FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission Registrant; State of Incorporation; I.R.S. Employer
File Number Address; and Telephone Number Identification No.
- ----------- ---------------------------------------- ------------------
333-21011 FIRSTENERGY CORP. 34-1843785
(An Ohio Corporation)
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
1-2578 OHIO EDISON COMPANY 34-0437786
(An Ohio Corporation)
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
1-2323 THE CLEVELAND ELECTRIC ILLUMINATING COMPANY 34-0150020
(An Ohio Corporation)
c/o FirstEnergy Corp.
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
1-3583 THE TOLEDO EDISON COMPANY 34-4375005
(An Ohio Corporation)
c/o FirstEnergy Corp.
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
1-3491 PENNSYLVANIA POWER COMPANY 25-0718810
(A Pennsylvania Corporation)
c/o FirstEnergy Corp.
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
1-3141 JERSEY CENTRAL POWER & LIGHT COMPANY 21-0485010
(A New Jersey Corporation)
c/o FirstEnergy Corp.
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
1-446 METROPOLITAN EDISON COMPANY 23-0870160
(A Pennsylvania Corporation)
c/o FirstEnergy Corp.
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
1-3522 PENNSYLVANIA ELECTRIC COMPANY 25-0718085
(A Pennsylvania Corporation)
c/o FirstEnergy Corp.
76 South Main Street
Akron, OH 44308
Telephone (800)736-3402
Indicate by check mark whether each of the registrants (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes X No
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Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
OUTSTANDING
CLASS AS OF AUGUST 8, 2002
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FirstEnergy Corp., $.10 par value ......................... 297,636,276
Ohio Edison Company, no par value ......................... 100
The Cleveland Electric Illuminating Company, no par value . 79,590,689
The Toledo Edison Company, $5 par value ................... 39,133,887
Pennsylvania Power Company, $30 par value ................. 6,290,000
Jersey Central Power & Light Company, $10 par value ....... 15,371,270
Metropolitan Edison Company, no par value ................. 859,500
Pennsylvania Electric Company, $20 par value .............. 5,290,596
FirstEnergy Corp. is the sole holder of Ohio Edison Company, The Cleveland
Electric Illuminating Company, The Toledo Edison Company, Jersey Central Power &
Light Company, Metropolitan Edison Company, and Pennsylvania Electric Company
common stock; Ohio Edison Company is the sole holder of Pennsylvania Power
Company common stock.
This combined Form 10-Q is separately filed by FirstEnergy Corp.,
Ohio Edison Company, Pennsylvania Power Company, The Cleveland Electric
Illuminating Company, The Toledo Edison Company, Jersey Central Power & Light
Company, Metropolitan Edison Company and Pennsylvania Electric Company.
Information contained herein relating to any individual registrant is filed by
such registrant on its own behalf. No registrant makes any representation as to
information relating to any other registrant, except that information relating
to any of the FirstEnergy subsidiary registrants is also attributed to
FirstEnergy.
This Form 10-Q includes forward-looking statements based on
information currently available to management. Such statements are subject to
certain risks and uncertainties. These statements typically contain, but are not
limited to, the terms "anticipate", "potential", "expect", "believe", "estimate"
and similar words. Actual results may differ materially due to the speed and
nature of increased competition and deregulation in the electric utility
industry, economic or weather conditions affecting future sales and margins,
changes in markets for energy services, changing energy 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.
TABLE OF CONTENTS
Pages
Part I. Financial Information
Notes to Financial Statements............................... 1-9
FirstEnergy Corp.
Consolidated Statements of Income........................... 10
Consolidated Balance Sheets................................. 11-12
Consolidated Statements of Cash Flows....................... 13
Report of Independent Accountants........................... 14
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 15-26
Ohio Edison Company
Consolidated Statements of Income........................... 27
Consolidated Balance Sheets................................. 28-29
Consolidated Statements of Cash Flows....................... 30
Report of Independent Accountants........................... 31
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 32-34
The Cleveland Electric Illuminating Company
Consolidated Statements of Income........................... 35
Consolidated Balance Sheets................................. 36-37
Consolidated Statements of Cash Flows....................... 38
Report of Independent Accountants........................... 39
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 40-43
The Toledo Edison Company
Consolidated Statements of Income........................... 44
Consolidated Balance Sheets................................. 45-46
Consolidated Statements of Cash Flows....................... 47
Report of Independent Accountants........................... 48
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 49-52
Pennsylvania Power Company
Statements of Income........................................ 53
Balance Sheets.............................................. 54-55
Statements of Cash Flows.................................... 56
Report of Independent Accountants........................... 57
Management's Discussion and Analysis of Results of
Operations and Financial Condition....................... 58-59
Jersey Central Power & Light Company
Consolidated Statements of Income........................... 60
Consolidated Balance Sheets................................. 61-62
Consolidated Statements of Cash Flows....................... 63
Report of Independent Accountants........................... 64
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 65-69
TABLE OF CONTENTS (Cont'd)
Pages
Metropolitan Edison Company
Consolidated Statements of Income........................... 70
Consolidated Balance Sheets................................. 71-72
Consolidated Statements of Cash Flows....................... 73
Report of Independent Accountants........................... 74
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 75-78
Pennsylvania Electric Company
Consolidated Statements of Income........................... 79
Consolidated Balance Sheets................................. 80-81
Consolidated Statements of Cash Flows....................... 82
Report of Independent Accountants........................... 83
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 84-87
Part II. Other Information
PART I. FINANCIAL INFORMATION
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FIRSTENERGY CORP. AND SUBSIDIARIES
OHIO EDISON COMPANY AND SUBSIDIARIES
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARIES
THE TOLEDO EDISON COMPANY AND SUBSIDIARY
PENNSYLVANIA POWER COMPANY
JERSEY CENTRAL POWER & LIGHT COMPANY AND SUBSIDIARIES
METROPOLITAN EDISON COMPANY AND SUBSIDIARIES
PENNSYLVANIA ELECTRIC COMPANY AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1 - FINANCIAL STATEMENTS:
The principal business of FirstEnergy Corp. (FirstEnergy) is the
holding, directly or indirectly, of all of the outstanding common stock of its
eight principal electric utility operating subsidiaries, Ohio Edison Company
(OE), The Cleveland Electric Illuminating Company (CEI), The Toledo Edison
Company (TE), Pennsylvania Power Company (Penn), American Transmission Systems,
Inc. (ATSI), Jersey Central Power & Light Company (JCP&L), Metropolitan Edison
Company (Met-Ed) and Pennsylvania Electric Company (Penelec). These utility
subsidiaries are referred to throughout as "Companies." Penn is a wholly owned
subsidiary of OE. FirstEnergy's results include the results of JCP&L, Met-Ed and
Penelec from the November 7, 2001 merger date with GPU, Inc., the former parent
company of JCP&L, Met-Ed and Penelec. The merger was accounted for by the
purchase method of accounting and the applicable effects were reflected on the
financial statements of JCP&L, Met-Ed and Penelec as of the merger date.
Accordingly, the post-merger financial statements reflect a new basis of
accounting, and pre-merger period and post-merger period financial results of
JCP&L, Met-Ed and Penelec (separated by a heavy black line) are presented.
FirstEnergy's consolidated financial statements also include its other principal
subsidiaries: FirstEnergy Solutions Corp. (FES); FirstEnergy Facilities Services
Group, LLC (FEFSG); MYR Group, Inc. (MYR); MARBEL Energy Corporation;
FirstEnergy Nuclear Operating Company (FENOC); GPU Capital, Inc.; GPU Power,
Inc.; FirstEnergy Service Company (FECO); and GPU Service, Inc. (GPUS). FES
provides energy-related products and services and, through its FirstEnergy
Generation Corp. (FGCO) subsidiary, operates FirstEnergy's nonnuclear generation
business. FENOC operates the Companies' nuclear generating facilities. FEFSG is
the parent company of several heating, ventilating, air conditioning and energy
management companies, and MYR is a utility infrastructure construction service
company. MARBEL is a fully integrated natural gas company. GPU Capital owns and
operates electric distribution systems in foreign countries and GPU Power owns
and operates generation facilities in foreign countries. FECO and GPUS provide
legal, financial and other corporate support services to affiliated FirstEnergy
companies.
The condensed unaudited financial statements of FirstEnergy and each
of the Companies reflect all normal recurring adjustments that, in the opinion
of management, are necessary to fairly present results of operations for the
interim periods. These statements should be read in conjunction with the
financial statements and notes included in the combined Annual Report on Form
10-K for the year ended December 31, 2001 for FirstEnergy and the Companies.
Significant intercompany transactions have been eliminated. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States 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 those estimates. The reported results of operations are not
indicative of results of operations for any future period. Certain prior year
amounts have been reclassified to conform with the current year presentation.
Preferred Securities-
The sole assets of the OE and the CEI subsidiary trusts that is the
obligor on their respective preferred securities included in FirstEnergy's, OE's
and CEI's capitalization are $123,711,350 and $103,093,000 principal amount of
9% Junior Subordinated Debentures of OE due December 31, 2025 and of CEI due
December 31, 2006, respectively. OE's preferred securities and the related
Junior Subordinated Debentures will be optionally redeemed August 15, 2002.
Met-Ed and Penelec have each formed statutory business trusts for
substantially similar transactions as OE and CEI for the issuance of $100
million each of preferred securities due 2039. However, ownership of the
respective Met-Ed and Penelec trusts is through separate wholly-owned limited
partnerships, of which a wholly-owned subsidiary of each company is the sole
general partner. In these transactions, the sole assets and sources of revenues
of each trust are the preferred securities of the applicable limited
partnership, whose sole assets are in the 7.35% and 7.34% subordinated
1
debentures (aggregate principal amount of $103.1 million each) of Met-Ed and
Penelec, respectively. In each case, the applicable parent company has
effectively provided a full and unconditional guarantee of its obligations under
its trust's preferred securities.
Securitized Transition Bonds-
On June 11, 2002, JCP&L Transition Funding LLC (the Issuer), a wholly
owned limited liability company of JCP&L, sold $320 million of transition bonds
to securitize the recovery of JCP&L's bondable stranded costs associated with
the previously divested Oyster Creek Nuclear Generating Station.
JCP&L does not own or did not purchase any of the transition bonds,
which are included in Long-term debt on FirstEnergy's and JCP&L's Consolidated
Balance Sheet. The transition bonds represent obligations only of the Issuer and
are collateralized solely by the equity and assets of the Issuer, which consist
primarily of bondable transition property. The bondable transition property is
solely the property of the Issuer.
Bondable transition property is a presently existing property right
which includes the right to charge, collect and receive from JCP&L's utility
customers, through a non-bypassable transition bond charge, the principal amount
and interest on the transition bonds and other fees and expenses associated with
their issuance. JCP&L, as servicer, manages and administers the bondable
transition property, including the billing, collection and remittance of the
transition bond charge, pursuant to a servicing agreement with the Issuer. JCP&L
is entitled to a quarterly servicing fee of $100,000 that is payable from
transition bond charge collections.
Derivative Accounting-
On January 1, 2001, FirstEnergy 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 cumulative effect to January 1,
2001 was a charge of $8.5 million (net of $5.8 million of income taxes) or $.03
per share of common stock.
FirstEnergy is exposed to financial risks resulting from the
fluctuation of interest rates and commodity prices, including electricity,
natural gas and coal. To manage the volatility relating to these exposures,
FirstEnergy uses a variety of non-derivative and derivative instruments,
including forward contracts, options, futures contracts and swaps. The
derivatives are used principally for hedging purposes, and to a lesser extent,
for trading purposes. FirstEnergy's Risk Policy Committee, comprised of
executive officers, exercises an independent risk oversight function to ensure
compliance with corporate risk management policies and prudent risk management
practices.
FirstEnergy uses derivatives to hedge the risk of price, interest
rate and foreign currency fluctuations. FirstEnergy's primary ongoing hedging
activity involves cash flow hedges of electricity and natural gas purchases. The
maximum periods over which the variability of electricity and natural gas cash
flows are hedged are two and three years, respectively. Gains and losses from
hedges of commodity price risks are included in net income when the underlying
hedged commodities are delivered. The current net deferred loss of $133.0
million included in Accumulated Other Comprehensive Loss (AOCL) as of June 30,
2002, for derivative hedging activity as compared to the March 31, 2002 balance
of $133.6 million in AOCL, resulted from the sale of $6.0 million of derivative
losses with Avon, a $3.8 million loss related to current hedging activity and
$1.6 million of net hedge gains included in earnings during the quarter.
Approximately $15.7 million (after tax) of the current net deferred loss on
derivative instruments in AOCL is expected to be reclassified to earnings during
the next twelve months as hedged transactions occur. However, the fair value of
these derivative instruments will fluctuate from period to period based on
various market factors and will generally be more than offset by the margin on
related sales and revenues.
FirstEnergy engages in the trading of commodity derivatives and
periodically experiences net open positions. FirstEnergy's risk management
policies limit the exposure to market risk from open positions and require daily
reporting to management of potential financial exposures.
2 - COMMITMENTS, GUARANTEES AND CONTINGENCIES:
Capital Expenditures-
FirstEnergy's current forecast reflects expenditures of approximately
$3.2 billion (OE-$195 million, CEI-$256 million, TE-$129 million, Penn-$45
million, JCP&L-$572 million, Met-Ed-$336 million, Penelec-$387 million,
ATSI-$118 million, FES-$814 million and other subsidiaries-$309 million) for
property additions and improvements from 2002-2006, of which approximately $911
million (OE-$92 million, CEI-$152 million, TE-$101 million, Penn-$36 million,
JCP&L-$115 million, Met-Ed-$56 million, Penelec-$51 million, ATSI-$28 million,
FES-$184 million and other subsidiaries -$96 million) is applicable to 2002.
Investments for additional nuclear fuel during the 2002-2006 period are
estimated to be
2
approximately $515 million (OE-$141 million, CEI-$169 million,
TE-$114 million and Penn-$91 million), of which approximately $54 million
(OE-$16 million, CEI-$17 million, TE-$11 million and Penn-$10 million) applies
to 2002.
Environmental Matters-
Various federal, state and local authorities regulate the Companies
with regard to air and water quality and other environmental matters.
FirstEnergy estimates additional capital expenditures for environmental
compliance of approximately $235 million, which is included in the construction
forecast provided under "Capital Expenditures" for 2002 through 2006.
The Companies are required to meet federally approved sulfur dioxide
(SO2) regulations. Violations of such regulations can result in shutdown of the
generating unit involved and/or civil or criminal penalties of up to $31,500 for
each day the unit is in violation. The Environmental Protection Agency (EPA) has
an interim enforcement policy for SO2 regulations in Ohio that allows for
compliance based on a 30-day averaging period. The Companies cannot predict what
action the EPA may take in the future with respect to the interim enforcement
policy.
The Companies believe they are in compliance with the current SO2 and
nitrogen oxides (NOx) reduction requirements under the Clean Air Act Amendments
of 1990. SO2 reductions are being achieved by burning lower-sulfur fuel,
generating more electricity from lower-emitting plants, and/or using emission
allowances. NOx reductions are being achieved through combustion controls and
the generation of more electricity at lower-emitting plants. In September 1998,
the EPA finalized regulations requiring additional NOx reductions from the
Companies' Ohio and Pennsylvania facilities. The EPA's NOx Transport Rule
imposes uniform reductions of NOx emissions (an approximate 85% reduction in
utility plant NOx emissions from projected 2007 emissions) across a region of
nineteen states and the District of Columbia, including New Jersey, Ohio and
Pennsylvania, based on a conclusion that such NOx emissions are contributing
significantly to ozone pollution in the eastern United States. State
Implementation Plans (SIP) must comply by May 31, 2004 with individual state NOx
budgets established by the EPA. Pennsylvania submitted a SIP that requires
compliance with the NOx budgets at the Companies' Pennsylvania facilities by May
1, 2003 and Ohio submitted a "draft" SIP that requires compliance with the NOx
budgets at the Companies' Ohio facilities by May 31, 2004.
In July 1997, the EPA promulgated changes in the National Ambient Air
Quality Standard (NAAQS) for ozone emissions and proposed a new NAAQS for
previously unregulated ultra-fine particulate matter. In May 1999, the U.S.
Court of Appeals for the D.C. Circuit found constitutional and other defects in
the new NAAQS rules. In February 2001, the U.S. Supreme Court upheld the new
NAAQS rules regulating ultra-fine particulates but found defects in the new
NAAQS rules for ozone and decided that the EPA must revise those rules. The
future cost of compliance with these regulations may be substantial and will
depend if and how they are ultimately implemented by the states in which the
Companies operate affected facilities.
In 1999 and 2000, the EPA issued Notices of Violation (NOV) or a
Compliance Order to nine utilities covering 44 power plants, including the W. H.
Sammis Plant. In addition, the U.S. Department of Justice filed eight civil
complaints against various investor-owned utilities, which included a complaint
against OE and Penn in the U.S. District Court for the Southern District of
Ohio. The NOV and complaint allege violations of the Clean Air Act based on
operation and maintenance of the Sammis Plant dating back to 1984. The complaint
requests permanent injunctive relief to require the installation of "best
available control technology" and civil penalties of up to $27,500 per day of
violation. Although unable to predict the outcome of these proceedings,
FirstEnergy believes the Sammis Plant is in full compliance with the Clean Air
Act and the NOV and complaint are without merit. Penalties could be imposed if
the Sammis Plant continues to operate without correcting the alleged violations
and a court determines that the allegations are valid. The Sammis Plant
continues to operate while these proceedings are pending.
In December 2000, the EPA announced it would proceed with the
development of regulations regarding hazardous air pollutants from electric
power plants. The EPA identified mercury as the hazardous air pollutant of
greatest concern. The EPA established a schedule to propose regulations by
December 2003 and issue final regulations by December 2004. The future cost of
compliance with these regulations may be substantial.
As a result of the Resource Conservation and Recovery Act of 1976, as
amended, and the Toxic Substances Control Act of 1976, federal and state
hazardous waste regulations have been promulgated. Certain fossil-fuel
combustion waste products, such as coal ash, were exempted from hazardous waste
disposal requirements pending the EPA's evaluation of the need for future
regulation. The EPA has issued its final regulatory determination that
regulation of coal ash as a hazardous waste is unnecessary. In April 2000, the
EPA announced that it will develop national standards regulating disposal of
coal ash under its authority to regulate nonhazardous waste.
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of June 30, 2002, based on estimates of the total
costs of cleanup, the Companies' proportionate responsibility for such costs and
the financial ability of other nonaffiliated entities to pay. The Companies have
been named as "potentially responsible parties" (PRPs) at waste disposal sites
which may require cleanup under the Comprehensive Environmental Response,
3
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. In addition, JCP&L
has accrued liabilities for environmental remediation of former manufactured gas
plants in New Jersey; those costs are being recovered by JCP&L through a
non-bypassable societal benefits charge. The Companies have total accrued
liabilities aggregating approximately $57.3 million (JCP&L-$50.0 million,
CEI-$2.8 million, TE-$0.2 million, Met-Ed-$0.2 million, Penelec-$0.4 million and
other-$3.7 million) as of June 30, 2002. FirstEnergy does not believe
environmental remediation costs will have a material adverse effect on its
financial condition, cash flows or results of operations.
Other Commitments, Guarantees and Contingencies-
GPU made significant investments in foreign businesses and facilities
through its GPU Power subsidiary. Although FirstEnergy attempts to mitigate its
risks related to foreign investments, it faces additional risks inherent in
operating in such locations, including foreign currency fluctuations.
El Barranquilla, a wholly owned subsidiary of GPU Power, is a 28.67%
equity investor in Termobarranquilla S.A., Empresa de Servicios Publicos
(TEBSA), which owns a Colombian independent power generation project. GPU Power
is committed, under certain circumstances, to make additional standby equity
contributions of $21.3 million, which FirstEnergy has guaranteed. The total
outstanding senior debt of the TEBSA project is $286 million as of June 30,
2002. The lenders include the Overseas Private Investment Corporation, US Export
Import Bank and a commercial bank syndicate. FirstEnergy has also guaranteed the
obligations of the operators of the TEBSA project, up to a maximum of $5.9
million (subject to escalation) under the project's operations and maintenance
agreement.
In June 2002, the private TEBSA equity investors, including El
Barranquilla, entered into global settlement agreements with the TEBSA Project
lenders, and CORELCA (the government-owned Colombian electric utility with an
ownership interest in the Project) resolving all outstanding events of default
and other disclosure related issues which had been raised regarding the Project.
Also in June 2002, the DIAN (the Colombian national tax authority)
notified TEBSA that it had determined that TEBSA did not violate certain foreign
exchange regulations regarding the Project lease finance arrangements (for which
the DIAN had initially sought to assess statutory penalties of approximately
$200 million) and that the DIAN had closed the matter.
3 - PENDING DIVESTITURES:
FirstEnergy identified certain former GPU international operations
for divestiture within twelve months of the merger date. These operations
constitute individual "lines of business" as defined in Accounting Principles
Board Opinion (APB) No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," with physically and
operationally separable activities. Application of Emerging Issues Task Force
(EITF) Issue No. 87-11, "Allocation of Purchase Price to Assets to Be Sold,"
required that expected, pre-sale cash flows, including incremental interest
costs on related acquisition debt, of these operations be considered part of the
purchase price allocation. Accordingly, subsequent to the merger date, results
of operations and incremental interest costs related to these international
subsidiaries were not included in FirstEnergy's Consolidated Statements of
Income. Additionally, assets and liabilities of these international operations
were segregated under separate captions in the Consolidated Balance Sheet as
"Assets Pending Sale" and "Liabilities Related to Assets Pending Sale."
Upon completion of its merger with GPU, FirstEnergy accepted an
October 2001 offer from Aquila, Inc. (formerly UtiliCorp United) to purchase
Avon Energy Partners Holdings, FirstEnergy's wholly owned holding company of
Midlands Electricity plc, for $2.1 billion including the assumption of $1.7
billion of debt. FirstEnergy received approximately $155 million in cash
proceeds and approximately $87 million of long-term notes (representing the
present value of $19 million per year to be received over six years beginning in
2003) from Aquila for its 79.9 percent interest. As of May 8, 2002, Avon had
approximately $380 million in cash and cash equivalents. The transaction closed
on May 8, 2002 and reflected the March 2002 modification of Aquila's initial
offer such that Aquila acquired a 79.9 percent interest in Avon for
approximately $1.9 billion (including the assumption of $1.7 billion of debt).
FirstEnergy and Aquila together own all of the outstanding shares of Avon
through a jointly owned subsidiary, with each company having a 50-percent voting
interest. Originally, in accordance with applicable accounting guidance, the
earnings of those foreign operations were anticipated cash flows not recognized
in current earnings from the date of the GPU acquisition until February 6, 2002.
However, the revision to the initial offer by Aquila caused a reversal of this
accounting in the first quarter of 2002, resulting in the recognition of a
cumulative effect of a change in accounting which increased net income by $31.7
million. This resulted from the application of guidance provided by EITF Issue
No. 90-6, "Accounting for Certain Events Not Addressed in Issue No. 87-11
relating to an Acquired Operating Unit to Be Sold," accounting under EITF Issue
No. 87-11, recognizing the net income of Avon from November 7, 2001 to February
6, 2002 that previously was not recognized by FirstEnergy in its consolidated
earnings as discussed above.
4
GPU's former Argentina operations were also identified by FirstEnergy
for divestiture within twelve months of the merger date. FirstEnergy determined
the fair value of its Argentina operations, GPU Empresa Distribuidora Electrica
Regional S.A. and affiliates (Emdersa), based on the best available information
as of the date of the merger. Subsequent to that date, a number of economic
events have occurred in Argentina which may have an impact on FirstEnergy's
ability to realize Emdersa's estimated fair value. These events include currency
devaluation, restrictions on repatriation of cash, and the anticipation of
future asset sales in that region by competitors. Based on its assessment of the
probability of sale and several other key assumptions such as pricing, growth of
customer base and the timing of an economic recovery, FirstEnergy has determined
that it is not probable that the current economic conditions in Argentina have
eroded the fair value recorded for Emdersa; as a result, an impairment writedown
of this investment is not warranted as of June 30, 2002. FirstEnergy will
continue to assess the potential impact of these and other related events on the
realizability of the value recorded for Emdersa. FirstEnergy continues to pursue
divesting Emdersa and, in accordance with EITF Issue No. 87-11, has classified
its assets and liabilities in the Consolidated Balance Sheet as "Assets Pending
Sale" and "Liabilities Related to Assets Pending Sale". Potential investors
recently retained a financial advisor to assist in the due diligence process and
FirstEnergy expects that preliminary negotiations with those investors may be
completed in the third quarter of 2002. If FirstEnergy has not completed the
sale of all of its interest in Emdersa or has not reached a definitive agreement
to sell such interest by November 6, 2002, those assets would no longer be
classified as "Assets Pending Sale" on FirstEnergy's Consolidated Balance Sheet
and Emdersa's results of operations would be included on FirstEnergy's
Consolidated Statement of Income. In addition, Emdersa's cumulative results of
operations (from November 7, 2001 through the date that it would become probable
that a definitive sale agreement for all of FirstEnergy's interest would not be
reached by November 6, 2002) would be reflected on FirstEnergy's Consolidated
Statement of Income as a "Cumulative Effect of a Change in Accounting". As of
June 30, 2002, that adjustment would have reduced FirstEnergy's net income by
approximately $95 million ($0.33 per share of common stock). Other international
operations are being considered for sale; however, as of the merger date those
sales were not judged to be probable of occurring within twelve months.
