companies due to higher costs at the Beaver Valley Plant, which
were offset in part by lower costs at the Perry Plant. Reduced
emission allowance sales in the year-to-date 1998 period and
higher third quarter and year-to-date 1998 costs at the Sammis
Plant compared to the corresponding periods of 1997 contributed
to the increase in other operation and maintenance expenses were down in the first six months of 1998 from the same
period in 1997.expenses.
Inclusion of the former Centerior companies also
increased other operating expenses. Excluding those companies'
1998 costs, the provision for depreciation and amortization
increased $9.9decreased $13.4 million or 5.3%in the third quarter of 1998 from the
same period in 1997 due primarily to the net effect of the OE and
Penn rate plans. The rate restructuring plan authorized by the
PPUC for Penn in the six-month period ending June 30,second quarter caused the reduction in
depreciation expense in the third quarter due to the reduction of
nuclear generating unit investment resulting from the
discontinued application of SFAS 71. Penn's rate restructuring
plan also resulted in a reclassification of accelerated Perry
Plant depreciation in the third quarter to amortization of net
regulatory assets, further reducing reported depreciation
expense. The reclassification of depreciation resulted in a
corresponding increase in the amortization of net regulatory
assets in both the first nine months of 1998 and in the third
quarter of 1998 compared to the first halfsame periods of 1997. Of thatAlso
contributing to the increase $9.1
million occurred in the second quarter ofyear-to-date 1998 resulting
principally from accelerated depreciation under OE's regulatory
plan. Amortization of net regulatory assets also increased in the
first half of 1998 from the comparable 1997 period due toamortization
was the absence in 1998 of certain regulatory credits which were
fully amortized inby the end of the second quarter of 1997.
Other income (expense) infor the second quarter ofyear-to-date period
ending September 30, 1998 includedreflects the $25$28 million after-tax
reserve for credit losses discussed above. For the OE companies, other income was down
slightlyAlso included in the
first half of 1998 and the secondthird quarter of 1998 comparedwere after tax losses of $26 million
resulting from purchases of energy to replace scheduled third
quarter deliveries from a power marketer which defaulted on its
power contracts to FirstEnergy Trading and Power Marketing Corp.
due to the same periods of 1997, due principally to reduced
investment income.unprecedented June 1998 price fluctuations.
Interest expenses increased due to the inclusion of the
former Centerior companies for both the six-monthnine-month period ended
JuneSeptember 30, 1998 and the secondthird quarter of 1998, from the
corresponding periods in 1997. Excluding the impact of the
merger, interest on long-term debt for the OE companies decreased
due to redemptions of long-term debt totaling $333.9$273.8 million
since JulyOctober 1997. Other interest expense increased as a result
of increased short-
termshort-term borrowing levels in 1998.
Capital Resources- 11 -
FIRSTENERGY CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
from General Public Utilities 87 megawatts of capacity at the
Seneca Pumped-Storage Hydroelectric Plant. The added
hydroelectric plant capacity will enhance the Company's ability
to meet demand during peak periods.
Regulatory Matters
On September 16, 1998, the Company, together with
representatives of the three other Ohio investor-owned utilities,
presented proposed legislation for restructuring the electric
utility industry in Ohio to a private working group formed by the
leadership of the Ohio General Assembly. The working group, which
includes numerous interested parties, will consider the utility
proposal -- a proposal that represents a balanced approach for
bringing choice to Ohio's electric consumers -- as well as other
restructuring proposals. Passage of a restructuring bill appears
unlikely in 1998.
On September 24, 1998, the Federal Environmental
Protection Agency issued a final rule establishing tighter
nitrogen oxide emission ceilings for Ohio, Pennsylvania and Liquidity20
other Eastern states and the District of Columbia (see
"Environmental Matters" in Note 2). Controls must be in place by
May 2003, with required reductions achieved during the five-month
summer ozone season (May through September). The Companies have continuing cash requirementsnew rule is
expected to increase the cost of producing electricity; however,
the Company believes that it is in a better position than a
number of other utilities in achieving compliance due to its
nuclear and hydroelectric generation capability.
In connection with the regulatory plans for planned capital expenditures and debt maturities. During the last
half of 1998, capital requirements for property additions and
capital leases for theits utility
operating companies areto reduce fixed costs and lower rates, the
Company continued to take steps to restructure its operations for
improved efficiency and effectiveness in the changing electric
utility industry. The Company announced plans to transfer its
transmission assets into a new subsidiary, American Transmission
Systems, Inc. (ATS), with the transfer expected to be about $181 million, including $19 millionfinalized
by early 1999. The new subsidiary represents a first step toward
the Company's goal of establishing or becoming part of a larger
independent transmission company (TransCo). FirstEnergy believes
that a TransCo better addresses the Federal Energy Regulatory
Commission's (FERC) stated transmission objectives of providing
non-discriminatory service, while providing for nuclear fuel.streamlined and
cost-efficient operation. In working toward the goal of forming a
larger regional transmission entity, the Company, American
Electric Power and Virginia Power announced on November 6, 1998,
that they would prepare a FERC filing during the first quarter of
1999 for such a regional transmission entity. The Companies have additional cash requirements of approximately
$85.6 millionentity would be
designed to meet sinking fund requirementsthe goals of reducing transmission costs that
result when transferring power over several transmission systems,
ensuring transmission reliability and providing non-
discriminatory access to the transmission grid.
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 the Company's programs that have date-
sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000.
The Company has developed a multi-phase program for
preferred
stockYear 2000 compliance that consists of: (i) assessment of the
corporate systems and maturing long-term debt duringoperations of the remainderCompany that could be
affected by the Year 2000 problem; (ii) remediation or
replacement of noncompliant systems and components; and (iii)
testing of systems and components following such remediation or
replacement. The Company has focused its Year 2000 review on
three areas: centralized system applications, noncentralized
systems and relationships with third parties (including suppliers
as well as end-use customers).
The Company currently believes that with modifications
to existing software and conversions to new software, the Year
2000 issue will pose no significant operational problems for its
computer systems. Most of the Company's Year 2000 problems will
be resolved through system replacement. Of the Company's major
- 13 -
FIRSTENERGY CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
centralized systems, the general ledger system and inventory
management and procurement accounts payable system will be
replaced by the end of 1998. These cash requirements are expectedThe Company's payroll system was
enhanced to be satisfiedYear 2000 compliant in July 1998; all employees
will be converted to the new system by January 1999. The customer
service system is due to be replaced in mid-1999.
The Company has categorized its noncentralized systems
into sixteen separate areas, and has already determined that five
of such areas pose no material Year 2000 problem. The Company has
identified certain Year 2000 issues in nine areas and is in the
process of remediating them. The Company has plans to complete
the assessment of the final two areas by the end of 1998. The
Company plans to complete the entire Year 2000 project by
September 1999. If the already identified modifications and
conversions are not made or are not completed on a timely basis,
or if the Company identifies material additional modifications
which are not completed on a timely basis, the Year 2000 issue
would have a material adverse impact on operations.
The Company has initiated formal communications with
many of its major suppliers to determine the extent to which it
is vulnerable to those third parties' failure to resolve their
own Year 2000 problems and is still in the assessment phase as to
whether and to what extent such third parties have a Year 2000
issue. There can be no guarantee that the failure of other
companies to resolve their own Year 2000 issue will not have a
material adverse effect on the Company's business, financial
condition and results of operations.
The Company is utilizing both internal cashand external
resources to reprogram and/or short-term credit arrangements.replace and test the Company's
software for Year 2000 modifications. Of the $111 million total
project cost, approximately $90 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 benefits resulting from the system
replacements). The remaining $21 million will be expensed as
incurred. As of JuneSeptember 30, 1998, the CompaniesCompany had about $71.0expended a
total of $43 million for Year 2000 capital projects and had
expensed approximately $6 million for Year 2000 related
maintenance activities. The Company's total Year 2000 project
cost, as well as its estimates of cashthe time needed to complete
remedial efforts, are based on currently available information
and temporary investmentsdo not include the estimated costs and $202.7 milliontime associated with
the impact of short-
term indebtedness.third party Year 2000 issues.
The Companies' unused borrowing capability
included $235 million under revolving lines of creditCompany believes the most reasonably likely worst
case scenario from the Year 2000 issue to be disruption in power
plant monitoring systems, thereby producing inaccurate data and
$15
million of bank facilities that provide for borrowings onpotential failures in electronic switching mechanisms at
transmission junctions. This would prolong localized outages, as
technicians would have to manually activate switches. Such an
event could have a short-term basis at the banks' discretion.
On July 3, 1998, CEI optionally redeemed $150 million
principal amount of first mortgage bonds having a weighted
average interest rate of 8.56%. TE completed an optional
redemption of a $26 million, 7.5% first mortgage bondmaterial, but presently undeterminable, effect
on the same
date.
- 10 -
Under the Company's "Energy for Education" program,
eligible public schools in CEI's service area entered into a
special eight-year contract to receive a 10% base rate reduction
and a discount for prepaying their estimated electric bills
through the year 2005. In April 1998, CEI received a $116.6
million prepayment under this program.
CEI and TE residential customers received a $3 reduction
in their monthly bills beginning June 5, 1998, as part of the
Rate Reduction and Economic Development Plan approved last year
by the PUCO. This reduction will reduce annual revenues by
approximately $34 million (approximately $19 million in 1998).
The Companies issued $25 million of 5.375% tax exempt
bonds in the second quarter of 1998 to fund construction of an
oxidation plant which will convert non-hazardous waste from the
Bruce Mansfield Plant environmental system to gypsum. The gypsum
will be sold to a plant owned by National Gypsum Co. for use in
the production of wallboard.
On June 8, 1998, the Company completed its acquisition of
Marbel Energy Corp., a fully integrated natural gas company.
During the second quarter of 1998, the Company made three
additional acquisitions which increased the mechanical
construction and energy services portion of its business:
Colonial Mechanical Corp., based in Richmond, Virginia; Elliott-
Lewis Corp. headquartered in Philadelphia, Pennsylvania; and
Edwards Electrical & Mechanical, Inc. based in Indianapolis,
Indiana. In combination with two previous acquisitions, the
Company now anticipates approximately $300 million in annual
revenues from the mechanical construction and energy management
portion of its business.
New Accounting Standard
In June 1998, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 133 (SFAS
133), Accounting for Derivative Instruments and Hedging
Activities. The Statement establishes accounting and reporting
standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be
recorded on the balance sheet as either an asset or liability
measured at its fair value. The Statement requires that changes
in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in
the income statement. SFAS 133 is effective for fiscal years
beginning after June 15, 1999. A company may implement the
Statement for any fiscal quarter beginning after June 16, 1998.financial results. The Company has not yet
quantifieddeveloped a contingency plan to address the impactseffects of adopting SFAS
133any delay
in becoming Year 2000 compliant but currently expects to have a
contingency plan by the spring of 1999.
The costs of the project and the dates on its financial statementswhich the
Company plans 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 hasother 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 determinedlimited to, the timing
or methodavailability and cost of its adoption.trained
personnel, the ability to locate and correct all relevant
computer code, and similar uncertainties.
- 1114 -
OHIO EDISON COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended SixNine Months Ended
JuneSeptember 30, JuneSeptember 30,
----------------------------------------- ----------------------
1998 1997 1998 1997
---------- ------------------ ---------- ----------
(In thousands)
OPERATING REVENUES $618,598 $593,250 $1,216,463 $1,198,024$696,226 $652,660 $1,912,689 $1,850,684
-------- -------- ---------- ----------
OPERATING EXPENSES AND TAXES:
Fuel and purchased power 153,133 100,689 267,048 209,790146,194 111,724 413,242 321,514
Nuclear operating costs 69,222 67,320 140,988 135,84369,336 66,990 210,324 202,833
Other operating costs 107,912 107,079 200,185 195,069114,156 101,937 314,341 297,006
-------- -------- ---------- ----------
Total operation and maintenance expenses 330,267 275,088 608,221 540,702329,686 280,651 937,907 821,353
Provision for depreciation 95,676 86,615 196,519 186,57393,005 106,402 289,524 292,975
Amortization of net regulatory assets 17,849 11,288 7,421 22,575 14,84140,424 26,129
General taxes 58,969 55,436 118,494 116,97359,714 58,986 178,208 175,959
Income taxes 28,750 42,736 65,873 86,63255,288 54,277 121,161 140,909
-------- -------- ---------- ----------
Total operating expenses and taxes 524,950 467,296 1,011,682 945,721555,542 511,604 1,567,224 1,457,325
-------- -------- ---------- ----------
OPERATING INCOME 93,648 125,954 204,781 252,303140,684 141,056 345,465 393,359
OTHER INCOME 11,766 14,075 24,268 27,57012,589 12,035 36,857 39,605
-------- -------- ---------- ----------
INCOME BEFORE NET INTEREST CHARGES 105,414 140,029 229,049 279,873153,273 153,091 382,322 432,964
-------- -------- ---------- ----------
NET INTEREST CHARGES:
Interest on long-term debt 46,329 51,713 92,997 104,33847,258 50,799 140,255 155,137
Allowance for borrowed funds used during
construction and capitalized interest (469) (381) (1,129) (761)(363) (1,056) (1,492) (1,817)
Other interest expense 9,391 7,955 18,885 15,6737,811 7,669 26,696 23,342
Subsidiaries' preferred stock dividend
requirements 3,856 3,856 7,713 7,7133,857 3,857 11,570 11,570
-------- -------- ---------- ----------
Net interest charges 59,107 63,143 118,466 126,96358,563 61,269 177,029 188,232
-------- -------- ---------- ----------
INCOME BEFORE EXTRAORDINARY ITEM 46,307 76,886 110,583 152,91094,710 91,822 205,293 244,732
EXTRAORDINARY ITEM (NET OF INCOME TAXES) (Note 3) (30,522)- - (30,522) -
-------- -------- ---------- ----------
NET INCOME 15,785 76,886 80,061 152,91094,710 91,822 174,771 244,732
PREFERRED STOCK DIVIDEND REQUIREMENTS 3,018 3,125 6,037 6,2493,020 3,124 9,057 9,373
-------- -------- ---------- ----------
EARNINGS ON COMMON STOCK $ 12,76791,690 $ 73,76188,698 $ 74,024165,714 $ 146,661235,359
======== ======== ========== ==========
The preceding Notes to Financial Statements as they relate to Ohio Edison Company are an integral
part of these statements.
