EXHIBIT 13.7
PENNSYLVANIA ELECTRIC COMPANY
2001 ANNUAL REPORT TO STOCKHOLDERS
Pennsylvania Electric Company is a wholly owned electric utility
operating subsidiary of FirstEnergy Corp. It engages in the distribution and
sale of electric energy in an area of approximately 17,600 square miles in
western Pennsylvania. It also engages in the sale, purchase and interchange of
electric energy with other electric companies. The area it serves has a
population of approximately 1.6 million. The Company, as lessee of the property
of the Waverly Electric Light & Power Company, also serves a population of about
13,400 in Waverly, New York and vicinity.
In August 2000, FirstEnergy entered into an agreement to merge with GPU,
Inc., under which FirstEnergy would acquire all of the outstanding shares of
GPU, Inc.'s common stock for approximately $4.5 billion in cash and FirstEnergy
common stock. The merger became effective on November 7, 2001 and is being
accounted for by the purchase method. Prior to that time, Pennsylvania Electric
Company was a wholly owned subsidiary of GPU, Inc.
Contents Page
- -------- ----
Selected Financial Data........................................... 1
Management's Discussion and Analysis.............................. 2-8
Consolidated Statements of Income................................. 9
Consolidated Balance Sheets....................................... 10
Consolidated Statements of Capitalization......................... 11
Consolidated Statements of Common Stockholder's Equity............ 12
Consolidated Statements of Preferred Stock........................ 12
Consolidated Statements of Cash Flows............................. 13
Consolidated Statements of Taxes.................................. 14
Notes to Consolidated Financial Statements........................ 15-22
Reports of Independent Public Accountants......................... 23-24
PENNSYLVANIA ELECTRIC COMPANY
SELECTED FINANCIAL DATA
Years Ended December 31,
Nov. 7 - Jan. 1 - --------------------------------------------------
Dec. 31, 2001 Nov. 6, 2001 2000 1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Operating Revenues............................. $ 140,062 | $ 834,548 $ 901,881 $ 921,965 $ 1,032,226 $ 1,052,936
=========== | =========== =========== ========== =========== ===========
|
Operating Income............................... $ 14,341 | $ 70,049 $ 80,336 $ 140,925 $ 125,623 $ 157,950
=========== | =========== =========== ========== =========== ===========
|
Income Before Extraordinary Item............... $ 10,795 | $ 23,718 $ 39,250 $ 152,491 $ 58,590 $ 95,023
=========== | =========== =========== ========== =========== ===========
|
Net Income..................................... $ 10,795 | $ 23,718 $ 39,250 $ 152,491 $ 39,640 $ 95,023
=========== | =========== =========== ========== =========== ===========
|
Earnings on Common Stock....................... $ 10,795 | $ 23,718 $ 39,250 $ 151,611 $ 38,945 $ 94,358
=========== | =========== =========== ========== =========== ===========
|
Total Assets................................... $ 3,300,269 | $ 2,331,484 $2,463,052 $ 3,565,747 $ 2,499,703
=========== | =========== ========== =========== ===========
|
|
Capitalization: |
Common Stockholder's Equity.................... $ 1,306,576 | $ 469,837 $ 461,182 $ 767,304 $ 791,338
Cumulative Preferred Stock..................... -- | -- -- 16,681 16,681
Company-Obligated Mandatorily Redeemable |
Preferred Securities........................ -- | -- -- 105,000 105,000
Company-Obligated Trust Preferred Securities... 92,000 | 100,000 100,000 -- --
Long-Term Debt................................. 472,400 | 519,481 426,795 629,027 679,716
----------- | ----------- ---------- ----------- -----------
Total Capitalization........................... $ 1,870,976 | $ 1,089,318 $ 987,977 $ 1,518,012 $ 1,592,735
=========== | =-========= ========== =========== ===========
|
|
Capitalization Ratios: |
Common Stockholder's Equity.................... 69.8%| 43.1% 46.7% 50.5% 49.7%
Cumulative Preferred Stock..................... -- | -- -- 1.1 1.0
Company-Obligated Mandatorily Redeemable |
Preferred Securities........................ -- | -- -- 6.9 6.6
Company-Obligated Trust Preferred Securities... 4.9 | 9.2 10.1 -- --
Long-Term Debt................................. 25.3 | 47.7 43.2 41.5 42.7
------ | ----- ----- ----- ------
Total Capitalization........................... 100.0%| 100.0% 100.0% 100.0% 100.0%
===== | ===== ===== ===== =====
|
|
Transmission and Distribution |
Kilowatt-Hour deliveries (Millions): |
Residential.................................... 721 | 3,264 3,949 3,864 3,756 3,801
Commercial..................................... 758 | 3,733 4,509 4,319 4,198 4,098
Industrial..................................... 685 | 3,658 4,698 4,865 4,996 4,835
Other.......................................... 7 | 34 40 43 42 45
----- | ------- -------- ------ ------ ------
Total Retail................................... 2,171 | 10,689 13,196 13,091 12,992 12,779
Total Wholesale................................ 107 | 1,351 2,885 4,219 4,309 3,461
----- | ------- -------- ------- ------ ------
Total.......................................... 2,278 | 12,040 16,081 17,310 17,301 16,240
===== | ====== ======== ====== ====== ======
|
|
Transmission and Distribution Deliveries |
Customers Served:: |
Residential.................................... 502,901 | 502,052 500,930 499,484 498,229
Commercial..................................... 76,005 | 74,282 73,979 73,014 72,271
Industrial..................................... 2,652 | 2,703 2,844 2,910 2,949
Other.......................................... 1,099 | 1,110 1,110 1,111 1,117
------- | -------- ------- ------- -------
Total.......................................... 582,657 | 580,147 578,863 576,519 574,566
======= | ======== ======= ======= =======
1
PENNSYLVANIA ELECTRIC COMPANY
Management's Discussion and Analysis of
Results of Operations and Financial Condition
This discussion includes forward-looking statements based on information
currently available to management that is subject to certain risks and
uncertainties. Such statements typically contain, but are not limited to, the
terms anticipate, potential, expect, believe, estimate and similar words. Actual
results may differ materially due to the speed and nature of increased
competition and deregulation in the electric utility industry, economic or
weather conditions affecting future sales and margins, changes in markets for
energy services, changing energy and commodity market prices, legislative and
regulatory changes (including revised environmental requirements), the
availability and cost of capital, ability to accomplish or realize anticipated
benefits from strategic initiatives and other similar factors.
Results of Operations
- ---------------------
Earnings on common stock decreased 12.1% to $34.5 million in 2001 from
$39.2 million in 2000. In 2001, earnings were negatively impacted by higher
other operating costs, as well as lower other income. Offsetting this were
higher revenues and lower net interest charges. In 2000, earnings on common
stock decreased 74.1% to $39.2 million from $151.6 million in 1999. The decrease
was primarily due to greater purchased power costs, the absence of a net gain
related to wholesale operations from the sale of substantially all of our
generating facilities in 1999, and, to a lesser extent, higher net interest
charges. Lower other operating costs and depreciation expense positively
affected earnings on common stock in 2000.
Operating revenues increased by $72.7 million in 2001 following a $20.1
million decrease in 2000. The sources of the changes in operating revenues
during 2001 and 2000, as compared to the prior year, are summarized in the
following table.
Sources of Revenue Changes 2001 2000
--------------------------------------------------------------------
Increase (Decrease) (In millions)
Change in kilowatt-hour sales due
to level of retail customers
shopping for generation service.................. $134.5 $ 9.5
Change in other retail kilowatt-hour sales......... (12.2) 10.1
Decrease in wholesale sales........................ (50.6) (32.4)
All other changes.................................. 1.0 (7.3)
--------------------------------------------------------------------
Net Increase (Decrease) in Operating Revenues...... $ 72.7 $(20.1)
====================================================================
Electric Sales
In 2001, a major source of the increase in operating revenues was the
increase in retail generation kilowatt-hour sales due to a large number of
customers returning to us in 2001 as full service customers, after receiving
their power from alternate suppliers in 2000. In 2001, 85.3% of total retail
sales were to full service customers as compared to 62.7% in 2000. Residential
sales remained relatively flat, while commercial sales were slightly lower in
2001 compared to 2000, primarily due to lower usage. Industrial sales also
decreased in 2001 compared to 2000 due almost evenly to a decrease in the number
of customers and lower usage by existing customers. Sales to wholesale customers
decreased in 2001 compared to 2000 due to a reduction in our available capacity.
The primary source of the decrease in operating revenues in 2000,
compared to the prior year, was lower sales to the wholesale market, as a result
of us having additional power available in 1999 due to the delay of the
divestiture of our generating assets. Operating revenues also increased due to
higher residential and commercial sales, partially offset by lower industrial
sales. Changes in kilowatt-hour sales by customer class in 2001 and 2000 are
summarized in the following table:
2
Changes in Kilowatt-hour Sales 2001 2000
--------------------------------------------------
Increase (Decrease)
Residential.................. 0.9% 2.2%
Commercial................... (0.4)% 4.4%
Industrial................... (7.6)% (3.4)%
--------------------------------------------------
Total Retail................. (2.5)% 0.8%
Wholesale.................... (49.5)% (31.6)%
--------------------------------------------------
Total Sales.................. (11.0)% (7.1)%
--------------------------------------------------
Operating Expenses and Taxes
Total operating expenses and taxes increased $68.7 million in 2001 and
$40.5 million in 2000, compared to the preceding year. Higher purchased power
costs accounted for the majority of the increased costs in 2001. Purchased power
costs also increased significantly in 2000 but were partially offset by lower
nuclear costs, other operating costs and depreciation expenses.
Purchased power costs increased $54.5 million in 2001, compared to 2000.