Sale of Generating Assets-
On November 29, 2001, FirstEnergy reached an agreement to sell four
coal-fired power plants totaling 2,535 MW to NRG Energy Inc. for $1.5 billion
($1.355 billion in cash and $145 million in debt assumption). On August 8, 2002,
FirstEnergy notified NRG that it was canceling the agreement because NRG stated
that it could not complete the transaction under the original terms of the
agreement. FirstEnergy also notified NRG that FirstEnergy is reserving the right
to pursue legal action against NRG, its affiliate and its parent, Xcel Energy,
for damages based on the anticipatory breach of the agreement. As a result,
FirstEnergy will pursue opportunities with other parties who have expressed
interest in purchasing the plants. FirstEnergy believes that an agreement can be
reached with another buyer on a timely basis and that no impairment of these
assets is appropriate. The net after-tax gain from such sale, based on the
difference between the sale price of the plants and their market price used in
the Ohio restructuring transition plan, will be credited to customers by
reducing the transition cost recovery period.
4 - REGULATORY MATTERS:
In Ohio, New Jersey and Pennsylvania, laws applicable to electric
industry deregulation included the following provisions which are reflected in
the Companies' respective state regulatory plans:
o allowing the Companies' electric customers to select their
generation suppliers;
o establishing provider of last resort (PLR) obligations to
non-shopping customers in the Companies' service areas;
o allowing recovery of potentially stranded investment (or transition
costs);
o itemizing (unbundling) the current price of electricity into its
component elements -- including generation, transmission,
distribution and stranded costs recovery charges;
o deregulating the Companies' electric generation businesses; and
o continuing regulation of the Companies' transmission and
distribution systems.
Ohio-
FirstEnergy's transition plan (which it filed on behalf of OE, CEI
and TE (Ohio Companies)) included approval for recovery of transition costs,
including regulatory assets, as filed in the transition plan through no later
than 2006 for OE, mid-2007 for TE and 2008 for CEI, except where a longer period
of recovery is provided for in the settlement agreement. The approved plan also
granted preferred access over FirstEnergy's subsidiaries to nonaffiliated
marketers, brokers and aggregators to 1,120 MW of generation capacity through
2005 at established prices for sales to the Ohio Companies' retail customers.
Customer prices are frozen through a five-year market development period
(2001-2005), except for certain limited statutory exceptions including a 5%
reduction in the price of generation for residential customers.
5
FirstEnergy's Ohio customers choosing alternative suppliers receive
an additional incentive applied to the shopping credit (generation component) of
45% for residential customers, 30% for commercial customers and 15% for
industrial customers. The amount of the incentive is deferred for future
recovery from customers -- recovery will be accomplished by extending the
respective transition cost recovery period. If the customer shopping goals
established in the agreement are not achieved by the end of 2005, the transition
cost recovery periods could be shortened for OE, CEI and TE to reduce recovery
by as much as $500 million (OE-$250 million, CEI-$170 million and TE-$80
million), but any such adjustment would be computed on a class-by-class and
pro-rata basis. Based on annualized shopping levels as of June 30, 2002,
FirstEnergy believes the remaining maximum potential recovery reductions are
OE's of approximately $31 million.
New Jersey-
JCP&L's 2001 Final Decision and Order (Final Order) with respect to
its rate unbundling, stranded cost and restructuring filings confirmed rate
reductions set forth in its 1999 Summary Order, which remain in effect at
increasing levels through July 2003, with the level of unbundled rate components
after July 31, 2003 to be determined in a rate case, which JCP&L filed on August
1, 2002. All parties will have an opportunity to participate in the process and
to examine JCP&L's proposed unbundled rates, including distribution and market
transition charge rates. The New Jersey Board of Public Utilities (NJBPU) will
review the unbundled rate components to establish the appropriate level of rates
after July 31, 2003. In addition to basic electric industry deregulation
provisions discussed above, the Final Order also confirms the establishment of a
non-bypassable societal benefits charge (SBC) to recover costs which include
nuclear plant decommissioning and manufactured gas plant remediation, as well as
a non-bypassable market transition charge (MTC) primarily to recover stranded
costs. JCP&L submitted two rate filings with NJBPU on August 1, 2002. The first
filing related to the level of unbundled rate components after July 31, 2003.
The second filing was a request to recover deferred costs that exceeded amounts
being recovered under the current MTC and SBC rates; one proposed method of
recovery of these costs is securitization of the deferred balance. The deferred
costs and JCP&L's current Oyster Creek securitization methodology which is
similar to the rate filing proposal is discussed in the following paragraph.
However, the NJBPU deferred making a final determination of the net proceeds and
stranded costs related to prior generating asset divestitures until JCP&L's
request for an Internal Revenue Service (IRS) ruling regarding the treatment of
associated federal income tax benefits is acted upon. Should the IRS ruling
support the return of the tax benefits to customers, there would be no effect to
FirstEnergy's or JCP&L's net income since the contingency existed prior to the
merger.
JCP&L's PLR obligation to provide basic generation service (BGS) to
non-shopping customers is supplied almost entirely from contracted and open
market purchases. JCP&L is permitted to defer for future collection from
customers the amounts by which its costs of supplying BGS to non-shopping
customers and costs incurred under nonutility generation (NUG) agreements exceed
amounts collected through BGS and MTC rates. As of June 30, 2002, the
accumulated deferred cost balance totaled approximately $365 million. The Final
Order provided for the ability to securitize stranded costs associated with the
divested Oyster Creek Nuclear Generation Station. In February 2002, JCP&L
received NJBPU authorization to issue $320 million of transition bonds to
securitize the recovery of these costs. The NJBPU order also provided for a
usage-based non-bypassable transition bond charge and for the transfer of the
bondable transition property to another entity. JCP&L sold $320 million
transition bonds through a new wholly owned subsidiary, JCP&L Transition Funding
LLC, in May 2002, which is recognized on the Consolidated Balance Sheet. The
Final Order also allows for additional securitization of JCP&L's deferred
balance to the extent permitted by law upon application by JCP&L and a
determination by the NJBPU that the conditions of the New Jersey restructuring
legislation are met. There can be no assurance as to the extent, if any, that
the NJBPU will permit such securitization.
In December 2001, the NJBPU authorized the auctioning of BGS for the
period from August 1, 2002 through July 31, 2003 to meet the electric demands of
all customers who have not selected an alternative supplier. The auction, which
ended on February 13, 2002 and was approved by the NJBPU on February 15, 2002,
removed JCP&L's BGS obligation of 5,100 MW for the period August 1, 2002 through
July 31, 2003. The auction provides a transitional mechanism and a different
model for the procurement of BGS commencing August 1, 2003 may be adopted.
Pennsylvania-
The Pennsylvania Public Utility Commission (PPUC) authorized 1998
rate restructuring plans for Penn, Met-Ed and Penelec. In 2000, the PPUC
disallowed a portion of the requested additional stranded costs above those
amounts granted in Met-Ed's and Penelec's 1998 rate restructuring plan orders.
The PPUC required Met-Ed and Penelec to seek an IRS ruling regarding the return
of certain unamortized investment tax credits and excess deferred income tax
benefits to customers. Similar to JCP&L's situation, if the IRS ruling
ultimately supports returning these tax benefits to customers, there would be no
effect to FirstEnergy's, Met-Ed's or Penelec's net income since the contingency
existed prior to the merger.
6
As a result of their generating asset divestitures, Met-Ed and
Penelec obtain their supply of electricity to meet their PLR obligations almost
entirely from contracted and open market purchases. In 2000, Met-Ed and Penelec
filed a petition with the PPUC seeking permission to defer, for future recovery,
energy costs in excess of amounts reflected in their capped generation rates;
the PPUC subsequently consolidated this petition in January 2001 with the
FirstEnergy/GPU merger proceeding.
In June 2001, the PPUC entered orders approving the Settlement
Stipulation with all of the major parties in the combined merger and rate relief
proceedings which approved the merger and provided Met-Ed and Penelec PLR rate
relief. The PPUC permitted Met-Ed and Penelec to defer for future recovery the
difference between their actual energy costs and those reflected in their capped
generation rates, retroactive to January 1, 2001. Correspondingly, in the event
that energy costs incurred by Met-Ed and Penelec are below their respective
capped generation rates, that difference will reduce costs that had been
deferred for recovery in future periods. This deferral accounting procedure will
cease on December 31, 2005. Thereafter, costs which had been deferred through
that date would be recoverable through application of competitive transition
charge (CTC) revenues received by Met-Ed and Penelec through December 31, 2010.
Met-Ed's and Penelec's PLR obligations extend through December 31, 2010; during
that period CTC revenues will be applied first to PLR costs, then to non-NUG
stranded costs and finally to NUG stranded costs. Met-Ed and Penelec would be
permitted to recover any remaining stranded costs through a continuation of the
CTC after December 31, 2010 through 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 filed Petitions for Review in June and July 2001
with the Commonwealth Court of Pennsylvania regarding the June 2001 PPUC orders.
On February 21, 2002, the Court affirmed the PPUC decision regarding the
FirstEnergy/GPU 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 PLR obligations of Met-Ed and Penelec, and rejected those parts of the
settlement that permitted the companies to defer for accounting purposes the
difference between their wholesale power costs and the amount that they collect
from retail customers. FirstEnergy filed a Petition for Allowance of Appeal with
the Pennsylvania Supreme Court on March 25, 2002, asking it to review the
Commonwealth Court decision. Also on March 25, 2002, Citizens Power filed a
motion seeking an appeal of the Commonwealth Court's decision to affirm the
FirstEnergy and GPU merger with the Supreme Court of Pennsylvania. If the
February 21, 2002 Order is not overturned by the Pennsylvania Supreme Court,
there would be no adverse effect to FirstEnergy's, Met-Ed's or Penelec's net
income since the contingency existed prior to the merger.
5 - NEW 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 all business combinations initiated after June
30, 2001, to 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 the GPU merger, which was accounted for as a
purchase transaction, and have not materially affected the accounting for this
transaction. Under SFAS 142, amortization of existing goodwill ceased January 1,
2002. Instead, goodwill will be tested for impairment at least on an annual
basis -- based on the results of the transition analysis, no impairment of
goodwill is required. Prior to the adoption of SFAS 142, FirstEnergy amortized
about $57 million ($.25 per share of common stock) of goodwill annually. There
was no goodwill amortization in 2001 associated with the GPU merger under the
provisions of the new standard. FirstEnergy's net income in the second quarter
of 2001 and the first half of 2001 of $146 million and $244 million,
respectively, would have been $160 million and $271 million, respectively,
excluding goodwill amortization.
In June 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. FirstEnergy has identified various applicable legal obligations as
defined under the new standard and expects to complete an analysis of their
financial impact in the second half of 2002.
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. FirstEnergy's adoption of this Statement, effective
January 1, 2002, will result in its 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.
7
6 - SEGMENT INFORMATION:
FirstEnergy operates under the following reportable segments:
regulated services, competitive services and other (primarily corporate support
services and international operations). FirstEnergy's primary segment is
regulated services, which include eight electric utility operating companies in
Ohio, Pennsylvania and New Jersey that provide electric transmission and
distribution services. Its other material business segment consists of the
subsidiaries that operate unregulated energy and energy-related businesses.
Certain prior year amounts have been reclassified to conform with the current
year presentation.
The regulated services segment designs, constructs, operates and
maintains FirstEnergy's regulated transmission and distribution systems. It also
provides generation services to regulated franchise customers who have not
chosen an alternative, competitive generation supplier. The regulated services
segment obtains a portion of its required generation through power supply
agreements with the competitive services segment.
8
Segment Financial Information
-----------------------------
Regulated Competitive Reconciling
Services Services Other Adjustments Consolidated
--------- ----------- ----- ----------- ------------
(In millions)
Three Months Ended:
- -------------------
June 30, 2002
-------------
External revenues..................... $ 2,161 $ 696 $ 86 $ 6 (a) $ 2,949
Internal revenues..................... 177 417 125 (719) (b) --
Total revenues..................... 2,338 1,113 211 (713) 2,949
Depreciation and amortization......... 233 6 12 -- 251
Net interest charges.................. 156 7 102 (15) (b) 250
Income taxes.......................... 213 5 (33) -- 185
Income before cumulative effect of a
change in accounting............... 273 7 (47) -- 233
Net income (loss)..................... 273 7 (47) -- 233
Total assets.......................... 30,261 2,010 2,009 -- 34,280
Property additions.................... 120 72 32 -- 224
June 30, 2001
-------------
External revenues..................... $ 1,260 $ 499 $ 1 $ 44 (a) $ 1,804
Internal revenues..................... 223 448 64 (735) (b) --
Total revenues..................... 1,483 947 65 (691) 1,804
Depreciation and amortization......... 196 4 7 -- 207
Net interest charges.................. 107 13 8 (7) (b) 121
Income taxes.......................... 158 (41) 3 -- 120
Income before cumulative effect of
a change in accounting............. 159 (17) 4 -- 146
Net income (loss)..................... 159 (17) 4 -- 146
Total assets.......................... 15,494 2,154 490 -- 18,138
Property additions.................... 36 84 5 -- 125
Six Months Ended:
- ----------------
June 30, 2002
-------------
External revenues..................... $ 4,156 $1,374 $ 209 $ 12 (a) $ 5,751
Internal revenues..................... 532 827 242 (1,601) (b) --
Total revenues..................... 4,688 2,201 451 (1,589) 5,751
Depreciation and amortization......... 477 13 24 -- 514
Net interest charges.................. 317 17 205 (29) (b) 510
Income taxes.......................... 375 (37) (73) -- 265
Income before cumulative effect of a
change in accounting............... 471 (53) (100) -- 318
Net income (loss)..................... 471 (53) (68) -- 350
Total assets.......................... 30,261 2,010 2,009 -- 34,280
Property additions.................... 264 110 46 -- 420
June 30, 2001
-------------
External revenues..................... $ 2,569 $1,132 $ 2 $ 87 (a) $ 3,790
Internal revenues..................... 557 948 129 (1,634) (b) --
Total revenues..................... 3,126 2,080 131 (1,547) 3,790
Depreciation and amortization......... 411 8 15 -- 434
Net interest charges.................. 252 9 16 (30) (b) 247
Income taxes.......................... 225 (28) 7 -- 204
Income before cumulative effect of
a change in accounting............. 282 (41) 11 -- 252
Net income (loss)..................... 282 (49) 11 -- 244
Total assets.......................... 15,494 2,154 490 -- 18,138
Property additions.................... 89 178 9 -- 276
<FN>
Reconciling adjustments to segment operating results from internal management
reporting to consolidated external financial reporting:
(a) Principally fuel marketing revenues which are reflected as reductions to expenses for internal management reporting purposes.
(b) Elimination of intersegment transactions.
</FN>
9
FIRSTENERGY CORP.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(In thousands, except per share amounts)
REVENUES:
Electric utilities..................................... $2,210,316 $1,260,511 $4,264,292 $2,571,800
Unregulated businesses................................. 738,392 543,635 1,486,573 1,218,087
---------- ---------- ---------- ----------
Total revenues..................................... 2,948,708 1,804,146 5,750,865 3,789,887
---------- ---------- ---------- ----------
EXPENSES:
Fuel and purchased power............................... 802,623 300,528 1,527,642 625,107
Purchased gas.......................................... 145,954 173,557 352,181 526,374
Other operating expenses............................... 936,156 643,846 1,946,807 1,289,249
Provision for depreciation and amortization............ 250,705 206,606 513,533 433,820
General taxes.......................................... 145,106 92,186 317,094 211,608
---------- ---------- ---------- ----------
Total expenses..................................... 2,280,544 1,416,723 4,657,257 3,086,158
---------- ---------- ---------- ----------
INCOME BEFORE INTEREST AND INCOME TAXES................... 668,164 387,423 1,093,608 703,729
---------- ---------- ---------- ----------
NET INTEREST CHARGES:
Interest expense....................................... 231,782 116,342 473,347 234,561
Capitalized interest................................... (6,605) (12,296) (12,419) (21,119)
Subsidiaries' preferred stock dividends................ 25,105 16,919 49,176 33,853
---------- ---------- ---------- ----------
Net interest charges............................... 250,282 120,965 510,104 247,295
---------- ---------- ---------- ----------
INCOME TAXES.............................................. 184,572 120,439 265,401 204,208
---------- ---------- ---------- ----------
INCOME BEFORE CUMULATIVE EFFECT OF A CHANGE
IN ACCOUNTING.......................................... 233,310 146,019 318,103 252,226
Cumulative effect of accounting change (net of income
taxes(benefit) of $13,600,000 and $(5,839,000),
respectively)(Notes 1 and 3)... ....................... -- -- 31,700 (8,499)
---------- ---------- ---------- ----------
NET INCOME................................................ $ 233,310 $ 146,019 $ 349,803 $ 243,727
========== ========== ========== ==========
BASIC EARNINGS PER SHARE OF COMMON STOCK:
Income before cumulative effect of accounting change... $ .80 $ .67 $1.08 $1.16
Cumulative effect of accounting change (net of
income taxes)(Notes 1 and 3)........................... -- -- .11 (.04)
------ ------ ----- -----
Net income............................................ $ .80 $ .67 $1.19 $1.12
====== ====== ===== =====
WEIGHTED AVERAGE NUMBER OF BASIC SHARES
OUTSTANDING............................................ 293,080 218,372 292,935 218,239
======= ======= ======= =======
DILUTED EARNINGS PER SHARE OF COMMON STOCK:
Income before cumulative effect of accounting change... $ .79 $ .67 $1.08 $1.15
Cumulative effect of accounting change (net of income
taxes)(Notes 1 and 3).................................. -- -- .11 (.04)
------ ------ ----- -----
Net income............................................ $ .79 $ .67 $1.19 $1.11
====== ====== ===== =====
WEIGHTED AVERAGE NUMBER OF DILUTED SHARES
OUTSTANDING............................................ 294,589 219,540 294,472 219,235
======= ======= ======= =======
DIVIDENDS DECLARED PER SHARE OF COMMON STOCK.............. $.375 $.375 $ .75 $ .75
===== ===== ====== ======
<FN>
The preceding Notes to Financial Statements as they relate to FirstEnergy Corp. are an integral part of these
statements.
</FN>
10
FIRSTENERGY CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
----------- ------------
(In thousands)
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 359,050 $ 220,178
Receivables-
Customers (less accumulated provisions of $63,387,000 and $65,358,000,
respectively, for uncollectible accounts)............................. 1,069,580 1,074,664
Other (less accumulated provisions of $7,490,000 and $7,947,000,
respectively, for uncollectible accounts)............................. 562,201 473,550
Materials and supplies, at average cost-
Owned................................................................... 243,785 256,516
Under consignment....................................................... 157,312 141,002
Other..................................................................... 355,996 336,610
----------- -----------
2,747,924 2,502,520
----------- -----------
ASSETS PENDING SALE (Note 3)................................................. 299,502 3,418,225
----------- -----------
PROPERTY, PLANT AND EQUIPMENT:
In service................................................................ 20,330,032 19,981,749
Less--Accumulated provision for depreciation.............................. 8,428,662 8,161,022
----------- -----------
11,901,370 11,820,727
Construction work in progress............................................. 582,559 607,702
----------- -----------
12,483,929 12,428,429
----------- -----------
INVESTMENTS:
Capital trust investments................................................. 1,109,606 1,166,714
Nuclear plant decommissioning trusts...................................... 1,063,306 1,014,234
Letter of credit collateralization........................................ 277,763 277,763
Pension investments....................................................... 288,609 273,542
Other..................................................................... 964,699 898,311
----------- -----------
3,703,983 3,630,564
----------- -----------
DEFERRED CHARGES:
Regulatory assets......................................................... 8,593,052 8,912,584
Goodwill.................................................................. 5,604,967 5,600,918
Other..................................................................... 846,231 858,273
----------- -----------
15,044,250 15,371,775
----------- -----------
$34,279,588 $37,351,513
=========== ===========
11
FIRSTENERGY CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
------------ ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock...................... $ 2,320,010 $ 1,867,657
Short-term borrowings..................................................... 644,849 614,298
Accounts payable.......................................................... 741,958 704,184
Accrued taxes............................................................. 505,275 418,555
Other..................................................................... 989,722 1,064,763
----------- -----------
5,201,814 4,669,457
----------- -----------
LIABILITIES RELATED TO ASSETS PENDING SALE (Note 3).......................... 135,531 2,954,753
----------- -----------
CAPITALIZATION:
Common stockholders' equity-
Common stock, $.10 par value, authorized 375,000,000 shares -
297,636,276 shares outstanding........................................ 29,764 29,764
Other paid-in capital................................................... 6,106,334 6,113,260
Accumulated other comprehensive loss.................................... (134,035) (169,003)
Retained earnings....................................................... 1,652,006 1,521,805
Unallocated employee stock ownership plan common stock -
4,461,795 and 5,117,375 shares, respectively.......................... (88,615) (97,227)
----------- -----------
Total common stockholders' equity................................... 7,565,454 7,398,599
Preferred stock of consolidated subsidiaries-
Not subject to mandatory redemption..................................... 335,123 480,194
Subject to mandatory redemption......................................... 20,379 65,406
Subsidiary-obligated mandatorily redeemable preferred securities.......... 409,658 529,450
Long-term debt............................................................ 11,076,972 11,433,313
----------- -----------
19,407,586 19,906,962
----------- -----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 2,757,711 2,684,219
Accumulated deferred investment tax credits............................... 247,990 260,532
Nuclear plant decommissioning costs....................................... 1,252,100 1,201,599
Power purchase contract loss liability.................................... 3,207,954 3,566,531
Other postretirement benefits............................................. 870,703 838,943
Other..................................................................... 1,198,199 1,268,517
----------- -----------
9,534,657 9,820,341
----------- -----------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)...........................
----------- -----------
$34,279,588 $37,351,513
=========== ===========
<FN>
The preceding Notes to Financial Statements as they relate to FirstEnergy Corp.
are an integral part of these balance sheets.
</FN>
12
FIRSTENERGY CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 233,310 $ 146,019 $ 349,803 $ 243,727
Adjustments to reconcile net income to net cash from
operating activities-
Provision for depreciation and amortization........ 250,705 206,606 513,533 433,820
Nuclear fuel and lease amortization................ 19,598 24,226 40,563 48,201
Other amortization, net............................ (4,386) (4,039) (7,923) (7,672)
Deferred costs recoverable as regulatory assets.... (68,936) -- (139,070) --
Deferred income taxes, net......................... 50,355 (19,373) 43,421 (35,308)
Investment tax credits, net........................ (6,967) (4,988) (13,713) (9,986)
Cumulative effect of accounting change............. -- -- (45,300) 14,338
Receivables........................................ (150,157) (5,609) (83,567) 23,585
Materials and supplies............................. (21,742) (37,219) (3,579) (44,262)
Accounts payable................................... 47,766 (38,019) 37,774 (107,679)
Other.............................................. (87,423) (99,111) 34,265 (168,168)
--------- --------- --------- ---------
Net cash provided from operating activities...... 262,123 168,493 726,207 390,596
--------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Long-term debt....................................... 261,699 254,877 366,730 255,499
Short-term borrowings, net........................... -- 16,367 30,551 58,481
Redemptions and Repayments-
Common stock......................................... -- -- -- 15,308
Preferred stock...................................... 5,000 10,716 190,299 10,716
Long-term debt....................................... 194,738 74,345 378,643 95,561
Short-term borrowings, net........................... 85,005 -- -- --
Common stock dividend payments......................... 109,876 81,864 219,602 163,617
--------- --------- --------- ---------
Net cash used for (provided from) financing
activities ..................................... 132,920 (104,319) 391,263 (28,778)
--------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions..................................... 224,399 125,322 419,691 276,498
Proceeds from sale of Midlands......................... (155,034) -- (155,034) --
Avon cash and cash equivalents(Note 3)................. 380,496 -- (31,326) --
Net assets held for sale............................... (63,624) -- (2,059) --
Cash investments....................................... (68,365) (3,463) (64,022) (32,601)
Other.................................................. 99,998 (11,770) 28,822 19,516
--------- --------- --------- ---------
Net cash used for investing activities........... 417,870 110,089 196,072 263,413
--------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents...... (288,667) 162,723 138,872 155,961
Cash and cash equivalents at beginning of period*......... 647,717 42,496 220,178 49,258
--------- --------- --------- ---------
Cash and cash equivalents at end of period*............... $ 359,050 $ 205,219 $ 359,050 $ 205,219
========= ========= ========= =========
<FN>
* Excludes amounts in "Assets Pending Sale" on the Consolidated Balance Sheets.
The preceding Notes to Financial Statements as they relate to FirstEnergy Corp. are an integral part of these
statements.
</FN>
13
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of FirstEnergy Corp.:
We have reviewed the accompanying consolidated balance sheet of FirstEnergy
Corp. and its subsidiaries as of June 30, 2002, and the related consolidated
statements of income and cash flows for each of the three-month and six-month
periods ended June 30, 2002. These financial statements are the responsibility
of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
14
FIRSTENERGY CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FirstEnergy Corp. is a registered public utility holding company. Its
subsidiaries and affiliates provide regulated and competitive electricity and
other energy and energy-related services (see Results of Operations - Business
Segments).
FirstEnergy - which acquired the former GPU, Inc., in November of 2001
- - provides domestic regulated electric distribution services through its seven
wholly owned electric utility subsidiaries. Ohio Edison Company (OE), The
Cleveland Electric Illuminating Company (CEI), Pennsylvania Power Company (Penn)
and The Toledo Edison Company (TE) provide regulated electric distribution
services to customers in Ohio and Pennsylvania, and American Transmission
Systems, Inc. provides transmission services. Metropolitan Edison Company
(Met-Ed), Pennsylvania Electric Company (Penelec), and Jersey Central Power &
Light Company (JCP&L) - which were acquired through the GPU merger - provide
regulated electric distribution and transmission services to customers in
Pennsylvania and New Jersey.