- 1215 -
OHIO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
------------------------- -------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service, at original cost $8,143,187$8,159,009 $8,666,272
Less--Accumulated provision for depreciation 3,457,9293,542,085 3,546,594
---------- ----------
4,685,2584,616,924 5,119,678
---------- ----------
Construction work in progress-
Electric plant 118,161125,512 99,158
Nuclear fuel 13,89714,129 21,360
---------- ----------
132,058139,641 120,518
---------- ----------
4,817,3164,756,565 5,240,196
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
PNBV Capital Trust 478,542477,986 482,220
Nuclear plant decommissioning trusts 123,817114,496 109,883
Letter of credit collateralization 277,763 277,763
Other. 305,197Other 314,740 419,525
---------- ----------
1,185,3191,184,985 1,289,391
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents 33,04643,338 4,680
Receivables-
Customers (less accumulated provisions of
$6,227,000$6,273,000 and $5,618,000, respectively,
for uncollectible accounts) 223,839240,035 235,332
Associated companies 263,400407,922 25,348
Other 48,55954,347 87,566
Materials and supplies, at average cost-
Owned 68,15167,245 75,580
Under consignment 50,73945,133 47,890
Prepayments and other 99,75074,995 78,348
---------- ----------
787,484933,015 554,744
---------- ----------
DEFERRED CHARGES:
Regulatory assets 1,788,7461,753,528 1,601,709
Property taxes 100,878101,119 100,043
Unamortized sale and leaseback costs 92,59791,348 95,096
Other 58,15055,646 96,276
---------- ----------
2,040,3712,001,641 1,893,124
---------- ----------
$8,830,490$8,876,206 $8,977,455
========== ==========
- 1316 -
OHIO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
------------- -------------------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, $9 par value, authorized 175,000,000
shares - 100 shares outstanding $ 1 $ 1
Other paid-in capital 2,105,2402,098,114 2,102,644
Retained earnings 486,377533,398 621,674
---------- ----------
Total common stockholder's equity 2,591,6182,631,513 2,724,319
Preferred stock-
Not subject to mandatory redemption 160,965 160,965
Subject to mandatory redemption 15,00010,000 15,000
Preferred stock of consolidated subsidiary-
Not subject to mandatory redemption 50,905 50,905
Subject to mandatory redemption 15,000 15,000
OE obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely OE
subordinated debentures 120,000 120,000
Long-term debt 2,605,5262,405,875 2,569,802
---------- ----------
5,559,0145,394,258 5,655,991
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock 70,254276,337 278,492
Short-term borrowings-
Associated companies 192,04045,385 -
Other 193,726260,800 302,229
Accounts payable-
Associated companies 126,037 -212,470 1,751
Other 94,529 115,83684,139 114,085
Accrued taxes 205,402206,478 157,095
Accrued interest 45,08746,573 53,165
Other 109,031158,088 115,256
---------- ----------
1,036,1061,290,270 1,022,073
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes 1,627,1891,602,443 1,698,354
Accumulated deferred investment tax credits 161,379157,483 184,804
Postretirement benefits 168,202173,136 158,038
Other 278,600258,616 258,195
---------- ----------
2,235,3702,191,678 2,299,391
---------- ----------
COMMITMENTS, GUARANTEES AND
CONTINGENCIES (Note 2) ---------- ----------
$8,830,490$8,876,206 $8,977,455
========== ==========
The preceding Notes to Financial Statements as they relate to Ohio Edison Company are an integral
part of these balance sheets.
- 1417 -
OHIO EDISON COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended SixNine Months Ended
JuneSeptember 30, JuneSeptember 30,
---------------------- ------------------------------------------- ---------------------
1998 1997 1998 1997
-------- -------- -------- ----------------- ---------- ---------- ---------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 15,78594,710 $ 76,88691,822 $ 80,061 $152,910174,771 $244,732
Adjustments to reconcile net income to net
cash from operating activities-
Provision for depreciation 95,676 86,615 196,519 186,57393,005 106,402 289,524 292,975
Nuclear fuel and lease amortization 6,563 14,297 13,346 28,6428,244 12,040 21,590 40,682
Other amortization, net 11,023 7,119 22,038 14,22917,954 10,996 39,992 25,225
Deferred income taxes, net (37,613) (8,255) (51,526) (16,696)(14,837) (14,796) (66,363) (31,492)
Investment tax credits, net (3,622) (3,338) (7,448) (7,164)(3,897) (4,058) (11,345) (11,222)
Extraordinary item 51,730- - 51,730 -
Receivables (73,744) 6,612 (41,876) 23,964(166,506) (3,405) (208,382) 20,559
Materials and supplies 4,755 (10,613) 4,580 (9,561)6,512 (135) 11,092 (9,696)
Accounts payable 92,415 9,176 109,590 5,31276,043 (9,219) 185,633 (3,907)
Other (3,781) (16,143) 46,123 1,03860,844 46,527 106,967 47,565
--------- -------- -------- ------------------ --------
Net cash provided from operating activities 159,187 162,356 423,137 379,247172,072 236,174 595,209 615,421
--------- -------- -------- ------------------ --------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Long-term debt 104,822 41,318 107,460 70,52310,039 9,694 117,499 80,217
Short-term borrowings, net - - 83,5373,956 -
Redemptions and Repayments-
Preferred stock 5,000 5,000 5,000 5,000
Long-term debt 141,774 104,056 281,635 216,5434,522 121,163 286,157 337,706
Short-term borrowings, net 15,619 13,99679,581 10,303 - 43,50353,806
Dividend Payments-
Common stock 39,884 56,419 209,782 109,96044,597 53,109 254,379 163,069
Preferred stock 2,834 3,057 5,859 6,1533,093 3,817 8,952 9,970
--------- -------- -------- ------------------ --------
Net cash used for financing activities 95,289 136,210 306,279 305,636126,754 183,698 433,033 489,334
--------- -------- -------- ------------------ --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions 47,354 29,196 88,370 63,57736,793 52,147 125,163 115,724
Other (4,847) 1,748 122 4,798(1,767) 2,374 (1,645) 7,172
--------- -------- -------- ----------------- --------
Net cash used for investing activities 42,507 30,944 88,492 68,37535,026 54,521 123,518 122,896
--------- -------- -------- ----------------- --------
Net increase (decrease) in cash and cash equivalents 21,391 (4,798) 28,366 5,23610,292 (2,045) 38,658 3,191
Cash and cash equivalents at beginning of period 11,655 15,28733,046 10,489 4,680 5,253
--------- -------- -------- ----------------- --------
Cash and cash equivalents at end of period $ 33,04643,338 $ 10,4898,444 $ 33,04643,338 $ 10,4898,444
========= ======== ======== ================= ========
The preceding Notes to Financial Statements as they relate to Ohio Edison Company are an integral
part of these statements.
- 1518 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Ohio Edison Company:
We have reviewed the accompanying consolidated balance sheet of
Ohio Edison Company (an Ohio corporation and wholly owned
subsidiary of FirstEnergy Corp.) and subsidiaries as of JuneSeptember
30, 1998, and the related consolidated statements of income and
cash flows for the three-month and six-monthnine-month periods ended
JuneSeptember 30, 1998 and 1997. These financial statements are the
responsibility of the company's management.
We conducted our review in accordance with standards established
by the American Institute of Certified Public Accountants. A
review of interim financial information consists principally of
applying analytical procedures to financial data and making
inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the financial statements
referred to above for them to be in conformity with generally
accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of Ohio Edison
Company and subsidiaries as of December 31, 1997 (not presented
herein), and, in our report dated February 13, 1998, we expressed
an unqualified opinion on that statement. In our opinion, the
information set forth in the accompanying consolidated balance
sheet as of December 31, 1997, is fairly stated, in all material
respects, in relation to the balance sheet from which it has been
derived.
ARTHUR ANDERSEN LLP
Cleveland, Ohio
August 12,November 13, 1998
- 1619 -
OHIO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
Earnings were adversely affected in the six-monthnine-month
period ended JuneSeptember 30, 1998, and in the second quarter of 1998, compared to the same periodsperiod of
1997 by an extraordinary item resulting from deregulation of
Penn's generation business and the corresponding discontinuation
of SFAS 71 with respect to its
generationthat business. This action was taken
following the June 18, 1998, authorization by the PPUC of a
restructuring plan for Penn (see below and Note 3). Excluding the
extraordinary item, earnings on common stock were $104.5$196.2 million
in the first halfnine months of 1998 compared to $146.7$235.4 million in
the same period last year; for the secondthird quarter of 1998,
earnings on common stock were $43.3$91.7 million compared to $73.8$88.7
million in the secondthird quarter of 1997. ResultsEarnings were also
adversely affected in the nine-month period by increased
purchased power costs in 1998 occasioned by unprecedented market
prices for the six-monthelectricity and second quarter periods of 1998 were
affected by a sharpunscheduled generating unit outages.
This increase in purchased power costs which wasmore than offset an
increase in part by higher operating revenues.
Operating revenues increased $18.4$62.0 million during the
first halfnine months of 1998, compared to the same period of 1997,
and increased $25.3$43.6 million in the secondthird quarter of 1998 compared
to the secondthird quarter of 1997. Year-to-date retail kilowatt-hour
sales decreased 0.2%increased 1.7%, with a 3.2%4.1% increase in residential sales
and a 4.7% increase in commercial sales offset, in part, by a
2.1% decrease in industrial sales. Industrial sales for 1998 were
affected by the August 1997 closure of a major customer's
electric arc furnace in the Penn service area. Excluding sales to
that facility,customer, industrial sales increased 0.2%0.1% and retail sales
were 0.8%2.6% higher. Residential sales were down
slightly in the year-to-date period ending June 30, 1998, with a
0.4% decrease from last year. Sales to wholesale customers increased 7.8%
compared to the first halfnine months of 1997. This increase
contributed to the 1.1%2.7% increase in total kilowatt-hour sales
during the period.
Retail kilowatt-hour sales in the secondthird quarter of 1998
increased 2.4%5.4% with residential and commercial sales being 4.0%13.1%
and 8.5%7.5% higher, respectively. Residential sales benefited from
higher air-conditioning loads due to hotter weather and
commercial sales benefited from continued growth in the service
sector of the area economy during the period. Industrial sales
decreased 2.4%2.0% during the secondthird quarter of 1998 compared to the
same period of 1997. However,1997; removing the impact of the electric arc
furnace closure, industrial sales were slightly higher.relatively flat. A general
decline in energy use by primary metal manufacturers and the
General Motors strike also dampened industrial sales in the third
quarter of 1998. Sales to wholesale customers increased 16.4%7.8% in
the secondthird quarter compared to the same period last year,
contributing to the increase in total kilowatt-hour sales which were 4.6% higher.of
5.8%.
Operation and maintenance expenses increased $67.5$116.6
million infor the first halfnine months of 1998 compared to the first
sixnine months of 1997. Most of the increase resulted from purchased
power expenses which were up $57.7$82.1 million in the first halfnine
months of 1998 from the same period in 1997. ThatMost of the increase
wasoccurred in the result ofsecond quarter and resulted from a combination of
factors. In late June 1998, the midwestern and southern regions
of the United States experienced electricity shortages caused
mainly by record temperatures and humidity and unscheduled
generating unit outages. Due in part to unscheduled outages at
the Beaver Valley Units 1 and 2 which continued throughPlant, the second quarter of 1998, OE companies' production
capabilities were reduced to the point that they purchased
significant amounts of power onduring this period. Temperatures
continued above last year's levels in the spot marketthird quarter of 1998
as well and the Beaver Valley Plant remained out of service for
most of that period. As a result, OE purchased significant
amounts of power at unusually high spot market prices, causing
the increase in purchased power expense. Excludingcosts.
Nuclear operating costs were higher in the first nine
months of 1998 than the same period last year's
credits fromyear due to higher costs
at the Beaver Valley Plant which were offset in part by lower
costs at the Perry Plant. Reduced emission allowance sales in the
year-to-date 1998 period and higher third quarter and year-to-
- 20 -
OHIO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
date 1998 costs at the Sammis Plant compared to the corresponding
periods of 1997 contributed to the increase in other operation
and maintenance expenses were downexpenses.