The higher costs resulted from increased quantities of power purchased through
the PJM Power Pool due to a large number of customers returning to us in 2001
after receiving their power from alternate suppliers in 2000, as well as higher
average prices of power purchased under two-party agreements. Also included in
2001 purchased power costs was a $16 million charge related to the termination
of a wholesale energy contract with Allegheny Electric Cooperative. Offsetting
these increases was the effect of the Pennsylvania Public Utility Commission's
(PPUC) June 2001 order that allowed us to defer, for future rate recovery from
customers, energy costs in excess of our fixed generation tariff rates,
retroactive to January 1, 2001, in connection with our provider of last resort
(PLR) obligation.
In 2000, fuel and purchased power costs increased $183.2 million over
1999. The majority of the increase was due to the need to purchase substantially
all of our energy requirements following the sales of generating assets in 1999,
and the absence of deferred accounting treatment for these costs. An offsetting
decrease in fuel costs also resulted from the sales of generating assets. The
sale of Unit 1 of the Three Mile Island Nuclear Plant, completed in December
1999, eliminated essentially all of our nuclear operating costs in 2000.
Other operating costs increased $9.9 million in 2001, compared to 2000,
primarily due the absence in 2001 of a pension curtailment gain associated with
employees who were terminated at the time of the sale of our generating assets.
This gain was realized in 2000 as a result of the PPUC's Phase II Order. Other
operating costs also increased due to costs related to Voluntary Enhanced
Retirement Programs offered to certain bargaining unit employees. In 2000, other
operating costs decreased $68.7 million compared to the previous year. The
primary reason for the decline was a reduction in expenses associated with the
operation of generating stations due to the sale of all our remaining generating
assets in 1999. Other operating costs were also reduced as a result of the net
impact of the PPUC's Phase II Order issued in December 2000, which allowed us to
realize the pension curtailment gain discussed above, offset by a write-off for
the disallowance of a portion of our stranded costs. The sale of generating
assets in 1999 was also the cause for a decrease in depreciation expense of
$21.9 million in 2000 from the previous year.
Other Income
Other income decreased $10.3 million in 2001 from the previous year. The
decrease was attributed to charges for a sustainable energy fund and renewable
energy projects in accordance with the Stipulation of Settlement related to the
merger of FirstEnergy and GPU, Inc. Also contributing to the decrease was lower
interest income. In 2000, other income decreased $48.9 million from the previous
year. The decrease was due to the absence in 2000 of net gains related to
wholesale operations as a result of the sale of substantially all our generating
stations and lower interest income. Partially offsetting these reductions was
the reversal of an estimated 1999 tax penalty.
Net Interest Charges
Net interest charges decreased by $1.5 million in 2001 after increasing
$3.7 million in 2000 compared to the prior year. In 2001, the decrease was due
to the absence of prior year expense associated with a federal income tax
deficiency, higher deferred interest income, and lower short-term borrowing
levels. These decreases were partially offset by additional interest expense on
$93 million of senior notes issued during 2000. The issuance of the $93 million
of senior notes during 2000 was also responsible for the increase in interest
expense in 2000 compared to 1999.
3
Capital Resources and Liquidity
- -------------------------------
We had approximately $39 million of cash and temporary investments and
$77.6 million of short-term indebtedness on December 31, 2001. We may borrow
from our affiliates on a short-term basis. We will not issue first mortgage
bonds (FMB) other than as collateral for senior notes, since our senior note
indentures prohibit (subject to certain exceptions) us from issuing any debt
which is senior to the senior notes. As of December 31, 2001, we had the
capability to issue $450 million of additional senior notes based upon FMB
collateral. We have no restrictions on the issuance of preferred stock.
At the end of 2001, our common equity as a percentage of capitalization,
including debt relating to assets held for sale, stood at 70% compared to 43% at
the end of 2000. This increase resulted from the allocation of the purchase
price in the merger between FirstEnergy and GPU.
Following approval of the merger of FirstEnergy and GPU by the New
Jersey Board of Public Utilities on September 26, 2001, Standard and Poor's
adjusted our corporate credit rating from A/A-1 to BBB/A-2, and our senior
unsecured debt rating from A to BBB. The lower credit ratings reflect Standard &
Poor's consolidated rating methodology, which resulted in essentially the same
corporate credit rating for all of FirstEnergy's electric utility operating
companies. The credit rating outlook of Standard & Poor's is stable. On February
22, 2002, Moody's announced a change in its outlook for our credit ratings from
stable to negative based upon a decision by the Commonwealth Court of
Pennsylvania to reverse the PPUC's decision to grant us rate relief (see
Regulatory Matters).
Our cash requirements in 2002 for operating expenses, construction
expenditures, scheduled debt maturities and preferred stock redemptions are
expected to be met without increasing our net debt and preferred stock
outstanding. Major contractual obligations for future cash payments are
summarized in the following table:
Contractual Obligations 2002 2003 2004 2005 2006 Thereafter Total
- -------------------------------------------------------------------------------
(In millions)
Long-term debt..................$ 50 $ -- $125 $ 8 $ -- $ 336 $ 519
Mandatory preferred stock....... 100 100
Capital leases ................. 1 1 -- -- -- -- 2
Unconditional power purchases... 415 261 200 194 197 1,882. 3,149
- -------------------------------------------------------------------------------
$466 $262 $325 $202 $197 $2,318 $3,770
===============================================================================
Our capital spending for the period 2002-2006 is expected to be about
$375 million, of which approximately $72 million applies to 2002.
Market Risk Information
- -----------------------
We use various market risk sensitive instruments, including derivative
contracts, primarily to manage the risk of price and interest rate fluctuations.
Our Risk Policy Committee, comprised of FirstEnergy executive officers,
exercises an independent risk oversight function to ensure compliance with
corporate risk management policies and prudent risk management practices.
Commodity Price Risk
We are exposed to market risk primarily due to fluctuations in
electricity and natural gas prices. To manage the volatility relating to these
exposures, we use a variety of derivative instruments, including options,
futures contracts and swaps. These derivatives are used principally for hedging
purposes. The change in the fair value of commodity derivative contracts related
to energy production during 2001 is summarized in the table below:
Increase (Decrease)in the Fair Value of Commodity Derivative Contracts
-----------------------------------------------------------------------
Nov. 7-Dec. 31 Jan. 1-Nov. 6
2001 2001
-----------------------------------------------------------------------
(In millions)
Outstanding as of beginning of period with
SFAS 133 cumulative adjustment.............. $3.6 $12.8
Contract value when entered................... 0.3 5.2
Decrease in value of existing contracts....... (2.5) (3.5)
Change in techniques/assumptions.............. -- (10.6)
Settled contracts............................. (0.1) (0.3)
-----------------------------------------------------------------------
Outstanding as of end of period............... $1.3 $3.6
=======================================================================
4
While the valuation of derivative contracts is always based on active
market prices when they are available, longer-term contracts can require the use
of model-based estimates of prices in later years due to the absence of
published market prices. Currently, substantially all of our derivatives are
valued based on active market prices.
We perform sensitivity analyses to estimate our exposure to the market
risk of our commodity position. A hypothetical 10% adverse shift in quoted
market prices in the near term on our derivative instruments would not have had
a material effect on our consolidated financial position or cash flows as of
December 31, 2001.
Interest Rate Risk
Our exposure to fluctuations in market interest rates is reduced since a
significant portion of our debt has fixed interest rates, as noted in the table
below. We are subject to the inherent interest rate risks related to refinancing
maturing debt by issuing new debt securities. Changes in the market value of our
nuclear decommissioning trust funds are recognized by making corresponding
changes to the decommissioning liability, as described in Note 1 to the
consolidated financial statements.
Comparison of Carrying Value to Fair Value
- --------------------------------------------------------------------------------
There- Fair
2002 2003 2004 2005 2006 after Total Value
- --------------------------------------------------------------------------------
(Dollars in millions)
Investments other
than Cash and Cash
Equivalents:
Fixed Income............. -- -- -- -- -- $192 $192 $194
Average interest rate.. 4.7% 4.7%
- --------------------------------------------------------------------------------
________________________________________________________________________________
Liabilities
- --------------------------------------------------------------------------------
Long-term Debt:
Fixed rate............... $ 50 -- $125 $ 8 -- $336 $519 $509
Average interest rate.. 6.5% 5.8% 7.5% 6.4% 6.3%
Variable rate............
Average interest rate..
Short-term Borrowings.... $ 78 -- -- -- -- -- $ 78$ 78
Average interest rate.. 4.9% 4.9%
- --------------------------------------------------------------------------------
Preferred Stock.......... -- -- -- -- -- $100 $100 $ 90
Average dividend rate.. 7.4% 7.4%
- --------------------------------------------------------------------------------
Interest Rate Swap Agreements
We use interest rate swap agreements to manage the risk of increases in
variable interest rates. All of the agreements convert variable rate debt to
fixed rate debt. As of December 31, 2001, interest rate swaps had a weighted
average fixed interest rate of 7.16%. The swap agreements in effect as of
December 31, 2001 had a notional amount of $50 million, a maturity date of 2002
and a fair value of ($1.8) million.
Outlook
- -------
Our industry continues to transition to a more competitive environment.
As of January 1, 1999, all of our customers could select alternative energy
suppliers. We continue to deliver power to homes and businesses through our
existing distribution system, which remains regulated. The PPUC authorized our
rate restructuring plan, establishing separate charges for transmission,
distribution, generation and stranded cost recovery, which is recovered through
a competitive transition charge (CTC). Customers electing to obtain power from
an alternative supplier have their bills reduced based on the regulated
generation component, and the customers receive a generation charge from the
alternative supplier. We have a continuing responsibility to provide power to
those customers not choosing to receive power from an alternative energy
supplier, subject to certain limits, which is referred to as our PLR obligation.