Other FirstEnergy subsidiaries and affiliates sell energy and
energy-related products and services, including electricity, natural gas and
energy management services, in competitive markets. These products and services
are often bundled under master contracts. Among FirstEnergy subsidiaries and
affiliates supplying services in competitive markets are FirstEnergy Solutions
(FES), MARBEL Energy Corporation, FirstEnergy Facilities Services Group, LLC,
and MYR Group, Inc. FirstEnergy also offers electric distribution services
through international operations that were acquired in the GPU merger, including
GPU Capital, Inc., and GPU Power, Inc. GPU Capital, Inc. and its subsidiaries
provide electric distribution services and GPU Power, Inc., and its subsidiaries
develop, own and operate electric generation facilities.
Results of Operations
- ---------------------
Net income in the second quarter of 2002 was $233.3 million, or basic
earnings of $0.80 per share of common stock ($0.79 diluted), compared to $146.0
million, or $0.67 per share of common stock (basic and diluted) in the second
quarter of 2001. During the first six months of 2002, net income was $349.8
million, or $1.19 per share of common stock (basic and diluted), compared to net
income of $243.7 million, or basic earnings of $1.12 per share of common stock
($1.11 diluted) in the first six months of 2001. Results in the first half of
2002 and 2001 include the cumulative effect of accounting changes (described
below). Before the cumulative effect of accounting changes, net income was
$318.1 million in the first six months of 2002, compared to $252.2 million for
the same period of 2001. Basic and diluted earnings per share of common stock
before the cumulative effect of accounting changes were $1.08 in the first half
of 2002, compared to $1.16 ($1.15 diluted) in the first six months of 2001.
Results for the second quarter and first half of 2002 reflect the
merger of FirstEnergy and GPU, which became effective on November 7, 2001, and
therefore include the results of the former GPU companies. As a result of the
merger, FirstEnergy issued nearly 73.7 million shares of its common stock, which
are reflected in the calculation of earnings per share of common stock in the
second quarter and year-to-date periods of 2002. Costs related to the extended
outage at the Davis-Besse nuclear plant (see Supply Plan) reduced earnings by
$0.09 per share in the second quarter and year-to-date periods of 2002. Several
one-time charges resulted in a comparative net reduction to earnings of $0.14
per share of common stock. The cessation of goodwill amortization beginning
January 1, 2002, upon implementation of Statement of Financial Accounting
Standard No. (SFAS) 142, "Goodwill and Other Intangible Assets," added $0.05 per
share of common stock (basic and diluted), in the second quarter of 2002,
compared to the same period last year and $0.09 per share of common stock (basic
and diluted) in the first half of 2002, compared to the corresponding period of
2001.
Revenues
Total revenues increased $1.1 billion in the second quarter and $2.0
billion in the first six months of 2002, compared to the same periods in 2001.
Excluding results of the former GPU companies, total revenues decreased by $12.2
million or 0.7% in the second quarter and $344.6 million or 9.1% in the first
half of 2002, compared to the corresponding periods of 2001. Sources of changes
in pre-merger and post-merger revenues during the second quarter and first six
months of 2002, compared with the corresponding periods of 2001, are summarized
in the following table:
15
Sources of Revenue Changes
--------------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
----------- -----------
(In millions)
Pre-Merger Companies:
Electric Utilities (Regulated Services):
Retail electric sales........................ $ (16.3) $ (217.5)
Other revenues............................... (20.2) (17.7)
-------- --------
Total Electric Utilities....................... (36.5) (235.2)
-------- --------
Unregulated Businesses (Competitive Services):
Retail electric sales........................ 8.2 (0.8)
Wholesale electric sales..................... 62.9 124.3
Gas sales.................................... (14.9) (141.6)
Other businesses............................. (31.9) (91.3)
-------- --------
Total Unregulated Businesses................... 24.3 (109.4)
-------- --------
Total Pre-Merger Companies..................... (12.2) (344.6)
-------- --------
Former GPU Companies:
Electric utilities........................... 986.3 1,927.8
Unregulated businesses....................... 230.8 487.2
-------- --------
Total Former GPU Companies..................... 1,217.1 2,415.0
Intercompany Revenues.......................... (60.3) (109.4)
-------- --------
Net Revenue Increase........................... $1,144.6 $1,961.0
======== ========
Electric Sales
Shopping by Ohio customers for alternative energy suppliers combined
with a weak but recovering economy reduced retail electric sales revenues for
FirstEnergy's pre-merger electric utility operating companies (EUOCs) by $16.3
million in the second quarter and $217.5 million in the first six months of
2002, compared to the same periods of 2001. Kilowatt-hour sales to regulated
retail customers decreased 10.1% in the second quarter and 18.4% in the first
half of 2002, which reduced retail electric sales revenues by $24.5 million and
$127.0 million, respectively. Sales of electric generation by alternative
suppliers in the EUOCs' franchise areas increased to 21.1% of total energy
delivered in the second quarter of 2002, compared to 11.8% in the same quarter
last year. In the first six months of 2002, the EUOCs' share of franchise-area
sales declined by 13.4 percentage points, compared to the same period of 2001.
Although generation kilowatt-hour sales continued to be adversely affected by
economic conditions in the regional industrial base, the second quarter impact
was moderated by a gradual recovery, as well as warmer weather in June, compared
to the second quarter of 2001.
Revenue from distribution deliveries increased by $28.4 million, more
than offsetting the lower generation sales revenues in the second quarter of
2002, compared to the same quarter of 2001, due to an overall 0.6% net increase
in kilowatt-hour deliveries to franchise customers. The net increase resulted
from additional kilowatt-hour deliveries to residential customers (9.4% higher)
that were substantially offset by a 2.4% decrease in deliveries to commercial
and industrial customers. Unusually warm weather in June 2002 increased the
air-conditioning demand of residential customers, compared to last year. During
the first six months of 2002, a 4.6% decline in kilowatt-hour deliveries to
franchise customers reduced retail electric sales revenues by $42.1 million,
compared to the same period in 2001. The reduced distribution deliveries
resulted from a 6.9% reduction in deliveries to the commercial and industrial
sectors, which were offset in part by a 1.2% increase in kilowatt-hour
deliveries to residential customers. While some evidence of a modest economic
recovery began in the first half of 2002, the tentative recovery has not been
broad based and reduced sales to the steel sector continue to depress
FirstEnergy's industrial sector.
The remaining decrease in regulated retail electric sales revenues
resulted from additional transition plan incentives provided to customers to
promote customer shopping for alternative suppliers - $20.5 million in the
second quarter and $48.4 million in the first half of 2002, compared to the same
periods of 2001. These reductions to revenue are deferred for future recovery
under FirstEnergy's Ohio transition plan and do not materially affect current
period earnings.
Retail electric sales revenue of the competitive services segment
increased $8.2 million in the second quarter resulting from a 14.9% increase in
kilowatt-hour sales from the same quarter last year. Despite a 6.7% increase in
kilowatt-hour sales in the first six months of 2002, a change in sales mix
resulted in revenues that were nearly unchanged, compared to the corresponding
period of 2001. The increase in FirstEnergy's competitive kilowatt-hour sales in
2002
16
occurred primarily in Ohio. As of June 30, 2002, approximately one-third of
FirstEnergy's Ohio franchise-area customers serviced by alternative suppliers
were supplied by FES.
Wholesale revenues increased $65.7 million in the second quarter and
$140.1 million in the year-to-date period of 2002, compared to the corresponding
periods last year. Kilowatt-hour sales to the wholesale markets were
correspondingly higher, increasing by 67% in the second quarter and by 83% in
the first six months of 2002, compared to the same periods last year. The higher
kilowatt-hour sales resulted from the increased availability of power for the
wholesale market, due to additional internal generation and reduced
kilowatt-hour demand from retail customers, which allowed FirstEnergy to take
advantage of wholesale market opportunities. Nonaffiliated retail energy
suppliers having access to 1,120 megawatts of FirstEnergy's generation capacity
made available under its transition plan also contributed to the increase in
sales to the wholesale market. Overall, electric sales revenues in the second
quarter of 2002 showed an increase of $57.3 million, compared to the same period
last year, due to a firming economy, warmer weather in June and increased sales
to the wholesale market. The first half of 2002 reflected a decrease of $78.5
million, compared to the first six months of last year, principally due to the
weak economic environment and customer choice in Ohio including transition
incentives.
Other Sales
Other sales revenues declined by $47.0 million in the second quarter
and $233.0 million in the first six months of 2002 from the corresponding
periods of 2001. The elimination of coal trading activities in the second half
of 2001 and reduced natural gas revenues were the primary factors contributing
to the lower revenues. Reduced gas revenues resulted from lower prices, which
were offset in part by higher sales volumes. Despite lower gas prices, gross
margins for gas sales improved in 2002 (see Expenses). Reduced revenues from the
facilities services group also contributed to the decrease in other sales
revenue in the second quarter and year-to-date periods of 2002, compared to the
same periods of 2001.
Expenses
Total expenses increased $863.8 million in the second quarter and
$1,571.1 million in the first six months of 2002 compared to the corresponding
periods of 2001, including $985.6 million and $1,965.3 million of incremental
expenses related to the former GPU companies, respectively. For the pre-merger
companies, total expenses decreased by $59.9 million in the second quarter and
$282.0 million in the first half of 2002, compared to the same periods of 2001.
Sources of changes in pre-merger and post-merger companies' expenses in the
second quarter and first six months of 2002, compared to the prior year, are
summarized in the following table:
Sources of Expense Changes
--------------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
---------- -----------
(In millions)
Pre-Merger Companies:
Fuel and purchased power.............. $ 35.0 $ (16.2)
Purchased gas......................... (27.6) (174.1)
Other operating expenses.............. (43.6) (10.0)
Depreciation and amortization......... (43.1) (104.7)
General taxes......................... 19.4 23.0
------ --------
Total Pre-Merger Companies............ (59.9) (282.0)
Former GPU Companies.................... 985.6 1,965.3
Intercompany Expenses................... (61.9) (112.2)
------ --------
Net Expense Increase.................... $863.8 $1,571.1
====== ========
The following comparisons reflect variances for the pre-merger
companies only, excluding the incremental expenses for the former GPU companies
in the second quarter and first half of 2002.
Fuel and purchased power costs increased $35.0 million in the second
quarter but declined by $16.2 million during the first six months of 2002,
compared to the same periods of 2001. Fuel expense increased in both the second
quarter and first six months of 2002 ($34.5 million and $60.1 million,
respectively) principally due to additional internal generation and an increased
mix of higher-cost fossil generation, as well as higher unit costs for coal
consumed in 2002. An extended outage at the Davis-Besse nuclear plant (see
Supply Plan) contributed to declines in nuclear production of 16.6% and 9.8% in
the second quarter and year-to-date periods of 2002 from the same periods in
2001. Fossil plant production increased 27.3% and 21.7% in the second quarter
and first six months of 2002, compared to the same periods of 2001. Overall,
internal generation was approximately 8% higher in both the second quarter and
first six months of 2002 than the corresponding periods of 2001. Purchased power
costs were nearly unchanged in the second quarter and $76.3 million
17
lower in the first six months of 2002, compared to the same periods last year.
Both periods benefited from lower unit costs for purchased power; however,
increased volume requirements resulting in part from the Davis-Besse unplanned
extended outage substantially offset the effect of lower costs in the second
quarter of 2002.
Declining gas prices resulted in reductions to purchased gas costs of
$27.6 million in the second quarter and $174.1 million for the first six months
of 2002, compared to the same periods of 2001 - despite an increase in gas
volumes purchased. The gross margins on gas sales improved by $12.6 million in
the second quarter and $32.5 million in the first six months of 2002 from the
same periods last year.
Other operating costs decreased by $43.6 million in the second quarter
of 2002, compared to the same period of 2001. Higher expenses associated with
the extended outage at the Davis-Besse nuclear plant (see Supply Plan) were more
than offset by lower costs for the fossil plants. The elimination of coal
trading activities in the second half of 2001 was the largest factor ($44.5
million) reducing other operating costs in the second quarter of 2002, compared
to the second quarter of 2001. The decrease in other operating costs for the
six-month period reflects several factors: elimination of coal trading ($88.1
million), reduced facilities service business ($24.0 million), and lower outage
related fossil plant expenditures ($35.6 million). Those reductions were offset
in part by additional costs related to nuclear refueling and unplanned outages
($54.7 million) and several one-time factors ($78.2 million) in 2002, including:
o A $30.4 million equity investment write-off related to a bankruptcy
o An $18.1 million mark-to-market adjustment of a long-term purchased
power contract resulting from the update of a model-based long-term
electricity price forecast.
o A charge of $17.1 million related to a generation project opportunity
that FirstEnergy decided not to pursue
o Impairment of certain telecommunication investments totaling $10.1
million ($12.6 million including former GPU investments)
Charges for depreciation and amortization decreased $43.1 million in
the second quarter and $104.7 million in the first six months of 2002 from the
corresponding periods last year. These decreases resulted from several factors
including: shopping incentive deferrals and tax-related deferrals under the Ohio
transition plan, the elimination of depreciation associated with the planned
sale of four power plants and the cessation of goodwill amortization beginning
January 1, 2002. FirstEnergy's goodwill amortization in the second quarter and
year-to-date periods of 2001 totaled $14.0 million and $28.0 million,
respectively.
General taxes increased $19.4 million in the second quarter and $23.0
million in the first six months of 2002 from the same periods in 2001. These
increases were due in large part to the successful resolution of certain
property tax issues in the second quarter of 2001 resulting in a one-time
benefit of $15 million in that quarter. Additional property taxes partially
offset by reductions related to the Ohio restructuring accounted for the
remaining net increase in the second quarter and first six months of 2002,
compared to the same periods last year.
Net Interest Charges
Net interest charges increased $129.3 million in the second quarter
and $262.8 million in the first half of 2002, compared to the same periods of
2001. These increases included interest of $68.0 million in the second quarter
and $141.9 million in the first six months of 2002 on $4 billion of long-term
debt issued by FirstEnergy in connection with the merger. Excluding the results
of the former GPU companies and the merger-related financing, net interest
charges decreased by $8.0 million in the second quarter and $9.8 million in the
first six months of 2002 from the corresponding periods in 2001. Redemption and
refinancing activities completed in the first six months of 2002 totaled $446.1
million and are expected to result in annualized savings of $32.1 million
(interest rate swap effect not included - see Market Risk Information, New
Interest Rate Swap Agreements).
Cumulative Effect of Accounting Changes
Year-to-date earnings in 2002 and 2001 were affected by accounting
changes. In connection with the November 2001 merger, certain former GPU
international operations were identified as "assets pending sale." Subsequent to
the merger date, results of operations and incremental interest costs related to
these international subsidiaries were not included in FirstEnergy's Consolidated
Statement of Income. On February 6, 2002, discussions began with Aquila, Inc. on
modifying its initial offer for the acquisition of Avon Energy Partners
Holdings, which resulted in a change in accounting for this investment,
increasing year-to-date net income in 2002 by $31.7 million. In the first
quarter of 2001, FirstEnergy adopted SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities," resulting in an $8.5 million after-tax
charge.
18
Results of Operations - Business Segments
- -----------------------------------------
FirstEnergy manages its business as two separate major business
segments - regulated services and competitive services. The regulated services
segment designs, constructs, operates and maintains FirstEnergy's regulated
domestic transmission and distribution systems. It also provides generation
services to regulated franchise customers who have not chosen an alternative
generation supplier. The regulated services segment obtains a portion of its
required generation through power supply agreements with the competitive
services segment. The competitive services segment includes all domestic
unregulated energy and energy-related services including commodity sales (both
electricity and natural gas) in the retail and wholesale markets, marketing,
generation, trading and sourcing of commodity requirements, as well as other
competitive energy application services. Competitive products are increasingly
marketed to customers as bundled services, often under master contracts.
Financial results discussed below include intersegment revenue. A reconciliation
of segment financial results to consolidated financial results is provided in
Note 6 to the consolidated financial statements.
Regulated Services
Net income increased to $272.9 million in the second quarter of 2002
and $470.8 million in the first half of 2002, compared to $159.2 million and
$281.8 million in the corresponding periods of 2001. Excluding results of the
former GPU companies, net income increased by $25.9 million to $185.2 million in
the second quarter and by $28.7 million to $310.5 million in the first six
months of 2002. The factors contributing to the increase in pre-merger net
income are summarized in the following table:
Regulated Services
------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
-------- --------
(In millions)
Revenues.................................... $(52.0) $(260.2)
Expenses.................................... (77.5) (271.5)
------ -------
Income Before Interest and Income Taxes..... 25.5 11.3
Net interest charges........................ (21.4) (51.2)
Income taxes................................ 21.0 33.8
------ -------
Net Income Increase......................... $ 25.9 $ 28.7
====== =======
Lower generation sales and additional transition plan incentive
credits combined to reduce revenues in the second quarter of 2002 from the same
period in 2001. In the first six months of 2002, retail generation sales and
distribution throughput were both down, reflecting the combined influences of
tepid economic conditions and shopping by Ohio customers for alternative energy
suppliers. Sales to FES were also lower, due to less available generation for
sale because of the unplanned outage at Davis-Besse.
Expenses were lower in the second quarter and first half of 2002 than
the corresponding periods of 2001, primarily due to lower purchased power,
depreciation and amortization, and other operating expenses. Lower generation
sales reduced the need to purchase power from FES, which contributed to a $31.5
million expense decrease in the second quarter and a $121.4 million decrease in
the first six months of 2002, compared to the same periods last year.
Depreciation and amortization declined by $48.2 million in the second quarter
and $114.0 million in the first half of 2002, compared to the corresponding
periods of 2001, due to new deferred regulatory assets under the Ohio transition
plan, the elimination of depreciation associated with the planned sale of four
power plants and the cessation of goodwill amortization beginning January 1,
2002. Other operating expenses also decreased $13.7 million in the second
quarter and $48.7 million in the first six months of 2002, compared to the same
periods last year. Reduced expenses from jobbing and contracting work lowered
other operating expenses by approximately $16.6 million in the second quarter
and first half of 2002, compared to the same periods of 2001. Net interest
charges in the second quarter and year-to-date periods of 2002 decreased by
$21.4 million and $51.2 million, respectively, from the corresponding periods of
2001, reflecting the impact of net debt and preferred stock redemptions and
refinancings.
Competitive Services
Net income was $6.4 million in the second quarter of 2002, compared to
a net loss of $17.0 million in the same period of 2001. For the first six months
of 2002 the net loss increased to $53.3 million ($14.4 million excluding
one-time items) from $48.8 million in the first half of last year. Excluding
results of the former GPU companies, net income was $5.7 million in the second
quarter, and the net loss was $55.2 million in the first six months of 2002. The
factors contributing to the changes in pre-merger earnings are summarized in the
following table:
19
Competitive Services
--------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
-------- --------
(In millions)
Revenues..................................... $ 20.4 $(164.5)
Expenses..................................... (20.4) (147.6)
------ -------
Income Before Interest and Income Taxes...... 40.8 (16.9)
Net interest charges......................... 2.4 8.3
Income taxes................................. 15.7 (10.3)
Cumulative effect of a change in accounting.. -- 8.5
------ -------
Net Income Increase (Decrease)............... $ 22.7 $ (6.4)
====== =======
The increased availability of power for the electric wholesale market,
due to additional internal generation and reduced kilowatt-hour sales to
affiliates, allowed FES to take advantage of additional wholesale market
opportunities in 2002 -- increasing sales by $62.9 million in the second quarter
and $124.3 million in the first six months of 2002, compared to the prior year.
FES retail electric sales revenue contributed $8.2 million to the increase in
the second quarter of 2002 and was nearly unchanged over the first half of 2002.
As a result, electricity sales to non-affiliates increased $71.1 million in the
second quarter and $123.4 million in the first half of 2002 from the same
periods last year. In the second quarter, this increase was partially offset by
reduced sales to regulated affiliates reflecting the impact of shopping by Ohio
customers for alternative power providers, reduced natural gas revenues
resulting from lower prices and less revenue from the facilities services group,
resulting in a net $20.4 million increase. In the year-to-date period,
additional electricity sales to non-affiliates were more than offset by lower
sales to regulated affiliates, reduced gas revenues and lower revenues from the
facilities services group.
Expenses decreased by $20.4 million in the second quarter and $147.6
million in the first six months of 2002, compared to the same periods of 2001.
The decrease in second quarter expenses was primarily attributable to lower
purchased gas costs reflecting reduced unit costs, lower operating costs and
reduced expenses from the facilities service group due to reduced business
activity. Other operating costs and purchased power costs were lower despite
incremental expenses ($12.3 million other operating costs and $33.6 million of
replacement purchased power costs) related to the extended outage at Davis-Besse
(see Supply Plan). Partially offsetting these lower expenses was additional fuel
expense resulting from additional internal generation and an increased mix of
higher-cost fossil generation. Higher unit costs for coal consumed in 2002 also
added to the increase in fuel expense. Reduced expenses for the first six months
of 2002 primarily reflect lower purchased gas and purchased power costs,
partially offset by higher fuel costs and other operating expenses. Several
one-time charges (see Expenses) increased other operating expenses in the first
six months of 2002 by $65.6 million.
Capital Resources and Liquidity
- -------------------------------
FirstEnergy and its subsidiaries have continuing cash needs for
planned capital expenditures, maturing debt and preferred stock sinking fund
requirements. During the last half of 2002, capital requirements for property
additions and capital leases are expected to be about $585 million, including
$34 million for nuclear fuel. These capital requirements include $60 million of
additional repair costs for the unplanned extended outage at the Davis-Besse
nuclear plant (see Supply Plan). FirstEnergy has additional cash requirements of
approximately $615.4 million to meet sinking fund requirements for preferred
stock and maturing long-term debt during the remainder of 2002. FirstEnergy also
anticipates optional preferred stock redemptions during the last half
of 2002 totaling about $145.0 million. These cash requirements are expected to
be satisfied from internal cash and short-term credit arrangements. Mandatory
and optional redemptions and refinancings (excluding a fixed-to-floating rate
conversion - discussed below) over the remainder of the year are expected to
reduce interest and preferred dividends by approximately $62.7 million annually.
The sale of a 79.9% interest in Avon to Aquila on May 8, 2002, resulted in the
elimination from FirstEnergy's balance sheet of approximately $1.7 billion of
Avon's debt, which is non-recourse to FirstEnergy. In total, FirstEnergy expects
to reduce debt and preferred stock by about $760.4 million in the last two
quarters of 2002. JCP&L issued $320 million of transition bonds in June 2002,
which securitize recovery of certain stranded costs. Net proceeds from the
issuance will be used to redeem higher cost debt and preferred stock during the
second half of 2002.
During the second quarter of 2002, FirstEnergy entered into five
interest rate swap agreements designed to exchange fixed interest rate
obligations associated with existing long-term debt for variable interest rate
payments. The agreements effectively converted $668.5 million of FirstEnergy's
debt from fixed rate to floating rate. Two additional interest rate swaps were
completed in July 2002 for debt with a principal value of $325 million (see
Market Risk Information).
20
As of June 30, 2002, FirstEnergy and its subsidiaries had about $359.1
million of cash and temporary investments and $644.8 million of short-term
indebtedness. Available borrowings included $1.035 billion from unused revolving
lines of credit and $76 million from unused bank facilities. Excluding property
already released under the applicable mortgage indentures related to the planned
sale of four power plants, OE, CEI, TE and Penn had the capability to issue $2.0
billion of additional first mortgage bonds (FMB) on the basis of property
additions and retired bonds, as of June 30, 2002. JCP&L, Met-Ed and Penelec had
the capability to issue $816 million of additional senior notes based upon FMB
collateral, as of June 30, 2002. Based upon applicable charter earnings coverage
tests through June 30, 2002, OE, Penn, TE and JCP&L could issue $7.6 billion of
preferred stock (assuming no additional debt was issued). CEI, Met-Ed and
Penelec have no restrictions on the issuance of preferred stock.
On July 31, 2002, Fitch revised its rating outlook for FirstEnergy,
CEI and TE securities to negative from stable. The revised outlook reflects the
adverse impact of the unplanned outage at the Davis-Besse Plant and Fitch's
judgment at that time about NRG's financial ability to consummate the purchase
of four power plants from FirstEnergy and Fitch's expectation of subsequent
delay in debt reduction.
On August 1, 2002, the Standard & Poor's Utilities Ratings Team (S&P)
concluded that while NRG's liquidity position added uncertainty to its sale of
power plants to NRG, FirstEnergy's ratings would not be affected. S&P found
FirstEnergy cash flows sufficiently stable to support a continued (although
delayed) program of debt and preferred stock redemption. S&P noted that it would
continue to closely monitor FirstEnergy's progress on various initiatives.
Market Risk Information
- -----------------------
FirstEnergy uses various market sensitive instruments, including
derivative contracts, primarily to manage the risk of price, interest rate and
foreign currency fluctuations. FirstEnergy's Risk Policy Committee, comprised of
executive officers, exercises an independent risk oversight function to ensure
compliance with corporate risk management policies and prudent risk management
practices.
New Interest Rate Swap Agreements
- ---------------------------------
During the second quarter of 2002, FirstEnergy entered into five
interest rate swap agreements and two additional interest rate swap agreements
were subsequently completed in July 2002. The transactions collectively
increased the proportion of variable rate obligations in FirstEnergy's debt
portfolio from 14% at the beginning of 2002 to a level of approximately 22%
expected by year end, with the variable interest rate payments based on the six
month LIBOR rate plus a fixed spread. These derivatives are treated as fair
value hedges of fixed-rate, long-term debt issues - protecting against the risk
changes in the fair value of fixed-rate debt instruments due to lower interest
rates. Swap maturities, call options and interest payment dates match those of
the underlying obligations. The following summarizes the principal
characteristics of the new swap agreements.