The provision for depreciation and amortization
decreased $13.4 million in the first six monthsthird quarter of 1998 from the
same period in 1997.1997 due primarily to the net effect of the OE and
Penn rate plans. The provisionrate restructuring plan authorized by the
PPUC for Penn in the second quarter caused the reduction in
depreciation expense in the third quarter due to the reduction of
nuclear generating unit investment resulting from the
discontinued application of SFAS 71. Penn's rate restructuring
plan also resulted in a reclassification of accelerated Perry
Plant depreciation in the third quarter to amortization of net
regulatory assets, further reducing reported depreciation
expense. The reclassification of depreciation resulted in a
corresponding increase in the amortization of net regulatory
assets in both the first nine months of 1998 and amortization increased
$9.9 million or 5.3% forin the six-month period ending June 30,third
quarter of 1998 compared to the first halfsame periods of 1997. Of thatAlso
contributing to the increase $9.1
million occurred in the second quarter ofyear-to-date 1998 resulting
principally from accelerated depreciation under OE's regulatory
plan. Amortization of net regulatory assets also increased in the
first half of 1998 from the comparable 1997 period due toamortization
was the absence in 1998 of certain regulatory credits which were
fully amortized in 1997.
- 17 -
Interest expenses decreased for bothby the six-month period
ended June 30, 1998 andend of the second quarter of 1998 from
corresponding periods in 1997.
Interest on long- termlong-term debt decreased due to redemptionredemptions
of long-term debt totaling $333.9$273.8 million since July 1997, while otherOctober 1997.
Other interest expense increased as a result of increased short-termshort-
term borrowing levels in 1998.
Capital Resources and Liquidity
The OE and Penn (OE companies)companies have continuing cash requirements for
planned capital expenditures and debt maturities. During the
last two quartersfourth quarter of 1998, capital requirements for property
additions and capital leases are expected to be about $92$57
million, including $12$13 million for nuclear fuel. The OE companies
have additional cash requirements of approximately $10.4$2.7 million
to meet sinking fund requirements for preferred stock and maturing long-term debt
during the remainder of 1998. These cash requirements are
expected to be satisfied with internal cash and/or short-term
credit arrangements.
As of JuneSeptember 30, 1998, the OE companies had about
$33.0$43.3 million of cash and temporary investments. The OE companies also
had $385.8investments and $306.2
million of short-term indebtedness. In addition, the OE
companies' unused borrowing capability included $135$100 million
under revolving lines of credit and $15$22 million of bank
facilities that provide for borrowings on a short-term basis at
the banks' discretion.
Transition to Retail Competition
On June 18, 1998,FirstEnergy signed an agreement in principle with
Duquesne Light Company that would result in the PPUC authorized a plan which will
restructure Penn's rates and provide customers with direct access
to alternative electricity suppliers. Customer choice will be
phasedtransfer of 1,436
megawatts owned by Duquesne at five generating plants in over two years with 66%exchange
for 1,298 megawatts at three plants owned by FirstEnergy's
electric utility operating companies (see "Pending Exchange of
each customer class having
direct access to alternative suppliersAssets" in Note 2), including the OE companies. A final agreement
on the exchange of generation by January
2, 1999, and all remaining customers having access as of January
2, 2000. Under the plan, Penn will continue to deliver power to
homes and businesses through its transmission and distribution
system, which will remain regulated. However, Penn's rates have
been restructured to establish separate charges for transmission
and distribution; generation,assets, which will be subjectstructured as a tax-free
transaction to competition;the extent possible, is expected to be reached by
the end of the year. The transaction benefits the Companies by
providing them with exclusive ownership and strandedoperating control of
all the generating assets that are now jointly owned and operated
under the Central Area Power Coordination Group agreement.
Regulatory Matters
On September 16, 1998, FirstEnergy, together with
representatives of the three other Ohio investor-owned utilities,
presented proposed legislation for restructuring the electric
utility industry in Ohio to a private working group formed by the
leadership of the Ohio General Assembly. The working group, which
includes numerous interested parties, will consider the utility
proposal -- a proposal that represents a balanced approach for
bringing choice to Ohio's electric consumers -- as well as other
restructuring proposals. Passage of a restructuring bill appears
unlikely in 1998.
- 21 -
OHIO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
On September 24, 1998, the Federal Environmental
Protection Agency issued a final rule establishing tighter
nitrogen oxide emission ceilings for Ohio, Pennsylvania and 20
other Eastern states and the District of Columbia (see
"Environmental Matters" in Note 2). Controls must be in place by
May 2003, with required reductions achieved during the five-month
summer ozone season (May through September). The new rule is
expected to increase the cost recovery.of producing electricity; however,
the OE companies believe that they are in a better position than
a number of other utilities in achieving compliance due to their
nuclear generation capability.
In connection with the regulatory plans for its utility
operating companies to reduce fixed costs and lower rates,
FirstEnergy continued to take steps to restructure its operations
for improved efficiency and effectiveness in the changing
electric utility industry. FirstEnergy announced plans to
transfer its transmission assets (including the OE companies'
assets) into a new subsidiary, American Transmission Systems,
Inc. (ATS), with the transfer expected to be finalized by early
1999. The generationnew subsidiary represents a first step toward
FirstEnergy's goal of establishing or becoming part of a larger
independent transmission company (TransCo). FirstEnergy believes
that a TransCo better addresses the Federal Energy Regulatory
Commission's (FERC) stated transmission objectives of providing
non-discriminatory service, while providing for streamlined and
cost-efficient operation. In working toward the goal of forming a
larger regional transmission entity, FirstEnergy, American
Electric Power and Virginia Power announced on November 6, 1998,
that they would prepare a FERC filing during the first quarter of
1999 for such a regional transmission entity. The entity would be
designed to meet the goals of reducing transmission costs that
result when transferring power over several transmission systems,
ensuring transmission reliability and providing non-
discriminatory access to the transmission grid.
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 the OE companies' programs that have
date-sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000.
The OE companies have developed a multi-phase program
for Year 2000 compliance that consists of: (i) assessment of the
corporate systems and operations of the OE companies that could
be affected by the Year 2000 problem; (ii) remediation or
replacement of non-compliant systems and components; and (iii)
testing of systems and components following such remediation or
replacement. The OE companies have focused their Year 2000 review
on three areas: centralized system applications, non-centralized
systems and relationships with third parties (including suppliers
as well as end-use customers).
The OE companies currently believe that with
modifications to existing software and conversions to new
software, the Year 2000 issue will pose no significant
operational problems for their computer systems. Most of the OE
companies' Year 2000 problems will be resolved through system
replacement. Of the OE companies' major centralized systems, the
general ledger system and inventory management and procurement
accounts payable system will be replaced by the end of 1998. The
OE companies' payroll system was enhanced to be Year 2000
compliant in July 1998. The customer service system is due to be
replaced in mid-1999.
The OE companies have categorized their non-centralized
systems into sixteen separate areas, and have already determined
that five of such areas pose no material Year 2000 problem. The
OE companies have identified certain Year 2000 issues in nine of
such areas and are in the process of remediating them. The OE
companies have plans to complete the assessment of the final two
areas by the end of 1998. The OE companies plan to complete the
entire Year 2000 project by September 1999. If the already
identified modifications and conversions are not made or are not
completed on a timely basis, or if the OE companies identify
- 22 -
OHIO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
material additional modifications which are not completed on a
timely basis, the Year 2000 issue would have a material adverse
impact on operations.
The OE companies have initiated formal communications
with many of their major suppliers to determine the extent to
which they are vulnerable to those third parties' failure to
resolve their own Year 2000 problems and are still in the
assessment phase as to whether and to what extent such third
parties have a Year 2000 issue. There can be no guarantee that
the failure of other companies to resolve their own Year 2000
issue will not have a material adverse effect on the OE
companies' business, financial condition and results of
operations.
The OE companies are utilizing both internal and
external resources to reprogram and/or replace and test the OE
companies' software for Year 2000 modifications. Of the $53
million total project cost, approximately $43 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 unbundled rates represents a "shopping credit." Inbenefits resulting from
the event customers obtain power from an alternative source, the
generation portion of Penn's ratesystem replacements). The remaining $10 million will be
excludedexpensed as incurred. As of September 30, 1998, the OE companies
have expended a total of $20 million for Year 2000 capital
projects and have expensed approximately $3 million for Year 2000
related maintenance activities. The OE companies' total Year 2000
project cost, as well as their estimates of time needed to
complete remedial efforts, are based on currently available
information and do not include the estimated costs and time
associated with the impact of third party Year 2000 issues.
The OE companies believe the most reasonably likely
worst case scenario from their
billthe Year 2000 issue to be disruption in
power plant monitoring systems, thereby producing inaccurate data
and potential failures in electronic switching mechanisms at
transmission junctions. This would prolong localized outages, as
technicians would have to manually activate switches. Such an
event could have a material, but presently undeterminable, effect
on the OE companies' financial results. The OE companies have not
yet developed a contingency plan to address the effects of any
delay in becoming Year 2000 compliant but currently expect to
have a contingency plan by the spring of 1999.
The costs of the project and the customersdates on which the OE
companies 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 receive a generation chargebe completed as planned and
actual results could differ materially from the alternative supplier. The strandedestimates.
Specific factors that might cause material differences include,
but are not limited to, the availability and cost recovery portion of rates
provides for recovery of certain amounts not otherwise considered
recoverable in a competitive generation market. Penn will recover
$234 million of stranded costs through a competitive transition
charge starting in 1999trained
personnel, the ability to locate and ending in 2005.correct all relevant
computer code, and similar uncertainties.
- 1823 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
JuneSeptember 30, 1998 JuneSeptember 30, 1997
----------------------- ---------------------
Three SixNine Three SixNine
Months Months Months Months
Ended Ended Ended Ended
---------- ----------- --------- -------- -------- ------------------
(In thousands)
|
OPERATING REVENUES $465,225 $880,252$512,616 $1,392,868 | $428,246 $859,873$499,468 $1,359,341
-------- ------------------ | -------- ------------------
OPERATING EXPENSES AND TAXES: |
Fuel and purchased power 137,569 226,546127,342 358,704 | 102,090 212,620111,095 329,347
Nuclear operating costs 16,320 38,40519,836 55,335 | 23,888 44,98423,617 65,029
Other operating costs 89,826 169,41282,272 249,774 | 91,412 175,65577,407 251,002
-------- ------------------ | -------- ------------------
Total operation and maintenance expenses 243,715 434,363229,450 663,813 | 217,390 433,259212,119 645,378
Provision for depreciation and amortization 50,372 98,55550,002 148,557 | 55,225 110,52355,611 166,134
Amortization of net regulatory assets 6,567 13,13419,701 | 6,567 13,13419,701
General taxes 53,863 108,37455,356 163,730 | 57,274 113,96056,864 170,824
Income taxes 23,253 47,67548,077 95,752 | 14,352 31,55436,836 68,390
-------- ------------------ | -------- ------------------
Total operating expenses and taxes 377,770 702,101389,452 1,091,553 | 350,808 702,430367,997 1,070,427
-------- ------------------ | -------- ------------------
OPERATING INCOME 87,455 178,151123,164 301,315 | 77,438 157,443131,471 288,914
|
OTHER INCOME (EXPENSE) 5,857 13,4508,166 21,616 | (5,221) (8,885)7,544 (1,341)
-------- ------------------ | -------- ------------------
INCOME BEFORE NET INTEREST CHARGES 93,312 191,601131,330 322,931 | 72,217 148,558139,015 287,573
-------- ------------------ | -------- ------------------
NET INTEREST CHARGES: |
Interest on long-term debt 60,751 120,81157,072 177,883 | 54,669 107,55066,901 174,451
Allowance for borrowed funds used during |
construction (404) (956) (664) (1,620)| (252) (711)(729) (1,440)
Other interest expense (credit) (1,882) (2,726) (95) (2,821)| 3,830 7,5195,101 12,620
-------- ------------------ | -------- ------------------
Net interest charges 58,465 117,12956,313 173,442 | 58,247 114,35871,273 185,631
-------- ------------------ | -------- ------------------
NET INCOME 34,847 74,47275,017 149,489 | 13,970 34,20067,742 101,942
|
PREFERRED STOCK DIVIDEND REQUIREMENTS 7,438 8,5068,547 17,053 | 9,096 18,4118,876 27,287
-------- ---------- | -------- | ------- ------------------
EARNINGS ON COMMON STOCK $ 27,40966,470 $ 65,966132,436 | $ 4,87458,866 $ 15,78974,655
======== ========== | ======== | ======= ==================
The preceding Notes to Financial Statements as they relate to The Cleveland Electric Illuminating
Company are an integral part of these statements.