Regulatory Matters
In June 2001, we entered into a settlement agreement with major parties
in the combined merger and rate proceedings that, in addition to resolving
certain issues concerning the PPUC's approval of our merger with FirstEnergy,
also addressed our request for PLR relief. We are permitted to defer, for future
recovery, the difference between our actual energy costs and those reflected in
our capped generation rates. Those costs will continue to be deferred through
December 31, 2005. If energy costs incurred during that period are below our
capped generation rates, the difference would be used to reduce our recoverable
deferred costs. Our PLR obligation was extended through December 31, 2010. Our
CTC
5
revenues will be applied first to PLR costs, then to stranded costs other than
for non-utility generation (NUG) and finally to NUG stranded costs through
December 31, 2010. We would be permitted to recover any remaining stranded costs
through a continuation of the CTC after December 31, 2010; however, such
recovery would extend to no later than December 31, 2015. Any amounts not
expected to be recovered by December 31, 2015 would be written off at the time
such nonrecovery becomes probable. Several parties had appealed this PPUC
decision to the Commonwealth Court of Pennsylvania. On February 21, 2002, the
Court affirmed the PPUC decision regarding approval of the merger, remanding the
decision to the PPUC only with respect to the issue of merger savings. The Court
reversed the PPUC's decision regarding our PLR obligation, and denied our
related requests for rate relief. We are considering our response to the Court's
decision, which could include asking the Pennsylvania Supreme Court to review
the decision. We are unable to predict the outcome of these matters.
Supply Plan
As part of our Restructuring Order, we are obligated to supply
electricity to customers who do not choose an alternate supplier. The total
forecasted peak of this obligation in 2002 is 2,300 megawatts (MW). Our current
supply portfolio contains approximately 400 MW of long-term purchases from NUGs,
and our remaining obligation is expected to be met through a mix of multi-year
forward purchases, short-term forward (less than one year) purchases and spot
market purchases.
Environmental Matters
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of December 31, 2001, based on estimates of the
total costs of cleanup, our proportionate responsibility for such costs and the
financial ability of other nonaffiliated entities to pay. The Company has been
named as a "potentially responsible party" (PRP) at waste disposal sites which
may require cleanup under the Comprehensive Environmental Response, Compensation
and Liability Act of 1980. Allegations of disposal of hazardous substances at
historical sites, and the liability involved, are often unsubstantiated and
subject to dispute. Federal law provides that all PRPs for a particular site be
held liable on a joint and several basis. We have total accrued liabilities
aggregating approximately $1 million as of December 31, 2001. We do not believe
environmental remediation costs will have a material adverse effect on our
financial condition, cash flows or results of operations.
Legal Matters
Various lawsuits, claims and proceedings related to our normal business
operations are pending against us, the most significant of which is described
below.
We have a 25% ownership interest in Unit 2 of the Three Mile Island
Nuclear Plant (TMI-2), which was damaged during a 1979 accident. As a result of
the accident, claims for alleged personal injury were filed against us, Jersey
Central Power & Light Company, Metropolitan Edison Company and GPU in the U.S.
District Court for the Middle District of Pennsylvania. In 1996, the District
Court granted a motion for summary judgment filed by the defendants and
dismissed the ten initial "test cases" which had been selected for a test case
trial, as well as all of the remaining 2,100 pending claims. In November 1999,
the U.S. Court of Appeals for the Third Circuit affirmed the District Court's
dismissal of the ten test cases, but set aside the dismissal of the additional
pending claims, remanding them to the District Court for further proceedings.
Following the resolution of judicial proceedings dealing with admissible
evidence, we have again requested summary judgment of the remaining 2,100 claims
in the District Court. On January 15, 2002, the District Court granted our
motion. On February 14, 2002, the plaintiffs filed a notice of appeal of this
decision (see Note 6 - Other Legal Proceedings). Although unable to predict the
outcome of this litigation, we believe that any liability to which we might be
subject by reason of the TMI-2 accident will not exceed our financial protection
under the Price-Anderson Act.
Significant Accounting Policies
- -------------------------------
We prepare our consolidated financial statements in accordance with
accounting principles generally accepted in the United States. Application of
these principles often requires a high degree of judgment, estimates and
assumptions that affect our financial results. All of our assets are subject to
their own specific risks and uncertainties and are continually reviewed for
impairment. Assets related to the application of the policies discussed below
are similarly reviewed with their risks and uncertainties reflecting these
specific factors. Our more significant accounting policies are described below:
Purchase Accounting
On November 7, 2001, the merger between FirstEnergy and GPU became
effective, and we became a wholly owned subsidiary of FirstEnergy. The merger
was accounted for by the purchase method of accounting, which requires judgment
regarding the allocation of the purchase price based on the fair values of the
assets acquired (including
6
intangible assets) and the liabilities assumed. The fair values of the acquired
assets and assumed liabilities were based primarily on estimates. The
adjustments reflected in our records, which are subject to adjustment in 2002
when finalized, primarily consist of: (1) revaluation of certain property, plant
and equipment; (2) adjusting preferred stock subject to mandatory redemption and
long-term debt to estimated fair value; (3) recognizing additional obligations
related to retirement benefits; and (4) recognizing estimated severance and
other compensation liabilities. The excess of the purchase price over the
estimated fair values of the assets acquired and liabilities assumed was
recognized as goodwill, which will be reviewed for impairment at least annually.
As of December 31, 2001, we had recorded goodwill of approximately $797.4
million related to the merger.
Regulatory Accounting
We are subject to regulation that sets the prices (rates) we are
permitted to charge our customers based on costs that the regulatory agencies
determine we are permitted to recover. At times, regulators permit the future
recovery through rates of costs that would be currently charged to expense by an
unregulated company. This rate-making process results in the recording of
regulatory assets based on anticipated future cash inflows. As a result of the
changing regulatory framework in Pennsylvania, a significant amount of
regulatory assets have been recorded. As of December 31, 2001, we had regulatory
assets of $769.8 million. We continually review these assets to assess their
ultimate recoverability within the approved regulatory guidelines. Impairment
risk associated with these assets relates to potentially adverse legislation,
judicial or regulatory actions in the future.
Derivative Accounting
Determination of appropriate accounting for derivative transactions
requires the involvement of management representing operations, finance and risk
assessment. In order to determine the appropriate accounting for derivative
transactions, the provisions of the contract need to be carefully assessed in
accordance with the authoritative accounting literature and management's
intended use of the derivative. New authoritative guidance continues to shape
the application of derivative accounting. Management's expectations and
intentions are key factors in determining the appropriate accounting for a
derivative transaction and, as a result, such expectations and intentions must
be documented. Derivative contracts that are determined to fall within the scope
of Statement of Financial Accounting Standards (SFAS) No. 133, as amended, must
be recorded at their fair value. Active market prices are not always available
to determine the fair value of the later years of a contract, requiring that
various assumptions and estimates be used in their valuation. We continually
monitor our derivative contracts to determine if our activities, expectations,
intentions, assumptions and estimates remain valid. As part of our normal
operations we enter into commodities contracts, which increase the impact of
derivative accounting judgments.
Revenue Recognition
We follow the accrual method of accounting for revenues, recognizing
revenue for kilowatt-hours that have been delivered but not yet billed through
the end of the year. The determination of unbilled revenues requires management
to make various estimates including:
- Net energy purchased or generated for retail load
- Losses of energy over distribution lines
- Mix of kilowatt-hour usage by residential, commercial and industrial
customers
- Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards
- ------------------------------------
The Financial Accounting Standards Board (FASB) approved SFAS 141,
"Business Combinations," and SFAS 142, "Goodwill and Other Intangible Assets,"
on June 29, 2001. SFAS 141 requires that all business combinations initiated
after June 30, 2001 be accounted for using purchase accounting. The provisions
of the new standard relating to the determination of goodwill and other
intangible assets have been applied to our 2001 merger, which was accounted for
as a purchase transaction. Under SFAS 142, amortization of existing goodwill
will cease January 1, 2002. Instead, goodwill will be tested for impairment at
least on an annual basis, and no impairment of goodwill is anticipated as a
result of a preliminary analysis. We did not have any goodwill prior to our 2001
merger, and we did not amortize goodwill associated with the merger under the
provisions of the new standard.
In July 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations." The new statement provides accounting standards for retirement
obligations associated with tangible long-lived assets, with adoption required
by January 1, 2003. SFAS 143 requires that the fair value of a liability for an
asset retirement obligation be recorded in the period in which it is incurred.
The associated asset retirement costs are capitalized as part of the carrying
amount of the long-lived asset. Over time the capitalized costs are depreciated
and the present value of the asset retirement liability increases, resulting in
a period expense. Upon retirement, a gain or loss will be recorded if the cost
to settle the retirement obligation differs from the carrying amount. We are
currently assessing the new standard and have not yet determined the impact on
our financial statements.
7
In September 2001, the FASB issued SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS 144 supersedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." The Statement also supersedes the accounting and reporting
provisions of APB 30. Our adoption of this Statement, effective January 1, 2002,
will result in our accounting for any future impairments or disposals of
long-lived assets under the provisions of SFAS 144, but will not change the
accounting principles used in previous asset impairments or disposals.
Application of SFAS 144 is not anticipated to have a major impact on accounting
for impairments or disposal transactions compared to the prior application of
SFAS 121 or APB 30.