Debt Hedged
-----------------
Fixed Principal June 30, 2002
Issuer Coupon Amount Swap Fair Value
------ ------ --------- -------------
($ millions)
Completed in June 2002
- ----------------------
JCP&L 6.750% $150.0 $ (1.5)
CEI 9.000% 150.0 (4.0)
OE 7.625% 75.0 (2.5)
OE 7.875% 93.5 (2.4)
FE 5.500% 200.0 (0.3)
------ ------
668.5 $(10.7)
======
Completed in July 2002
- ----------------------
JCP&L 7.500% 125.0
FE 5.500% 200.0
------
Total $993.5
======
The average fixed rate of the hedged debt above is 6.85%, compared to
an average variable rate of 3.16% to be paid by FirstEnergy under the swap
agreements. FirstEnergy accrues interest on the hedged debt at the lower,
variable rate. In the event FirstEnergy or its swap counterparties terminate the
transactions before the underlying debt issues mature, payments are made or
received equal to the fair value of the swaps at that time and are amortized
over the remaining life of the hedged debt.
21
Commodity Price Risk
FirstEnergy is exposed to market risk primarily due to fluctuations in
electricity, natural gas and coal prices. To manage the volatility relating to
these exposures, FirstEnergy uses a variety of non-derivative and derivative
instruments, including forward contracts, options, futures contracts and swaps.
The derivatives are used principally for hedging purposes and, to a much lesser
extent, for trading purposes. The change in the fair value of commodity
derivative contracts related to energy production during the second quarter of
2002 is summarized in the following table:
Change in the Fair Value of Commodity Derivative Contracts
----------------------------------------------------------
(In millions)
Outstanding net asset as of March 31, 2002................. $ 25.6
New contract value when entered............................ 0.1
Decrease in value of existing contracts.................... (22.9)
Change in techniques/assumptions........................... --
Settled contracts.......................................... (0.8)
------
Outstanding net asset as of June 30, 2002................ $ 2.0
======
* Does not include $1.1 million of derivative contract fair
value increase, as of June 30, 2002, representing
FirstEnergy's 50% share of Great Lakes Energy Partners, LLC
The valuation of derivative contracts is based on observable market
information to the extent that such information is available. In cases where
such information is not available, FirstEnergy relies on model-based
information. The model provides estimates of future regional prices for
electricity and an estimate of related price volatility. FirstEnergy utilizes
these results in developing estimates of fair value for financial reporting
purposes and for internal management decision making. Sources of information for
the valuation of derivative contracts by year are summarized in the following
table:
Source of Information - Fair Value by Contract Year
- ---------------------------------------------------
2002* 2003 2004 Thereafter Total
----- ---- ---- ---------- -----
(In millions)
Prices actively quoted......... $(15.5) $(0.6) $(9.0) $ -- $(25.1)
Prices based on models**....... -- -- -- 27.1 27.1
---------------------------------------------
Total...................... $(15.5) $(0.6) $(9.0) $27.1 $ 2.0
=============================================
* For the last half of 2002.
** Includes $22.2 million from an embedded option that is offset by a
regulatory liability and does not affect earnings.
FirstEnergy performs sensitivity analyses to estimate its exposure to
the market risk of its commodity positions. A hypothetical 10% adverse shift in
quoted market prices in the near term on both FirstEnergy's trading and
nontrading derivative instruments would not have had a material effect on its
consolidated financial position or cash flows as of June 30, 2002. FirstEnergy
estimates that if energy commodity prices experienced an adverse 10 percent
change, net income for the next twelve months would decrease by approximately
$5.4 million.
State Regulatory Matters
- ------------------------
Ohio
The transition cost portion of FirstEnergy's Ohio EUOC rates provides
for recovery of certain amounts not otherwise recoverable in a competitive
generation market (such as regulatory assets). Transition costs are paid by all
customers whether or not they choose an alternative supplier. Under the
PUCO-approved transition plan, FirstEnergy assumed the risk of not recovering up
to $500 million of transition costs if the rate of customers (excluding
contracts and full-service accounts) switching their service from OE, CEI and TE
does not reach 20% for any consecutive twelve-month period by December 31, 2005
- - the end of the market development period. As of June 30, 2002, the annualized
customer-switching rate had reduced FirstEnergy's risk of not recovering
transition costs to approximately $31 million. FirstEnergy began accepting
customer applications for switching to alternative suppliers on December 8,
2000; as of June 30, 2002 its Ohio EUOC had been notified that over 725,000 of
their customers requested generation services from other authorized suppliers,
including FES, a wholly owned subsidiary.
22
New Jersey
Under New Jersey transition legislation, all electric distribution
companies in that state are required to file rate cases by August 1, 2002. On
August 1, 2002, FirstEnergy submitted two rate filings for JCP&L with the New
Jersey Board of Public Utilities (NJBPU). The first related to base electric
rates (Delivery Charge Filing). The second was a request to recover deferred
costs (Deferral Filing) primarily associated with mandated purchase-power
contracts with non-utility generators (NUGs) - which produce power at prices
that exceed wholesale market prices - and providing Basic Generation Service
(BGS) to customers in excess of the state's generation rate cap. The new rate
structure, when approved, becomes effective on August 1, 2003.
Delivery Charge Filing -
The delivery charge filing includes recovery of JCP&L's distribution,
transmission, customer service, administrative and general costs, along with
taxes and some assessment fees. FirstEnergy is requesting a decrease in the
JCP&L delivery charge of $11 million, or a 0.6% rate reduction. The filing uses
calendar year 2002 as the test year and is based on a net rate base value of
$2.1 billion and allowed return on common equity of 12%. The December 31, 2001
capital structure used in the filing has been modified to eliminate purchase
accounting adjustments from the merger of FirstEnergy and GPU, Inc. and to
remove a pre-merger $300 million deferred balance write-off required by the
NJBPU merger approval order (See Deferral Filing). The modified capital
structure is comparable to JCP&L's pre-merger capital structure.
Deferral Filing -
The deferral filing addresses the current Market Transition Charge
(MTC) and the Societal Benefits Charge (SBC), which were confirmed by a 2001
rate order. The combined effect of JCP&L's MTC and SBC requests would result in
a 2.8% rate increase with securitization of a deferred balance; if
securitization is not available, there would be an additional 6.5% increase with
a four-year amortization of the deferred balance.
JCP&L was authorized to defer energy-related costs incurred in
providing BGS to non-shopping retail customers and costs incurred under NUG
agreements and purchased power agreements that exceeded the amounts collected
under the current BGS and MTC rates. Additionally, in 2001, JCP&L wrote off $300
million of deferred costs upon receipt of the NJBPU merger approval order, in
order to ensure that customers receive the benefit of future merger savings.
This amount is not included in the requested deferred cost recovery.
JCP&L's filing proposes to recover the MTC deferred balance through a
securitization transaction involving the issuance of transition bonds in a
principal amount equal to the projected July 31, 2003 MTC deferred balance of
$684 million. The transition bond-related rate increase would be approximately
$69 million per year, or a 3.5% increase. An alternative to securitization of
the deferred balance would be to recover the deferred balance over a four-year
amortization period with interest. This alternative approach would require an
MTC rate increase of $195 million or an increase of 10%. JCP&L's securitization
proposal minimizes the required customer rate increase.
Stranded cost securitization would create a transition bond charge
(TBC) which would be the revenue collection mechanism for the transition bond
principal and interest payments. In June 2002, JCP&L sold $320 million principal
amount of transition bonds to securitize its net investment in the Oyster Creek
nuclear generating facility. The TBC was offset by a corresponding reduction in
the MTC since the stranded Oyster Creek investment was initially being amortized
through the MTC. Securitization of the deferred energy-related cost balance
would require an increase in the TBC.
The 2001 rate order confirmed the establishment of the SBC to recover
costs which include nuclear plant decommissioning and manufactured gas plant
remediation. JCP&L's request would reduce the SBC by $14 million, or a 0.7% rate
decrease.
Sale of Power Plants
- --------------------
On November 29, 2001 FirstEnergy announced an agreement to sell four
of its older coal-fired power plants located along Lake Erie in Ohio to NRG (see
Note 3). By constructing peaking units and selling these larger generating
plants, FirstEnergy is reshaping its generating capability to more efficiently
meet the needs of its target market. On August 8, 2002, FirstEnergy notified NRG
that it was canceling the agreement because NRG stated that it could not
complete the transaction under the original terms of the agreement. FirstEnergy
also notified NRG that FirstEnergy is reserving the right to pursue legal action
against NRG, its affiliate and its parent, Xcel Energy, for damages based on the
anticipatory breach of the agreement. As a result, FirstEnergy will pursue
opportunities with other parties who have expressed interest in purchasing the
plants. FirstEnergy believes that an agreement can be reached with another buyer
on a timely basis and that no impairment of these assets is appropriate.
23
Emdersa Divestiture
-------------------
FirstEnergy determined the fair value of its Argentina operations, GPU
Empresa Distribuidora Electrica Regional S.A. and affiliates (Emdersa), based on
the best available information as of the date of the merger. Subsequent to that
date, a number of economic events have occurred in Argentina which may have an
impact on FirstEnergy's ability to realize Emdersa's estimated fair value. These
events include currency devaluation, restrictions on repatriation of cash, and
the anticipation of future asset sales in that region by competitors.
FirstEnergy has determined that it is not probable that the subsequent economic
conditions in Argentina have eroded the fair value recorded for Emdersa; as a
result, an impairment writedown of this investment is not warranted as of June
30, 2002. FirstEnergy continues to assess the potential impact of these and
other related events on the realizability of the value recorded for Emdersa.
FirstEnergy continues to pursue divesting Emdersa and, in accordance with EITF
Issue No. 87-11, has classified its assets and liabilities in the Consolidated
Balance Sheet as "Assets Pending Sale" and "Liabilities Related to Assets
Pending Sale." FirstEnergy believes it is probable that a completed sale or a
definitive agreement to sell its interest in Emdersa could be achieved by
November 6, 2002. Potential investors recently retained a financial advisor to
assist in the due diligence process and FirstEnergy expects that preliminary
negotiations with those investors may be completed in the third quarter of 2002.
If FirstEnergy has not completed the sale of all of its interest in Emdersa or
has not reached a definitive agreement to sell such interest by November 6,
2002, those assets would no longer be classified as "Assets Pending Sale" on
FirstEnergy's Consolidated Balance Sheet and Emdersa's results of operations
would be included on FirstEnergy's Consolidated Statement of Income. In
addition, Emdersa's cumulative results of operations (from November 7, 2001
through the date that it would become probable that a definitive sale agreement
for all of FirstEnergy's interest would not be reached by November 6, 2002)
would be reflected on FirstEnergy's Consolidated Statement of Income as a
"Cumulative Effect of a Change in Accounting". As of June 30, 2002, that
adjustment would have reduced FirstEnergy's net income by approximately $95
million ($0.33 per share of common stock).
Supply Plan
- -----------
On April 30, 2002, the Nuclear Regulatory Commission (NRC) initiated a
formal inspection process at the Davis-Besse nuclear plant. This action was
taken in response to corrosion found by FirstEnergy in the reactor vessel head
near the nozzle penetration hole during a refueling outage in the first quarter
of 2002. The purpose of the formal inspection process is to establish criteria
for NRC oversight of the licensee's performance and to provide a record of the
major regulatory and licensee actions taken, and technical issues resolved,
leading to the NRC's approval of restart of the plant.
On May 23, 2002, FirstEnergy purchased an unused reactor vessel head
from Consumers Energy's Midland Nuclear Plant - similar in design to the
Davis-Besse Plant. In addition to refurbishment and installation work at the
plant, FirstEnergy has made significant changes in senior and mid-level managers
at the plant and in its corporate nuclear organization. It has also established
an independent oversight panel consisting of industry experts to assist in
Davis-Besse restart efforts and to provide advice regarding the safe return of
Davis-Besse to service. FirstEnergy expects to complete refurbishment and
installation of the replacement reactor head as well as any other work related
to restart of the plant in the fourth quarter of this year. The NRC must
authorize restart of the plant following its formal inspection process before
the unit can be returned to service.
The estimated, incremental costs (capital and expense) associated with
the extended Davis-Besse outage in 2002 are:
Incremental Costs of Davis-Besse Extended Outage
------------------------------------------------
Expenditure Range
-----------------
(In millions)
Replace reactor vessel head (principally capital expenditures). $55-$75
Primarily operating expenses (pre-tax):
Additional maintenance (including acceleration of programs).... $50-$70
Replacement power for July and August 2002..................... $40
Replacement power for September through December .............. $40-$60
FirstEnergy has fully hedged its on-peak replacement energy supply for
Davis-Besse through the end of 2002. FirstEnergy's fossil units performed very
well in the first half of 2002, more than replaced the reduced nuclear output.
Although FirstEnergy expects to return Davis-Besse to service before the end of
the year, it has made on-peak power purchases for delivery in early 2003 to meet
a portion of FirstEnergy's incremental power needs if the Davis-Besse restart
date is delayed.
FirstEnergy continues to enter into power contracts to cover its
"provider of last resort" obligations for the 2003-2005 period. Market
conditions are currently relatively favorable, therefore minimizing
FirstEnergy's exposure to the commodity market and reducing potential negative
impacts related to the pending appeal to the Pennsylvania Supreme Court with
respect to the Met-Ed and Penelec deferred energy mechanism. FirstEnergy is now
over 90% hedged for the projected 2003 summer peak and approximately 85% hedged
for the projected 2004 and 2005 summer peak loads.
24
Environmental Matters
- ---------------------
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of June 30, 2002, based on estimates of the total
costs of cleanup, the EUOCs' proportionate responsibility for such costs and the
financial ability of other nonaffiliated entities to pay. The EUOCs have been
named as "potentially responsible parties" (PRPs) at waste disposal sites which
may require cleanup under the Comprehensive Environmental Response, Compensation
and Liability Act of 1980. Allegations of disposal of hazardous substances at
historical sites and the liability involved are often unsubstantiated and
subject to dispute. Federal law provides that all PRPs for a particular site be
held liable on a joint and several basis. In addition, JCP&L has accrued
liabilities for environmental remediation of former manufactured gas plants in
New Jersey; those costs are being recovered by JCP&L through a non-bypassable
societal benefits charge. The EUOCs have total accrued liabilities aggregating
approximately $57.3 million as of June 30, 2002. FirstEnergy does not believe
environmental remediation costs will have a material adverse effect on its
financial condition, cash flows or results of operations.
Significant Accounting Policies
- -------------------------------
FirstEnergy prepares its consolidated financial statements in
accordance with accounting principles that are generally accepted in the United
States. Application of these principles often requires a high degree of
judgment, estimates and assumptions that affect financial results. All of
FirstEnergy's assets are subject to their own specific risks and uncertainties
and are regularly reviewed for impairment. Assets related to the application of
the policies discussed below are similarly reviewed with their risks and
uncertainties reflecting these specific factors. FirstEnergy's more significant
accounting policies are described below:
Purchase Accounting - Acquisition of GPU
Purchase accounting requires judgment regarding the allocation of the
purchase price based on the fair values of the assets acquired (including
intangible assets) and the liabilities assumed. The fair values of the acquired
assets and assumed liabilities for GPU were based primarily on estimates. The
more significant of these included the estimation of the fair value of the
international operations, certain domestic operations and the fair value of the
pension and other post retirement benefit assets and liabilities. The
preliminary purchase price allocations for the GPU acquisition are subject to
adjustment in 2002 when finalized. The excess of the purchase price over the
estimated fair values of the assets acquired and liabilities assumed was
recognized as goodwill, which must be reviewed for impairment at least annually.
FirstEnergy's most recent review was completed in June 2002. The results of that
review indicate that no impairment of goodwill is appropriate. As of June 30,
2002, FirstEnergy had $5.6 billion of goodwill that primarily relates to its
regulated services segment.
Regulatory Accounting
FirstEnergy's regulated services segment is subject to regulation that
sets the prices (rates) it is permitted to charge its customers based on costs
that the regulatory agencies determine FirstEnergy is permitted to recover. At
times, regulators permit the future recovery through rates of costs that would
be currently charged to expense by an unregulated company. This rate-making
process results in the recording of regulatory assets based on anticipated
future cash inflows. As a result of the changing regulatory framework in each
state in which FirstEnergy operates, a significant amount of regulatory assets
have been recorded -- $8.6 billion as of June 30, 2002. FirstEnergy regularly
reviews these assets to assess their ultimate recoverability within the approved
regulatory guidelines. Impairment risk associated with these assets relates to
potentially adverse legislative, judicial or regulatory actions in the future.
Derivative Accounting
Determination of appropriate accounting for derivative transactions
requires the involvement of management representing operations, finance and risk
assessment. In order to determine the appropriate accounting for derivative
transactions, the provisions of the contract need to be carefully assessed in
accordance with the authoritative accounting literature and management's
intended use of the derivative. New authoritative guidance continues to shape
the application of derivative accounting. Management's expectations and
intentions are key factors in determining the appropriate accounting for a
derivative transaction and, as a result, such expectations and intentions are
documented. Derivative contracts that are determined to fall within the scope of
SFAS 133, as amended, must be recorded at their fair value. Active market prices
are not always available to determine the fair value of the later years of a
contract, requiring that various assumptions and estimates be used in their
valuation. FirstEnergy continually monitors its derivative contracts to
determine if its activities, expectations, intentions, assumptions and estimates
remain valid. As part of its normal operations, FirstEnergy enters into
significant commodity contracts, as well as interest rate and currency swaps,
which increase the impact of derivative accounting judgments.
25
Revenue Recognition
FirstEnergy follows the accrual method of accounting for revenues,
recognizing revenue for kilowatt-hours that have been delivered but not yet
billed through the end of the accounting period. The determination of unbilled
revenues requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 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 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 cost to settle the retirement obligation differs from the carrying
amount. FirstEnergy has identified various applicable legal obligations as
defined under the new standard and expects to complete an analysis of their
financial impact in the second half of 2002.
26
OHIO EDISON COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ------------------------
2002 2001 2002 2001
-------- -------- ---------- ----------
(In thousands)
OPERATING REVENUES........................................ $744,550 $744,712 $1,452,349 $1,527,815
-------- -------- ---------- ----------
OPERATING EXPENSES AND TAXES:
Fuel................................................... 15,129 13,408 29,419 27,554
Purchased power........................................ 213,172 237,795 454,651 544,212
Nuclear operating costs................................ 80,700 76,987 175,934 169,232
Other operating costs.................................. 78,497 79,716 158,108 160,672
-------- -------- ---------- ----------
Total operation and maintenance expenses............. 387,498 407,906 818,112 901,670
Provision for depreciation and amortization............ 91,521 104,205 183,651 221,161
General taxes.......................................... 42,524 26,133 87,900 71,087
Income taxes........................................... 84,403 68,540 127,018 107,141
-------- -------- ---------- ----------
Total operating expenses and taxes................... 605,946 606,784 1,216,681 1,301,059
-------- -------- ---------- ----------
OPERATING INCOME.......................................... 138,604 137,928 235,668 226,756
OTHER INCOME.............................................. 15,087 17,821 15,599 30,186
-------- -------- ---------- ----------
INCOME BEFORE NET INTEREST CHARGES........................ 153,691 155,749 251,267 256,942
-------- -------- ---------- ----------
NET INTEREST CHARGES:
Interest on long-term debt............................. 30,312 39,527 63,385 78,914
Allowance for borrowed funds used during
construction and capitalized interest................ (883) 1,612 (1,504) (1,306)
Other interest expense................................. 2,801 5,806 7,948 12,718
Subsidiaries' preferred stock dividend requirements.... 3,626 3,626 7,252 7,252
-------- -------- ---------- ----------
Net interest charges................................. 35,856 50,571 77,081 97,578
-------- -------- ---------- ----------
NET INCOME................................................ 117,835 105,178 174,186 159,364
PREFERRED STOCK DIVIDEND REQUIREMENTS..................... 2,597 2,702 5,193 5,404
-------- -------- ---------- ----------
EARNINGS ON COMMON STOCK.................................. $115,238 $102,476 $ 168,993 $ 153,960
======== ======== ========== ==========
<FN>
The preceding Notes to Financial Statements as they relate to Ohio Edison
Company are an integral part of these statements.
</FN>
27
OHIO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
----------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................. $5,000,153 $4,979,807
Less--Accumulated provision for depreciation............................... 2,507,148 2,461,972
---------- ----------
2,493,005 2,517,835
---------- ----------
Construction work in progress-
Electric plant........................................................... 98,938 87,061
Nuclear fuel............................................................. 816 11,822
---------- ----------
99,754 98,883
---------- ----------
2,592,759 2,616,718
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
PNBV Capital Trust......................................................... 416,152 429,040
Letter of credit collateralization......................................... 277,763 277,763
Nuclear plant decommissioning trusts....................................... 295,381 277,337
Long-term notes receivable from associated companies....................... 504,439 505,028
Other...................................................................... 308,084 303,409
---------- ----------
1,801,819 1,792,577
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents.................................................. 24,139 4,588
Receivables-
Customers (less accumulated provisions of $4,692,000 and
$4,522,000, respectively, for uncollectible accounts).................. 341,330 311,744
Associated companies..................................................... 470,053 523,884
Other (less accumulated provisions of $1,000,000 for uncollectible
accounts at both dates)................................................ 33,053 41,611
Notes receivable from associated companies................................. 243,961 108,593
Materials and supplies, at average cost-
Owned.................................................................... 55,072 53,900
Under consignment........................................................ 17,573 13,945
Other...................................................................... 19,268 50,541
---------- ----------
1,204,449 1,108,806
---------- ----------
DEFERRED CHARGES:
Regulatory assets.......................................................... 2,130,457 2,234,227
Other...................................................................... 165,262 163,625
---------- ----------
2,295,719 2,397,852
---------- ----------
$7,894,746 $7,915,953
========== ==========
28
OHIO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30 December 31,
2002 2001
----------- -------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, without par value, authorized 175,000,000 shares -
100 shares outstanding................................................. $2,098,729 $2,098,729
Retained earnings........................................................ 640,065 572,272
---------- ----------
Total common stockholder's equity.................................... 2,738,794 2,671,001
Preferred stock not subject to mandatory redemption........................ 60,965 160,965
Preferred stock of consolidated subsidiary-
Not subject to mandatory redemption...................................... 39,105 39,105
Subject to mandatory redemption.......................................... 14,250 14,250
Company obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely Company
subordinated debentures.................................................. -- 120,000
Long-term debt............................................................. 1,483,805 1,614,996
---------- ----------
4,336,919 4,620,317
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock....................... 700,837 576,962
Short-term borrowings-
Associated companies..................................................... 42,538 26,076
Other.................................................................... 177,131 219,750
Accounts payable-
Associated companies..................................................... 95,645 110,784
Other.................................................................... 15,497 19,819
Accrued taxes.............................................................. 465,091 258,831
Accrued interest........................................................... 31,090 33,053
Other...................................................................... 64,160 63,140
---------- ----------
1,591,989 1,308,415
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes.......................................... 1,125,037 1,175,395
Accumulated deferred investment tax credits................................ 92,829 99,193
Nuclear plant decommissioning costs........................................ 294,544 276,500
Other postretirement benefits.............................................. 169,629 166,594
Other...................................................................... 283,799 269,539
---------- ----------
1,965,838 1,987,221
---------- ----------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)............................
---------- ----------
$7,894,746 $7,915,953
========== ==========
<FN>
The preceding Notes to Financial Statements as they relate to Ohio Edison
Company are an integral part of these balance sheets.
</FN>
29
OHIO EDISON COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- --------- -------- ---------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $117,835 $ 105,178 $174,186 $ 159,364
Adjustments to reconcile net income to net cash from
operating activities-
Provision for depreciation and amortization........ 91,521 104,205 183,651 221,161
Nuclear fuel and lease amortization................ 12,133 11,920 23,535 23,677
Deferred income taxes, net......................... (8,886) (22,160) (22,056) (42,562)
Investment tax credits, net........................ (3,762) (3,341) (7,535) (6,694)
Receivables........................................ (31,345) (137,091) 32,803 (194,795)
Materials and supplies............................. (3,158) 914 (4,800) 54,060
Accounts payable................................... (1,166) 35,497 (19,461) (52,684)
Accrued taxes ..................................... 149,376 (20,063) 206,260 18,211
Other.............................................. (29,119) (54,008) (5,643) (46,627)
-------- --------- -------- ---------
Net cash provided from operating activities...... 293,429 21,051 560,940 133,111
-------- --------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Long-term debt....................................... -- 249,042 -- 249,542
Redemptions and Repayments-
Long-term debt....................................... 244,179 30,560 228,741 37,710
Short-term borrowings, net........................... 66,464 21,062 26,158 15,447
Dividend Payments-
Common stock......................................... -- -- 101,200 37,300
Preferred stock...................................... 2,596 2,706 5,193 5,404
-------- --------- -------- ---------
Net cash used for (provided from) financing
activities 313,239 (194,714) 361,292 (153,681)
-------- --------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions..................................... 25,377 15,608 55,721 41,006
Loans to associated companies.......................... -- 136,257 135,325 311,829
Loan payments from associated companies................ (3,402) (506) (546) (506)
Sale of assets to associated companies................. -- (33,002) -- (154,596)
Other.................................................. (8,431) (4,567) (10,403) (6,046)
-------- --------- -------- ---------
Net cash used for investing activities........... 13,544 113,790 180,097 191,687
-------- --------- -------- ---------
Net increase (decrease) in cash and cash equivalents...... (33,354) 101,975 19,551 95,105
Cash and cash equivalents at beginning of period.......... 57,493 11,399 4,588 18,269
-------- --------- -------- ---------
Cash and cash equivalents at end of period................ $ 24,139 $ 113,374 $ 24,139 $ 113,374
======== ========= ======== =========
<FN>
The preceding Notes to Financial Statements as they relate to Ohio Edison
Company are an integral part of these statements.