- 1924 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
----------------------- ------------
(In thousands)
ASSETS
------
ASSETS
------
UTILITY PLANT:
In service $4,568,827$4,626,360 $4,578,649
Less--Accumulated provision for depreciation 1,501,8811,589,311 1,470,084
---------- ----------
3,066,9463,037,049 3,108,565
---------- ----------
Construction work in progress-
Electric plant 45,21345,947 41,261
Nuclear fuel 9,88610,115 6,833
---------- ----------
55,09956,062 48,094
---------- ----------
3,122,0453,093,111 3,156,659
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Shippingport Capital Trust 543,126543,161 575,084
Nuclear plant decommissioning trusts 111,337114,265 105,334
Other. 20,88618,223 21,482
---------- ----------
675,349675,649 701,900
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents 14,54927,776 33,775
Receivables-
Customers 16,37317,427 29,759
Associated companies 5,2449,945 8,695
Other 199,031241,175 98,077
Notes receivable from associated companies 136,90026,628 -
Materials and supplies, at average cost-
Owned 40,80729,483 47,489
Under consignment 42,81540,455 25,411
Prepayments and other 68,26352,068 57,763
---------- ----------
523,982444,957 300,969
---------- ----------
DEFERRED CHARGES:
Regulatory assets 564,699559,453 579,711
Goodwill 1,521,6131,511,635 1,552,483
Property taxes 126,414 125,204
Other 12,87215,627 23,358
---------- ----------
2,225,5982,213,129 2,280,756
---------- ----------
$6,546,974$6,426,846 $6,440,284
========== ==========
- 2025 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
----------------------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, without par value, authorized
105,000,000 shares - 79,590,689 shares
outstanding $ 931,614931,312 $ 931,614
Retained earnings 63,446101,251 19,290
---------- ----------
Total common stockholder's equity 995,0601,032,563 950,904
Preferred stock-
Not subject to mandatory redemption 238,325 238,325
Subject to mandatory redemption 169,460168,460 183,174
Long-term debt 3,046,2132,956,689 3,189,590
---------- ----------
4,449,0584,396,037 4,561,993
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred
stock 265,099181,476 121,965
Accounts payable-
Associated companies 85,66251,831 56,109
Other 123,12258,332 90,737
Notes payable to associated companies 30,31060,838 56,802
Accrued taxes 162,061238,418 194,394
Accrued interest 68,80970,078 67,896
Other 42,79143,068 52,297
---------- ----------
777,854704,041 640,200
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes 532,276533,755 496,437
Accumulated deferred investment tax credits 93,53892,242 96,131
Pensions and other postretirement benefits 202,202204,152 198,642
Other 492,046496,619 446,881
---------- ----------
1,320,0621,326,768 1,238,091
---------- ----------
COMMITMENTS, GUARANTEES AND
CONTINGENCIES (Note 2) ---------- ----------
$6,546,974$6,426,846 $6,440,284
========== ==========
The preceding Notes to Financial Statements as they relate to The Cleveland Electric Illuminating
Company are an integral part of these balance sheets.
- 2126 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
JuneSeptember 30, 1998 JuneSeptember 30, 1997
---------------------- ---------------------
-------------------
Three SixNine Three SixNine
Months Months Months Months
Ended Ended Ended Ended
---------- ---------- ---------- --------- -------- -------- --------
(In thousands)
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
Net income $ 34,84775,017 $ 74,472149,489 | $ 13,970 $ 34,20067,742 $101,942
Adjustments to reconcile net income to net |
cash from operating activities- |
Provision for depreciation and amortization 50,372 98,55550,002 148,557 | 55,225 110,52355,611 166,134
Nuclear fuel and lease amortization 6,127 16,3568,154 24,510 | 11,775 25,18612,924 38,110
Other amortization (2,850) 3,7175,974 9,691 | 6,567 13,13419,701
Deferred income taxes, net 16,576 30,7914,229 35,020 | 11,461 22,19712,057 34,254
Investment tax credits, net (1,297) (2,593)(1,296) (3,889)| (2,001) (4,002)(6,003)
Allowance for equity funds used during |
construction - - | (398) (725)(465) (1,190)
Receivables (77,237) (87,568)(44,448) (132,016)| (28,395) 14,965(8,096) 6,869
Materials and supplies (6,374) (10,722)13,684 2,962 | (5,207) (4,140)2,465 (1,675)
Accounts payable 63,340 32,385 (69,068) (36,683)| 14,281 (11,321)(15,214) (26,535)
Accrued taxes 76,357 44,024 | 8,379 (14,060)
Other (42,710) (68,639)4,771 (31,535)| (20,312) (37,569)
-------- --------42,415 27,285
--------- ---------- | -------- --------
Net cash provided from operating activities 40,794 86,754123,376 210,130 | 56,966 162,448
-------- --------182,384 344,832
--------- ---------- | -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES: |
New Financing- |
Equity contributions from parent - - | 4,500 4,500
Long-term debt 5,822- 5,822 | 574,947 574,947168,118 743,065
Short-term borrowings, net 30,528 4,036 | - - | 26,252 29,033
Ohio Schools Council Prepayment Program 116,598- 116,598 | - -
Redemptions and Repayments- |
Preferred stock 13,714 13,7141,000 14,714 | 13,714 28,7141,000 29,714
Long-term debt 15,029 26,581172,192 198,773 | 13,711 26,161192,475 218,636
Short-term borrowings, net 45,290 26,492- - | - -37,651 8,618
Dividend Payments- |
Common stock 25,469 25,46928,653 54,122 | 29,605 59,21029,606 88,816
Preferred stock 8,870 17,7418,559 26,300 | 9,206 18,742
-------- --------8,889 27,631
--------- --------- | -------- --------
Net cash provided from (used for) financing |
activities 14,048 12,423 (179,876) (167,453)| 534,963 471,153
-------- --------(97,003) 374,150
--------- --------- | -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES: |
Property additions 12,080 27,41416,327 43,741 | 21,701 54,97231,733 86,705
Loans to associated companies 59,900 136,900- 26,628 | - -
Loan payments from associated companies (110,272) - | - -
Capital trust investments - (31,958)35 (31,923)| 569,389 569,389(10,576) 558,813
Other (18,137) (13,953)24,183 10,230 | 5,411 17,387
-------- --------(673) 16,714
--------- --------- | -------- ----------------- ---------
Net cash used for (provided from) |
investing activities 53,843 118,403(69,727) 48,676 | 596,501 641,748
-------- --------20,484 662,232
--------- --------- | -------- ----------------- ---------
Net increase (decrease) in cash and cash equivalents 999 (19,226)13,227 (5,999)| (4,572) (8,147)64,897 56,750
Cash and cash equivalents at beginning of period 13,55014,549 33,775 | 26,69822,126 30,273
-------- ----------------- --------- | -------- ----------------- ---------
Cash and cash equivalents at end of period $ 14,54927,776 $ 14,54927,776 | $ 22,12687,023 $ 22,126
======== ========87,023
========= ========= | ======== ================= =========
The preceding Notes to Financial Statements as they relate to The Cleveland Electric Illuminating
Company are an integral part of these statements.
- 2227 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The Cleveland Electric Illuminating Company:
We have reviewed the accompanying consolidated balance sheet of
The Cleveland Electric Illuminating Company (an Ohio corporation
and wholly owned subsidiary of FirstEnergy Corp.) and subsidiary
as of JuneSeptember 30, 1998, and the related consolidated statements
of income and cash flows for the three-month and six-monthnine-month
periods ended JuneSeptember 30, 1998 and 1997. These financial
statements are the responsibility of the company's management.
We conducted our review in accordance with standards established
by the American Institute of Certified Public Accountants. A
review of interim financial information consists principally of
applying analytical procedures to financial data and making
inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the financial statements
referred to above for them to be in conformity with generally
accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of The
Cleveland Electric Illuminating Company and subsidiary as of
December 31, 1997 (not presented herein), and, in our report dated
February 13, 1998, we expressed an unqualified opinion on that
statement. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of December 31, 1997,
is fairly stated, in all material respects, in relation to the
balance sheet from which it has been derived.
ARTHUR ANDERSEN LLP
Cleveland, Ohio
August 12,November 13, 1998
- 2328 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
Financial results reflect the application of purchase
accounting to the merger of CEI's former parent company,
Centerior, with OE to form FirstEnergy on November 8, 1997. The
application of this accounting resulted in fair value adjustments
which were "pushed down" or reflected on the separate financial
statements of Centerior's direct subsidiaries as of the merger
date, including CEI's financial statements. Accordingly, the
post-merger financial statements for the first halfnine months and
secondthird quarter of 1998 and the December 31, 1997 Consolidated
Balance Sheet reflect a new basis of accounting. Material effects
of this new basis of accounting are identified below.
Earnings on common stock increased to $66.0$132.4 million
for the six-monthnine-month period ended JuneSeptember 30, 1998, from $15.8$74.7
million in the same period last year. For the secondthird quarter of
1998, earnings increased to $27.4$66.5 million, compared to $4.9$58.9
million in the secondthird quarter of 1997. The increases reflect
increased operating revenues, benefits provided by the Bruce
Mansfield Plant lease refinancing and lower operating expenses.net reductions in the
provision for depreciation and amortization resulting from the
fair value adjustment of nuclear plant in connection with the
merger. The above factors were offset in part by an increase in
purchased power costs in the second quarter of 1998.costs.
Operating revenues increased $20.4$33.5 million during the
six-
monthnine-month period ended JuneSeptember 30, 1998, compared to the same
period of 1997 and increased $37.0$13.1 million in the secondthird quarter
of 1998 from the corresponding 1997 period. Operating revenues in
the year-to-date 1998 periodsperiod included $9.2 million received as a
termination charge for a canceled power supply contract. Year-to-dateYear-to-
date retail kilowatt-hour sales increased 0.5% with a 3.5% increase in
commercial sales partially offset by a 3.8% decrease in
residential sales. Residential sales were adversely affected by
unusually mild weather conditions in the first quarter of 1998.
Sales to industrial customers increased 0.9% in the first six
months of 19981.9% from the same
period in 1997.of 1997, with residential, commercial and industrial
customers all contributing to the increase with increases of
2.4%, 1.9% and 1.6%, respectively. Sales to wholesale customers
decreased 52.2%50.6% compared to the first halfnine months of 1997 due in
part to unplanned generating unit outages which reduced available
energy for sale to other utilities. This resulted in a 5.9%4.9%
decrease in total kilowatt-hour sales during the six-monthnine-month
period compared to 1997.
Retail kilowatt-hour sales in the secondthird quarter of 1998
increased 3.6%4.5% from the secondthird quarter of 1997 with residential,
commercial and industrial customers all contributing to the
increase.1997. Residential sales
benefited from higher air-
conditioningair-conditioning loads due to hotter
weather in 1998, increasing 1.9%15.0%. Commercial and industrialThe large increase in
residential sales increased 6.5% and 2.4%,
respectively, benefiting from growthwas offset in part by a 1.0% decline in
commercial sales reflecting a softening in the area economy.service sector.
However, sales to industrial customers increased 3.0%. Sales to
wholesale customers decreased 40.7%48.1% in the secondthird quarter of 1998
compared to the same period in 1997. Overall, reduced off-
systemoff-system
sales more than offset the increase in retail sales leading to a
decline in total kilowatt-hour sales of 0.3%3.0% for the secondthird
quarter of 1998 compared to the secondthird quarter of 1997.
Fuel and purchased power expenses increased in both the
first halfnine months of 1998 and the secondthird quarter of 1998 compared
to the same periods of 1997. The increases resulted from higher
purchased power costs, in the second quarter of 1998, which resulted fromwere due to a combination of
factors. In late June 1998, the midwestern and southern regions
of the United States experienced electricity shortages caused
mainly by record temperatures and humidity and unscheduled
generating unit outages. During this period, Beaver Valley Unit 2
remainedwas out of service and the Davis-Besse Nuclear Power StationPlant was removed from
service as a result of damage to transmission facilities caused
by a tornado. Also, Avon Lake Unit 9 experienced an unscheduled
outage during the period due to lightning-related transformer
damage. Temperatures continued above last year's levels
throughout the third quarter of 1998 as well and Beaver Valley
Unit 2 remained out of service for most of that period. As a
result, CEI purchased significant amounts of power on the spot
market at unusually high prices, causing the increase in
purchased power expense. Nuclearcosts. On a net basis, nuclear operating costs
were lower for the year-to-date and secondthird quarter periods of 1998
compared to 1997, offsetting part of the increase in fuel and
purchased power expense discussed above.
Lower costs at the Perry and Beaver
Valley Plants contributed to the reduction.
- 2429 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
Lower depreciable asset balances resulting from the
purchase accounting adjustment reduced the provision for
depreciation in the first halfnine months of 1998 compared to the
same period last year and for the secondthird quarter of 1998 compared
to the secondthird quarter of 1997. These reductions were partially
offset by the amortization of goodwill recognized with the
application of purchase accounting.
Interest income from investments related to the
refinancing of the Mansfield Plant lease increased other income
in the first nine months of 1998 compared to the first half and secondsame period of
1997. Interest expense decreased $15 million in the third quarter
of 1997.
Total interest charges were also higher1998 compared to the same period of 1997 due to secured notes
issuedrefinancings
and redemptions completed in connection with the refinancing of the Mansfield Plant
lease. Partially offsetting the increased interest charges waslast twelve months and the
amortization of net premiums associated with the revaluation of long-termlong-
term debt in connection with the merger.
Capital Resources and Liquidity
CEI has continuing cash requirements for planned
capital expenditures and debt maturities. During the last halffourth
quarter of 1998, capital requirements for property additions and
capital leases are expected to be about $62$45 million, including $5$4
million for nuclear fuel. CEI has additional cash requirements of
approximately $62.5$51.5 million to meet sinking fund requirements for
preferred stock and
maturing long-term debt during the remainder of 1998. These cash
requirements are expected to be satisfied with internal cash
and/or short-term credit arrangements.
As of JuneSeptember 30, 1998, CEI had approximately $151.4$54.4
million of cash and temporary investments and $30.3$60.8 million of
short-term indebtedness to an associated company. Upon completion
of the merger, application of purchase accounting reduced
bondable property such that CEI is not currently able to issue
additional first mortgage bonds, except against retired bonds.
FirstEnergy signed an agreement in principle with
Duquesne Light Company that would result in the transfer of 1,436
megawatts owned by Duquesne at five generating plants in exchange
for 1,298 megawatts at three plants owned by FirstEnergy's
electric utility operating companies (see "Pending Exchange of
Assets" in Note 2), including CEI. A final agreement on the
exchange of assets, which will be structured as a tax-free
transaction to the extent possible, is expected to be reached by
the end of the year. The transaction benefits the Companies by
providing them with exclusive ownership and operating control of
all the generating assets that are now jointly owned and operated
under the Central Area Power Coordination Group agreement.