8
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF INCOME
Nov 7 - Jan. 1 - For the Years Ended Dec.31,
Dec. 31, 2001 Nov. 6, 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
(In thousands)
OPERATING REVENUES........................................ $140,062 | $834,548 $901,881 $921,965
-------- | -------- -------- --------
|
OPERATING EXPENSES AND TAXES: |
Fuel and purchased power............................... 79,815 | 519,838 545,117 361,901
Nuclear operating costs................................ -- | -- -- 30,626
Other operating costs.................................. 20,015 | 138,543 148,698 217,408
-------- | -------- -------- --------
Total operation and maintenance expenses............. 99,830 | 658,381 693,815 609,935
Provision for depreciation and amortization............ 8,613 | 49,191 56,505 78,384
General taxes.......................................... 6,281 | 39,532 45,890 42,046
Income taxes........................................... 10,997 | 17,395 25,335 50,675
-------- | -------- -------- ---------
Total operating expenses and taxes................... 125,721 | 764,499 821,545 781,040
-------- | -------- -------- --------
|
OPERATING INCOME.......................................... 14,341 | 70,049 80,336 140,925
|
OTHER INCOME (EXPENSE).................................... 3,049 | (6,610) 6,716 55,641
-------- | -------- -------- --------
|
INCOME BEFORE NET INTEREST CHARGES........................ 17,390 | 63,439 87,052 196,566
-------- | -------- -------- --------
|
NET INTEREST CHARGES: |
Subsidiaries preferred dividends....................... 1,101 | 6,239 7,034 8,953
Interest on long-term debt............................. 3,972 | 28,751 29,964 31,837
Allowance for borrowed funds used during |
construction......................................... 47 | (494) (742) (1,074)
Deferred interest income............................... (504) | (783) -- --
Other interest expense ................................ 1,979 | 6,008 11,546 4,359
-------- | -------- -------- --------
Net interest charges................................... 6,595 | 39,721 47,802 44,075
-------- | -------- -------- --------
|
NET INCOME................................................ 10,795 | 23,718 39,250 152,491
|
PREFERRED STOCK DIVIDEND |
REQUIREMENTS........................................... -- | -- -- 154
-------- | -------- -------- --------
|
LOSS ON PREFERRED STOCK REACQUISITION..................... -- | -- -- 726
-------- | -------- -------- --------
|
EARNINGS ON COMMON STOCK.................................. $ 10,795 | $ 23,718 $ 39,250 $151,611
======== | ======== ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
9
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED BALANCE SHEETS
As of December 31, 2001 2000
- ------------------------------------------------------------------------------------------------------------------
(In thousands)
ASSETS
UTILITY PLANT:
In service..................................................................... $1,845,187 | $1,794,259
Less-Accumulated provision for depreciation.................................... 630,957 | 588,377
---------- | ----------
1,214,230 | 1,205,882
---------- - ----------
Construction work in progress- |
Electric plant............................................................... 12,857 | 25,895
---------- | ----------
1,227,087 | 1,231,777
---------- | ----------
OTHER PROPERTY AND INVESTMENTS: |
Nonutility generation trusts................................................... 154,067 | 190,710
Nuclear plant decommissioning trusts........................................... 96,610 | 98,426
Long-term notes receivable from associated companies........................... 15,515 | 15,515
Other.......................................................................... 2,265 | 833
---------- | ----------
268,457 | 305,484
---------- | ----------
CURRENT ASSETS: |
Cash and cash equivalents...................................................... 39,033 | 581
Receivables- |
Customers (less accumulated provisions of $14,719,000 and $14,851,000 |
respectively, for uncollectible accounts)................................. 107,170 | 117,515
Associated companies......................................................... 40,203 | 9,558
Other........................................................................ 14,842 | 21,205
Prepayments ................................................................... 8,605 | 11,868
---------- | ----------
209,853 | 160,727
---------- | ----------
DEFERRED CHARGES: |
Regulatory assets.............................................................. 769,807 | 614,182
Goodwill....................................................................... 797,362 | --
Other.......................................................................... 27,703 | 19,314
---------- | ----------
1,594,872 | 633,496
---------- | ----------
$3,300,269 | $2,331,484
---------- | ----------
CAPITALIZATION AND LIABILITIES |
|
CAPITALIZATION (See Consolidated Statements of Capitalization): |
Common stockholder's equity.................................................... $1,306,576 | $ 469,837
Company-obligated trust preferred securities................................... 92,000 | 100,000
Long-term debt................................................................. 472,400 | 519,481
---------- | ----------
1,870,976 | 1,089,318
---------- | ----------
CURRENT LIABILITIES: |
Currently payable long-term debt and preferred stock........................... 50,756 | 499
Short-term borrowings (Note 5)- |
Associated companies......................................................... 77,623 | --
Other........................................................................ -- | 55,800
Accounts payable- |
Associated companies......................................................... 126,390 | 29,788
Other........................................................................ 38,720 | 49,452
Accrued taxes.................................................................. 29,255 | 23,895
Accrued interest............................................................... 12,284 | 11,582
Other.......................................................................... 10,993 | 7,970
---------- | ----------
346,021 | 178,986
---------- | ----------
DEFERRED CREDITS: |
Accumulated deferred income taxes.............................................. 21,682 | 25,013
Accumulated deferred investment tax credits.................................... 11,956 | 13,098
Nuclear plant decommissioning costs............................................ 135,483 | 132,717
Nuclear fuel disposal costs.................................................... 18,453 | 17,728
Power purchase contract loss liability......................................... 867,046 | 846,992
Other.......................................................................... 28,652 | 27,632
---------- | ----------
1,083,272 | 1,063,180
---------- | ----------
COMMITMENTS AND CONTINGENCIES |
(Notes 3 and 6) ---------- | ----------
$3,300,269 | $2,331,484
========== | ==========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these balance sheets.
10
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF CAPITALIZATION
As of December 31, 2001 2000
- -------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)
COMMON STOCKHOLDER'S EQUITY:
Common stock, par value $20 per share, authorized 5,400,000 shares
5,290,596 shares outstanding................................................... $ 105,812 | $ 105,812
Other paid-in capital............................................................ 1,188,190 | 320,487
Accumulated other comprehensive income (Note 4E)................................. 1,779 | 23
Retained earnings (Note 4A)...................................................... 10,795 | 43,515
---------- | ----------
Total common stockholder's equity.............................................. 1,306,576 | 469,837
---------- | ----------
|
COMPANY OBLIGATED TRUST |
PREFERRED SECURITIES |
OF SUBSIDIARY TRUST |
(NOTE 4C): |
7.34% due 2039................................................................. 92,000 | 100,000
|
LONG-TERM DEBT (Note 4D): |
First mortgage bonds: |
6.125% due 2007................................................................ 4,110 | 4,110
5.35% due 2010................................................................. 12,310 | 12,310
5.35% due 2010................................................................. 12,000 | 12,000
5.80% due 2020................................................................. 20,000 | 20,000
6.05% due 2025................................................................. 25,000 | 25,000
---------- | ----------
Total first mortgage bonds................................................... 73,420 | 73,420
---------- | ----------
|
Unsecured notes: |
6.42% due 2002................................................................. 25,000 | 25,000
6.47% due 2002................................................................. 25,000 | 25,000
5.75% due 2004................................................................. 125,000 | 125,000
7.50% due 2005................................................................. 8,000 | 8,000
6.125% due 2009................................................................ 100,000 | 100,000
7.77% due 2010................................................................. 35,000 | 35,000
6.625% due 2019................................................................ 125,000 | 125,000
7.69% due 2039................................................................. 2,998 | 3,012
---------- | ----------
Total senior notes........................................................... 445,998 | 446,012
---------- | ----------
|
Capital lease obligations (Note 3)............................................... 1,670 | 2,153
---------- | ----------
Net unamortized premium (discount) on debt....................................... 2,068 | (1,605)
---------- | ----------
Long-term debt due within one year............................................... (50,756) | (499)
---------- | ----------
Total long-term debt............................................................. 472,400 | 519,481
---------- | ----------
TOTAL CAPITALIZATION................................................................ $1,870,976 | $1,089,318
========== | ==========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
11
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
Common Stock Accumulated
------------ Other Other
Comprehensive Number Par Paid-In Comprehensive Retained
Income of Shares Value Capital Income (Loss) Earnings
------------- --------- ----- ------- ------------- --------
(Dollars in thousands)
Balance, January 1, 1999....................... 5,290,596 $105,812 $ 285,487 $8,353 $ 367,653
Net income.................................. $152,491 152,491
Net unrealized gain (loss) on investments... 2,101 2,101
Minimum pension liability................... 165 165
--------
Comprehensive income........................ 154,757
--------
Loss on preferred stock reacquisition....... (725)
Cash dividends on preferred stock........... (154)
Cash dividends on common stock.............. (460,000)
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999..................... 5,290,596 105,812 285,487 10,619 59,265
Net income.................................. 39,250 39,250
Net unrealized gain (loss) on investments... (10,596) (10,596)
--------
Comprehensive income........................ 28,654
--------
Contributions from parent company........... 35,000
Cash dividends on common stock.............. (55,000)
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000..................... 5,290,596 105,812 320,487 23 43,515
Net income.................................. 23,718 23,718
Net unrealized gain on investments.......... 12 12
Net unrealized gain (loss) on derivative
instruments............................... (1,064) (1,064)
--------
Comprehensive income........................ 22,666
--------
Contributions from parent company........... 50,000
- -----------------------------------------------------------------------------------------------------------------------------
Balance, November 6, 2001...................... 5,290,596 105,812 370,487 (1,029) 67,233
Purchase accounting fair value adjustment... 817,703 1,029 (67,233)
_____________________________________________________________________________________________________________________________
Balance, November 7, 2001...................... 5,290,596 105,812 1,188,190 -- --
Net income.................................. 10,795 10,795
Net unrealized gain (loss) on investments... (2) (2)
Net unrealized gain (loss) on
derivative instruments.................... 1,781 1,781
--------
Comprehensive Income........................ $ 12,574
--------
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001..................... 5,290,596 $105,812 $1,188,190 $1,779 $ 10,795
=============================================================================================================================