</FN>
30
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Ohio Edison Company:
We have reviewed the accompanying consolidated balance sheet of Ohio Edison
Company and its subsidiaries as of June 30, 2002, and the related consolidated
statements of income and cash flows for each of the three-month and six-month
periods ended June 30, 2002. These financial statements are the responsibility
of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
31
OHIO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
OE is a wholly owned, electric utility subsidiary of FirstEnergy. OE
and its wholly owned subsidiary, Penn, conduct business in portions of Ohio and
Pennsylvania, providing regulated electric distribution services. OE and Penn
(OE Companies) also provide generation services to those customers electing to
retain them as their power supplier. The OE Companies provide power directly to
wholesale customers under previously negotiated contracts, as well as to
alternative energy suppliers under OE's transition plan. The OE Companies have
unbundled the price of electricity into its component elements - including
generation, transmission, distribution and transition charges. Power supply
requirements of the OE Companies are provided by FES - an affiliated company.
Results of Operations
- ---------------------
Operating revenues were nearly unchanged in the second quarter and
decreased $75.5 million or 4.9% in the first half of 2002, as compared to the
corresponding periods of 2001. Changes in operating revenues reflect the
combined effects of a weak but recovering economy, shopping by Ohio customers
for alternative energy providers, reduced revenues from wholesale customers and
weather. While retail kilowatt-hour sales declined by 3.3% in the second quarter
of 2002, compared to the second quarter of 2001, favorable price variances
resulting from a change in sales mix resulted in a relatively small reduction in
generation sales revenue. During the first six months of 2002, however,
kilowatt-hour sales declined in all customer sectors - residential, commercial
and industrial - resulting in a 12.1% reduction overall and reduced operating
revenues by $41.0 million. OE's lower generation kilowatt-hour sales in both
periods resulted principally from customer choice in Ohio. Sales of electric
generation by alternative suppliers as a percent of total sales delivered in the
OE Companies' franchise area increased to 19.0% in the second quarter of 2002
from 13.7% in the same period last year. During the first six months of 2002,
OE's share of electric generation sales in its franchise areas decreased by 9.5
percentage points, compared to the same period of 2001.
Distribution deliveries increased 3.0% in the second quarter of 2002,
which increased revenues from electricity throughput by $14.0 million, compared
with the second quarter of 2001. The second quarter of 2002 benefited from a
slight pick up in economic activity and warmer June weather. Despite the
stronger second quarter performance, distribution deliveries and revenues were
lower in the first six months of 2002, compared to the same period last year,
declining by 2.0% and $7.0 million, respectively, primarily due to the weaker
economic environment earlier in the year.
Transition plan incentives, provided to customers to encourage
switching to alternative energy providers, further reduced operating revenues in
the second quarter and first six months of 2002, compared to the corresponding
periods of 2001 - reducing comparable revenues by $6.7 million and $16.6
million, respectively. These revenue reductions are deferred for future recovery
under OE's transition plan and do not materially affect current period earnings.
Sales revenues from wholesale customers were also lower in both the
second quarter and year-to-date periods of 2002, compared to the same periods
last year. Increased revenues from kilowatt-hour sales to nonaffiliated
wholesale customers were more than offset by reduced revenues from FES.
The sources of changes in operating revenues during the second quarter
and first six months of 2002, compared with the corresponding periods of 2001,
are summarized in the following table:
Sources of Operating Revenue Changes
------------------------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
-------- --------
(In millions)
Retail:
Generation sales......................... $(1.0) $(41.0)
Distribution deliveries.................. 14.0 (7.0)
Increased shopping incentives............ (6.7) (16.6)
----- ------
Total Retail............................. 6.3 (64.6)
Wholesale.................................. (3.6) (10.2)
Other.................................... (2.9) (0.7)
----- ------
Net Decrease in Operating Revenue.......... $(0.2) $(75.5)
===== ======
32
Operating Expenses and Taxes
Total operating expenses and taxes were slightly lower in the second
quarter and declined $84.4 million in the first six months of 2002 from the
corresponding periods of 2001. Purchased power costs decreased $24.6 million in
the second quarter and $89.6 million in the first six months of 2002, compared
to the same periods last year, due to lower unit costs and reduced volume
requirements supporting lower generation kilowatt-hour sales. Nuclear operating
costs increased $3.7 million in the second quarter and $6.7 million in the first
half of 2002 from the same periods in 2001. The six-month increase reflected
additional amounts related to the first quarter refueling outage at Beaver
Valley Unit 2 (55.62% owned) that exceeded refueling outage costs for the Perry
Plant (35.24% owned) in the same period of 2001.
Charges for depreciation and amortization decreased by $12.7 million
in the second quarter and $37.5 million in the first six months of 2002,
compared to the same periods last year. These decreases primarily resulted from
higher shopping incentive deferrals and tax-related deferrals under OE's
transition plan in 2002.
General taxes increased by $16.4 million in the second quarter and
$16.8 million in the first six months of 2002 from the same periods in 2001, due
in large part to the successful resolution of certain property tax issues in the
second quarter of 2001. This resulted in a one-time benefit of $15 million in
the second quarter of 2001.
Other Income
Other income decreased $2.7 million in the second quarter and $14.6
million in the first half of 2002 from the corresponding periods of 2001.
Reduced interest income was the principal factor in the second quarter decrease.
Most of the reduction for the year-to-date period resulted from a first quarter
2002 adjustment related to OE's low income housing investments.
Net Interest Charges
Net interest charges continued to trend lower, decreasing by $14.7 million
in the second quarter and $20.5 million in the first six months of 2002,
compared to the same periods last year, primarily due to debt redemption and
refinancing activities. During the first six months of 2002, maturing debt
redemptions totaled $140.1 million and will result in annualized savings of
$11.5 million.
Capital Resources and Liquidity
- -------------------------------
The OE Companies have continuing cash requirements for planned capital
expenditures and maturing debt. During the last two quarters of 2002, capital
requirements for property additions and capital leases are expected to be about
$98 million, including $20 million for nuclear fuel. The OE Companies also have
sinking fund requirements for preferred stock and maturing long-term debt of
$182.6 million and optional preferred stock redemptions of $220 million during
the remainder of 2002. These requirements are expected to be satisfied from
internal cash and/or short-term credit arrangements.
As of June 30, 2002, the OE Companies had about $268.1 million of cash
and temporary investments and $219.7 million of short-term indebtedness. Their
available borrowing capability included $250.0 million from unused revolving
lines of credit and $26 million from unused bank facilities. As of June 30,
2002, the OE Companies had the capability to issue up to $1.5 billion of
additional first mortgage bonds on the basis of property additions and retired
bonds. Under the earnings coverage tests contained in the OE Companies'
charters, $2.6 billion of preferred stock (assuming no additional debt was
issued) could be issued based on earnings through the second quarter of 2002.
State Regulatory Matters
- ------------------------
The transition cost portion of the OE Companies' rates provides for
recovery of certain amounts not otherwise recoverable in a competitive
generation market (such as regulatory assets). Transition costs are paid by all
customers whether or not they choose an alternative supplier. Under the
PUCO-approved transition plan, OE assumed the risk of not recovering up to $250
million of transition costs if the rate of customers (excluding contracts and
full-service accounts) switching their service from OE does not reach 20% for
any consecutive twelve-month period by December 31, 2005 - the end of the market
development period. As of June 30, 2002, the annualized customer-switching rate
essentially reduced OE's risk of not recovering transition costs to
approximately $31 million. OE began accepting customer applications for
switching to alternative suppliers on December 8, 2000 and has received
notifications as of June 30, 2002 that over 220,000 of its customers requested
generation services from other authorized suppliers.
33
Significant Accounting Policies
- -------------------------------
OE prepares its 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 OE's financial results. All of OE's assets are subject
to their own specific risks and uncertainties and are regularly reviewed for
impairment. Assets related to the application of the policies discussed below
are similarly reviewed with their risks and uncertainties reflecting these
specific factors. OE's more significant accounting policies are described below.
Regulatory Accounting
The OE Companies are subject to regulation that sets the prices
(rates) they are permitted to charge their customers based on the costs that
regulatory agencies determine the OE Companies are permitted to recover. At
times, regulators permit the future recovery through rates of costs that would
be currently charged to expense by an unregulated company. This rate-making
process results in the recording of regulatory assets based on anticipated
future cash inflows. As a result of the changing regulatory framework in Ohio
and Pennsylvania, a significant amount of regulatory assets have been recorded -
$2.1 billion as of June 30, 2002. OE regularly reviews these assets to assess
their ultimate recoverability within the approved regulatory guidelines.
Impairment risk associated with these assets relates to potentially adverse
legislative, judicial or regulatory actions in the future. As disclosed in Note
4 - Regulatory Matters - Ohio, OE's full recovery of transition costs is
dependent on achieving 20% shopping levels in any twelve-month period by 2005.
Revenue Recognition
The OE Companies follow the accrual method of accounting for revenues,
recognizing revenue for kilowatt-hours that have been delivered but not yet
billed through the end of the accounting period. The determination of unbilled
revenues requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Allocations to distribution companies within the FirstEnergy system
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 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 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 cost to settle the retirement obligation differs from the carrying
amount. The OE Companies have identified various applicable legal obligations as
defined under the new standard and expect to complete an analysis of their
financial impact in the second half of 2002.
34
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- -----------------------
2002 2001 2002 2001
-------- -------- -------- ----------
(In thousands)
OPERATING REVENUES........................................ $462,874 $498,766 $887,851 $1,015,183
-------- -------- -------- ----------
OPERATING EXPENSES AND TAXES:
Fuel................................................... 15,088 16,888 32,358 34,753
Purchased power........................................ 118,458 193,590 257,894 408,095
Nuclear operating costs................................ 38,785 28,679 110,202 78,629
Other operating costs.................................. 68,353 72,396 135,200 150,699
-------- -------- -------- ----------
Total operation and maintenance expenses........... 240,684 311,553 535,654 672,176
Provision for depreciation and amortization............ 28,333 52,964 56,804 109,728
General taxes.......................................... 36,493 34,080 75,239 71,950
Income taxes........................................... 44,610 21,579 52,078 29,294
-------- -------- -------- ----------
Total operating expenses and taxes................. 350,120 420,176 719,775 883,148
-------- -------- -------- ----------
OPERATING INCOME.......................................... 112,754 78,590 168,076 132,035
OTHER INCOME.............................................. 3,356 1,138 8,597 5,558
-------- -------- -------- ----------
INCOME BEFORE NET INTEREST CHARGES........................ 116,110 79,728 176,673 137,593
-------- -------- -------- ----------
NET INTEREST CHARGES:
Interest on long-term debt............................. 45,372 48,317 92,367 96,602
Allowance for borrowed funds used during construction.. (747) (216) (1,496) (1,073)
Other interest expense (credit)........................ (125) (879) (654) (2,075)
Subsidiaries' preferred stock dividend requirements.... 2,250 -- 4,400 --
-------- -------- -------- ----------
Net interest charges............................... 46,750 47,222 94,617 93,454
-------- -------- -------- ----------
NET INCOME................................................ 69,360 32,506 82,056 44,139
PREFERRED STOCK DIVIDEND REQUIREMENTS..................... 3,054 6,561 11,310 13,122
-------- -------- -------- ----------
EARNINGS ON COMMON STOCK.................................. $ 66,306 $ 25,945 $ 70,746 $ 31,017
======== ======== ======== ==========
<FN>
The preceding Notes to Financial Statements as they relate to The Cleveland Electric Illuminating Company are an integral part of
these statements.
</FN>
35
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
---------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $4,081,483 $4,071,134
Less--Accumulated provision for depreciation.............................. 1,771,704 1,725,727
---------- ----------
2,309,779 2,345,407
---------- ----------
Construction work in progress-
Electric plant.......................................................... 94,511 66,266
Nuclear fuel............................................................ 29,033 21,712
---------- ----------
123,544 87,978
---------- ----------
2,433,323 2,433,385
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Shippingport Capital Trust................................................ 448,149 475,543
Nuclear plant decommissioning trusts...................................... 226,910 211,605
Long-term notes receivable from associated companies...................... 103,205 103,425
Other..................................................................... 20,937 24,611
---------- ----------
799,201 815,184
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 290 296
Receivables-
Customers............................................................... 14,272 17,706
Associated companies.................................................... 56,035 75,113
Other (less accumulated provisions of $1,015,000 for uncollectible
accounts at both dates)............................................... 153,885 99,716
Notes receivable from associated companies................................ 430 415
Materials and supplies, at average cost-
Owned................................................................... 18,431 20,230
Under consignment....................................................... 33,538 28,533
Other..................................................................... 2,023 31,634
---------- ----------
278,904 273,643
---------- ----------
DEFERRED CHARGES:
Regulatory assets......................................................... 907,948 874,488
Goodwill.................................................................. 1,370,639 1,370,639
Other..................................................................... 96,880 88,767
---------- ----------
2,375,467 2,333,894
---------- ----------
$5,886,895 $5,856,106
========== ==========
36
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
----------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, without par value, authorized 105,000,000 shares -
79,590,689 shares outstanding......................................... $ 931,962 $ 931,962
Retained earnings....................................................... 220,863 150,183
---------- ----------
Total common stockholder's equity................................... 1,152,825 1,082,145
Preferred stock-
Not subject to mandatory redemption..................................... 96,404 141,475
Subject to mandatory redemption......................................... 6,129 6,288
Company obligated mandatorily redeemable preferred securities of
subsidiary trust holding solely Company subordinated debentures......... 100,000 100,000
Long-term debt............................................................ 2,037,118 2,156,322
---------- ----------
3,392,476 3,486,230
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock...................... 589,868 526,630
Accounts payable-
Associated companies.................................................... 121,915 81,463
Other................................................................... 16,259 30,332
Notes payable to associated companies..................................... 124,367 97,704
Accrued taxes............................................................. 142,505 129,830
Accrued interest.......................................................... 56,763 57,101
Other..................................................................... 46,236 60,664
---------- ----------
1,097,913 983,724
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 649,647 637,339
Accumulated deferred investment tax credits............................... 74,156 76,187
Nuclear plant decommissioning costs....................................... 236,103 220,798
Pensions and other postretirement benefits................................ 234,079 231,365
Other..................................................................... 202,521 220,463
---------- ----------
1,396,506 1,386,152
---------- ----------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)...........................
---------- ----------
$5,886,895 $5,856,106
========== ==========
<FN>
The preceding Notes to Financial Statements as they relate to The Cleveland Electric Illuminating Company are an integral part of
these balance sheets.
</FN>
37
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 69,360 $ 32,506 $ 82,056 $ 44,139
Adjustments to reconcile net income to net
cash from operating activities-
Provision for depreciation and amortization........ 28,333 52,964 56,804 109,728
Nuclear fuel and lease amortization................ 4,794 7,070 10,784 14,114
Other amortization................................. (4,275) (4,039) (8,167) (7,672)
Deferred income taxes, net......................... 5,904 4,607 13,100 4,660
Investment tax credits, net........................ (1,129) (970) (2,031) (1,939)
Receivables........................................ (38,473) (60,559) (31,657) 15,060
Materials and supplies............................. (1,840) 234 (3,206) 15,557
Accounts payable................................... 8,057 8,869 26,379 (46,181)
Accrued taxes...................................... 17,743 21,765 12,675 (26,704)
Other.............................................. (45,522) (13,482) (26,263) (67,065)
-------- -------- -------- --------
Net cash provided from operating activities...... 42,952 48,965 130,474 53,697
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Short-term borrowings, net........................... -- 96,323 26,663 128,586
Redemptions and Repayments-
Preferred stock...................................... -- 10,716 100,000 10,716
Long-term debt....................................... 96 21,264 190 29,904
Short-term borrowings, net........................... 48,821 -- -- --
Dividend Payments-
Common stock......................................... -- 84,000 -- 105,800
Preferred stock...................................... 3,133 7,040 8,385 14,077
-------- -------- -------- --------
Net cash used for financing activities........... 52,050 26,697 81,912 31,911
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions..................................... 25,452 5,363 61,922 15,580
Loans to associated companies.......................... -- 11,117 -- 11,117
Loan payments from associated companies................ (205) (188) (205) (188)
Capital trust investments.............................. (27,394) (1,071) (27,394) (16,279)
Sale of assets to associated companies................. -- (11,117) -- (11,117)
Other.................................................. 8,021 18,140 14,245 25,290
-------- -------- -------- --------
Net cash used for investing activities........... 5,874 22,244 48,568 24,403
-------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents...... (14,972) 24 (6) (2,617)
Cash and cash equivalents at beginning of period.......... 15,262 214 296 2,855
-------- -------- -------- --------
Cash and cash equivalents at end of period................ $ 290 $ 238 $ 290 $ 238
======== ======== ======== ========
<FN>
The preceding Notes to Financial Statements as they relate to The Cleveland Electric Illuminating Company are an integral part of
these statements.
</FN>
38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of The Cleveland
Electric Illuminating Company:
We have reviewed the accompanying consolidated balance sheet of The Cleveland
Electric Illuminating Company and its subsidiaries as of June 30, 2002, and the
related consolidated statements of income and cash flows for each of the
three-month and six-month periods ended June 30, 2002. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
39
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
CEI is a wholly owned, electric utility subsidiary of FirstEnergy. CEI
provides regulated electric distribution services in portions of northern Ohio.
CEI also provides generation services to those customers electing to retain CEI
as their power supplier. CEI continues to provide power directly to wholesale
customers under previously negotiated contracts, as well as to alternative
energy suppliers under its regulatory plan. CEI's regulatory plan itemizes, or
unbundles, the price of electricity into its component elements - including
generation, transmission, distribution and transition charges. Power supply
requirements of CEI are provided by FES - an affiliated company.
Results of Operations
- ---------------------
Operating revenues decreased $35.9 million or 7.2% in the second
quarter and $127.3 million or 12.5% in the first half of 2002, as compared to
the same periods of 2001. Reduced operating revenues reflect the combined
effects of a weak but recovering economy, shopping by Ohio customers for
alternative energy providers and reduced sales to wholesale customers.
Kilowatt-hour sales to generation customers decreased by 23.0% in the second
quarter and 30.8% in the first six months of 2002, compared to the same periods
last year, principally from customer choice in Ohio. Sales of electric
generation by alternative suppliers as a percent of total sales in the CEI
franchise area increased to 27.9% in the second quarter of 2002 from 12.1% in
the same period last year. During the first six months of 2002, CEI's share of
electric generation sales in its franchise area decreased by 20.8 percentage
points, compared to the same period of 2001. A very weak steel sector in CEI's
service area also contributed significantly to the decline in kilowatt-hour
sales to generation customers in both the second quarter and first six months of
2002 from the corresponding periods last year.
Despite lower distribution deliveries in the second quarter of 2002,
compared to the same quarter of 2001, distribution revenues increased by $5.8
million - reflecting an increase in the proportion of kilowatt-hour sales to
residential customers. Sales to residential customers benefited from warmer
weather in June 2002, increasing air-conditioning load, as compared to last
year. Distribution deliveries and revenues were lower in the first six months of
2002, compared to the same period last year, declining 10.7% and $27.8 million,
respectively, primarily due to the weaker economic conditions earlier in the
year.
Transition plan incentives, provided to customers to encourage
switching to alternative energy providers, further reduced operating revenues in
the second quarter and first six months of 2002, compared to the corresponding
periods of 2001 - reducing comparable revenues by $10.1 million and $24.1
million, respectively. These revenue reductions are deferred for future recovery
under CEI's transition plan and do not materially affect current period
earnings.
Revenues on sales to wholesale customers were lower in the second quarter
and slightly higher in the year-to-date period of 2002, compared to the same
periods last year, on lower kilowatt-hour sales in both periods. Increased
revenues from kilowatt-hour sales to nonaffiliated customers in the wholesale
market were more than offset by reduced revenues from FES in the second quarter
of 2002.
The sources of changes in operating revenues during the second quarter
and first six months of 2002, compared with the corresponding periods of 2001,
are summarized in the following table:
Sources of Operating Revenue Changes
------------------------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
-------- --------
(In millions)
Retail:
Generation sales...................... $(20.7) $ (70.9)
Distribution deliveries............... 5.8 (27.8)
Increased shopping incentives......... (10.1) (24.1)
------ -------
Total Retail.......................... (25.0) (122.8)
Wholesale............................... (7.8) 0.8
Other................................... (3.1) (5.3)
------ -------
Net Operating Revenue Decrease.......... $(35.9) $(127.3)
====== =======
40
Operating Expenses and Taxes
Total operating expenses and taxes declined by $70.1 million in the
second quarter and $163.4 million in the first six months of 2002 from the
corresponding periods of 2001. Purchased power costs decreased $75.1 million in
the second quarter and $150.2 million in the first six months of 2002, compared
to the same periods last year, due to lower unit costs and reduced volume
requirements supporting lower generation kilowatt-hour sales. Nuclear operating
costs increased $10.1 million in the second quarter and $31.6 million in the
first half of 2002 from the same periods in 2001. Costs related to the extended
outage at the Davis-Besse nuclear plant (see Capital Resources and Liquidity)
and to a lesser extent additional operating costs at Beaver Valley Unit 2 and
the Perry Plant, accounted for the increase in nuclear costs in the second
quarter compared to the second quarter of last year. In the year-to-date period,
2002 costs also include amounts incurred in the first quarter of 2002 resulting
from refueling outages at two nuclear plants (Beaver Valley Unit 2 and
Davis-Besse), compared to only one refueling outage (Perry) in the first quarter
of 2001.
Charges for depreciation and amortization decreased by $24.6 million
in the second quarter and $52.9 million in the first six months of 2002,
compared to the same periods last year. These decreases primarily resulted from
higher shopping incentive deferrals and tax-related deferrals under CEI's
transition plan in 2002, the elimination of depreciation associated with the
planned sale of the Ashtabula, Eastlake and Lakeshore generating plants (see
Note 3), and the cessation of goodwill amortization beginning January 1, 2002,
upon implementation of SFAS 142, "Goodwill and Other Intangible Assets." CEI's
goodwill amortization in the second quarter and first half of 2001 totaled $9.6
million and $19.1 million, respectively.
General taxes increased by $2.4 million in the second quarter and $3.3
million in the first six months of 2002. Higher property taxes were partially
offset by reductions due to state tax changes in connection with the Ohio
electric industry restructuring.
Other Income
A reduction in discounts associated with the factoring of accounts
receivable resulted in an increase in other income in the second quarter and
first six months of 2002, compared to the prior year - increasing other income
by $2.2 million and $3.0 million respectively.
Preferred Stock Dividend Requirements
Preferred stock dividend requirements decreased $3.5 million in the
second quarter and $1.8 million in the first half of 2002, compared to the same
periods last year, principally due to the completion of $100.0 million in
refinancings. Premiums related to the optional first quarter redemptions
partially offset the lower dividend requirements.
Capital Resources and Liquidity
- -------------------------------
CEI has continuing cash requirements for planned capital expenditures
and maturing debt. During the last two quarters of 2002, capital requirements
for property additions and capital leases are expected to be about $110 million,
including $9 million for nuclear fuel. These capital requirements include the
estimated incremental repair costs of the unplanned outage at the Davis-Besse
nuclear plant discussed below. CEI also has sinking fund requirements for
preferred stock and maturing long-term debt of $246.8 million and optional
preferred stock redemptions of $45.0 million during the remainder of 2002. These
cash requirements are expected to be satisfied from internal cash and short-term
credit arrangements.
As of June 30, 2002, CEI had about $0.7 million of cash and temporary
investments and $124.4 million of short-term indebtedness to associated
companies. Under its first mortgage indenture, excluding property additions
associated with the pending sale of coal-fired generating plants, CEI had the
capability to issue up to $314 million of additional first mortgage bonds on the
basis of property additions and retired bonds as of June 30, 2002. CEI has no
restrictions on the issuance of preferred stock.
On April 30, 2002, the Nuclear Regulatory Commission (NRC) initiated a
formal inspection process at the Davis-Besse nuclear plant. This action was
taken in response to corrosion found by FirstEnergy in the reactor vessel head
near the nozzle penetration hole during a refueling outage in the first quarter
of 2002. The purpose of the formal inspection process is to establish criteria
for NRC oversight of the licensee's performance and to provide a record of the
major regulatory and licensee actions taken, and technical issues resolved,
leading to the NRC's approval of restart of the plant.
On May 23, 2002, FirstEnergy purchased an unused reactor vessel head
from Consumers Energy's Midland Nuclear Plant - similar in design to the
Davis-Besse Plant. In addition to refurbishment and installation work at the
plant, FirstEnergy has made significant changes in senior and mid-level managers
at the plant and in its corporate nuclear organization. It has also established
an independent oversight panel consisting of industry experts to assist in
Davis-
41
Besse restart efforts and to provide advice regarding the safe return of
Davis-Besse to service. FirstEnergy expects to complete refurbishment and
installation of the replacement reactor head as well as any other work related
to restart of the plant in the fourth quarter of this year. The NRC must
authorize restart of the plant following its formal inspection process before
the unit can be returned to service.
The estimated, incremental costs (capital and expense) associated with
the extended Davis-Besse outage (CEI's share - 51.38%) in 2002 are:
Incremental Costs of Davis-Besse Extended Outage (100%)
- -------------------------------------------------------
Expenditure Range
-----------------
(In millions)
Replace reactor vessel head (principally capital expenditures). $55 - $75
Primarily operating expenses (pre-tax):
Additional maintenance (including acceleration of programs).... $50 - $70
Replacement power for July and August 2002..................... $40
Replacement power for September through December 2002.......... $40 - $60
On July 31, 2002, Fitch revised its rating outlook for CEI securities
to negative from stable. The revised outlook reflects the adverse impact of the
unplanned outage at the Davis-Besse Plant and Fitch's judgment at that time
about NRG's financial ability to consummate the purchase of four power plants
from FirstEnergy and Fitch's expectation of subsequent delays in debt reduction.