Regulatory Matters
On July 3,September 16, 1998, FirstEnergy, together with
representatives of the three other Ohio investor-owned utilities,
presented proposed legislation for restructuring the electric
utility industry in Ohio to a private working group formed by the
leadership of the Ohio General Assembly. The working group, which
includes numerous interested parties, will consider the utility
proposal -- a proposal that represents a balanced approach for
bringing choice to Ohio's electric consumers -- as well as other
restructuring proposals. Passage of a restructuring bill appears
unlikely in 1998.
On September 24, 1998, the Federal Environmental
Protection Agency issued a final rule establishing tighter
nitrogen oxide emission ceilings for Ohio, Pennsylvania and 20
other Eastern states and the District of Columbia (see
"Environmental Matters" in Note 2). Controls must be in place by
May 2003, with required reductions achieved during the five-month
summer ozone season (May through September). The new rule is
expected to increase the cost of producing electricity; however,
CEI optionally redeemed $150 million
principal amountbelieves that it is in a better position than a number of
first mortgage bonds having a weighted
average interest rate of 8.56%.
Under FirstEnergy's "Energyother utilities in achieving compliance due to its nuclear and
hydroelectric generation capability.
- 30 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITIONS (Cont.)
In connection with the regulatory plans for Education" program,
eligible public schoolsits utility
operating companies to reduce fixed costs and lower rates,
FirstEnergy continued to take steps to restructure its operations
for improved efficiency and effectiveness in the changing
electric utility industry. FirstEnergy announced plans to
transfer its transmission assets (including CEI's service area enteredassets) into a
special eight-year contractnew subsidiary, American Transmission Systems, Inc. (ATS), with
the transfer expected to receivebe finalized by early 1999. The new
subsidiary represents a 10% base rate reductionfirst step toward FirstEnergy's goal of
establishing or becoming part of a larger independent
transmission company (TransCo). FirstEnergy believes that a
TransCo better addresses the Federal Energy Regulatory
Commission's (FERC) stated transmission objectives of providing
non-discriminatory service, while providing for streamlined and
cost-efficient operation. In working toward the goal of forming a
discountlarger regional transmission entity, FirstEnergy, American
Electric Power and Virginia Power announced on November 6, 1998,
that they would prepare a FERC filing during the first quarter of
1999 for prepaying their estimated electric bills
throughsuch a regional transmission entity. The entity would be
designed to meet the goals of reducing transmission costs that
result when transferring power over several transmission systems,
ensuring transmission reliability and providing non-
discriminatory access to the transmission grid.
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 CEI's programs that have date-sensitive
software may recognize a date using "00" as the year 2005. In April 1998,1900 rather
than the year 2000.
CEI receivedhas developed a $116.6
million prepayment under this program.
CEI's residential customers received a $3 reduction on
their monthly bills beginning June 5, 1998, as partmulti-phase program for Year 2000
compliance that consists of: (i) assessment of the Rate
Reductioncorporate
systems and Economic Development Plan approved last yearoperations of CEI that could be affected by the PUCO.Year
2000 problem; (ii) remediation or replacement of noncompliant
systems and components; and (iii) testing of systems and
components following such remediation or replacement. CEI has
focused its Year 2000 review on three areas: centralized system
applications, noncentralized systems and relationships with third
parties (including suppliers as well as end-use customers).
CEI currently believes that, with modifications to
existing software and conversions to new software, the Year 2000
issue will pose no significant operational problems for its
computer systems. Most of CEI's Year 2000 problems will be
resolved through system replacement. Of CEI's major centralized
systems, the general ledger system and inventory management and
procurement accounts payable system will be replaced by the end
of 1998. CEI's payroll system was enhanced to be Year 2000
compliant in July 1998; all employees will be converted to the
new system by January 1999. The customer service system is due to
be replaced in mid-1999.
CEI has categorized its noncentralized systems into
sixteen separate areas, and has already determined that five of
such areas pose no material Year 2000 problem. CEI has identified
certain Year 2000 issues in nine of such areas and is in the
process of remediating them. CEI has plans to complete the
assessment of the final two areas by the end of 1998. CEI plans
to complete the entire Year 2000 project by September 1999. If
the already identified modifications and conversions are not made
or are not completed on a timely basis, or if CEI identifies
material additional modifications which are not completed on a
timely basis, the Year 2000 issue would have a material adverse
impact on operations.
CEI has initiated formal communications with many of
its major suppliers to determine the extent to which it is
vulnerable to those third parties' failure to resolve their own
Year 2000 problems and is still in the assessment phase as to
whether and to what extent such third parties have a Year 2000
issue. There can be no guarantee that the failure of other
companies to resolve their own Year 2000 issue will not have a
material adverse effect on CEI's business, financial condition
and results of operations.
- 31 -
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITIONS (Cont.)
CEI is utilizing both internal and external resources
to reprogram and/or replace and test CEI's software for Year 2000
modifications. Of the $38 million total project cost,
approximately $31 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 benefits resulting from the system replacements).
The remaining $7 million will be expensed as incurred. As of
September 30,1998, CEI has expended a total of $15 million for
Year 2000 capital projects and had expensed approximately $2
million for Year 2000 related maintenance activities. CEI's total
Year 2000 project cost, as well as its estimates of time needed
to complete remedial efforts, are based on currently available
information and do not include the estimated costs and time
associated with the impact of third party Year 2000 issues.
CEI believes the most reasonably likely worst case
scenario from the Year 2000 issue to be disruption in power plant
monitoring systems, thereby producing inaccurate data and
potential failures in electronic switching mechanisms at
transmission junctions. This reductionwould prolong localized outages, as
technicians would have to manually activate switches. Such an
event could have a material, but presently undeterminable, effect
on CEI's financial results. CEI has not yet developed a
contingency plan to address the effects of any delay in becoming
Year 2000 compliant but currently expects to have a contingency
plan by the spring of 1999.
The costs of the project and the dates on which CEI
plans 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 reduce annual revenues by approximately
$24 million (approximately $14 million in 1998).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.
- 2532 -
THE TOLEDO EDISON COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
JuneSeptember 30, 1998 JuneSeptember 30, 1997
--------------------------------------------- ---------------------
Three SixNine Three SixNine
Months Months Months Months
Ended Ended Ended Ended
---------- ----------- --------- -------- -------- ------------------
(In thousands)
|
OPERATING REVENUES $239,731 $460,834$253,282 $714,116 | $222,144 $439,204$241,282 $680,486
-------- -------- | -------- --------
OPERATING EXPENSES AND TAXES: |
Fuel and purchased power 70,658 103,06556,708 164,049 | 44,501 87,81547,976 140,792
Nuclear operating costs 35,877 72,08737,681 106,912 | 39,382 79,28338,027 113,854
Other operating costs 37,263 74,25542,680 115,515 | 41,996 84,37340,214 123,042
-------- -------- | -------- --------
Total operation and maintenance expenses 143,798 249,407137,069 386,476 | 125,879 251,471126,217 377,688
Provision for depreciation and amortization 20,276 38,82319,472 58,295 | 24,596 49,49024,542 74,032
Amortization of net regulatory assets 4,665 8,6684,286 12,954 | 4,291 8,58212,873
General taxes 20,928 41,95821,435 63,393 | 22,601 45,39522,729 68,124
Income taxes 12,220 32,16819,817 51,985 | 8,700 15,83214,132 29,964
-------- -------- | -------- --------
Total operating expenses and taxes 201,887 371,024202,079 573,103 | 186,067 370,770191,911 562,681
-------- -------- | -------- --------
OPERATING INCOME 37,844 89,81051,203 141,013 | 36,077 68,43449,371 117,805
|
OTHER INCOME 3,057 6,8992,674 9,573 | 353 335,058 5,091
-------- -------- | -------- --------
INCOME BEFORE NET INTEREST CHARGES 40,901 96,70953,877 150,586 | 36,430 68,46754,429 122,896
-------- -------- | -------- --------
NET INTEREST CHARGES: |
Interest on long-term debt 22,370 45,25621,524 66,780 | 20,748 41,58223,388 64,970
Allowance for borrowed funds used during |
construction (314) (583)(344) (927) | (11) (115)(124) (239)
Other interest expense (credit) (285) (1,099)10 (1,089) | 2,577 5,0443,946 8,990
-------- -------- | -------- --------
Net interest charges 21,771 43,57421,190 64,764 | 23,314 46,51127,210 73,721
-------- -------- | -------- --------
NET INCOME 19,130 53,13532,687 85,822 | 13,116 21,95627,219 49,175
|
PREFERRED STOCK DIVIDEND REQUIREMENTS 4,150 5,5354,145 9,680 | 4,211 8,4054,185 12,590
-------- -------- | --------------- --------
EARNINGS ON COMMON STOCK $ 14,98028,542 $ 47,60076,142 | $ 8,90523,034 $ 13,55136,585
======== ======== | =============== ========
The preceding Notes to Financial Statements as they relate to The Toledo Edison Company are an
integral part of these statements.
- 2633 -
THE TOLEDO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
------------------------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service $1,728,365$1,741,913 $1,763,495
Less--Accumulated provision for depreciation 588,916606,442 619,222
---------- ----------
1,139,4491,135,471 1,144,273
---------- ----------
Construction work in progress-
Electric plant 23,57723,885 19,901
Nuclear fuel 7,9298,114 6,632
---------- ----------
31,50631,999 26,533
---------- ----------
1,170,9551,167,470 1,170,806
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Shippingport Capital Trust 310,936310,696 312,873
Nuclear plant decommissioning trusts 92,32794,491 85,956
Other. 4,392Other 3,719 3,164
---------- ----------
407,655408,906 401,993
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents 4,56721,356 22,170
Receivables-
Associated companies 20,11421,663 15,199
Other 18,43810,501 21,664
Notes receivable from associated companies 85,45079,595 40,802
Materials and supplies, at average cost-
Owned 26,10524,136 31,892
Under consignment 18,83219,223 9,538
Prepayments and other 29,99122,211 26,437
---------- ----------
203,497198,685 167,702
---------- ----------
DEFERRED CHARGES:
Regulatory assets 429,768423,599 442,724
Goodwill 503,911500,532 514,462
Property taxes 43,355 45,338
Other 3,4075,127 15,127
---------- ----------
980,441972,613 1,017,651
---------- ----------
$2,762,548$2,747,674 $2,758,152
========== ==========
- 2734 -
THE TOLEDO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
------------------------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, $5 par value, authorized
60,000,000 shares - 39,133,887 shares
outstanding $ 195,670 $ 195,670
Other paid-in capital 328,362328,193 328,364
Retained earnings 35,51048,470 7,616
---------- ----------
Total common stockholder's equity 559,542572,333 531,650
Preferred stock-
Not subject to mandatory redemption 210,000 210,000
Subject to mandatory redemption - 1,690
Long-term debt 1,192,1901,086,227 1,210,190
---------- ----------
1,961,7321,868,560 1,953,530
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock 71,156142,492 69,979
Accounts payable-
Associated companies 37,51924,676 21,173
Other 63,10856,389 60,756
Accrued taxes 40,91447,997 34,441
Accrued interest 26,52024,806 26,633
Other 22,58335,138 22,603
---------- ----------
261,800331,498 235,585
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes 123,357125,061 104,543
Accumulated deferred investment tax credits 41,96941,319 43,265
Pensions and other postretirement benefits 115,441116,584 113,254
Other 258,249264,652 307,975
---------- ----------
539,016547,616 569,037
---------- ----------
COMMITMENTS, GUARANTEES AND
CONTINGENCIES (Note 2) ---------- ----------
$2,762,548$2,747,674 $2,758,152
========== ==========
The preceding Notes to Financial Statements as they relate to The Toledo Edison Company are an
integral part of these balance sheets.