CONSOLIDATED STATEMENTS OF PREFERRED STOCK
Not Subject to Subject to
Mandatory Redemption Mandatory Redemption
-------------------- --------------------
Number Carrying Number Carrying
of Shares Value of Shares Value
--------- ----- --------- -----
(Dollars in thousands)
Balance, January 1, 1999............ 165,485 $16,681 4,200,000 $105,000
Redemptions-
4.40% Series B................ (29,678) (3,026)
3.70% Series C................ (49,568) (4,983)
4.05% Series D................ (28,219) (2,852)
4.70% Series E................ (14,103) (1,411)
4.50% Series F................ (17,081) (1,714)
4.60% Series G................ (26,836) (2,695)
8.75% Series.................. (4,200,000) (105,000)
Issuances-
7.34% Series.................... 4,000,000 100,000
----------------------------------------------------------------------------------------
Balance, December 31, 1999.......... -- -- 4,000,000 100,000
========================================================================================
Balance, December 31, 2000.......... -- -- 4,000,000 100,000
========================================================================================
Purchase accounting fair
value adjustment............... (8,000)
----------------------------------------------------------------------------------------
Balance, December 31, 2001.......... -- $ -- 4,000,000 $ 92,000
========================================================================================
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
12
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nov. 7 - Jan. 1 - For the Years Ended Dec. 31,
Dec. 31, 2001 Nov. 6, 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income...........................................................$ 10,795 | $ 23,718 $ 39,250 $ 152,491
Adjustments to reconcile net income to net |
cash from operating activities: |
Provision for depreciation and amortization..................... 8,613 | 49,191 56,505 78,384
Nuclear fuel and lease amortization............................. -- | -- -- 6,036
Other amortization.............................................. 309 | 1,672 347 --
Impact of PPUC rate order, net.................................. -- | -- (21,550) --
Deferred costs, net............................................. (7,467) | (143,462) (76,957) (57,474)
Deferred income taxes, net...................................... (23,127) | 60,170 15,946 (394,872)
Investment tax credits, net..................................... (171) | (970) (1,142) (22,687)
Receivables..................................................... (26,592) | 16,566 (19,089) (11,216)
Materials and supplies.......................................... -- | -- -- 56,559
Accounts payable................................................ (19,382) | 29,462 (20,608) 6,110
Other........................................................... 41,590 | (36,884) (89,125) (81,187)
--------- | ---------- --------- ----------
Net cash used for operating activities........................ (15,432) | (537) (116,423) (267,856)
--------- | ---------- --------- ----------
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
New Financing- |
Long-term debt.................................................. -- | -- 118,000 348,218
Short-term borrowings, net...................................... 2,623 | 19,200 2,200 --
Company-obligated trust preferred securities.................... -- | -- -- 96,535
Contributions from parent....................................... -- | 50,000 35,000 --
Redemptions and Repayments- |
Preferred stock................................................. -- | -- -- 17,406
Long-term debt.................................................. -- | -- 25,000 600,011
Short-term borrowings, net...................................... -- | -- -- 32,423
Company-obligated mandatorily redeemable |
preferred securities......................................... -- | -- -- 105,383
Capital lease principal payments................................ -- | -- -- 7,907
Dividend Payments- |
Common stock.................................................... -- | -- 55,000 460,000
Preferred stock................................................. -- | -- -- 154
-------- | ---------- --------- ----------
Net cash used for (provided from) financing activities........ (2,623) | (69,200) (75,200) 778,531
-------- | ---------- --------- ----------
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
Property additions................................................... 9,687 | 50,543 73,247 78,331
Contributions to (proceeds from) nonutility generation trusts........ (29,944) | (18,339) (75,991) 266,701
Contributions to decommissioning trusts.............................. -- | 15 40 75,926
Sale of investments.................................................. -- | -- -- (1,493,444)
Other................................................................ 246 | 5,194 (6,617) (1,002)
-------- | ---------- --------- ----------
Net cash used for (provided from) investing activities........ (20,011) | 37,413 (9,321) (1,073,488)
-------- | ---------- --------- ----------
Net increase (decrease) in cash and cash equivalents................. 7,202 | 31,250 (31,902) 27,101
Cash and cash equivalents at beginning of period..................... 31,831 | 581 32,483 5,382
-------- | ---------- --------- ----------
Cash and cash equivalents at end of period...........................$ 39,033 | $ 31,831 $ 581 $ 32,483
======== | ========== ========= ==========
|
SUPPLEMENTAL CASH FLOWS INFORMATION: |
Cash Paid During the Year- |
Interest (net of amounts capitalized)...........................$ 2,018 | $ 35,134 $ 33,409 $ 46,826
======== | ========== ========= ==========
Income taxes (refund)...........................................$(12,176) | $ (14,542) $ 110,395 $ 413,810
======== | ========== ========= ==========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
13
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF TAXES
Nov. 7 - Jan. 1 - For the Years Ended Dec. 31,
Dec. 31, 2001 Nov. 6, 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------------
(In thousands)
GENERAL TAXES:
Real and personal property......................................... $ (146) | $ 1,622 $ 1,139 $ 5,998
State gross receipts............................................... 5,560 | 30,932 37,222 27,498
Other.............................................................. 867 | 6,978 7,529 8,550
-------- | ---------- --------- ----------
Total general taxes......................................... $ 6,281 | $ 39,532 $ 45,890 $ 42,046
======== | ========== ========= ==========
|
PROVISION FOR INCOME TAXES: |
Currently payable- |
Federal......................................................... $ 23,861 | $ (36,615) $ 11,593 $ 358,267
State........................................................... 7,667 | (3,183) 3,357 113,675
-------- | ---------- --------- ----------
31,528 | (39,798) 14,950 471,942
-------- | ---------- --------- ----------
Deferred, net- |
Federal......................................................... (17,511) | 46,346 11,732 (298,890)
State........................................................... (5,616) | 13,824 4,214 (95,982)
-------- | ---------- --------- ----------
(23,127) | 60,170 15,946 (394,872)
-------- | ---------- --------- ----------
Investment tax credit amortization................................. (171) | (970) (1,142) (22,687)
-------- | ---------- --------- ----------
Total provision for income taxes............................ $ 8,230 | $ 19,402 $ 29,754 $ 54,383
======== | ========== ========= ==========
|
INCOME STATEMENT CLASSIFICATION |
OF PROVISION FOR INCOME TAXES: |
Operating income................................................... $ 10,997 | $ 17,395 $ 25,335 $ 50,675
Other income....................................................... (2,767) | 2,007 4,419 3,708
-------- | ---------- --------- ----------
Total provision for income taxes............................ $ 8,230 | $ 19,402 $ 29,754 $ 54,383
======== | ========== ========= ==========
|
RECONCILIATION OF FEDERAL INCOME TAX |
EXPENSE AT STATUTORY RATE TO TOTAL |
PROVISION FOR INCOME TAXES: |
Book income before provision for income taxes $ 19,025 | $ 43,120 $ 69,003 $ 206,875
======== | ========== ========= ==========
Federal income tax expense at statutory rate....................... $ 6,659 | $ 15,092 $ 24,151 $ 72,406
Increases (reductions) in taxes resulting from- |
Amortization of investment tax credits.......................... (171) | (969) (1,140) (22,686)
Depreciation.................................................... 555 | 1,407 1,183 109
State income tax, net of federal tax............................ 1,404 | 7,156 3,590 14,951
Allocated share of consolidated tax savings..................... -- | (2,912) -- (880)
Other, net...................................................... (217) | (372) 1,970 (9,517)
-------- | ---------- --------- ----------
Total provision for income taxes............................ $ 8,230 | $ 19,402 $ 29,754 $ 54,383
======== | ========== ========= ==========
|
ACCUMULATED DEFERRED INCOME TAXES AT |
DECEMBER 31: |
Property basis differences......................................... $256,951 | $ 250,410 $ 257,820
Nuclear decommissioning............................................ (42,138) | (35,495) 2,693
Non-utility generation costs....................................... (214,492) | (112,291) (103,621)
Purchase accounting basis difference............................... (38,407) | -- --
Sale of generation assets.......................................... 5,302 | 5,302 (245,097)
Regulatory transition charge....................................... (9,329) | (9,329) 22,904
Customer receivables for future income taxes....................... 61,493 | 65,506 68,816
Other.............................................................. 2,302 | (139,090) 14,250
-------- | --------- ----------
Net deferred income tax liability........................... $ 21,682 | $ 25,013 $ 17,765
======== | ========= ==========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The consolidated financial statements include Pennsylvania Electric
Company (Company) and its wholly owned subsidiaries. All significant
intercompany transactions have been eliminated. The Company is a wholly owned
subsidiary of FirstEnergy Corp. FirstEnergy also holds directly all of the
issued and outstanding common shares of Ohio Edison Company (OE), The Cleveland
Electric Illuminating Company (CEI), The Toledo Edison Company (TE), American
Transmission Systems, Inc. (ATSI), Jersey Central Power & Light Company (JCP&L)
and Metropolitan Edison Company (Met-Ed). The Company, JCP&L and Met-Ed were
formerly wholly owned subsidiaries of GPU, Inc., which merged with FirstEnergy
on November 7, 2001. Pre-merger period and post-merger period financial results
are separated by a heavy black line.
The Company follows the accounting policies and practices prescribed by
the Pennsylvania Public Utility Commission (PPUC) and the Federal Energy
Regulatory Commission (FERC). The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
(GAAP) requires management to make periodic estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses and
disclosure of contingent assets and liabilities. Actual results could differ
from these estimates. Certain prior year amounts have been reclassified to
conform with the current year presentation.
REVENUES-
The Company's principal business is providing electric service to
customers in Pennsylvania. The Company's retail customers are metered on a cycle
basis. Revenue is recognized for unbilled electric service through the end of
the year.
Receivables from customers include sales to residential, commercial and
industrial customers and sales to wholesale customers. There was no material
concentration of receivables as of December 31, 2001 or 2000, with respect to
any particular segment of the Company's customers.
REGULATORY PLAN-
Pennsylvania enacted its electric utility competition law in 1996 with
the phase-in of customer choice for generation suppliers completed as of January
1, 2001. The PPUC authorized a rate restructuring plan for the Company in 1998
which essentially resulted in the deregulation of the Company's generation
business. The Company has a continuing responsibility to provide power to those
customers not choosing to receive power from an alternative energy supplier,
subject to certain limits, which is referred to as the Company's provider of
last resort (PLR) obligation.
In 2000, the PPUC disallowed a portion of the requested additional
stranded costs above those amounts granted in the Company's 1998 rate
restructuring plan order. The PPUC required the Company to seek an IRS ruling
regarding the return of certain unamortized investment tax credits and excess
deferred income tax benefits to ratepayers. If the IRS ruling ultimately
supports returning these tax benefits to ratepayers, the Company would then
reduce stranded costs by $25 million plus interest and record a corresponding
charge to income.