Environmental Matters
- ---------------------
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of June 30, 2002, based on estimates of the total
costs of cleanup, CEI's proportionate responsibility for such costs and the
financial ability of other nonaffiliated entities to pay. CEI has been named 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. CEI has accrued liabilities of
approximately $2.8 million as of June 30, 2002, and does not believe
environmental remediation costs will have a material adverse effect on its
financial condition, cash flows or results of operations.
Significant Accounting Policies
- -------------------------------
CEI prepares its 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 CEI's financial results. All of CEI's assets are subject
to their own specific risks and uncertainties and are regularly reviewed for
impairment. CEI's goodwill will be reviewed for impairment at least annually in
accordance with SFAS 142. FirstEnergy's most recent review was completed in June
2002. The results of that review indicate that no impairment of goodwill is
appropriate. Assets related to the application of the policies discussed below
are similarly reviewed with their risks and uncertainties reflecting these
specific factors. CEI's more significant accounting policies are described
below.
Regulatory Accounting
CEI is subject to regulation that sets the prices (rates) it is
permitted to charge customers based on the costs that regulatory agencies
determine CEI is permitted to recover. At times, regulators permit the future
recovery through rates of costs that would be currently charged to expense by an
unregulated company. This rate-making process results in the recording of
regulatory assets based on anticipated future cash inflows. As a result of the
changing regulatory framework in Ohio, a significant amount of regulatory assets
have been recorded - $908 million as of June 30, 2002. CEI regularly reviews
these assets to assess their ultimate recoverability within the approved
regulatory guidelines. Impairment risk associated with these assets relates to
potentially adverse legislative, judicial or regulatory actions in the future.
42
Revenue Recognition
CEI follows the accrual method of accounting for revenues, recognizing
revenue for kilowatt-hours that have been delivered but not yet billed through
the end of the accounting period. The determination of unbilled revenues
requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Allocations to distribution companies within the FirstEnergy system
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 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 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 cost to settle the retirement obligation differs from the carrying
amount. CEI has identified various applicable legal obligations as defined under
the new standard and expects to complete an analysis of their financial impact
in the second half of 2002.
43
THE TOLEDO EDISON COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
OPERATING REVENUES........................................ $250,307 $263,003 $494,474 $534,638
-------- -------- -------- --------
OPERATING EXPENSES AND TAXES:
Fuel................................................... 9,427 12,015 20,818 24,768
Purchased power........................................ 79,352 86,713 161,756 175,065
Nuclear operating costs................................ 45,542 37,111 120,640 84,759
Other operating costs.................................. 35,920 37,287 70,799 75,913
-------- -------- -------- --------
Total operation and maintenance expenses........... 170,241 173,126 374,013 360,505
Provision for depreciation and amortization............ 19,748 29,240 41,116 62,015
General taxes.......................................... 13,449 13,879 27,197 29,940
Income taxes........................................... 12,710 13,403 8,331 20,489
-------- -------- -------- --------
Total operating expenses and taxes................. 216,148 229,648 450,657 472,949
-------- -------- -------- --------
OPERATING INCOME.......................................... 34,159 33,355 43,817 61,689
OTHER INCOME.............................................. 3,743 2,178 8,086 5,966
-------- -------- -------- --------
INCOME BEFORE NET INTEREST CHARGES........................ 37,902 35,533 51,903 67,655
-------- -------- -------- --------
NET INTEREST CHARGES:
Interest on long-term debt............................. 15,601 16,616 31,473 33,860
Allowance for borrowed funds used during construction.. (382) (2,914) (810) (3,263)
Other interest expense (credit)........................ (360) (1,133) (1,095) (2,111)
-------- -------- -------- --------
Net interest charges............................... 14,859 12,569 29,568 28,486
-------- -------- -------- --------
NET INCOME................................................ 23,043 22,964 22,335 39,169
PREFERRED STOCK DIVIDEND REQUIREMENTS..................... 2,210 4,030 6,934 8,075
-------- -------- -------- --------
EARNINGS ON COMMON STOCK.................................. $ 20,833 $ 18,934 $ 15,401 $ 31,094
======== ======== ======== ========
<FN>
The preceding Notes to Financial Statements as they relate to The Toledo Edison Company are an integral part of these statements.
</FN>
44
THE TOLEDO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
----------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $1,588,298 $1,578,943
Less--Accumulated provision for depreciation.............................. 672,742 645,865
---------- ----------
915,556 933,078
---------- ----------
Construction work in progress-
Electric plant.......................................................... 61,370 40,220
Nuclear fuel............................................................ 26,383 19,854
---------- ----------
87,753 60,074
---------- ----------
1,003,309 993,152
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Shippingport Capital Trust................................................ 245,305 262,131
Nuclear plant decommissioning trusts...................................... 171,306 156,084
Long-term notes receivable from associated companies...................... 162,255 162,347
Other..................................................................... 3,684 4,248
---------- ----------
582,550 584,810
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 453 302
Receivables-
Customers............................................................... 6,993 5,922
Associated companies.................................................... 48,210 64,667
Other................................................................... 23,835 9,709
Notes receivable from associated companies................................ 15,906 7,607
Materials and supplies, at average cost-
Owned................................................................... 13,460 13,996
Under consignment....................................................... 19,406 17,050
Prepayments and other..................................................... 3,649 14,580
---------- ----------
131,912 133,833
---------- ----------
DEFERRED CHARGES:
Regulatory assets......................................................... 400,902 388,846
Goodwill.................................................................. 445,732 445,732
Other..................................................................... 31,505 25,745
---------- ----------
878,139 860,323
---------- ----------
$2,595,910 $2,572,118
========== ==========
45
THE TOLEDO EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
----------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, $5 par value, authorized 60,000,000 shares -
39,133,887 shares outstanding......................................... $ 195,670 $ 195,670
Other paid-in capital................................................... 328,559 328,559
Retained earnings....................................................... 123,237 113,436
---------- ----------
Total common stockholder's equity................................... 647,466 637,665
Preferred stock not subject to mandatory redemption....................... 126,000 126,000
Long-term debt............................................................ 566,624 646,174
---------- ----------
1,340,090 1,409,839
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock...................... 328,730 347,593
Accounts payable-
Associated companies.................................................... 67,896 53,960
Other................................................................... 7,133 27,418
Notes payable to associated companies..................................... 134,163 17,208
Accrued taxes............................................................. 49,229 39,848
Accrued interest.......................................................... 19,860 19,918
Other..................................................................... 27,730 40,222
---------- ----------
634,741 546,167
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 220,953 213,145
Accumulated deferred investment tax credits............................... 30,369 31,342
Nuclear plant decommissioning costs....................................... 177,648 162,426
Pensions and other postretirement benefits................................ 121,343 120,561
Other..................................................................... 70,766 88,638
---------- ----------
621,079 616,112
---------- ----------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)...........................
---------- ----------
$2,595,910 $2,572,118
========== ==========
<FN>
The preceding Notes to Financial Statements as they relate to The Toledo Edison Company are an integral part of these balance
sheets.
</FN>
46
THE TOLEDO EDISON COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 23,043 $ 22,964 $ 22,335 $ 39,169
Adjustments to reconcile net income to net
cash from operating activities-
Provision for depreciation and amortization........ 19,748 29,240 41,116 62,015
Nuclear fuel and lease amortization................ 2,671 5,236 6,244 10,410
Deferred income taxes, net......................... 578 994 5,892 3,152
Investment tax credits, net........................ (487) (487) (973) (973)
Receivables........................................ (18,762) (13,617) 1,260 4,000
Materials and supplies............................. (1,169) (711) (1,820) 10,712
Accounts payable................................... (9,210) (6,400) (6,349) (4,491)
Accrued sale leaseback costs ...................... (53,332) (19,528) (28,454) (29,157)
Other.............................................. 12,447 778 2,041 (19,397)
-------- -------- -------- --------
Net cash provided from (used for) operating
activities ..................................... (24,473) 18,469 41,292 75,440
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Short-term borrowings, net........................... 47,957 7,491 116,955 --
Redemptions and Repayments-
Preferred stock...................................... -- -- 85,299 --
Long-term debt....................................... 12,169 25,949 12,263 31,812
Short-term borrowings, net........................... -- -- -- 34,445
Dividend Payments-
Common stock......................................... -- -- 5,600 14,700
Preferred stock...................................... 2,210 4,028 5,635 8,073
-------- -------- -------- --------
Net cash used for (provided from) financing
activities ..................................... (33,578) 22,486 (8,158) 89,030
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions..................................... 14,702 8,481 40,261 20,509
Loans to associated companies.......................... 1,906 5,548 8,207 123,438
Loan payments from associated companies................ -- (21,556) -- (25,104)
Capital trust investments.............................. (16,883) (520) (16,826) (17,705)
Sale of assets to associated companies................. -- (5,548) -- (123,438)
Other.................................................. 11,536 9,936 17,657 9,746
-------- -------- -------- --------
Net cash used for (provided from) investing
activities ..................................... 11,261 (3,659) 49,299 (12,554)
-------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents...... (2,156) (358) 151 (1,036)
Cash and cash equivalents at beginning of period.......... 2,609 707 302 1,385
-------- -------- -------- --------
Cash and cash equivalents at end of period................ $ 453 $ 349 $ 453 $ 349
======== ======== ======== ========
<FN>
The preceding Notes to Financial Statements as they relate to The Toledo Edison Company are an integral part of these statements.
</FN>
47
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of The Toledo
Edison Company:
We have reviewed the accompanying consolidated balance sheet of The Toledo
Edison Company and its subsidiary as of June 30, 2002, and the related
consolidated statements of income and cash flows for each of the three-month and
six-month periods ended June 30, 2002. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
48
THE TOLEDO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
TE is a wholly owned, electric utility subsidiary of FirstEnergy. TE
provides regulated electric distribution services in portions of northern Ohio.
TE also provides generation services to those customers electing to retain TE as
their power supplier. TE continues to provide power directly to wholesale
customers under previously negotiated contracts, as well as to alternative
energy suppliers under its regulatory plan. TE's regulatory plan itemizes, or
unbundles, the price of electricity into its component elements - including
generation, transmission, distribution and transition charges. Power supply
requirements of TE are provided by FES - an affiliated company.
Results of Operations
- ---------------------
Operating revenues decreased by $12.7 million or 4.8% in the second quarter
and $40.2 million or 7.5% in the first half of 2002, as compared to the same
periods of 2001. Reduced operating revenues reflect the combined effects of a
weak but recovering economy, shopping by Ohio customers for alternative energy
providers and reduced sales to wholesale customers. Kilowatt-hour sales to
generation customers decreased by 3.5% in the second quarter and 11.7% in the
first six months of 2002, compared to the same periods last year, due
principally to customer choice in Ohio. Sales of electric generation by
alternative suppliers as a percent of total sales delivered in the TE franchise
area increased to 15.3% in the second quarter of 2002 from 6.1% in the same
period last year. Despite the reduction in generation load to alternative
suppliers in the second quarter, kilowatt-hour sales to generation customers
decreased only 3.5%, demonstrating some strength in the Toledo Edison service
area. Automotive and automotive-related industrial customers continue to provide
sales support in Toledo's franchise area. During the first six months of 2002,
TE's share of electric generation sales in its franchise areas decreased by 11.5
percentage points, compared to the same period in 2001.
Distribution deliveries increased by 7.0% in the second quarter of
2002 from the same quarter last year, increasing revenues from electricity
throughput by $8.6 million due to higher sales in all customer sectors -
residential, commercial and industrial. In addition to the benefit derived by
TE's franchise area economy from automotive and automotive-related
manufacturers, warmer weather in June 2002 increased air-conditioning load, as
compared to the second quarter last year. In the first half of 2002,
distribution deliveries increased slightly; however, revenues were lower
reflecting a net decrease in average unit prices.
Transition plan incentives, provided to customers to encourage
switching to alternative energy providers, further magnified the effect of
generation sales reductions to operating revenues in the second quarter and
first six months of 2002, compared to the corresponding periods of 2001 -
reducing comparable revenues by $3.6 million and $7.7 million, respectively.
These revenue reductions are deferred for future recovery under TE's transition
plan and do not materially affect current period earnings.
Sales to wholesale customers were also lower in both the second
quarter and year-to-date periods of 2002, compared to the same periods last
year, primarily reflecting reduced revenues from FES.
The sources of changes in operating revenues during the second quarter
and first six months of 2002, compared with the corresponding periods of 2001,
are summarized in the following table:
Sources of Operating Revenue Changes
------------------------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
-------- --------
(In millions)
Retail:
Generation sales...................... $ (2.8) $(15.0)
Distribution deliveries............... 8.6 (7.2)
Increased shopping incentives......... (3.6) (7.7)
------ ------
Total Retail.......................... 2.2 (29.9)
Wholesale............................... (15.0) (9.5)
Other................................... 0.1 (0.8)
------ ------
Net Decrease in Operating Revenue....... $(12.7) $(40.2)
====== ======
49
Operating Expenses and Taxes
Total operating expenses and taxes declined by $13.5 million in the
second quarter and $22.3 million in the first six months of 2002 from the
corresponding period of 2001. Purchased power costs decreased $7.4 million and
$13.3 million in the second quarter and first six months of 2002, compared to
the same periods last year, primarily due to lower unit costs in the second
quarter and reduced volume requirements supporting lower generation
kilowatt-hour sales in the year-to-date period.
Nuclear operating costs increased by $8.4 million in the second
quarter and $35.9 million in the first half of 2002 from the same periods in
2001. Costs related to the extended outage at the Davis-Besse nuclear plant (see
Capital Resources and Liquidity) and to a lesser extent additional operating
costs at Beaver Valley Unit 2 and the Perry Plant, accounted for the increase in
nuclear costs in the second quarter compared to the second quarter of last year.
During the first six months of 2002, costs also included amounts incurred in the
first quarter of 2002 from refueling outages at two nuclear plants (Beaver
Valley Unit 2 and Davis-Besse), compared to only one refueling outage (Perry) in
the first quarter of 2001.
Charges for depreciation and amortization decreased by $9.5 million in
the second quarter and $20.9 million in the first six months of 2002, compared
to the same periods last year. These decreases primarily resulted from higher
shopping incentive deferrals and tax-related deferrals under TE's transition
plan in 2002, the elimination of depreciation associated with the planned sale
of the Bay Shore generating plant (see Note 3), and the cessation of goodwill
amortization beginning January 1, 2002, upon implementation of SFAS 142,
"Goodwill and Other Intangible Assets." TE's goodwill amortization in the second
quarter and first half of 2001 totaled $3.1 million and $6.2 million,
respectively.
General taxes decreased by $2.7 million in the first six months of
2002, compared to the same period last year, due to state tax changes in
connection with the Ohio electric industry restructuring.
Net Interest Charges
Net interest charges increased by $2.3 million in the second quarter
of 2002, compared to the same quarter last year, reflecting in part TE's higher
short-term borrowing levels from affiliates.
Capital Resources and Liquidity
- -------------------------------
TE has continuing cash requirements for planned capital expenditures
and maturing debt. During the last half of 2002, capital requirements for
property additions are expected to be about $72 million, including $5 million
for nuclear fuel. These capital requirements include the estimated incremental
repair costs of the unplanned outage at the Davis-Besse nuclear plant discussed
below. TE also has sinking fund requirements for preferred stock and maturing
long-term debt of $152.4 million and optional debt redemptions of $15.0 million
during the remainder of 2002. These cash requirements are expected to be
satisfied from internal cash and short-term credit arrangements.
As of June 30, 2002, TE had about $16.4 million of cash and temporary
investments and $134.2 million of short-term indebtedness to associated
companies. Under its first mortgage indenture, excluding property additions
associated with the planned sale of the Bay Shore Plant. TE had the capability
to issue up to $131 million of additional first mortgage bonds on the basis of
property additions and retired bonds as of June 30, 2002. Under the earnings
coverage test contained in TE's charter, no preferred stock could be issued
based on earnings through the second quarter of 2002.
On April 30, 2002, the Nuclear Regulatory Commission (NRC) initiated a
formal inspection process at the Davis-Besse nuclear plant. This action was
taken in response to corrosion found by FirstEnergy in the reactor vessel head
near the nozzle penetration hole during a refueling outage in the first quarter
of 2002. The purpose of the formal inspection process is to establish criteria
for NRC oversight of the licensee's performance and to provide a record of the
major regulatory and licensee actions taken, and technical issues resolved,
leading to the NRC's approval of restart of the plant.
On May 23, 2002, FirstEnergy purchased an unused reactor vessel head
from Consumers Energy's Midland Nuclear Plant - similar in design to the
Davis-Besse Plant. In addition to refurbishment and installation work at the
plant, FirstEnergy has made significant changes in senior and mid-level managers
at the plant and in its corporate nuclear organization. It has also established
an independent oversight panel consisting of industry experts to assist in
Davis-Besse restart efforts and to provide advice regarding the safe return of
Davis-Besse to service. FirstEnergy expects to complete refurbishment and
installation of the replacement reactor head as well as any other work related
to restart of the plant in the fourth quarter of this year. The NRC must
authorize restart of the plant following its formal inspection process before
the unit can be returned to service.
50
The estimated, incremental costs (capital and expense) associated with
the extended Davis-Besse outage (TE share - 48.62%) in 2002 are:
Incremental Costs of Davis-Besse Extended Outage (100%)
- -------------------------------------------------------
Expenditure Range
-----------------
(In millions)
Replace reactor vessel head (principally capital expenditures). $55 - $75
Primarily operating expenses (pre-tax):
Additional maintenance (including acceleration of programs).... $50 - $70
Replacement power for July and August 2002..................... $40
Replacement power for September through December 2002.......... $40 - $60
On July 31, 2002, Fitch revised its rating outlook for TE securities
to negative from stable. The revised outlook reflects the adverse impact of the
unplanned outage at the Davis-Besse Plant and Fitch's judgment at that time
about NRG's financial ability to consummate the purchase of four power plants
from FirstEnergy and Fitch's expectation of subsequent delays in debt reduction.
State Regulatory Matters
- ------------------------
The transition cost portion of TE's rates provides for recovery of
certain amounts not otherwise recoverable in a competitive generation market
(such as regulatory assets). Transition costs are paid by all customers whether
or not they choose an alternative supplier. Under the PUCO-approved transition
plan, TE assumed the risk of not recovering up to $80 million of transition
revenue if the rate of customers (excluding contracts and full-service accounts)
switching their service from TE does not reach 20% for any consecutive
twelve-month period by December 31, 2005 - the end of the market development
period. As of June 30, 2002, the annualized customer-switching rate essentially
eliminated TE's risk of not recovering transition costs, since over 113,000 of
its customers have requested generation services from other authorized
suppliers.
Environmental Matters
- ---------------------
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of June 30, 2002, based on estimates of the total
costs of cleanup, TE's proportionate responsibility for such costs and the
financial ability of other nonaffiliated entities to pay. TE has been named 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. TE has accrued liabilities of
approximately $0.2 million as of June 30, 2002, and does not believe
environmental remediation costs will have a material adverse effect on its
financial condition, cash flows or results of operations.
Significant Accounting Policies
- -------------------------------
TE prepares its 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 TE's financial results. All of TE's assets are subject
to their own specific risks and uncertainties and are regularly reviewed for
impairment. TE's goodwill will be reviewed for impairment at least annually in
accordance with SFAS 142. FirstEnergy's most recent review was completed in June
2002. The results of that review indicate that no impairment of goodwill is
appropriate. Assets related to the application of the policies discussed below
are similarly reviewed with their risks and uncertainties reflecting these
specific factors. TE's more significant accounting policies are described below.
Regulatory Accounting
TE is subject to regulation that sets the prices (rates) it is
permitted to charge customers based on the costs that regulatory agencies
determine TE is permitted to recover. At times, regulators permit the future
recovery through rates of costs that would be currently charged to expense by an
unregulated company. This rate-making process results in the recording of
regulatory assets based on anticipated future cash inflows. As a result of the
changing regulatory framework in Ohio, a significant amount of regulatory assets
have been recorded - $401 million as of June 30, 2002. TE regularly reviews
these assets to assess their ultimate recoverability within the approved
regulatory guidelines. Impairment risk associated with these assets relates to
potentially adverse legislative, judicial or regulatory actions in the future.
51
Revenue Recognition
TE follows the accrual method of accounting for revenues, recognizing
revenue for kilowatt-hours that have been delivered but not yet billed through
the end of the accounting period. The determination of unbilled revenues
requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Allocations to distribution companies within the FirstEnergy system
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 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 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 cost to settle the retirement obligation differs from the carrying
amount. TE has identified various applicable legal obligations as defined under
the new standard and expects to have completed an analysis of their financial
impact in the second half of 2002.
52
PENNSYLVANIA POWER COMPANY
STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
OPERATING REVENUES........................................ $127,737 $124,701 $252,072 $253,098
-------- -------- -------- --------
OPERATING EXPENSES AND TAXES:
Fuel................................................... 6,379 5,887 12,712 12,528
Purchased power........................................ 35,663 33,791 75,626 79,559
Nuclear operating costs................................ 19,473 19,252 41,805 39,517
Other operating costs.................................. 9,717 11,897 19,669 22,193
-------- -------- -------- --------
Total operation and maintenance expenses........... 71,232 70,827 149,812 153,797
Provision for depreciation and amortization............ 14,208 14,267 28,412 28,530
General taxes.......................................... 6,006 1,261 12,010 5,741
Income taxes........................................... 14,835 15,482 25,251 26,157
-------- -------- -------- --------
Total operating expenses and taxes................. 106,281 101,837 215,485 214,225
-------- -------- -------- --------
OPERATING INCOME.......................................... 21,456 22,864 36,587 38,873
OTHER INCOME.............................................. 476 747 1,141 1,622
-------- -------- -------- --------
INCOME BEFORE NET INTEREST CHARGES........................ 21,932 23,611 37,728 40,495
-------- -------- -------- --------
NET INTEREST CHARGES:
Interest expense....................................... 4,268 4,674 8,366 9,402
Allowance for borrowed funds used during construction.. (345) (108) (597) (340)
-------- -------- -------- --------
Net interest charges............................... 3,923 4,566 7,769 9,062
-------- -------- -------- --------
NET INCOME................................................ 18,009 19,045 29,959 31,433
PREFERRED STOCK DIVIDEND REQUIREMENTS..................... 926 926 1,852 1,852
-------- -------- -------- --------
EARNINGS ON COMMON STOCK.................................. $ 17,083 $ 18,119 $ 28,107 $ 29,581
======== ======== ======== ========
<FN>
The preceding Notes to Financial Statements as they relate to Pennsylvania Power Company are an integral part of these statements.
</FN>
53
PENNSYLVANIA POWER COMPANY
BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
-------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $672,863 $664,432
Less--Accumulated provision for depreciation.............................. 301,051 290,216
-------- --------
371,812 374,216
-------- --------
Construction work in progress-
Electric plant.......................................................... 30,751 24,141
Nuclear fuel............................................................ 469 2,921
-------- --------
31,220 27,062
-------- --------
403,032 401,278
-------- --------
OTHER PROPERTY AND INVESTMENTS:
Nuclear plant decommissioning trusts...................................... 121,309 116,634
Long-term notes receivable from associated companies...................... 39,109 39,290
Other..................................................................... 21,916 21,597
-------- --------
182,334 177,521
-------- --------
CURRENT ASSETS:
Cash and cash equivalents................................................. 590 67
Receivables-
Customers (less accumulated provisions of $666,000 and $619,000,
respectively, for uncollectible accounts)............................. 48,991 40,890
Associated companies.................................................... 32,813 36,491
Other................................................................... 4,384 4,787
Notes receivable from associated companies................................ 37,718 54,411
Materials and supplies, at average cost................................... 27,881 25,598
Prepayments............................................................... 14,465 5,682
-------- --------
166,842 167,926
-------- --------
DEFERRED CHARGES:
Regulatory assets......................................................... 182,570 208,838
Other..................................................................... 4,596 4,534
-------- --------
187,166 213,372
-------- --------
$939,374 $960,097
======== ========
54
PENNSYLVANIA POWER COMPANY
BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
-------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, $30 par value, authorized 6,500,000 shares -
6,290,000 shares outstanding.......................................... $188,700 $188,700
Other paid-in capital................................................... (310) (310)
Retained earnings....................................................... 55,706 35,398
-------- --------
Total common stockholder's equity................................... 244,096 223,788
Preferred stock-
Not subject to mandatory redemption..................................... 39,105 39,105
Subject to mandatory redemption......................................... 14,250 14,250
Long-term debt-
Associated companies.................................................... -- 21,064
Other................................................................... 240,480 240,983
-------- --------
537,931 539,190
-------- --------
CURRENT LIABILITIES:
Currently payable long-term debt-
Associated companies.................................................... -- 18,090
Other................................................................... 12,077 12,075
Accounts payable-
Associated companies.................................................... 29,798 50,604
Other................................................................... 3,341 1,441
Accrued taxes............................................................. 41,942 18,853
Accrued interest.......................................................... 5,333 5,264
Other..................................................................... 9,063 9,675
-------- --------
101,554 116,002
-------- --------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 126,803 136,808
Accumulated deferred investment tax credits............................... 3,959 4,108
Nuclear plant decommissioning costs....................................... 121,771 117,096
Other..................................................................... 47,356 46,893
-------- --------
299,889 304,905
-------- --------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)...........................
-------- --------
$939,374 $960,097
======== ========
<FN>
The preceding Notes to Financial Statements as they relate to Pennsylvania Power Company are an integral part of these balance
sheets.