- 2835 -
THE TOLEDO EDISON COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
JuneSeptember 30, 1998 JuneSeptember 30, 1997
----------------------- ------------------------------------------- --------------------
Three SixNine Three SixNine
Months Months Months Months
Ended Ended Ended Ended
---------- ---------- --------- -------- -------- -----------------
(In thousands)
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
Net income $ 19,13032,687 $ 53,13585,822 | $ 13,11627,219 $ 21,956
-------- -------- | -------- --------49,175
Adjustments to reconcile net income to net |
cash from operating activities- |
Provision for depreciation and amortization 19,472 58,295 | amortization 20,276 38,823 | 24,596 49,49024,542 74,032
Nuclear fuel and lease amortization 3,629 10,9305,576 16,506 | 8,192 17,6349,264 26,898
Amortization of net regulatory assets 4,665 8,6684,286 12,954 | 4,291 8,58212,873
Deferred income taxes, net 11,564 21,0173,954 24,971 | (2,857) (3,126)(3,336) (6,462)
Investment tax credits, net (649) (1,298)(648) (1,946) | (1,080) (2,160)(3,240)
Allowance for equity funds used during |
construction - - | (54) (386)(291) (677)
Receivables (14,975) 3,2261,473 4,699 | (5,463) (5,103)
Materials and supplies (527) (3,507) | 1,350 1,772(203) 1,569
Accounts payable (1,329) 2,352(3,216) (864) | (8,413) (1,922)2,774 852
Accrued taxes 7,083 13,556 | 2,503 10,977
Other (15,099) (28,683)19,891 (15,265) | 19,990 12,05517,370 20,951
-------- -------- | -------- --------
Net cash provided from operating activities 92,136 196,799 | activities 26,685 104,663 | 53,668 98,792102,950 201,742
-------- -------- | -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES: |
New Financing- |
Long-term debt 3,657- 3,657 | 144,972 144,9726,973 151,945
Short-term borrowings, net - - | 85,000 85,000- 24,500
Redemptions and Repayments- |
Preferred stock 1,665- 1,665 | 1,665- 1,665
Long-term debt 33,127 41,69533,273 74,968 | 9,643 26,26049,692 75,952
Short-term borrowings, net - - | 60,500 -
Dividend Payments- |
Common stock 21,132 21,13215,654 36,786 | - -
Preferred stock 4,108 8,2354,074 12,309 | 4,204 8,3974,192 12,589
-------- -------- | -------- --------
Net cash provided from (used for) |
financing activities (56,375) (69,070)(53,001) (122,071) | 214,460 193,650(107,411) 86,239
-------- -------- | -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES: |
Property additions 6,898 14,64714,518 29,165 | 14,866 25,1198,761 33,880
Loans to associated companies - 44,64838,793 | - -
Loan payments from associated companies (33,150)(5,855) - | (43,748) (11,166)(27,651) (38,817)
Capital trust investments 66 (1,937)(240) (2,177) | 337,099 337,099(17,115) 319,984
Other (7,698) (4,162)13,923 9,761 | 825 3425,902 6,244
-------- -------- | -------- --------
Net cash used for (provided from) |
investing activities (33,884) 53,19622,346 75,542 | 309,042 351,394(30,103) 321,291
-------- -------- | -------- --------
Net increase (decrease) in cash and cash |
equivalents 4,194 (17,603)16,789 (814) | (40,914) (58,952)25,642 (33,310)
Cash and cash equivalents at beginning of |
period 3734,567 22,170 | 63,41622,502 81,454
-------- -------- | -------- --------
Cash and cash equivalents at end of period $ 4,56721,356 $ 4,56721,356 | $ 22,50248,144 $ 22,50248,144
======== ======== | ======== ========
The preceding Notes to Financial Statements as they relate to The Toledo Edison Company are an
integral part of these statements.
- 2936 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The Toledo Edison Company:
We have reviewed the accompanying consolidated balance sheet of
The Toledo Edison Company (an Ohio corporation and wholly owned
subsidiary of FirstEnergy Corp.) and subsidiary as of JuneSeptember
30, 1998, and the related consolidated statements of income and
cash flows for the three-month and six-monthnine-month periods ended
JuneSeptember 30, 1998 and 1997. These financial statements are the
responsibility of the company's management.
We conducted our review in accordance with standards established
by the American Institute of Certified Public Accountants. A
review of interim financial information consists principally of
applying analytical procedures to financial data and making
inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the financial statements
referred to above for them to be in conformity with generally
accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of The Toledo
Edison Company and subsidiary as of December 31, 1997 (not
presented herein), and, in our report dated February 13, 1998, we
expressed an unqualified opinion on that statement. In our
opinion, the information set forth in the accompanying
consolidated balance sheet as of December 31, 1997, is fairly
stated, in all material respects, in relation to the balance sheet
from which it has been derived.
ARTHUR ANDERSEN LLP
Cleveland, Ohio
August 12,November 13, 1998
- 3037 -
THE TOLEDO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
Financial results reflect the application of purchase
accounting to the merger of TE's former parent company,
Centerior, with OE to form FirstEnergy on November 8, 1997. The
application of this accounting resulted in fair value adjustments
which were "pushed down" or reflected on the separate financial
statements of Centerior's direct subsidiaries as of the merger
date, including TE's financial statements. Accordingly, the post-
merger financial statements for the first halfnine months and the secondthird
quarter of 1998 and the December 31, 1997 Consolidated Balance
Sheet reflect a new basis of accounting. Material effects of this
new basis of accounting are identified below.
Earnings on common stock increased to $47.6$76.1 million for
the six-monthnine-month period ended JuneSeptember 30, 1998, from $13.6$36.6
million in the same period last year. For the secondthird quarter of
1998, earnings increased to $15.0$28.5 million, compared to $8.9$23.0
million in the secondthird quarter of 1997. The increases reflect
increased operating revenues, benefits provided by the Bruce
Mansfield Plant lease refinancing and lower operating expenses.net reductions in the
provision for depreciation and amortization resulting from the
fair value adjustment of nuclear plant in connection with the
merger. The above factors were offset in part by an increase in
purchased power costs in the second quarter of 1998.costs.
Operating revenues increased $21.6$33.6 million during the
six-
monthnine-month period ended JuneSeptember 30, 1998 compared to the same
period inof 1997 and increased $17.6$12.0 million in the secondthird quarter
of 1998 from the corresponding period of 1997. Year-to-date
retail kilowatt-hour sales increased 9.2%8.0% from the same period
last year, with residential, commercial and industrial customers
all contributing to the increase. Residential sales benefited from
higher air-conditioning loads due to hotter weather, increasing
1.9%. Commercialincrease with increases of 5.3%, 5.1%
and industrial sales increased 6.6% and 13.8%10.5%, respectively. Commercial sales benefited from growth in the area
economy. Expanded production at the North Star
BHP Steel (North Star) facility was the primary factor in the
13.8% increase in industrial sales in the first halfnine months of 1998
from last year's level. Excluding North Star, industrial sales
increased 2.8%
during that period.0.2%. Sales to wholesale customers decreased 48.8%39.4%
compared to the first halfnine months of 1997 due in part to
unplanned generating unit outages which reduced available energy
for sale to other utilities. This resulted in a 4.1%2.1% decrease in
total kilowatt-hour sales during the six-monthnine-month period compared
to 1997.
Retail kilowatt-hour sales in the secondthird quarter of 1998
increased 11.7%5.7% from the secondthird quarter of 1997 with residential,
commercial and industrial customersincreased
demand from all contributing to the
increase.customer groups. Residential sales increased 6.7% benefitingbenefited from
thehigher air-conditioning loads due to hotter weather, increasing
12.4% in the secondthird quarter of this year1998, compared to the same period
of 1997. Commercial and industrial sales increased
12.1% and 13.5%, respectively. Commercial sales benefited fromContinued growth in the service sector of the area
economy.economy during the period contributed to a 2.2% increase in
commercial sales in the third quarter of 1998 compared to the
third quarter of 1997. Expanded production at the North Star facility was the primary factor
behind increasedremained
a major contributor to industrial sales duringin the secondperiod with sales
up 4.5% in the third quarter of 1998.1998 from the same period last
year. Excluding sales to North Star, industrial sales increased 2.2%
during that perioddecreased
4.7% in the third quarter of 1998 from the secondthird quarter of 1997.
A general decline in energy use by primary metal manufacturers
and the General Motors strike dampened industrial sales in the
third quarter of 1998. Sales to wholesale customers decreased
48.2%15.3% in the secondthird quarter of 1998 compared to the same period inof
1997. Overall, reducedReduced off-system sales offset, in part, the increase in
retail sales leading toresulting in a declinenet increase in total sales of 1.1%1.8%
for the secondthird quarter of 1998 compared to the secondthird quarter of
1997.
Fuel and purchased power expenses increased in both the
first halfnine months of 1998 and the secondthird quarter of 1998 compared
to the same periods of 1997. The increases resulted from higher
purchased power costs, in the second quarter of 1998, which resulted from a combination of
factors. In late June 1998, the midwestern and southern regions
of the United States experienced electricity shortages caused
mainly by record temperatures and humidity and unscheduled
generating unit outages. During this period, Beaver Valley Unit 2
remainedwas out of service and the Davis-Besse Nuclear Power StationPlant was removed from
service as a
- 31 -
result of damage to transmission facilities caused
- 38 -
THE TOLEDO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
by a tornado. Temperatures continued above last year's levels
throughout the third quarter of 1998 as well and Beaver Valley
Unit 2 remained out of service for most of that period. As a
result, TE purchased significant amounts of power on the spot
market at unusually high prices, causing the increase in
purchased power expense.costs.
Reduced nuclear operating costs and other operating
costs combined to substantially offset the year-to-date 1998
increase in fuel and purchased power expense compared to the same
period last year. On a net basis nuclear operating costs were
down at the three nuclear plants. Other operating costs were
lower for the year-to-date and
second quarter periodsfirst nine months of 1998 compared to 1997, substantially
offsetting the increase in fuel and purchased power expense
during the first half of 1998. Contributingsame
period last year due to the reduction were
lower operating costs at the Bay Shore Plant, lowerand
Mansfield plants. Lower rent expense as a result ofresulting from the
refinancing of the Mansfield Plant lease and reduced employee
levels.levels contributed to these reduced costs.
Lower depreciable asset balances resulting from the
purchase accounting adjustment reduced the provision for
depreciation in the first halfnine months of 1998 compared to the
same period last year and for the secondthird quarter of 1998 compared
to the secondthird quarter of 1997. These reductions were partially
offset by the amortization of goodwill recognized with the
application of purchase accounting.
Interest income from investments related to the
refinancing of the Mansfield Plant lease increased other income
in the first nine months of 1998 compared to the first half and second quartersame period of 1997.
Total interest charges decreased due in part to the amortization
of net premiums associated with the revaluation of long-term debt
in connection with the merger.
Capital Resources and Liquidity
TE has continuing cash requirements for planned capital
expenditures and debt maturities. During the last halffourth quarter of
1998, capital requirements for property additions and capital
leases are expected to be about $28$13 million, including $2 million
for nuclear fuel. TE has additional cash requirements of
approximately $12.7$12.4 million to meet sinking fund requirements for
preferred stock and
maturing long-term debt during the remainder of 1998. These cash
requirements are expected to be satisfied with internal cash
and/or short-term credit arrangements.
As of JuneSeptember 30, 1998, TE had approximately $90.0$101.0
million of cash and temporary investments and no short-term
indebtedness. Upon completion of the merger, application of
purchase accounting reduced bondable property such that TE is not
currently able to issue additional first mortgage bonds, except
against retired bonds.
Regulatory Matters
On September 16, 1998, FirstEnergy, together with
representatives of the three other Ohio investor-owned utilities,
presented proposed legislation for restructuring the electric
utility industry in Ohio to a private working group formed by the
leadership of the Ohio General Assembly. The working group, which
includes numerous interested parties, will consider the utility
proposal -- a proposal that represents a balanced approach for
bringing choice to Ohio's electric consumers -- as well as other
restructuring proposals. Passage of a restructuring bill appears
unlikely in 1998.
On September 24, 1998, the Federal Environmental
Protection Agency issued a final rule establishing tighter
nitrogen oxide emission ceilings for Ohio, Pennsylvania and 20
other Eastern states and the District of Columbia (see
"Environmental Matters" in Note 2). Controls must be in place by
May 2003, with required reductions achieved during the five-month
summer ozone season (May through September). The new rule is
expected to increase the cost of producing electricity; however,
- 39 -
THE TOLEDO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
TE believes that it is in a better position than a number of
other utilities in achieving compliance due to its nuclear
generation capability.
In connection with the regulatory plans for its utility
operating companies to reduce fixed costs and lower rates,
FirstEnergy continued to take steps to restructure its operations
for improved efficiency and effectiveness in the changing
electric utility industry. FirstEnergy announced plans to
transfer its transmission assets (including TE's assets) into a
new subsidiary, American Transmission Systems, Inc. (ATS), with
the transfer expected to be finalized by early 1999. The new
subsidiary represents a first step toward FirstEnergy's goal of
establishing or becoming part of a larger independent
transmission company (TransCo). FirstEnergy believes that a
TransCo better addresses the Federal Energy Regulatory
Commission's (FERC) stated transmission objectives of providing
non-discriminatory service, while providing for streamlined and
cost-efficient operation. In working toward the goal of forming a
larger regional transmission entity, FirstEnergy, American
Electric Power and Virginia Power announced on November 6, 1998,
that they would prepare a FERC filing during the first quarter of
1999 for such a regional transmission entity. The entity would be
designed to meet the goals of reducing transmission costs that
result when transferring power over several transmission systems,
ensuring transmission reliability and providing non-
discriminatory access to the transmission grid.
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 TE's programs that have date-sensitive
software may recognize a date using "00" as the year 1900 rather
than the year 2000.
TE has developed a multi-phase program for Year 2000
compliance that consists of: (i) assessment of the corporate
systems and operations of TE that could be affected by the Year
2000 problem; (ii) remediation or replacement of noncompliant
systems and components; and (iii) testing of systems and
components following such remediation or replacement. TE has
focused its Year 2000 review on three areas: centralized system
applications, noncentralized systems and relationships with third
parties (including suppliers as well as end-use customers).
TE currently believes that, with modifications to
existing software and conversions to new software, the Year 2000
issue will pose no significant operational problems for its
computer systems. Most of TE's Year 2000 problems will be
resolved through system replacement. Of TE's major centralized
systems, the general ledger system and inventory management and
procurement accounts payable system will be replaced by the end
of 1998. TE's payroll system was enhanced to be Year 2000
compliant in July 3,1998; all employees will be converted to the
new system by January 1999. The customer service system is due to
be replaced in mid-1999.