As a result of its generating asset divestitures, the Company obtains
its supply of electricity to meet its PLR obligation almost entirely from
contracted and open market purchases. During 2000, the Company's purchased power
costs substantially exceeded the amounts it could recover under its capped
generation rates, which are in effect for varying periods, pursuant to its 1998
rate restructuring plan. In November 2000, the Company filed a petition with the
PPUC seeking permission to defer for future recovery its energy costs in excess
of amounts reflected in its capped generation rates. In January 2001, the PPUC
consolidated this petition with the merger proceeding (see Note 2 - Merger) for
consideration and resolution in accordance with the FirstEnergy and GPU merger
procedural schedule.
In June 2001, the Company entered into a Settlement Stipulation with all of the
major parties in the combined merger and rate relief proceedings, that, in
addition to resolving certain issues concerning the PPUC's approval of the
merger, also addressed the Company's request for PLR relief. On June 20, 2001,
the PPUC entered orders approving the Settlement Stipulation, which approved the
merger and provided PLR relief. The Company is permitted to defer for future
recovery the difference between its actual energy costs and those reflected in
its capped generation rates, retroactive to January 1, 2001. Deferral accounting
will continue for such cost differences through December 31, 2005 and, should
energy costs incurred by the Company during that period be below its capped
generation rates, the difference would be used to reduce its recoverable
deferred costs. The Company's PLR obligation has been extended through December
31, 2010. The Company's competitive transition charge (CTC) revenues will be
applied first to PLR costs, then to stranded costs other than for non-utility
generation (NUG) and finally to NUG stranded costs through December 31, 2010.
The Company would be permitted to recover any remaining stranded costs through a
continuation of the CTC after December 31, 2010; however, such recovery would
extend to no later than December 31, 2015. Any amounts not expected to be
recovered by December 31, 2015 would be written off at the time such nonrecovery
becomes probable.
15
Several parties had filed Petitions for Review with the Commonwealth
Court of Pennsylvania regarding the PPUC's orders. On February 21, 2002, the
Court affirmed the PPUC decision regarding approval of the merger, remanding the
decision to the PPUC only with respect to the issue of merger savings. The Court
reversed the PPUC's decision regarding the Company's PLR obligation, and denied
the Company's related requests for rate relief. The Company is considering its
response to the Court's decision, which could include asking the Pennsylvania
Supreme Court to review the decision. The Company is unable to predict the
outcome of these matters.
The application of Statement of Financial Accounting Standards (SFAS)
No. 71, "Accounting for the Effects of Certain Types of Regulation," was
discontinued in 1998 with respect to the Company's generation operations. The
Company subsequently divested substantially all of its generating assets. The
Securities and Exchange Commission issued interpretive guidance regarding asset
impairment measurement, concluding that any supplemental regulated cash flows
such as a CTC should be excluded from the cash flows of assets in a portion of
the business not subject to regulatory accounting practices. If those assets are
impaired, a regulatory asset should be established if the costs are recoverable
through regulatory cash flows. All of the Company's regulatory assets are
expected to continue to be recovered under provisions of the Company's
regulatory orders.
PROPERTY, PLANT AND EQUIPMENT-
As a result of the merger, certain of the Company's property, plant
and equipment have been adjusted to reflect fair value. The majority of the
Company's property, plant and equipment is reflected at original cost since such
assets remain subject to rate regulation on a historical cost basis.
The Company provides for depreciation on a straight-line basis at
various rates over the estimated lives of property included in plant in service.
The annualized composite rate was approximately 2.9% in 2001, 2.7% in 2000 and
2.8% in 1999.
Annual depreciation expense in 2001 included approximately $1.5 million
for future decommissioning costs applicable to the Company's ownership in Unit 2
of the Three Mile Island Nuclear Plant (TMI-2), a demonstration nuclear reactor
owned by a wholly owned subsidiary of the Company (in conjunction with JCP&L and
Met-Ed) and decommissioning liabilities for its previously divested nuclear
generating units. The Company's share of the future obligation to decommission
these units is approximately $128.1 million in current dollars and (using a 4.0%
escalation rate) approximately $211.8 million in future dollars. The estimated
obligation and the escalation rate were developed based on site specific
studies. Decommissioning of the demonstration nuclear reactor is expected to be
completed in 2003; payments for decommissioning of TMI-2 are expected to begin
in 2014, when actual decommissioning work is expected to begin. The Company has
recovered approximately $50 million for decommissioning through its electric
rates from customers through December 31, 2001. The Company has also recognized
an estimated liability of approximately $2.3 million related to decontamination
and decommissioning of nuclear enrichment facilities operated by the United
States Department of Energy, as required by the Energy Policy Act of 1992.
In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS 143, "Accounting for Asset Retirement Obligations." The new statement
provides accounting treatment for retirement obligations associated with
tangible long-lived assets with adoption required as of January 1, 2003. SFAS
143 requires that the fair value of a liability for an asset retirement
obligation be recorded in the period in which it is incurred. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset. Over time the capitalized costs are depreciated and the
present value of the asset retirement liability increases, resulting in a period
expense. Upon retirement, a gain or loss will be recorded if the costs to settle
the retirement obligation differs from the carrying amount. Under the new
standard, additional assets and liabilities relating principally to nuclear
decommissioning obligations will be recorded, the pattern of expense recognition
will change and income from the external decommissioning trusts will be recorded
as investment income. The Company is currently assessing the new standard and
has not yet quantified the impact on its financial statements.
INCOME TAXES-
Details of the total provision for income taxes are shown on the
Consolidated Statements of Taxes. Deferred income taxes result from timing
differences in the recognition of revenues and expenses for tax and accounting
purposes. Investment tax credits, which were deferred when utilized, are being
amortized over the recovery period of the related property. The liability method
is used to account for deferred income taxes. Deferred income tax liabilities
related to tax and accounting basis differences are recognized at the statutory
income tax rates in effect when the liabilities are expected to be paid. Results
for the period January 1, 2001 through November 6, 2001 are included in the
final consolidated federal income tax return of GPU, and results for the period
November 7, 2001 through December 31, 2001 are included in FirstEnergy's 2001
consolidated federal income tax return. In both cases, the consolidated tax
liability is allocated on a "stand-alone" company basis, with the Company
recognizing the tax benefit for any tax losses or credits it contributed to the
consolidated return.
16
RETIREMENT BENEFITS-
Effective December 31, 2001, the Company's defined benefit pension
plan was merged into FirstEnergy's defined benefit pension plan. FirstEnergy's
trusteed, noncontributory defined benefit pension plan covers almost all of the
Company's full-time employees. Upon retirement, employees receive a monthly
pension based on length of service and compensation. On December 31, 2001, the
GPU pension plans were merged with the FirstEnergy plan. FirstEnergy uses the
projected unit credit method for funding purposes. The assets of the pension
plan consist primarily of common stocks, United States government bonds and
corporate bonds. The FirstEnergy and GPU postretirement benefit plans are
currently separately maintained; the information shown below is aggregated as of
December 31, 2001. Costs for the year 2001 include the former GPU companies'
pension and other postretirement benefit costs for the period November 7, 2001
through December 31, 2001.
The Company provides a minimum amount of noncontributory life insurance
to retired employees in addition to optional contributory insurance. Health care
benefits, which include certain employee deductibles and copayments, are also
available to retired employees, their dependents and, under certain
circumstances, their survivors. The Company pays insurance premiums to cover a
portion of these benefits in excess of set limits; all amounts up to the limits
are paid by the Company. The Company recognizes the expected cost of providing
other postretirement benefits to employees and their beneficiaries and covered
dependents from the time employees are hired until they become eligible to
receive those benefits.
The following sets forth the funded status of the plans and amounts
recognized on FirstEnergy's Consolidated Balance Sheet as of December 31, 2001:
Other
Pension Benefits Postretirement Benefits
---------------- -----------------------
(In millions)
Change in benefit obligation:
Benefit obligation as of January 1.. $1,506.1 $ 752.0
Service cost........................ 34.9 18.3
Interest cost....................... 133.3 64.4
Plan amendments..................... 3.6 --
Actuarial loss...................... 123.1 73.3
Voluntary early retirement program.. -- 2.3
GPU acquisition..................... 1,878.3 716.9
Benefits paid....................... (131.4) (45.6)
---------------------------------------------------------------------------
Benefit obligation as of December 31 3,547.9 1,581.6
---------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets
as of January 1................... 1,706.0 23.0
Actual return on plan assets........ 8.1 12.7
Company contribution................ -- 43.3
GPU acquisition..................... 1,901.0 462.0
Benefits paid....................... (131.4) (6.0)
---------------------------------------------------------------------------
Fair value of plan assets as
of December 31................... 3,483.7 535.0
---------------------------------------------------------------------------
Funded status of plan............... (64.2) (1,046.6)
Unrecognized actuarial loss (gain).. 222.8 212.8
Unrecognized prior service cost..... 87.9 17.7
Unrecognized net transition
obligation (asset)................ -- 101.6
---------------------------------------------------------------------------
Prepaid (accrued) benefit cost $ 246.5 $ (714.5)
===========================================================================
Assumptions used as of
December 31, 2001:
Discount rate....................... 7.25% 7.25%
Expected long-term return
on plan assets.................... 10.25% 10.25%
Rate of compensation increase....... 4.00% 4.00%
FirstEnergy's net pension and other postretirement benefit costs for the
year ended December 31, 2001 were computed as follows:
Other
Pension Benefits Postretirement Benefits
---------------- -----------------------
(In millions)
Service cost......................... $ 34.9 $18.3
Interest cost........................ 133.3 64.4
Expected return on plan assets (204.8) (9.9)
Amortization of transition
obligation (asset)................. (2.1) 9.2
Amortization of prior service cost... 8.8 3.2
Recognized net actuarial loss (gain). -- 4.9
Voluntary early retirement program... 6.1 2.3
--------------------------------------------------------------------------
Net benefit cost..................... $ (23.8) $92.4
==========================================================================
The composite health care trend rate assumption is approximately 10% in
2002, 9% in 2003 and 8% in 2004, trending to 4%-6% in later years. Assumed
health care cost trend rates have a significant effect on the amounts reported
17
for the health care plan. An increase in the health care trend rate assumption
by one percentage point would increase FirstEnergy's total service and interest
cost components by $14.6 million and the postretirement benefit obligation by
$151.2 million. A decrease in the same assumption by one percentage point would
decrease the total service and interest cost components by $12.7 million and the
postretirement benefit obligation by $131.3 million.