</FN>
55
PENNSYLVANIA POWER COMPANY
STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ----------------------
2002 2001 2002 2001
------- -------- -------- --------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $18,009 $ 19,045 $ 29,959 $ 31,433
Adjustments to reconcile net income to net
cash from operating activities-
Provision for depreciation and amortization........ 14,208 14,267 28,412 28,530
Nuclear fuel and lease amortization................ 4,852 4,359 9,568 9,241
Deferred income taxes, net......................... (1,950) (3,555) (3,875) (6,036)
Investment tax credits, net........................ (655) (699) (1,320) (1,410)
Receivables........................................ (3,338) (7,751) (4,020) 1,314
Materials and supplies............................. (1,711) (1,656) (2,283) 6,308
Accounts payable................................... (3,147) 7,347 (18,906) (26,007)
Accrued taxes ..................................... 12,439 (3,505) 23,089 3,369
Other.............................................. 7,220 7,128 (8,162) (8,616)
------- -------- -------- --------
Net cash provided from operating activities...... 45,927 34,980 52,462 38,126
------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
New Financing-
Long-term debt....................................... -- 32,603 -- 32,603
Redemptions and Repayments-
Long-term debt....................................... 623 4,804 41,290 9,722
Dividend Payments-
Common stock......................................... -- -- 7,800 6,300
Preferred stock...................................... 926 926 1,852 1,852
------- -------- -------- --------
Net cash used for (provided from) financing
activities ..................................... 1,549 (26,873) 50,942 (14,729)
------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions..................................... 8,343 8,552 16,426 13,910
Loans to associated companies.......................... 36,357 30,828 -- 30,828
Loan payment from parent............................... -- -- (16,706) (13,640)
Sale of assets to associated companies................. -- (6,053) -- (6,053)
Other.................................................. 89 (3,175) 1,277 (2,860)
------- -------- -------- --------
Net cash used for investing activities........... 44,789 30,152 997 22,185
------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents...... (411) 31,701 523 30,670
Cash and cash equivalents at beginning of period.......... 1,001 2,444 67 3,475
------- -------- -------- --------
Cash and cash equivalents at end of period................ $ 590 $ 34,145 $ 590 $ 34,145
======= ======== ======== ========
<FN>
The preceding Notes to Financial Statements as they relate to Pennsylvania Power Company are an integral part of these statements.
</FN>
56
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Pennsylvania
Power Company:
We have reviewed the accompanying balance sheet of Pennsylvania Power Company as
of June 30, 2002, and the related statements of income and cash flows for each
of the three-month and six-month periods ended June 30, 2002. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying interim financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
57
PENNSYLVANIA POWER COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Penn is a wholly owned electric utility subsidiary of OE. Penn
provides regulated electric distribution services in western Pennsylvania. Penn
also provides generation services to those customers electing to retain Penn as
their power supplier. Penn provides power directly to wholesale customers under
previously negotiated contracts. Penn's regulatory plan itemizes, or unbundles,
the price of electricity into its component elements - including generation,
transmission, distribution and transition charges. Penn's power supply
requirements are provided by FES - an affiliated company.
Results of Operations
- ---------------------
Operating revenues increased by $3.0 million or 2.4% in the second
quarter and decreased by $1.0 million or 0.4% in the first half of 2002, as
compared to the same periods of 2001. Higher operating revenues in the second
quarter of 2002 primarily resulted from the return of generation customers
previously served by alternative suppliers, while lower year-to-date operating
revenues principally resulted from reduced sales revenues to wholesale
customers. Sales of electric generation by alternative suppliers as a percent of
total sales delivered in Penn's franchise area decreased to 0.4% in the second
quarter of 2002 from 5.0% in the same period last year. During the first six
months of 2002, Penn's share of electric generation sales in its franchise area
increased by 6.9 percentage points, compared to the same period in 2001.
Distribution revenues changed very little in the second quarter and
first six months of 2002, compared to the same periods last year. Higher
residential sales, which benefited from warmer weather in June 2002, increased
in both periods but were more than offset in the first six months of 2002 by
reduced deliveries to commercial and industrial customers, as a result of the
decline in economic conditions.
Lower wholesale revenues partially offset higher generation and
distribution revenues in the second quarter of 2002 moderating the increase in
operating revenues in that period and resulted in a decrease in revenues during
the first six months of 2002, compared to the prior year. Reduced sales revenues
from FES accounted for nearly all of the decrease in wholesale revenues in both
periods.
The sources of changes in operating revenues during the second quarter
and first six months of 2002, compared with the corresponding periods of 2001,
are summarized in the following table:
Sources of Operating Revenue Changes
------------------------------------
Increase (Decrease)
Periods Ending June 30, 2002
----------------------------
3 Months 6 Months
-------- --------
(In millions)
Retail:
Generation sales............................. $ 6.4 $ 9.9
Distribution deliveries...................... 0.9 (0.2)
----- ------
Total Retail................................. 7.3 9.7
Wholesale...................................... (3.6) (11.7)
Other.......................................... (0.7) 1.0
----- ------
Net Increase (Decrease) in Operating Revenues.. $ 3.0 $ (1.0)
===== ======
Operating Expenses and Taxes
Total operating expenses and taxes increased by $4.4 million in the
second quarter and $1.3 million in the first six months of 2002 from the
corresponding period of 2001. Purchased power costs increased $1.9 million in
the second quarter of 2002 from the same quarter last year as a result of higher
volume requirements for customers returning from alternative suppliers. This
increase was partially offset by reduced unit costs. During the first six
months, purchased power costs decreased $3.9 million with lower unit costs more
than offsetting the additional volume purchased to supply generation
kilowatt-hour sales. In the first six months of 2002, nuclear operating costs
increased by $2.3 million from the same period last year, primarily due to a
larger ownership share of capacity in the refueling outage for Beaver Valley
Unit 2 (13.74% owned) in the first quarter of 2002, compared to the Perry Plant
(5.24% owned) in the first quarter of 2001.
58
General taxes increased by $4.7 million in the second quarter and $6.3
million in the first half of 2002 due in part to the successful resolution of
certain property tax issues in the second quarter of 2001, which provided a
one-time benefit of $3.0 million in that year. An increase in the gross receipts
tax rate for 2002 also contributed to the increase in general taxes for both
periods.
Capital Resources and Liquidity
- -------------------------------
Penn has continuing cash requirements for planned capital expenditures
and maturing debt. During the last two quarters of 2002, capital requirements
for property additions and capital leases are expected to be about $27 million,
including $5 million for nuclear fuel. Penn also has sinking fund requirements
for preferred stock and maturing long-term debt of $1.2 million during the
remainder of 2002. These requirements are expected to be satisfied from internal
cash and/or short-term credit arrangements.
As of June 30, 2002, Penn had about $38.3 million of cash and
temporary investments and no short-term indebtedness. Under its first mortgage
indenture, as of June 30, 2002, Penn had the capability to issue up to $290
million of additional first mortgage bonds on the basis of property additions
and retired bonds. Under the earnings coverage test contained in Penn's charter,
$188 million of preferred stock (assuming no additional debt was issued) could
be issued based on earnings through the second quarter of 2002.
Significant Accounting Policies
- -------------------------------
Penn prepares its 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 Penn's financial results. All of Penn's assets are subject to their
own specific risks and uncertainties and are regularly reviewed for impairment.
Assets related to the application of the policies discussed below are similarly
reviewed with their risks and uncertainties reflecting these specific factors.
Penn's more significant accounting policies are described below.
Regulatory Accounting
Penn is subject to regulation that sets the prices (rates) it is
permitted to charge customers based on the costs that regulatory agencies
determine Penn is 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 - $183 million as of
June 30, 2002. Penn regularly reviews these assets to assess their ultimate
recoverability within the approved regulatory guidelines. Impairment risk
associated with these assets relates to potentially adverse legislative,
judicial or regulatory actions in the future.
Revenue Recognition
Penn follows the accrual method of accounting for revenues,
recognizing revenue for kilowatt-hours that have been delivered but not yet
billed through the end of the accounting period. The determination of unbilled
revenues requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Allocations to distribution companies within the FirstEnergy system
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 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 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 cost to settle the retirement obligation differs from the carrying
amount. Penn has identified various applicable legal obligations as defined
under the new standard and expects to complete an analysis of their financial
impact in the second half of 2002.
59
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
OPERATING REVENUES........................................ $501,232 | $521,054 $951,945 | $982,736
-------- | -------- -------- | --------
| |
| |
OPERATING EXPENSES AND TAXES: | |
Fuel................................................... 1,298 | 1,440 2,474 | 2,778
Purchased power........................................ 249,466 | 275,627 460,451 | 491,293
Other operating costs.................................. 74,100 | 67,812 142,617 | 131,456
-------- | -------- -------- | --------
Total operation and maintenance expenses........... 324,864 | 344,879 605,542 | 625,527
Provision for depreciation and amortization............ 55,371 | 62,684 119,274 | 124,433
General taxes.......................................... 4,294 | 15,081 21,297 | 30,654
Income taxes........................................... 38,543 | 29,103 66,404 | 59,331
-------- | -------- -------- | --------
Total operating expenses and taxes................. 423,072 | 451,747 812,517 | 839,945
-------- | -------- -------- | --------
| |
OPERATING INCOME.......................................... 78,160 | 69,307 139,428 | 142,791
| |
OTHER INCOME.............................................. 2,196 | 2,401 5,022 | 3,559
-------- | -------- -------- | --------
| |
INCOME BEFORE NET INTEREST CHARGES........................ 80,356 | 71,708 144,450 | 146,350
-------- | -------- -------- | --------
| |
NET INTEREST CHARGES: | |
Interest on long-term debt............................. 22,768 | 22,821 45,485 | 44,030
Allowance for borrowed funds used during construction.. (97) | 3 (579) | (431)
Deferred interest...................................... (1,834) | (3,330) (1,385) | (6,406)
Other interest expense (credit)........................ (533) | 3,485 (1,777) | 6,371
Subsidiaries' preferred stock dividend requirements.... 2,672 | 2,675 5,347 | 5,350
-------- | -------- -------- | --------
Net interest charges............................... 22,976 | 25,654 47,091 | 48,914
-------- | -------- -------- | --------
| |
NET INCOME................................................ 57,380 | 46,054 97,359 | 97,436
| |
PREFERRED STOCK DIVIDEND REQUIREMENTS..................... 431 | 1,391 1,184 | 2,782
-------- | -------- -------- | --------
| |
EARNINGS ON COMMON STOCK.................................. $ 56,949 | $ 44,663 $ 96,175 | $ 94,654
======== | ======== ======== | ========
<FN>
The preceding Notes to Financial Statements as they relate to Jersey Central Power & Light Company are an integral part of these
statements.
</FN>
60
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
---------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $3,496,702 $3,431,823
Less--Accumulated provision for depreciation.............................. 1,369,453 1,313,259
---------- ----------
2,127,249 2,118,564
Construction work in progress - electric plant............................ 37,643 60,482
---------- ----------
2,164,892 2,179,046
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Nuclear plant decommissioning trusts...................................... 112,768 114,899
Nuclear fuel disposal trust............................................... 141,271 137,098
Long-term notes receivable from associated companies...................... 20,333 20,333
Other..................................................................... 11,908 6,643
---------- ----------
286,280 278,973
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 247,296 31,424
Receivables-
Customers (less accumulated provisions of $10,353,000 and $12,923,000,
respectively, for uncollectible accounts).............................. 221,683 226,392
Associated companies.................................................... 692 6,412
Other .................................................................. 21,221 20,729
Materials and supplies, at average cost................................... 1,303 1,348
Prepayments and other..................................................... 88,820 16,569
---------- ----------
581,015 302,874
---------- ----------
DEFERRED CHARGES:
Regulatory assets......................................................... 3,180,896 3,324,804
Goodwill.................................................................. 1,926,526 1,926,526
Other..................................................................... 27,944 27,775
---------- ----------
5,135,366 5,279,105
---------- ----------
$8,167,553 $8,039,998
========== ==========
61
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
---------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, par value $10 per share, authorized 16,000,000 shares -
15,371,270 shares outstanding......................................... $ 153,713 $ 153,713
Other paid-in capital................................................... 2,981,117 2,981,117
Accumulated other comprehensive loss.................................... (640) (472)
Retained earnings....................................................... 59,518 29,343
---------- ----------
Total common stockholder's equity................................... 3,193,708 3,163,701
Preferred stock-
Not subject to mandatory redemption..................................... 12,649 12,649
Subject to mandatory redemption......................................... -- 44,868
Company-obligated mandatorily redeemable preferred securities............. 125,247 125,250
Long-term debt............................................................ 1,223,520 1,224,001
---------- ----------
4,555,124 4,570,469
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock...................... 365,361 60,848
Accounts payable-
Associated companies.................................................... 179,264 171,168
Other................................................................... 114,587 89,739
Notes payable to associated companies..................................... -- 18,149
Accrued taxes............................................................. 7,323 35,783
Accrued interest.......................................................... 24,026 25,536
Other..................................................................... 136,305 79,589
---------- ----------
826,866 480,812
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 579,425 514,216
Accumulated deferred investment tax credits............................... 11,691 13,490
Power purchase contract loss liability.................................... 1,757,948 1,968,823
Nuclear fuel disposal costs............................................... 164,834 163,377
Nuclear plant decommissioning costs....................................... 137,308 137,424
Other..................................................................... 134,357 191,387
---------- ----------
2,785,563 2,988,717
---------- ----------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)...........................
---------- ----------
$8,167,553 $8,039,998
========== ==========
<FN>
The preceding Notes to Financial Statements as they relate to Jersey Central Power & Light Company are an integral part of these
balance sheets.
</FN>
62
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ------------------------
2002 2001 2002 2001
--------- -------- --------- ---------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: | |
Net income................................................ $ 57,380 | $ 46,054 $ 97,359 | $ 97,436
Adjustments to reconcile net income to net | |
cash from operating activities- | |
Provision for depreciation and amortization........ 55,371 | 62,684 119,274 | 124,433
Other amortization................................. 940 | 9,538 1,451 | 18,590
Deferred costs, net................................ (43,340) | (63,137) (108,948) | (113,874)
Deferred income taxes, net......................... 27,862 | 3,507 36,540 | 19,918
Investment tax credits, net........................ (900) | (900) (1,799) | (1,799)
Receivables........................................ (34,185) | (37,735) 9,937 | (105,386)
Materials and supplies............................. 39 | (815) 45 | (843)
Accounts payable................................... 37,910 | 47,133 32,944 | (30,031)
Prepayments ....................................... (76,906) | (64,927) (70,650) | 26,465
Accrued taxes ..................................... (63,030) | (1,910) (28,460) | 33,301
Other.............................................. (4,347) | 84 1,491 | (17,250)
--------- | -------- --------- | ---------
Net cash provided from (used for) operating | |
activities ..................................... (43,206) | (424) 89,184 | 50,960
--------- | -------- --------- | ---------
| |
| |
CASH FLOWS FROM FINANCING ACTIVITIES: | |
New Financing- | |
Long-term debt....................................... 318,106 | 148,796 318,106 | 148,796
Short-term borrowings, net........................... -- | 13,700 -- | 76,800
Redemptions and Repayments- | |
Preferred stock...................................... 5,000 | 2,500 5,000 | 2,500
Long-term debt....................................... -- | -- 50,000 | --
Short-term borrowings, net........................... -- | -- 18,149 | --
Dividend Payments- | |
Common stock......................................... 66,000 | -- 66,000 | 75,000
Preferred stock...................................... 991 | 1,391 1,744 | 2,782
--------- | -------- --------- | ---------
Net cash provided from financing activities...... 246,115 | 158,605 177,213 | 145,314
--------- | -------- --------- | ---------
| |
| |
CASH FLOWS FROM INVESTING ACTIVITIES: | |
Property additions..................................... 20,932 | 44,972 46,834 | 78,085
Decommissioning trust investments...................... 608 | 304 709 | 598
Other.................................................. 1,690 | 1,646 2,982 | 3,321
--------- | -------- --------- | ---------
Net cash used for investing activities........... 23,230 | 46,922 50,525 | 82,004
--------- | -------- --------- | ---------
| |
| |
Net increase in cash and cash equivalents................. 179,679 | 111,259 215,872 | 114,270
Cash and cash equivalents at beginning of period.......... 67,617 | 5,032 31,424 | 2,021
--------- | -------- --------- | ---------
Cash and cash equivalents at end of period................ $ 247,296 | $116,291 $ 247,296 | $ 116,291
========= | ======== ========= | =========
<FN>
The preceding Notes to Financial Statements as they relate to Jersey Power & Light Company are an integral part of these statements.
</FN>
63
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Jersey Central
Power & Light Company:
We have reviewed the accompanying consolidated balance sheet of Jersey Central
Power & Light Company and its subsidiaries as of June 30, 2002, and the related
consolidated statements of income and cash flows for each of the three-month and
six-month periods ended June 30, 2002. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
64
JERSEY CENTRAL POWER & LIGHT COMPANY
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
JCP&L is a wholly owned electric utility subsidiary of FirstEnergy.
JCP&L conducts business in northern, western and east central New Jersey,
offering regulated electric transmission and distribution services. JCP&L also
provides power to those customers electing to retain them as their power
supplier. JCP&L's regulatory plan itemizes, or unbundles, the price of
electricity into its component elements - including generation, transmission,
distribution and transition charges. JCP&L was formerly a wholly owned
subsidiary of GPU, Inc., which merged with FirstEnergy on November 7, 2001.
Results of Operations
- ---------------------
Operating revenues decreased by $19.8 million or 3.8% in the second
quarter of 2002, and by $30.8 million or 3.1% in the first half of 2002,
compared to the same periods in 2001. The sources of the changes in operating
revenues, as compared to the same periods in 2001, are summarized in the
following table.
Three Months Ended Six Months Ended
Sources of Operating Revenue Changes June 30, 2002 June 30, 2002
- --------------------------------------------------------------------------------
Increase (Decrease) (In millions)
Change in kilowatt-hour sales due to
level of retail customers shopping
for generation service ................ $ 16.1 $ 43.1
Change in other retail kilowatt-hour
sales ................................. (2.7) (38.3)
Change in wholesale sales ............... (38.9) (38.9)
All other changes ....................... 5.7 3.3
------- ------
Net Decrease in Operating Revenues ...... $(19.8) $(30.8)
====== ======
Electric Sales
In the first half of 2002, a significant reduction in the number of
customers who received their power from alternate suppliers continued to have a
positive effect on operating revenues. During the first six months of 2001, 8.7%
of kilowatt-hours delivered were to shopping customers, whereas only 0.5% of
kilowatt-hours delivered during the first six months of 2002 were to shopping
customers. More than offsetting this increase in revenues from returning
shopping customers were lower sales to wholesale customers during the first half
of 2002. A decline in economic conditions resulted in a decrease in sales to
industrial customers during the six months ended June 30, 2002; however,
conditions began to improve in the second quarter of 2002, resulting in a slight
increase in industrial sales during that period. Changes in kilowatt-hour
deliveries by customer class during the three and six months ended June 30,
2002, as compared to the same periods in 2001, are summarized in the following
table:
Changes in Distribution Deliveries Three Months Ended Six Months Ended
and Wholesale Generation Sales June 30, 2002 June 30, 2002
- --------------------------------------------------------------------------------
Increase (Decrease)
Residential............................ 1.1% (1.8)%
Commercial............................. -- % 0.5 %
Industrial............................. 0.8% (3.0)%
----- -----
Total Retail........................... 0.5% (1.1)%
Wholesale.............................. (72.0)% (71.1)%
----- -----
Total ................................. (8.7)% (6.4)%
===== =====
Operating Expenses and Taxes
Total operating expenses and taxes decreased by $28.7 million in the
second quarter of 2002, and $27.4 million in the first six months of 2002,
compared to the same periods in 2001. Purchased power costs decreased by $26.2
million and $30.8 million for the three and six month periods ended June 30,
2002, respectively, compared to the same periods in 2001, as a result of less
power required and lower unit costs. Higher other operating costs of $6.3
million and $11.2 million in the three and six month periods ended June 30,
2002, respectively, were partially attributable to increases in pension and
other employee benefit costs. Decreases in depreciation and amortization
expenses of $7.3 million and $5.2 million for the
65
three and six month periods ended June 30, 2002, respectively, were due
primarily to the cessation of amortization of regulatory assets related to the
net investment in the previously divested Oyster Creek Nuclear Generating
Station, which transferred to JCP&L Transition Funding LLC as bondable
transition property during the second quarter of 2002 (see New Jersey Regulatory
Matters for further discussion). These decreases were offset by higher
depreciation due to higher average depreciable plant balances in the quarter and
six months ended June 30, 2002 versus the same periods in 2001.
General taxes decreased by $10.8 million in the second quarter and
$9.4 million in the first six months of 2002, compared to the same periods in
2001 due principally to a reduction in the transitional energy facilities
assessment.
Net Interest Charges
Net interest charges decreased by $2.7 million in the second quarter
and $1.8 million in the first six months of 2002, compared to the same periods
in 2001, primarily due to reduced short-term borrowing levels and amortization
of fair value adjustments recognized in connection with the merger. Net interest
charges were also affected by the issuance of $150 million of notes in May 2001,
and $320 million of transition bonds by a special purpose finance subsidiary in
June 2002, as well as the redemption of $40 million of notes in November 2001
and $50 million of notes in March 2002. These transactions had an offsetting
effect on net interest charges for the quarter ended June 30, 2002, and resulted
in a $1.5 million increase in net interest charges for the six months ended June
30, 2002.
Capital Resources and Liquidity
- -------------------------------
JCP&L has continuing cash requirements for planned capital
expenditures and preferred stock sinking fund requirements, which are expected
to be satisfied from internal cash and/or short-term credit arrangements. During
the remaining six months of 2002, capital requirements for property additions
are expected to be about $70.0 million. As of June 30, 2002, JCP&L had mandatory
sinking fund requirements for preferred stock of $8.3 million, which JCP&L
satisfied in July 2002, in addition to $8.3 million of preferred stock it
redeemed pursuant to an optional sinking fund provision. In July and August
2002, JCP&L also used proceeds from the sale of transition bonds (see New Jersey
Regulatory Matters) to redeem $142.0 million of long-term debt and $29.8 million
of preferred stock.
As of June 30, 2002, JCP&L had about $247.3 million of cash and
temporary investments, and no short-term indebtedness. JCP&L may borrow from its
affiliates on a short-term basis. JCP&L will not issue first mortgage bonds
(FMBs) other than as collateral for senior notes, since its senior note
indenture prohibits (subject to certain exceptions) it from issuing any debt
which is senior to the senior notes. As of June 30, 2002, JCP&L had the
capability to issue up to $291 million of additional FMBs on the basis of
retired bonds. Based upon applicable earnings coverage tests and its charter,
JCP&L could issue $126.6 million of preferred stock (assuming no additional debt
was issued) based on earnings through June 30, 2002.
Market Risk Information
- -----------------------
JCP&L uses various market sensitive instruments, including derivative
contracts, primarily to manage the risk of price fluctuations. JCP&L's 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
JCP&L is exposed to market risk primarily due to fluctuations in
electricity and natural gas prices. To manage the volatility relating to these
exposures, JCP&L uses a variety of derivative instruments, including forward
contracts, options and futures contracts. The derivatives are used for hedging
purposes. The change in the fair value of commodity derivative contracts related
to energy production during the second quarter of 2002 is summarized in the
following table:
Change in the Fair Value of Commodity Derivative Contracts
----------------------------------------------------------
(In millions)
Outstanding net asset as of March 31, 2002.......... $14.6
Settled contracts................................... (3.2)
Change in techniques/assumptions.................... --
Decrease in value of existing contracts............. (5.3)
-----
Outstanding net asset as of June 30, 2002........... $ 6.1
=====
The valuation of derivative contracts is based on observable market
information to the extent that such information is available. In cases where
such information is not available, JCP&L relies on model-based information. The
model provides estimates of future regional prices for electricity and an
estimate of related price volatility. JCP&L utilizes these results in developing
estimates of fair value for the later years of applicable electricity contracts
for both financial
66
reporting purposes and for internal management decision
making. Sources of information for the valuation of derivative contracts by year
are summarized in the following table:
Source of Information - Fair Value by Contract Year
- ---------------------------------------------------
2002* 2003 2004 Thereafter Total
- --------------------------------------------------------------------------------
(In millions)
Prices actively quoted .... $0.4 $ -- $ -- $-- $0.4
Prices based on models** .. -- -- -- 5.7 5.7
---- ---- ---- ---- ----
Total ................... $0.4 $ -- $ -- $5.7 $6.1
==== ==== ==== ==== ====
* For the last half of 2002.
** Relates to an embedded option that is offset by a regulatory liability
and does not affect earnings.
JCP&L performs sensitivity analyses to estimate its exposure to the
market risk of its commodity position. A hypothetical 10% adverse shift in
quoted market prices and volatilities in the near term on derivative instruments
would not have had a material effect on JCP&L's consolidated financial position
or cash flows as of June 30, 2002.
New Jersey Regulatory Matters
- -----------------------------
Under New Jersey transition legislation, all electric distribution
companies in that state were required to file rate cases by August 1, 2002. On
August 1, 2002, JCP&L submitted two rate filings with the New Jersey Board of
Public Utilities (NJBPU). The first related to base electric rates (Delivery
Charge Filing). The second was a request to recover deferred costs (Deferral
Filing) primarily associated with mandated purchase-power contracts with
non-utility generators (NUGs) - which produce power at prices that exceed
wholesale market prices - and providing Basic Generation Service (BGS) to
customers in excess of the state's generation rate cap. The new rate structure,
when approved, becomes effective on August 1, 2003.
Delivery Charge Filing -
The delivery charge filing includes recovery of JCP&L's distribution,
transmission, customer service, administrative and general costs, along with
taxes and some assessment fees. JCP&L is requesting a decrease in the delivery
charge of $11 million, or a 0.6% rate reduction. The filing uses calendar year
2002 as the test year and is based on a net rate base value of $2.1 billion and
allowed return on common equity of 12%. The December 31, 2001 capital structure
used in the filing has been modified to eliminate purchase accounting
adjustments from the merger of FirstEnergy and GPU, Inc. and to remove a
pre-merger $300 million deferred balance write-off required by the NJBPU merger
approval order (See Deferral Filing). The modified capital structure is
comparable to JCP&L's pre-merger capital structure.