TE has categorized its noncentralized systems into
sixteen separate areas, and has already determined that five of
such areas pose no material Year 2000 problem. TE has identified
certain Year 2000 issues in nine of such areas and is in the
process of remediating them. TE has plans to complete the
assessment of the final two areas by the end of 1998. TE plans to
complete the entire Year 2000 project by September 1999. If the
already identified modifications and conversions are not made or
are not completed on a timely basis, or if TE identifies material
additional modifications which are not completed on a timely
basis, the Year 2000 issue would have a material adverse impact
on operations.
TE has initiated formal communications with many of its
major suppliers to determine the extent to which it is vulnerable
to those third parties' failure to resolve their own Year 2000
problems and is still in the assessment phase as to whether and
to what extent such third parties have a Year 2000 issue. There
- 40 -
THE TOLEDO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
can be no guarantee that the failure of other companies to
resolve their own Year 2000 issue will not have a material
adverse effect on TE's business, financial condition and results
of operations.
TE is utilizing both internal and external resources to
reprogram and/or replace and test TE's software for Year 2000
modifications. Of the $16 million total project cost,
approximately $13 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 benefits resulting from the system replacements).
The remaining $3 million will be expensed as incurred. As of
September 30, 1998, TE completedhas expended a total of $7 million for
Year 2000 capital projects and had expensed approximately $1
million for Year 2000 related maintenance activities. TE's total
Year 2000 project cost, as well as its estimates of time needed
to complete remedial efforts, are based on currently available
information and do not include the estimated costs and time
associated with the impact of third party Year 2000 issues.
TE believes the most reasonably likely worst case
scenario from the Year 2000 issue to be disruption in power plant
monitoring systems, thereby producing inaccurate data and
potential failures in electronic switching mechanisms at
transmission junctions. This would prolong localized outages, as
technicians would have to manually activate switches. Such an
optional redemptionevent could have a material, but presently undeterminable, effect
on TE's financial results. TE has not yet developed a contingency
plan to address the effects of any delay in becoming Year 2000
compliant but currently expects to have a $26
million, 7.5% first mortgage bond.
TE's residential customers received a $3 reduction on
their monthly bills beginning June 5, 1998, as partcontingency plan by the
spring of 1999.
The costs of the Rate
Reductionproject and Economic Development Plan approved last year by the PUCO. Thisdates on which TE
plans 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 reduce annual revenues by approximately $9
million (approximately $5 million in 1998).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.
- 3241 -
PENNSYLVANIA POWER COMPANY
STATEMENTS OF INCOME
(Unaudited)
Three Months Ended SixNine Months Ended
JuneSeptember 30, JuneSeptember 30,
-------------------- ----------------------------------------
1998 1997 1998 1997
---------- -------- -------- -------- ------------------ ---------
(In thousands)
OPERATING REVENUES $ 80,271 $79,220 $158,847 $158,197
--------$87,885 $85,239 $246,732 $243,436
------- ------- -------- --------
OPERATING EXPENSES AND TAXES:
Fuel and purchased power 23,089 15,215 40,887 31,11221,948 17,299 62,835 48,411
Nuclear operating costs 6,769 6,661 13,796 13,1346,720 6,407 20,516 19,541
Other operating costs 13,504 17,664 25,773 31,252
--------14,952 13,870 40,725 45,122
------- ------- -------- --------
Total operation and maintenance expenses 43,362 39,540 80,456 75,49843,620 37,576 124,076 113,074
Provision for depreciation 14,665 12,991 29,318 27,2824,719 15,621 34,037 42,903
Amortization of net regulatory assets 8,406 1,845 1,845 3,690 3,69012,096 5,535
General taxes 5,494 5,408 11,273 11,7075,335 5,913 16,608 17,620
Income taxes 4,906 6,432 11,472 13,383
--------9,375 8,649 20,847 22,032
------- ------- -------- --------
Total operating expenses and taxes 70,272 66,216 136,209 131,560
--------71,455 69,604 207,664 201,164
------- ------- -------- --------
OPERATING INCOME 9,999 13,004 22,638 26,63716,430 15,635 39,068 42,272
OTHER INCOME 634 324 1,373 994
--------569 795 1,942 1,789
------- ------- -------- --------
INCOME BEFORE NET INTEREST CHARGES 10,633 13,328 24,011 27,631
--------16,999 16,430 41,010 44,061
------- ------- -------- --------
NET INTEREST CHARGES:
Interest expense 5,223 5,641 10,717 11,3975,234 5,669 15,951 17,066
Allowance for borrowed funds used during
construction (62) (89) (144) (136)(52) (133) (196) (269)
------- ------- -------- ------- -------- --------
Net interest charges 5,161 5,552 10,573 11,2615,182 5,536 15,755 16,797
------- ------- -------- ------- -------- --------
INCOME BEFORE EXTRAORDINARY ITEM 5,472 7,776 13,438 16,37011,817 10,894 25,255 27,264
EXTRAORDINARY ITEM (NET OF INCOME TAXES) (Note 3) (30,522)- - (30,522) -
--------------- ------- -------- --------
NET INCOME (LOSS) (25,050) 7,776 (17,084) 16,37011,817 10,894 (5,267) 27,264
PREFERRED STOCK DIVIDEND REQUIREMENTS 1,156 1,156 2,313 2,313
--------1,157 1,157 3,470 3,470
------- ------- -------- --------
EARNINGS (LOSS) ON COMMON STOCK $(26,206)$10,660 $ 6,620 $(19,397)9,737 $ 14,057
========(8,737) $ 23,794
======= ======= ======== ========
The preceding Notes to Financial Statements as they relate to Pennsylvania Power Company are an
integral part of these statements.
- 3342 -
PENNSYLVANIA POWER COMPANY
BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
------------------------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service, at original cost $ 687,966$689,654 $1,237,562
Less--Accumulated provision for depreciation 281,175285,242 508,981
----------------- ----------
406,791404,412 728,581
----------------- ----------
Construction work in progress-
Electric plant 9,70010,977 7,427
Nuclear fuel 23118 6,788
----------------- ----------
9,72311,095 14,215
----------------- ----------
416,514415,507 742,796
----------------- ----------
OTHER PROPERTY AND INVESTMENTS 31,39732,259 26,157
----------------- ----------
CURRENT ASSETS:
Cash and cash equivalents 6,0874,094 660
Notes receivable from parent company 30,00034,400 17,500
Receivables-
Customers (less accumulated provisions
of $3,585,000$3,596,000 and $3,609,000,
respectively, for uncollectible accounts) 34,55634,949 33,934
Associated companies 15,110 12,59915,674 15,764
Other 10,347 14,4268,509 11,261
Materials and supplies, at average cost 15,14615,985 14,973
Prepayments 8,0505,511 1,707
--------- ---------
119,296-------- ----------
119,122 95,799
--------- ----------------- ----------
DEFERRED CHARGES:
Regulatory assets 392,510381,758 162,966
Other 5,0686,155 6,739
----------------- ----------
397,578387,913 169,705
----------------- ----------
$ 964,785$954,801 $1,034,457
================= ==========
- 3443 -
PENNSYLVANIA POWER COMPANY
BALANCE SHEETS
(Unaudited)
JuneSeptember 30, December 31,
1998 1997
------------------------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, $30 par value, authorized
6,500,000 shares - 6,290,000 shares
outstanding $ 188,700$188,700 $ 188,700
Other paid-in capital (400) (400)
Retained earnings 73,66278,900 103,677
----------------- ----------
Total common stockholder's equity 261,962267,200 291,977
Preferred stock-
Not subject to mandatory redemption 50,905 50,905
Subject to mandatory redemption 15,000 15,000
Long-term debt-
Associated companies 9,6247,785 9,231
Other 281,675281,636 280,074
----------------- ----------
619,166622,526 647,187
----------------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt-
Associated companies 5,2655,960 6,958
Other 493512 1,443
Accounts payable-
Associated companies 11,0137,768 6,788
Other 23,53214,284 22,751
Accrued taxes 13,81612,155 12,332
Accrued interest 6,6193,982 6,588
Other 13,56916,450 14,746
----------------- ----------
74,30761,111 71,606
----------------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes 209,172208,209 239,952
Accumulated deferred investment tax credits 8,9318,359 26,052
Other 53,20954,596 49,660
----------------- ----------
271,312271,164 315,664
----------------- ----------
COMMITMENTS, GUARANTEES AND
CONTINGENCIES (Note 2) ----------------- ----------
$ 964,785$954,801 $1,034,457
================= ==========
The preceding Notes to Financial Statements as they relate to Pennsylvania Power Company are an
integral part of these balance sheets.
- 3544 -
PENNSYLVANIA POWER COMPANY
STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended SixNine Months Ended
JuneSeptember 30, JuneSeptember 30,
-------------------- ---------------------------------------- ---------------------
1998 1997 1998 1997
-------- -------- -------- ------------------ --------- --------- ----------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(25,050) $ 7,776 $(17,084) $16,37011,817 $10,894 $ (5,267) $27,264
Adjustments to reconcile net income to net
cash from operating activities-
Provision for depreciation 14,665 12,991 29,318 27,2824,719 15,621 34,037 42,903
Nuclear fuel and lease amortization 852 2,320 1,792 4,8091,460 1,658 3,252 6,467
Other amortization, net 1,581 1,543 3,153 3,0788,511 1,553 11,664 4,631
Deferred income taxes, net (24,177) (3,466) (26,989) (6,607)931 (1,857) (26,058) (8,464)
Investment tax credits, net (572) (537) (1,144) (1,119)(573) (629) (1,717) (1,748)
Extraordinary item 51,730- - 51,730 -
Receivables (16) 11,001 946 11,487881 (122) 1,827 11,365
Materials and supplies 203 (553) (173) (928)(839) 328 (1,012) (600)
Accounts payable 3,842 (4,131) 5,006 (4,152)(12,493) (5,025) (7,487) (9,177)
Other 3,734 3,064 (5,867) (5,064)(1,638) 2,013 (7,505) (3,051)
-------- ------- -------- -------
Net cash provided from operating activities 26,792 30,008 40,688 45,15612,776 24,434 53,464 69,590
-------- ------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Long-term debt - 10,007 1,621 - 1,621 -10,007
Redemptions and Repayments-
Long-term debt 791 2,289 2,551 14,312
Notes payable, net - 5,000 - -1,443 12,103 3,994 26,415
Dividend Payments-
Common stock 5,347 5,347 10,693 10,69316,040 16,040
Preferred stock 1,081 1,081 2,238 2,2381,232 1,232 3,470 3,470
-------- ------- -------- -------
Net cash used for financing activities 5,598 13,717 13,861 27,2438,022 8,675 21,883 35,918
-------- ------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions 3,735 3,199 7,019 6,5304,541 3,529 11,560 10,059
Loan to parent 13,500 13,000 12,500 10,5004,400 11,500 16,900 22,000
Other 1,069 74 1,881 1,777(2,194) 1,211 (313) 2,988
-------- ------- -------- -------
Net cash used for investing activities 18,304 16,273 21,400 18,8076,747 16,240 28,147 35,047
-------- ------- -------- -------
Net increase (decrease) in cash and cash equivalents 2,890 18 5,427 (894)(1,993) (481) 3,434 (1,375)
Cash and cash equivalents at beginning of period 3,197 4756,087 493 660 1,387
-------- ------- -------- -------
Cash and cash equivalents at end of period $ 6,0874,094 $ 49312 $ 6,0874,094 $ 49312
======== ======= ======== =======
The preceding Notes to Financial Statements as they relate to Pennsylvania Power Company are an
integral part of these statements.
- 36 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Pennsylvania Power Company:
We have reviewed the accompanying balance sheet of Pennsylvania
Power Company (a Pennsylvania corporation and a wholly owned
subsidiary of Ohio Edison Company) as of JuneSeptember 30, 1998, and
the related statements of income and cash flows for the three-monththree-
month and six-monthnine-month periods ended JuneSeptember 30, 1998 and 1997.
These financial statements are the responsibility of the company's
management.
We conducted our review in accordance with standards established
by the American Institute of Certified Public Accountants. A
review of interim financial information consists principally of
applying analytical procedures to financial data and making
inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the financial statements
referred to above for them to be in conformity with generally
accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the balance sheet of Pennsylvania Power
Company as of December 31, 1997 (not presented herein), and, in
our report dated February 13, 1998, we expressed an unqualified
opinion on that statement. In our opinion, the information set
forth in the accompanying balance sheet as of December 31, 1997,
is fairly stated, in all material respects, in relation to the
balance sheet from which it has been derived.
ARTHUR ANDERSEN LLP
Cleveland, Ohio
August 12,November 13, 1998
- 3746 -
PENNSYLVANIA POWER COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
Earnings were adversely affected in the six-monthnine-month
period ended JuneSeptember 30, 1998, and in the second quarter of 1998 compared to the same periodsperiod of
1997, by an extraordinary item resulting from the deregulation of
Penn's generation business and the corresponding discontinuation
of SFAS 71 with respect to its
generationthat business. This action was taken
following the June 18, 1998, authorization by the PPUC of a
restructuring plan for Penn (see below and Note 3). Excluding the
extraordinary item, earnings on common stock were $11.1$21.8 million
in the first halfnine months of 1998 compared to $14.1$23.8 million in the
same period last year; for the secondthird quarter of 1998, earnings on
common stock were $4.3$10.7 million compared to $6.6$9.7 million in the
secondthird quarter of 1997.