Pre-Merger
As of December 31, 2000, the Company had on its balance sheet accrued
benefit costs of $1.0 million related to pension obligations. In addition, in
each of the years ended December 31, 2000 and 1999, the Company recognized in
income net benefit costs/(credits) of $0.1 million for pension benefits.
TRANSACTIONS WITH AFFILIATED COMPANIES-
During the three years ended December 31, 2001, GPU Service, Inc., an
affiliated company, provided legal, accounting, financial and other services to
the Company. In addition, prior to the sales of the Company's generating assets
in 1999, affiliated companies GPU Nuclear, Inc. and GPU Generation, Inc.
conducted generation operations for the company. The total cost of services
rendered by affiliates was $156 million, $139 million and $337 million for the
years 2001, 2000 and 1999, respectively. Of these amounts, $110 million, $109
million and $259 million were charged to income for the years 2001, 2000 and
1999, respectively.
SUPPLEMENTAL CASH FLOWS INFORMATION-
All temporary cash investments purchased with an initial maturity of
three months or less are reported as cash equivalents on the Consolidated
Balance Sheets at cost, which approximates their fair market value.
All borrowings with initial maturities of less than one year are defined
as financial instruments under GAAP and are reported on the Consolidated Balance
Sheets at cost, which approximates their fair market value. The following sets
forth the approximate fair value and related carrying amounts of all other
long-term debt, preferred stock subject to mandatory redemption and investments
other than cash and cash equivalents as of December 31:
2001 2000
----------------------------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
---------------------------------------------------------------------
(In millions)
Long-term debt............... $519 $509 $518 $497
Preferred stock.............. $ 92 $ 90 $100 $ 97
Investments other than cash
and cash equivalents....... $251 $251 $289 $289
---------------------------------------------------------------------
$862 $850 $907 $883
=====================================================================
The fair values of long-term debt and preferred stock reflect the
present value of the cash outflows relating to those securities based on the
current call price, the yield to maturity or the yield to call, as deemed
appropriate at the end of each respective year. The yields assumed were based on
securities with similar characteristics offered by corporations with credit
ratings similar to the Company's ratings. Long-term debt and preferred stock
subject to mandatory redemption were recognized at fair value in connection with
the merger.
The fair value of investments other than cash and cash equivalents
represent cost (which approximates fair value) or the present value of the cash
inflows based on the yield to maturity. The yields assumed were based on
financial instruments with similar characteristics and terms. Investments other
than cash and cash equivalents include decommissioning trust investments.
Unrealized gains and losses applicable to the decommissioning trusts have been
recognized in the trust investment with a corresponding change to the
decommissioning liability. The Company has no securities held for trading
purposes.
On January 1, 2001, the Company adopted SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities --
an amendment of FASB Statement No. 133." The adoption resulted in the
recognition of derivative assets on the Consolidated Balance Sheet as of January
1, 2001 in the amount of $26.0 million, with an offsetting amount, net of tax,
recorded in Regulatory Assets of $25.9 million. As of January 1, 2001, the
Company also recorded derivative liabilities in the amount of $1.0 million as a
result of adopting SFAS 133, with a substantially offsetting amount recorded in
Accumulated Other Comprehensive Income, of $0.5 million. As of January 1, 2001,
a cumulative effect of accounting change was recognized as an expense in Other
Income (Deductions), Net on the Consolidated Statement of Income in the amount
of $0.8 million.
The Company is exposed to financial risks resulting from the fluctuation
of interest rates and commodity prices, including electricity and natural gas.
To manage the volatility relating to these exposures, the Company uses a
18
variety Of derivative instruments, including options, futures contracts and
swaps. These derivatives are used principally for hedging purposes. FirstEnergy
has a Risk Policy Committee comprised of executive officers, which exercises an
independent risk oversight function to ensure compliance with corporate risk
management policies and prudent risk management practices.
The Company uses derivatives to hedge the risk of price and interest
rate fluctuations. The Company's primary ongoing hedging activity involves cash
flow hedges of electricity and natural gas purchases. The majority of the
Company's forward commodity contracts are considered "normal purchases and
sales," as defined by SFAS 133, and are therefore excluded from the scope of
SFAS 138. The options and futures contracts determined to be within the scope of
SFAS 133 are accounted for as cash flow hedges and expire on various dates
through 2002. Gains and losses from hedges of commodity price risks are included
in net income when the underlying hedged commodities are delivered. The Company
also uses interest rate swap agreements to manage the risk of increases in
variable interest rates. The interest rate swap agreements, which were entered
into to convert variable rate debt to fixed rate debt, are accounted for as cash
flow hedges under SFAS 133, and expire on various dates through 2002. There is
currently a net deferred gain of $1.8 million included in Accumulated Other
Comprehensive Income as of December 31, 2001 related to derivative hedging
activity, which will be reclassified to earnings during the next twelve months
as hedged transactions occur.
REGULATORY ASSETS-
The Companies recognize, as regulatory assets, costs which the FERC and
PPUC have authorized for recovery from customers in future periods. Without such
authorization, the costs would have been charged to income as incurred. All
regulatory assets are expected to continue to be recovered from customers under
the Company's regulatory plan. The Company continues to bill and collect
cost-based rates for its transmission and distribution services, which remain
regulated; accordingly, it is appropriate that the Company continues the
application of SFAS 71 to those operations.
Net regulatory assets on the Consolidated Balance Sheets are comprised
of the following:
2001 2000
------------------------------------------------------------
(In millions)
Regulatory transition charge...... $515.9 $439.4
Customer receivables for
future income taxes............. 140.2 149.4
Provider of last resort deferrals. 83.5 --
Nuclear decommissioning costs..... 24.0 18.5
Loss on reacquired debt........... 5.8 6.6
Other............................. 0.4 0.3
------------------------------------------------------------
Total......................... $769.8 $614.2
============================================================
2. MERGER:
On November 7, 2001, the merger of FirstEnergy and GPU became effective
pursuant to the Agreement and Plan of Merger, dated August 8, 2000. As a result
of the merger, GPU's former wholly owned subsidiaries, including the Company,
became wholly owned subsidiaries of FirstEnergy.
The merger was accounted for by the purchase method of accounting. The
assets acquired and liabilities assumed were recorded at estimated fair values
as determined by FirstEnergy's management based on information currently
available and on current assumptions as to future operations. Merger purchase
accounting adjustments recorded in the records of the Company primarily consist
of: (1) revaluation of certain property, plant and equipment; (2) adjusting
preferred stock subject to mandatory redemption and long-term debt to estimated
fair value; (3) recognizing additional obligations related to retirement
benefits; and (4) recognizing estimated severance and other compensation
liabilities. Other assets and liabilities were not adjusted since they remain
subject to rate regulation on a historical cost basis. The excess of the
purchase price over the estimated fair values of the assets acquired and
liabilities assumed was recognized as goodwill, which will not be amortized but
will be reviewed for impairment at least annually. As of December 31, 2001, we
had recorded goodwill of approximately $797.4 million related to the merger.
3. LEASES:
Consistent with regulatory treatment, the rentals for capital leases are
charged to operating expenses on the Consolidated Statements of Income. The
Company has a capital lease for an operations building, which expires in 2004.
In both 2001 and 2000, total rentals related to this capital lease were $0.7
million, comprised of an interest element of $0.2 million and other costs of
$0.5 million.
19
As of December 31, 2001, the future minimum lease payments on the
Company's capital lease discussed above are: $0.7 million, $0.7 million and $0.6
million for the years 2002 through 2004. The present value of the net minimum
lease payments is $1.7 million and the total interest portion is $0.3 million.
4. CAPITALIZATION:
(A) RETAINED EARNINGS-
The merger purchase accounting adjustments included resetting the
retained earnings balance to zero at the November 7, 2001 merger date.
In general, the Company's first mortgage bond (FMB) indentures restrict
the payment of dividends or distributions on or with respect to the Company's
common stock to amounts credited to earned surplus since approximately the date
of its indenture. At such date, the Company had a balance of $10.1 million in
its earned surplus account, which would not be available for dividends or other
distributions. As of December 31, 2001, the Company had retained earnings
available to pay common stock dividends of $0.7 million, net of amounts
restricted under the Company's FMB indentures.
(B) PREFERRED AND PREFERENCE STOCK-
The Company's preferred stock authorization consists of 11.435 million
shares without par value. No preferred shares are currently outstanding.
(C) COMPANY-OBLIGATED MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY PARTNERSHIP PREFERRED SECURITIES-
The Company has formed a statutory business trust, Penelec Capital
Trust, which is owned through a wholly-owned limited partnership of the Company,
Penelec Capital II, L.P., of which a wholly-owned subsidiary of the Company is
the sole general partner. In this transaction, Penelec Capital Trust invested
the gross proceeds from the sale of $100.0 million of its 7.34% trust preferred
securities in the preferred securities of Penelec Capital II, L.P., which in
turn invested those proceeds in $103.1 million of 7.34% subordinated debentures
of the Company. The sole assets of Penelec Capital Trust are the preferred
securities of Penelec Capital II, L.P., whose sole assets are the Company's
subordinated debentures with the same rate and maturity date as the preferred
securities. The Company has effectively provided a full and unconditional
guarantee of its obligations under its trust's preferred securities. The trust
preferred securities, which mature in 2039 and have a liquidation value of
$25.00 per security, are redeemable at the option of the Company beginning in
September 2004 at 100% of their principal amount. The interest on the
subordinated debentures (and therefore the distributions on the preferred
securities) may be deferred for up to 60 months, but the Company may not pay
dividends on, or redeem or acquire, any of its cumulative preferred or common
stock until deferred payments on its subordinated debentures are paid in full.
(D) LONG-TERM DEBT-
The first mortgage indentures and their supplements, which secure all of
the Company's FMBs, serve as direct first mortgage liens on substantially all
property and franchises, other than specifically excepted property, owned by the
Company.
Based on the amount of bonds authenticated by the Trustee through
December 31, 2001, the Company's annual sinking and improvement fund
requirements for all bonds issued under the mortgage amount to $12.7 million.
The Company expects to fulfill its sinking and improvement fund obligation by
providing bondable property additions to the Trustee.
Sinking fund requirements for FMBs and maturing long-term debt
(excluding capital leases) for the next five years are:
(In millions)
---------------------
2002........ $ 50.2
2003........ 0.2
2004........ 125.2
2005........ 8.2
2006........ 0.2
----------------------
20
The Company's obligations to repay certain pollution control revenue
bonds are secured by several series of FMBs. Certain pollution control revenue
bonds are entitled to the benefit of noncancelable municipal bond insurance
policies of $69.3 million to pay principal of, or interest on, the pollution
control revenue bonds.
(E) COMPREHENSIVE INCOME-
Comprehensive income includes net income as reported on the Consolidated
Statements of Income and all other changes in common stockholder's equity except
those resulting from transactions with the Company's parent. As of December 31,
2001, accumulated other comprehensive income consisted primarily of unrealized
gains on derivative instrument hedges of $1.8 million.
5. SHORT-TERM BORROWINGS:
The Company may borrow from its affiliates on a short-term basis. As of
December 31, 2001, the Company had total short-term borrowings of $77.6 million
from its affiliates with a weighted average interest rate of approximately 4.9%.
6. COMMITMENTS, GUARANTEES AND CONTINGENCIES:
CAPITAL EXPENDITURES-
The Company's current forecast reflects expenditures of approximately
$375 million for property additions and improvements from 2002-2006, of which
approximately $72 million is applicable to 2002.
NUCLEAR INSURANCE-
The Price-Anderson Act limits the public liability relative to a single
incident at a nuclear power plant to $9.5 billion. The amount is covered by a
combination of private insurance and an industry retrospective rating plan.
Based on its present ownership interest in TMI-2, the Company is exempt from any
potential assessment under the industry retrospective rating plan.
The Company is also insured as to its interest in TMI-2 under a policy
issued to the operating company for the plant. Under this policy, $150 million
is provided for property damage and decontamination and decommissioning costs.
Under this policy, the Company can be assessed a maximum of approximately $0.2
million for incidents at any covered nuclear facility occurring during a policy
year which are in excess of accumulated funds available to the insurer for
paying losses.
The Company intends to maintain insurance against nuclear risks as
described above as long as it is available. To the extent that property damage,
decontamination, decommissioning, repair and replacement costs and other such
costs arising from a nuclear incident at TMI-2 exceed the policy limits of the
insurance in effect with respect to that plant, to the extent a nuclear incident
is determined not to be covered by the Company's insurance policies, or to the
extent such insurance becomes unavailable in the future, the Company would
remain at risk for such costs.
ENVIRONMENTAL MATTERS-
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of December 31, 2001, based on estimates of the
total costs of cleanup, the Company's proportionate responsibility for such
costs and the financial ability of other nonaffiliated entities to pay. The
Company has been named as a "potentially responsible party" (PRP) at waste
disposal sites which may require cleanup under the Comprehensive Environmental
Response, Compensation and Liability Act of 1980. Allegations of disposal of
hazardous substances at historical sites, and the liability involved, are often
unsubstantiated and subject to dispute. Federal law provides that all PRPs for a
particular site be held liable on a joint and several basis. The Company has
total accrued liabilities aggregating approximately $1 million as of December
31, 2001. The Company does not believe environmental remediation costs will have
a material adverse effect on its financial condition, cash flows or results of
operations.
OTHER LEGAL PROCEEDINGS-
Various lawsuits, claims and proceedings related to the Company's normal
business operations are pending against the Company, the most significant of
which is described below.
21
TMI-2, which was damaged during a 1979 accident, is jointly owned by the
Company, JCP&L and Met-Ed, with the Company having a 25% ownership percentage.
Claims for alleged personal injury against the Company, JCP&L, Met-Ed and GPU
(the defendants) were filed in the U.S. District Court for the Middle District
of Pennsylvania. In 1996, the District Court granted a motion for summary
judgment filed by the defendants and dismissed the ten initial "test cases"
which had been selected for a test case trial, as well as all of the remaining
2,100 pending claims. In November 1999, the U.S. Court of Appeals for the Third
Circuit affirmed the District Court's dismissal of the ten "test cases," but set
aside the dismissal of the additional pending claims, remanding them to the
District Court for further proceedings. In September 2000, the defendants filed
for a summary judgment in the District Court. Meanwhile, the plaintiffs appealed
to the Third Circuit for a review of the District Court's decision placing
limitations on the remaining plaintiffs' suit. In April 2001, the Third Circuit
affirmed the District Court's decision. In July 2001, the defendants renewed
their motion for a summary judgment on the remaining 2,100 claims in the
District Court. On January 15, 2002, the District Court granted the defendants'
amended motion for summary judgment. On February 14, 2002, plaintiffs filed a
notice of appeal to the United States Court of Appeals for the Third Circuit. In
addition to the approximately 2,100 claims for which summary judgment has been
granted, there is other pending litigation arising out of the TMI-2 accident.
This litigation consists of the following: eight personal injury cases that were
not consolidated with the above-referenced approximately 2,100 claims; two class
actions brought on behalf of plaintiffs alleging additional injuries diagnosed
after the filing of the complaints in the above-referenced case; a case alleging
exposure during the post-accident cleanup of the TMI-2 plant; and claims by
individual businesses for economic loss resulting from the TMI-2 accident.
Although unable to predict the outcome of this litigation, the Company believes
that any liability to which it might be subject by reason of the TMI-2 accident
will not exceed its financial protection under the Price-Anderson Act.
7. SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED):
The following summarizes certain consolidated operating results by
quarter for 2001 and 2000.
Three Months Ended
-------------------------------
March 31, June 30, September 30, Oct. 1-Nov. 6, Nov. 7-Dec. 31,
2001 2001 2001 2001 2001
- ----------------------------------------------------------------------------------------------
(In millions)
Operating Revenues............ $243.8 $230.6 $265.6 $94.5 | $140.1
Operating Expenses and Taxes.. 235.0 212.2 238.8 78.5 | 125.7
- ----------------------------------------------------------------------------|-----------------
Operating Income.............. 8.8 18.4 26.8 16.0 | 14.4
Other Income (Expense)........ 0.6 1.4 (1.2) (7.4) | 3.0
Net Interest Charges.......... 11.5 12.6 11.2 4.4 | 6.6
- ----------------------------------------------------------------------------|-----------------
Net Income (Loss)............. $ (2.1) $ 7.2 $ 14.4 $ 4.2 | $ 10.8
============================================================================|=================
Three Months Ended
---------------------------------------------
March 31, June 30, September 30,December 31,
2000 2000 2000 2000
- ------------------------------------------------------------------------------
(In millions)
Operating Revenues............ $220.1 $206.8 $236.7 $238.3
Operating Expenses and Taxes.. 184.4 193.2 237.8 206.2
- ------------------------------------------------------------------------------
Operating Income (Loss)....... 35.7 13.6 (1.1) 32.1
Other Income (Expense)........ 0.3 2.0 (0.8) 5.2
Net Interest Charges.......... 9.1 11.1 12.1 15.5
- ------------------------------------------------------------------------------
Net Income (Loss)............. $ 26.9 $ 4.5 $(14.0) $ 21.8
==============================================================================
22
Report of Independent Public Accountants
To the Stockholders and Board of Directors of
Pennsylvania Electric Company:
We have audited the accompanying consolidated balance sheet and consolidated
statement of capitalization of Pennsylvania Electric Company (a Pennsylvania
corporation and wholly owned subsidiary of FirstEnergy Corp.) and subsidiaries
as of December 31, 2001 (post-merger), and the related consolidated statements
of income, common stockholder's equity, preferred stock, cash flows and taxes
for the period from January 1, 2001 to November 6, 2001 (pre-merger) and the
period from November 7, 2001 to December 31, 2001 (post-merger). These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The financial statements of Pennsylvania Electric Company and
subsidiaries as of December 31, 2000 and for each of the two years in the period
ended December 31, 2000 (pre-merger), were audited by other auditors whose
report dated January 31, 2001, expressed an unqualified opinion on those
statements.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the 2001 financial statements referred to above present fairly,
in all material respects, the financial position of Pennsylvania Electric
Company and subsidiaries as of December 31, 2001 (post-merger), and the results
of their operations and their cash flows for the period from January 1, 2001 to
November 6, 2001 (pre-merger) and the period from November 7, 2001 to December
31, 2001 (post-merger), in conformity with accounting principles generally
accepted in the United States.
Arthur Andersen LLP
Cleveland, Ohio,
March 18, 2002.
23
Report of Independent Accountants
To the Board of Directors and Stockholder of
Pennsylvania Electric Company:
In our opinion, the consolidated balance sheet as of December 31, 2000 and the
related consolidated statements of income, and cash flows for each of the two
years in the period ended December 31, 2000 (appearing on the accompanying index
of the Pennsylvania Electric Company 2001 Annual Report to Stockholders
incorporated by reference in this Form 10-K) present fairly, in all material
respects, the financial position, results of operations and cash flows of
Pennsylvania Electric Company and Subsidiary Companies at December 31, 2000 and
for each of the two years in the period ended December 31, 2000, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
January 31, 2001
24