Retail kilowatt-hour sales decreased 2.7%1.7% in the first
sixnine months of 1998 and 2.5%increased 0.4% in the secondthird quarter of
1998 from the same periods in 1997, due to1997. Year-to-date results reflect
a decline in industrial sales.sales which was more than offset in the
third quarter by growth in the residential and commercial
sectors. Closure of an electric arc facility at Caparo Steel
Company in August 1997, caused the reduced industrial sales.
Excluding sales to Caparo, sales to industrial customers in the
first halfnine months of 1998 increased 3.6%2.7% and sales in the secondthird
quarter of 1998 were up 2.5%0.9% from the corresponding periods last
year. A general decline in electricity demand by primary metal
manufacturers also dampened industrial sales in the third quarter
of 1998. Residential sales increased 3.4%5.1% during the first sixnine
months of 1998 compared to the first halfnine months of 1997 and 4.6%8.5%
in the secondthird quarter of 1998 from the same period last year.
Residential sales benefited from higher air-conditioning loads
due to hotter weather. Commercial sales also increased in both
the sixnine month and secondthird quarter periods of 1998 from the
corresponding periods last year, by 6.3%7.8% and 10.1%10.7%, respectively,
reflecting continued growth in the service sector economy. Sales
to wholesale customers decreased
3.5%increased 9.9% in the first sixnine months of
1998 compared to the first halfnine months of 1997 and were down 3.3%up 34.1%
in the secondthird quarter of 1998 compared to the same period last
year.year due to increased generation availability.
Fuel and purchased power expenses increased in both the
first halfnine months of 1998 and in the secondthird quarter of 1998
compared to the same periods of 1997. The increases resulted primarily from
higherMost of the increase in
purchased power costs occurred in the second quarter of 1998,
resulting from a combination of factors. In late June 1998, the
midwestern and southern regions of the United States experienced
electricity shortages caused mainly by record temperatures and
humidity and unscheduled generating unit outages. Due in part to
an unscheduled outage at Beaver Valley Unit 1, which continued
through the second quarter of 1998, Penn's production
capability was reduced to the point that Penn purchased
significant amounts of power onduring this period. Temperatures
continued above last year's levels in the spot marketthird quarter of 1998
as well and Beaver Valley Unit 1 remained out of service for
approximately half of that period. As a result, Penn purchased
significant amounts of power at unusually high spot market
prices, causing the increase in purchased power expense.costs.
Other operating costs decreased in the first sixnine
months of
1998 and in second quarter of 1998 compared to the same periodsperiod of 1997 due to a $3
million charge for uncollectible accounts in the second quarter
of 1997. The increases in the provision for depreciation and amortization
duringdecreased $10.9 million in the six-month period and
secondthird quarter of 1998 from the
first half andsame period of 1997 primarily due to the effects of Penn's rate
restructuring plan authorized by the PPUC in the second quarter.
The rate restructuring plan resulted in a reduction in nuclear
generating unit investment due to the discontinued application of
SFAS 71 with a corresponding reduction in reported depreciation
expense. Penn's rate restructuring plan also resulted in a
reclassification of accelerated Perry 1 depreciation in the third
quarter of 1997, were due1998 to higher levelsamortization of acceleratednet regulatory assets, further
reducing depreciation. The reclassification of depreciation
andresulted in an increase in the amortization of net regulatory
assets in the third quarter of 1998 under Penn's Rate Stability and Economic
Development Plan.compared to the third quarter
of 1997.
- 47 -
PENNSYLVANIA POWER COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
Capital Resources and Liquidity
Penn has continuing cash requirements for planned
capital expenditures. During the last two quartersfourth quarter of 1998, capital
requirements for property additions and capital leases are
expected to be about $12$8 million, including $2 million for nuclear
fuel. These requirements are expected to be satisfied with
internal cash.
As of JuneSeptember 30, 1998, Penn had approximately $36.1$38.5
million of cash and temporary investments and no short-term
indebtedness. Penn had $2 million of unused short-term bank lines of creditfacilities as of
JuneSeptember 30, 1998, and $7 million of bank facilities which may be borrowed for up to several days
at the banks' discretion.
- 38 -
TransitionIn connection with the regulatory plans for its utility
operating companies to Retail Competition
On June 18,reduce fixed costs and lower rates,
FirstEnergy continued to take steps to restructure its operations
for improved efficiency and effectiveness in the changing
electric utility industry. FirstEnergy announced plans to
transfer its transmission assets (including Penn's assets) into a
new subsidiary, American Transmission Systems, Inc. (ATS), with
the transfer expected to be finalized by early 1999. The new
subsidiary represents a first step toward FirstEnergy's goal of
establishing or becoming part of a larger independent
transmission company (TransCo). FirstEnergy believes that a
TransCo better addresses the Federal Energy Regulatory
Commission's (FERC) stated transmission objectives of providing
non-discriminatory service, while providing for streamlined and
cost-efficient operation. In working toward the goal of forming a
larger regional transmission entity, FirstEnergy, American
Electric Power and Virginia Power announced on November 6, 1998,
that they would prepare a FERC filing during the PPUC authorizedfirst quarter of
1999 for such a plan which will
restructure Penn's ratesregional transmission entity. The entity would be
designed to meet the goals of reducing transmission costs that
result when transferring power over several transmission systems,
ensuring transmission reliability and provide customers with directproviding non-
discriminatory access to alternative electricity suppliers. Customer choice will be
phasedthe transmission grid.
FirstEnergy signed an agreement in over two yearsprinciple with
66%Duquesne Light Company that would result in the transfer of each customer class having
direct access to alternative suppliers1,436
megawatts owned by Duquesne at five generating plants in exchange
for 1,298 megawatts at three plants owned by FirstEnergy's
utility operating companies (see "Pending Exchange of generation by January
2, 1999, and all remaining customers having access asAssets" in
Note 2) including Penn. A final agreement on the exchange of
January
2, 2000. Under the plan, Penn will continue to deliver power to
homes and businesses through its transmission and distribution
system, which will remain regulated. However, Penn's rates have
been restructured to establish separate charges for transmission
and distribution; generation,assets, which will be subjectstructured as a tax-free transaction to competition;the
extent possible, is expected to be reached by the end of the
year. The transaction benefits the Companies by providing them
with exclusive ownership and strandedoperating control of all the
generating assets that are now jointly owned and operated under
the Central Area Power Coordination Group agreement. Certain
details of the arrangement such as the specific allocation of
generation assets among the Companies remains to be determined.
On September 24, 1998, the Federal Environmental
Protection Agency issued a final rule establishing tighter
nitrogen oxide emission ceilings for Pennsylvania, Ohio and 20
other Eastern states and the District of Columbia (see
"Environmental Matters" in Note 2). Controls must be in place by
May 2003, with required reductions achieved during the five-month
summer ozone season (May through September). The new rule is
expected to increase the cost recovery.of producing electricity; however,
Penn believes that it is in a better position than a number of
other utilities in achieving compliance due to its nuclear
generation capability.
Impact of the Year 2000 Issue
The generationYear 2000 issue is the result of computer programs
being written using two digits rather than four to identify the
applicable year. Any of Penn's programs that have date-sensitive
software may recognize a date using "00" as the year 1900 rather
than the year 2000.
- 48 -
PENNSYLVANIA POWER COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Cont.)
Penn has developed a multi-phase program for Year 2000
compliance that consists of: (i) assessment of the corporate
systems and operations of Penn that could be affected by the Year
2000 problem; (ii) remediation or replacement of noncompliant
systems and components; and (iii) testing of systems and
components following such remediation or replacement. Penn has
focused its Year 2000 review on three areas: centralized system
applications, noncentralized systems and relationships with third
parties (including suppliers as well as end-use customers).
Penn currently believes that, with modifications to
existing software and conversions to new software, the Year 2000
issue will pose no significant operational problems for its
computer systems. Most of Penn's Year 2000 problems will be
resolved through system replacement. Of Penn's major centralized
systems, the general ledger system and inventory management and
procurement accounts payable system will be replaced by the end
of 1998. Penn's payroll system was enhanced to be Year 2000
compliant in July 1998. The customer service system is due to be
replaced in mid-1999.
Penn has categorized its noncentralized systems into
sixteen separate areas, and has already determined that five of
such areas pose no material Year 2000 problem. Penn has
identified certain Year 2000 issues in nine areas and is in the
process of remediating them. Penn has plans to complete the
assessment of the final two areas by the end of 1998. Penn plans
to complete the entire Year 2000 project by September 1999. If
the already identified modifications and conversions are not made
or are not completed on a timely basis, or if Penn identifies
material additional modifications which are not completed on a
timely basis, the Year 2000 issue would have a material adverse
impact on operations.
Penn has initiated formal communications with many of
its major suppliers to determine the extent to which it is
vulnerable to those third parties' failure to resolve their own
Year 2000 problems and is still in the assessment phase as to
whether and to what extent such third parties have a Year 2000
issue. There can be no guarantee that the failure of other
companies to resolve their own Year 2000 issue will not have a
material adverse effect on Penn's business, financial condition
and results of operations.
Penn is utilizing both internal and external resources
to reprogram and/or replace and test Penn's software for Year
2000 modifications. Of the $7 million total project cost,
approximately $6 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 unbundled rates represents a "shopping credit"benefits resulting from the system replacements).
In the
event customers obtain power from an alternative source, the
generation portion of Penn's rateThe remaining $1 million will be excludedexpensed as incurred. As of
September 30, 1998, Penn had expended a total of $3 million for
Year 2000 capital projects and had expensed approximately
$400,000 for Year 2000 related maintenance activities. Penn's
total Year 2000 project cost, as well as its estimates of the
time needed to complete remedial efforts, are based on currently
available information and do not include the estimated costs and
time associated with the impact of third party Year 2000 issues.
Penn believes the most reasonably likely worst case
scenario from their
billthe Year 2000 issue to be disruption in power plant
monitoring systems, thereby producing inaccurate data and
potential failures in electronic switching mechanisms at
transmission junctions. This would prolong localized outages, as
technicians would have to manually activate switches. Such an
event could have a material, but presently undeterminable, effect
on Penn's financial results. Penn has not yet developed a
contingency plan to address the effects of any delay in becoming
Year 2000 compliant but currently expects to have a contingency
plan by the spring of 1999.
The costs of the project and the customersdates on which Penn
plans 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 receive a generation chargebe completed as planned and
actual results could differ materially from the alternative supplier. The strandedestimates.
Specific factors that might cause material differences include,
but are not limited to, the availability and cost recovery portion of rates
provides for recovery of certain amounts not otherwise considered
recoverable in a competitive generation market. Penn will recover
$234 million of stranded costs through a competitive transition
charge starting in 1999trained
personnel, the ability to locate and ending in 2005.correct all relevant
computer code, and similar uncertainties.
- 3949 -
PART II. OTHER INFORMATION
- ---------------------------
Item 5. Other Information
-----------------
FirstEnergy's Code of Regulations requires a shareholder
to give appropriate notice to the Company before any
business requested to be brought before an annual meeting
of the Company's shareholders by that shareholder can be
considered at the meeting. Appropriate notice in this
case is notice to the Company's Corporate Secretary
received at least 60 days prior to the meeting. Business
that a shareholder requests be brought before the 1999
Annual Meeting as to which appropriate notice is given to
the Company on or before February 3, 1999, will be
referred to in the Company's proxy materials for that
meeting, but such business as to which the Company
receives notice after that date will not. In either case,
the rules contained in Regulation 14a-4(c) under the
Securities Exchange Act of 1934 relating to the
conferring of discretionary voting authority in a proxy
will apply.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
Exhibit
Number
-------------
FirstEnergy, OE, CEI and Penn
-----------------------------
15 Letter from independent public accountants.
TE
--
None
Pursuant to paragraph (b)(4)(iii)(A) of Item 601 of
Regulation S-K, FirstEnergy, or, respectively, any of
the Companies, has not filed as an exhibit to this Form
10-Q any instrument with respect to long-term debt if
the respective total amount of securities authorized
thereunder does not exceed 10% of the total assets of
FirstEnergy and its subsidiaries on a consolidated
basis, or respectively, any of the Companies, but hereby
agrees to furnish to the Commission on request any such
documents.
(b) Reports on Form 8-K
FirstEnergy, OE, CEI, TE, Penn - OneTwo combined
report------------------------------
reports on
------------------------------ Form 8-K waswere filed since March 31,June 30, 1998.
A report dated July 6, 1998 reported events
affecting second quarter 1998 results of operations
for FirstEnergy and its four operating subsidiaries
including power supply transactions, power marketing
and trading transactions, and Penn's rate
restructuring plan. A report dated October 15, 1998
reported that FirstEnergy will transfer its
transmission assets into a new subsidiary and has
signed an agreement in principle with Duquesne
Light Company (Duquesne) that would result in an
exchange of certain generating assets between
FirstEnergy's operating subsidiaries and Duquesne.
- 4050 -
SIGNATURE
Pursuant to the requirements of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly authorized.
August 12,November 13, 1998
FIRSTENERGY CORP.
---------------------------------
Registrant
OHIO EDISON COMPANY
-------------------
Registrant
THE CLEVELAND ELECTRIC
----------------------
ILLUMINATING COMPANY
--------------------
Registrant
THE TOLEDO EDISON COMPANY
-------------------------
Registrant
/s/ Harvey L. Wagner
---------------------------------------------------------------
Harvey L. Wagner
Controller
Principal Accounting Officer
PENNSYLVANIA POWER COMPANY
--------------------------
Registrant
/s/ Harvey L. Wagner
----------------------------------------------------------------
Harvey L. Wagner
Comptroller
Principal Accounting Officer
- 41 -
51 -