Deferral Filing -
The deferral filing addresses the current Market Transition Charge
(MTC) and Societal Benefits Charge (SBC), which were confirmed by a 2001 rate
order. The combined effect of JCP&L's MTC and SBC requests would result in a
2.8% rate increase with securitization of a deferred balance; if securitization
is not available, there would be an additional 6.5% increase with a four-year
amortization of the deferred balance.
JCP&L was authorized to defer energy-related costs incurred in
providing BGS to non-shopping retail customers and costs incurred under NUG
agreements and purchased power agreements that exceeded the amounts collected
under the current BGS and MTC rates. Additionally, in 2001, JCP&L wrote off $300
million of deferred costs upon receipt of the NJBPU merger approval order, in
order to ensure that customers receive the benefit of future merger savings.
This amount is not included in the requested deferred cost recovery.
JCP&L's filing proposes to recover the MTC deferred balance through a
securitization transaction involving the issuance of transition bonds in a
principal amount equal to the projected July 31, 2003 MTC deferred balance of
$684 million. The transition bond-related rate increase would be approximately
$69 million per year, or a 3.5% increase. An alternative to securitization of
the deferred balance would be to recover the deferred balance over a four-year
amortization period with interest. This alternative approach would require an
MTC rate increase of $195 million or an increase of 10%. JCP&L's securitization
proposal minimizes the required customer rate increase.
Stranded cost securitization would create a transition bond charge
(TBC) which would be the revenue collection mechanism for the transition bond
principal and interest payments. In June 2002, JCP&L sold $320 million principal
amount of transition bonds to securitize its net investment in the Oyster Creek
Nuclear Generating Facility. The TBC was offset by a
67
corresponding reduction in the MTC since the stranded Oyster Creek investment
was initially being amortized through the MTC. Securitization of the deferred
energy-related cost balance would require an increase in the TBC.
The 2001 rate order confirmed the establishment of the SBC to recover
costs which include nuclear plant decommissioning and manufactured gas plant
remediation. JCP&L's request would reduce the SBC by $14 million, or a 0.7% rate
decrease.
Environmental Matters
- ---------------------
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of June 30, 2002, based on estimates of the total
costs of cleanup, JCP&L's proportionate responsibility for such costs and the
financial ability of other nonaffiliated entities to pay. JCP&L 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. In addition, JCP&L has accrued
liabilities for environmental remediation of former manufactured gas plants in
New Jersey; those costs are being recovered through the SBC. JCP&L has accrued
liabilities aggregating approximately $50.0 million as of June 30, 2002. JCP&L
does not believe environmental remediation costs will have a material adverse
effect on its financial condition, cash flows or results of operations.
Significant Accounting Policies
- -------------------------------
JCP&L prepares its 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 financial results. All of JCP&L's assets are subject to
their own specific risks and uncertainties and are regularly reviewed for
impairment. Assets related to the application of the policies discussed below
are similarly reviewed with their risks and uncertainties reflecting these
specific factors. JCP&L's more significant accounting policies are described
below.
Purchase Accounting - Acquisition of GPU
On November 7, 2001, the merger between FirstEnergy and GPU became
effective, and JCP&L 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 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 JCP&L's 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. FirstEnergy's most recent review was completed in
June 2002. The results of that review indicate that no impairment of JCP&L's
$1.9 billion of goodwill is appropriate.
Regulatory Accounting
JCP&L is subject to regulation that sets the prices (rates) it is
permitted to charge customers based on costs that regulatory agencies determine
JCP&L is permitted to recover. At times, regulators permit the future recovery
through rates of costs that would be currently charged to expense by an
unregulated company. This rate-making process results in the recording of
regulatory assets based on anticipated future cash inflows. As a result of the
changing regulatory framework in New Jersey, a significant amount of regulatory
assets have been recorded - $3.2 billion as of June 30, 2002. JCP&L regularly
reviews these assets to assess their ultimate recoverability within the approved
regulatory guidelines. Impairment risk associated with these assets relates to
potentially adverse legislative, judicial or regulatory actions in the future.
Derivative Accounting
Determination of appropriate accounting for derivative transactions
requires the involvement of management representing operations, finance and risk
assessment. In order to determine the appropriate accounting for derivative
transactions, the provisions of the contract need to be carefully assessed in
accordance with the authoritative accounting literature and management's
intended use of the derivative. New authoritative guidance continues to shape
the application of derivative accounting. Management's expectations and
intentions are key factors in determining the appropriate accounting for a
derivative transaction and, as a result, such expectations and intentions must
be documented. Derivative contracts that are determined to fall within the scope
of SFAS 133, as amended, must be recorded at their fair value. Active market
prices are not always available to determine the fair value of the later years
of a contract, requiring that various assumptions and estimates be used in their
valuation. JCP&L continually monitors its derivative contracts to determine if
its
68
activities, expectations, intentions, assumptions and estimates remain
valid. As part of its normal operations, JCP&L enters into commodity contracts,
which increase the impact of derivative accounting judgments.
Revenue Recognition
JCP&L follows the accrual method of accounting for revenues,
recognizing revenue for kilowatt-hours that have been delivered but not yet
billed through the end of the accounting period. The determination of unbilled
revenues requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 2001, the Financial Accounting Standards Board 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 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 cost to settle
the retirement obligation differs from the carrying amount. JCP&L has identified
various applicable legal obligations as defined under the new standard and
expects to complete an analysis of their financial impact in the second half of
2002.
69
METROPOLITAN EDISON COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
OPERATING REVENUES........................................ $240,003 | $222,536 $485,793 | $443,556
-------- | -------- -------- | --------
| |
OPERATING EXPENSES AND TAXES: | |
Purchased power........................................ 139,961 | 128,375 288,910 | 253,602
Other operating costs.................................. 33,570 | 30,287 62,575 | 66,840
-------- | -------- -------- | --------
Total operation and maintenance expenses........... 173,531 | 158,662 351,485 | 320,442
Provision for depreciation and amortization............ 15,046 | 21,435 30,338 | 39,229
General taxes.......................................... 14,815 | 10,601 31,727 | 21,233
Income taxes........................................... 9,656 | 7,161 19,212 | 13,574
-------- | -------- -------- | --------
Total operating expenses and taxes................. 213,048 | 197,859 432,762 | 394,478
-------- | -------- -------- | --------
| |
OPERATING INCOME.......................................... 26,955 | 24,677 53,031 | 49,078
| |
OTHER INCOME.............................................. 5,456 | 5,317 10,587 | 10,002
-------- | -------- -------- | --------
| |
INCOME BEFORE NET INTEREST CHARGES........................ 32,411 | 29,994 63,618 | 59,080
-------- | -------- -------- | --------
| |
NET INTEREST CHARGES: | |
Interest on long-term debt............................. 10,227 | 9,155 20,682 | 18,309
Allowance for borrowed funds used during construction.. (280) | (27) (564) | (186)
Deferred interest...................................... (42) | -- (235) | --
Other interest expense................................. 898 | 3,137 1,171 | 5,373
Subsidiaries' preferred stock dividend requirements.... 1,941 | 1,837 3,779 | 3,675
-------- | -------- -------- | --------
Net interest charges............................... 12,744 | 14,102 24,833 | 27,171
-------- | -------- -------- | --------
| |
| |
NET INCOME................................................ $ 19,667 | $ 15,892 $ 38,785 | $ 31,909
======== | ======== ======== | ========
<FN>
The preceding Notes to Financial Statements as they relate to Metropolitan Edison Company are an integral part of these statements.
</FN>
70
METROPOLITAN EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
----------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $1,630,079 $1,609,974
Less--Accumulated provision for depreciation.............................. 552,723 530,006
---------- ----------
1,077,356 1,079,968
Construction work in progress.............................................. 12,654 14,291
---------- ----------
1,090,010 1,094,259
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Nuclear plant decommissioning trusts...................................... 162,208 157,699
Long-term notes receivable from associated companies...................... 12,418 12,418
Other..................................................................... 23,131 13,391
---------- ----------
197,757 183,508
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 5,335 25,274
Receivables-
Customers (less accumulated provisions of $10,477,000 and $12,271,000,
respectively, for uncollectible accounts)............................. 114,217 112,257
Associated companies.................................................... 17,515 8,718
Other................................................................... 19,726 16,675
Prepayments and other..................................................... 23,665 12,239
---------- ----------
180,458 175,163
---------- ----------
DEFERRED CHARGES:
Regulatory assets......................................................... 1,290,057 1,320,412
Goodwill.................................................................. 784,443 784,443
Other..................................................................... 48,877 49,402
---------- ----------
2,123,377 2,154,257
---------- ----------
$3,591,602 $3,607,187
========== ==========
71
METROPOLITAN EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
---------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
Common stockholder's equity-
Common stock, without par value, authorized 900,000 shares -
859,500 shares outstanding............................................ $1,274,325 $1,274,325
Accumulated other comprehensive income (loss)........................... (91) 11
Retained earnings....................................................... 23,402 14,617
---------- ----------
Total common stockholder's equity................................... 1,297,636 1,288,953
Company-obligated trust preferred securities.............................. 92,304 92,200
Long-term debt............................................................ 570,968 583,077
---------- ----------
1,960,908 1,964,230
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt.......................................... 60,029 30,029
Accounts payable-
Associated companies.................................................... 60,403 67,351
Other................................................................... 40,773 36,750
Notes payable to associated companies..................................... 71,152 72,011
Accrued taxes............................................................. 1,949 7,037
Accrued interest.......................................................... 17,904 17,468
Other..................................................................... 11,267 13,652
---------- ----------
263,477 244,298
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 315,630 300,438
Accumulated deferred investment tax credits............................... 12,886 13,310
Purchase power contract loss liability.................................... 686,517 730,662
Nuclear fuel disposal costs............................................... 37,235 36,906
Nuclear plant decommissioning costs....................................... 270,499 268,967
Other..................................................................... 44,450 48,376
---------- ----------
1,367,217 1,398,659
---------- ----------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)...........................
---------- ----------
$3,591,602 $3,607,187
========== ==========
<FN>
The preceding Notes to Financial Statements as they relate to Metropolitan Edison Company are an integral part of these balance
sheets.
</FN>
72
METROPOLITAN EDISON COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: | |
Net income................................................ $ 19,667 | $ 15,892 $ 38,785 | $ 31,909
Adjustments to reconcile net income to net | |
cash from operating activities- | |
Provision for depreciation and amortization........ 15,046 | 21,435 30,338 | 39,229
Other amortization................................. (456) | 519 (1,394) | 756
Deferred costs, net................................ (8,826) | (24,690) (2,937) | (24,394)
Deferred income taxes, net......................... 6,937 | 9,505 9,504 | 10,877
Investment tax credits, net........................ (212) | (212) (424) | (424)
Receivables........................................ (26,722) | (13,973) (13,808) | (14,146)
Accounts payable................................... 17,887 | 60,029 (2,925) | 57,746
Other.............................................. 14,375 | 7,070 (36,956) | (33,403)
-------- | -------- -------- | --------
Net cash provided from operating activities...... 37,696 | 75,575 20,183 | 68,150
-------- | -------- -------- | --------
| |
CASH FLOWS FROM FINANCING ACTIVITIES: | |
New Financing- | |
Long-term debt....................................... 49,750 | -- 49,750 | --
Short-term borrowings, net........................... -- | 11,100 -- | 51,400
Redemptions and Repayments- | |
Long-term debt....................................... -- | -- 30,000 | --
Short-term borrowings, net........................... 56,406 | -- 859 | --
Dividend Payments- | |
Common stock......................................... 30,000 | -- 30,000 | 15,000
-------- | -------- -------- | --------
Net cash used for (provided from) financing | |
activities ..................................... 36,656 | (11,100) 11,109 | (36,400)
-------- | -------- -------- | --------
| |
CASH FLOWS FROM INVESTING ACTIVITIES: | |
Property additions..................................... 11,691 | 13,229 20,787 | 25,022
Decommissioning trust investments...................... 4,826 | 2,371 7,987 | 4,742
Other.................................................. -- | 1,564 239 | 4,555
-------- | -------- -------- | --------
Net cash used for investing activities........... 16,517 | 17,164 29,013 | 34,319
-------- | -------- -------- | --------
| |
Net increase (decrease) in cash and cash equivalents...... (15,477) | 69,511 (19,939) | 70,231
Cash and cash equivalents at beginning of period.......... 20,812 | 4,159 25,274 | 3,439
-------- | -------- -------- | --------
Cash and cash equivalents at end of period................ $ 5,335 | $ 73,670 $ 5,335 | $ 73,670
======== | ======== ======== | ========
<FN>
The preceding Notes to Financial Statements as they relate to Metropolitan Edison Company are an integral part of these statements.
</FN>
73
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Metropolitan
Edison Company:
We have reviewed the accompanying consolidated balance sheet of Metropolitan
Edison Company and its subsidiaries as of June 30, 2002, and the related
consolidated statements of income and cash flows for each of the three-month and
six-month periods ended June 30, 2002. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
74
METROPOLITAN EDISON COMPANY
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
Met-Ed is a wholly owned electric utility subsidiary of FirstEnergy.
Met-Ed conducts business in the eastern and south central portions of
Pennsylvania, offering regulated electric transmission and distribution
services. Met-Ed also provides power to those customers electing to retain them
as their power supplier. Met-Ed's regulatory plan itemizes, or unbundles, the
price of electricity into its component elements - including generation,
transmission, distribution and transition charges. Met-Ed was formerly a wholly
owned subsidiary of GPU, Inc., which merged with FirstEnergy on November 7,
2001.
Results of Operations
- ---------------------
Operating revenues increased by $17.4 million or 7.9% in the second
quarter of 2002, and by $42.2 million or 9.5% in the first six months of 2002,
compared to the same periods in 2001. The sources of the changes in operating
revenues, as compared to the same periods in 2001, are summarized in the
following table.
Three Months Ended Six Months Ended
Sources of Operating Revenue Changes June 30, 2002 June 30, 2002
- --------------------------------------------------------------------------------
Increase (Decrease) (In millions)
Change in kilowatt-hour sales due to level
of retail customers shopping for
generation service ..................... $21.3 $56.8
Change in other retail kilowatt-hour
sales .................................. 5.5 (0.7)
Change in wholesale sales.................. (8.7) (9.7)
All other changes.......................... (0.7) (4.2)
----- -----
Net Increase in Operating Revenues......... $17.4 $42.2
===== =====
Electric Sales
In the first half of 2002, a significant reduction in the number of
customers who received their power from alternate suppliers continued to have a
positive effect on operating revenues. During the first half of 2001, 26.7% of
kilowatt-hours delivered were to shopping customers, whereas only 9.2% of
kilowatt-hours delivered during the first half of 2002 were to shopping
customers. Partially offsetting this increase in revenues from returning
shopping customers were lower sales to industrial customers due to a decline in
economic conditions, as well as reduced revenues from wholesale customers.
Milder weather in the first quarter of 2002 resulted in a decrease in
kilowatt-hour sales to residential customers in the first six months 2002,
compared to the same period in
75
2001. Changes in kilowatt-hour deliveries by customer class during the three and
six months ended June 30, 2002, as compared to the same periods in 2001, are
summarized in the following table:
Changes in Distribution Deliveries Three Months Ended Six Months Ended
and Wholesale Generation Sales June 30, 2002 June 30, 2002
- -------------------------------------------------------------------------------
Increase (Decrease)
Residential............................ 1.1 % (3.6)%
Commercial............................. 1.4 % 1.1 %
Industrial............................. (4.6)% (6.7)%
---- ----
Total Retail........................... (0.8)% (3.2)%
Wholesale.............................. 4.6 % 5.9 %
---- ----
Total ................................. (0.3)% (2.5)%
---- ----
Operating Expenses and Taxes
Total operating expenses and taxes increased by $15.2 million in the
second quarter of 2002, and $38.3 million in the first half of 2002, compared to
the same periods in 2001. A majority of the increase in both periods was due to
higher purchased power costs, as Met-Ed required additional power to satisfy its
provider of last resort (PLR) obligation to customers who returned from
alternate suppliers in the first half of 2002, as well as an increase in general
taxes. The $3.3 million increase in other operating costs in the second quarter
of 2002 compared to the same period in
76
2001 was primarily attributable to higher occupancy rents and employee-related
costs. The $4.3 million decrease in other operating costs in the six months
ended June 30, 2002 compared to the same period of 2001 was primarily due to the
absence of costs related to early retirement programs offered to certain
bargaining unit employees in the first quarter of 2001, offset by higher
rental costs and pension and other employee related costs.
Net Interest Charges
Net interest charges decreased by $1.4 million in the second quarter
of 2002 and $2.3 million in the first six months of 2002, compared to the same
periods in 2001, primarily due to reduced short-term borrowing levels and
amortization of fair market value adjustments recorded in connection with the
merger. An additional reduction was attributable to the redemption of $30
million of notes in the first quarter of 2002; however, this was partially
offset by increased interest on long-term debt due to the issuance of $100
million of notes in September 2001 and $50 million of notes in May 2002 which
was used to refinance $30 million of notes in July 2002.
Capital Resources and Liquidity
- -------------------------------
Met-Ed has continuing cash requirements for planned capital
expenditures. During the remaining six months of 2002, capital requirements for
property additions are expected to be about $33.5 million. These requirements
are expected to be satisfied from internal cash and/or short-term credit
arrangements.
As of June 30, 2002, Met-Ed had about $5.3 million of cash and
temporary investments and $71.2 million of short-term indebtedness. Met-Ed may
borrow from its affiliates on a short-term basis. Met-Ed will not issue first
mortgage bonds (FMBs) other than as collateral for senior notes, since its
senior note indenture prohibits (subject to certain exceptions) it from issuing
any debt which is senior to the senior notes. As of June 30, 2002, Met-Ed had
the capability to issue up to $62 million of additional FMBs on the basis of
property additions and retired bonds. Met-Ed has no restrictions on the issuance
of preferred stock.
Market Risk Information
- -----------------------
Met-Ed uses various market sensitive instruments, including derivative
contracts, primarily to manage the risk of price fluctuations. Met-Ed's 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
Met-Ed is exposed to market risk primarily due to fluctuations in
electricity and natural gas prices. To manage the volatility relating to these
exposures, Met-Ed uses a variety of derivative instruments, including options
and futures contracts. The derivatives are used for hedging purposes. The change
in the fair value of commodity derivative contracts related to energy production
during the second quarter of 2002 is summarized in the following table:
Change in the Fair Value of Commodity Derivative Contracts
----------------------------------------------------------
(In millions)
Outstanding net asset as of March 31, 2002.......... $21.3
Settled contracts................................... (0.2)
Change in techniques/assumptions.................... --
Decrease in value of existing contracts............. (9.8)
-----
Outstanding net asset as of June 30, 2002........... $11.3
=====
The valuation of derivative contracts is based on observable market
information to the extent that such information is available. In cases where
such information is not available, Met-Ed relies on model-based information. The
model provides estimates of future regional prices for electricity and an
estimate of related price volatility. Met-Ed utilizes these results in
developing estimates of fair value for the later years of applicable electricity
contracts for financial reporting purposes and for internal management decision
making. Sources of information for the valuation of derivative contracts by year
are summarized in the following table:
77
Source of Information - Fair Value by Contract Year
- ---------------------------------------------------
2002* 2003 2004 Thereafter Total
- --------------------------------------------------------------------------------
(In millions)
Prices actively quoted ...... $(0.1) $0.1 $ -- $ -- $ --
Prices based on models** .... -- -- -- 11.3 11.3
----- ---- ---- ----- -----
Total ..................... $(0.1) $0.1 $ -- $11.3 $11.3
===== ==== ==== ===== =====
* Last half of 2002.
** Relates to an embedded option that is offset by a regulatory liability
and does not affect earnings.
Met-Ed performs sensitivity analyses to estimate its exposure to the
market risk of its commodity position. A hypothetical 10% adverse shift in
quoted market prices and volatilities in the near term on derivative instruments
would not have had a material effect on Met-Ed's consolidated financial position
or cash flows as of June 30, 2002.
Pennsylvania Regulatory Matters
- -------------------------------
In June 2001, Met-Ed 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 FirstEnergy's merger
with GPU, also addressed Met-Ed's request for PLR rate relief. Several parties
appealed the 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 Met-Ed's PLR
obligation, and denied Met-Ed's related request for rate relief. On March 25,
2002, Met-Ed filed a petition asking the Supreme Court of Pennsylvania to review
the Commonwealth Court decision denying Met-Ed the ability to defer costs
associated with its PLR obligation. Also on March 25, 2002, Citizens Power filed
a motion seeking an appeal of the Commonwealth Court's decision to affirm the
FirstEnergy and GPU merger with the Supreme Court of Pennsylvania. Met-Ed is
unable to predict the outcome of these matters.
Significant Accounting Policies
- -------------------------------
Met-Ed prepares its 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 financial results. All of Met-Ed's assets are subject to
their own specific risks and uncertainties and are regularly reviewed for
impairment. Assets related to the application of the policies discussed below
are similarly reviewed with their risks and uncertainties reflecting these
specific factors. Met-Ed's more significant accounting policies are described
below.
Purchase Accounting - Acquisition of GPU
On November 7, 2001, the merger between FirstEnergy and GPU became
effective, and Met-Ed 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 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 Met-Ed's 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. FirstEnergy's most recent
review was completed in June 2002. The results of that review indicate that no
impairment of the $784.4 million of goodwill is appropriate.
Regulatory Accounting
Met-Ed is subject to regulation that sets the prices (rates) it is
permitted to charge customers based on costs that regulatory agencies determine
Met-Ed is permitted to recover. At times, regulators permit the future recovery
through rates of costs that would be currently charged to expense by an
unregulated company. This rate-making process results in the recording of
regulatory assets based on anticipated future cash inflows. As a result of the
changing regulatory framework in Pennsylvania, a significant amount of
regulatory assets have been recorded - $1.3 billion as of June 30, 2002. Met-Ed
regularly reviews these assets to assess their ultimate recoverability within
the approved regulatory guidelines. Impairment risk associated with these assets
relates to potentially adverse legislative, judicial or regulatory actions in
the future.
78
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 SFAS 133, as amended, must be recorded at their fair value. Active market
prices are not always available to determine the fair value of the later years
of a contract, requiring that various assumptions and estimates be used in their
valuation. Met-Ed continually monitors its derivative contracts to determine if
its activities, expectations, intentions, assumptions and estimates remain
valid. As part of its normal operations, Met-Ed enters into commodity contracts,
which increase the impact of derivative accounting judgments.
Revenue Recognition
Met-Ed follows the accrual method of accounting for revenues,
recognizing revenue for kilowatt-hours that have been delivered but not yet
billed through the end of the accounting period. The determination of unbilled
revenues requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 2001, the Financial Accounting Standards Board 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 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 cost to settle
the retirement obligation differs from the carrying amount. Met-Ed has
identified various applicable legal obligations as defined under the new
standard and expects to complete an analysis of their financial impact in the
second half of 2002.
78
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
OPERATING REVENUES........................................ $237,576 | $230,600 $480,396 | $474,427
-------- | -------- -------- | --------
| |
| |
OPERATING EXPENSES AND TAXES: | |
Purchased power........................................ 143,219 | 142,327 289,367 | 311,391
Other operating costs.................................. 38,418 | 37,682 72,218 | 80,765
-------- | -------- -------- | --------
Total operation and maintenance expenses........... 181,637 | 180,009 361,585 | 392,156
Provision for depreciation and amortization............ 14,814 | 15,099 29,645 | 29,628
General taxes.......................................... 14,426 | 12,461 29,456 | 24,151
Income taxes........................................... 6,414 | 4,638 15,586 | 1,302
-------- | -------- -------- | --------
Total operating expenses and taxes................. 217,291 | 212,207 436,272 | 447,237
-------- | -------- -------- | --------
| |
OPERATING INCOME.......................................... 20,285 | 18,393 44,124 | 27,190
| |
OTHER INCOME.............................................. 789 | 1,414 1,087 | 2,019
-------- | -------- -------- | --------
| |
| |
INCOME BEFORE NET INTEREST CHARGES........................ 21,074 | 19,807 45,211 | 29,209
-------- | -------- -------- | --------
| |
NET INTEREST CHARGES: | |
Interest on long-term debt............................. 7,907 | 8,178 16,328 | 16,419
Allowance for borrowed funds used during construction.. (163) | (140) (283) | (284)
Deferred interest...................................... (691) | -- (1,442) | --
Other interest expense................................. 834 | 2,744 1,439 | 4,319
Subsidiaries' preferred stock dividend requirements.... 1,942 | 1,835 3,777 | 3,670
-------- | -------- -------- | --------
Net interest charges............................... 9,829 | 12,617 19,819 | 24,124
-------- | -------- -------- | --------
| |
NET INCOME................................................ $ 11,245 | $ 7,190 $ 25,392 | $ 5,085
======== | ======== ======== | ========
<FN>
The preceding Notes to Financial Statements as they relate to Pennsylvania Electric Company are an integral part of these
statements.
</FN>
79
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
---------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $1,860,346 $1,845,187
Less--Accumulated provision for depreciation.............................. 656,265 630,957
---------- ----------
1,204,081 1,214,230
Construction work in progress-
Electric plant.......................................................... 13,720 12,857
---------- ----------
1,217,801 1,227,087
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Non-utility generation trusts............................................. 122,162 154,067
Nuclear plant decommissioning trusts...................................... 94,733 96,610
Long-term notes receivable from associated companies...................... 15,515 15,515
Other..................................................................... 6,673 2,265
---------- ----------
239,083 268,457
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 20,311 39,033
Receivables-
Customers (less accumulated provisions of $11,432,000 and
$14,719,000, respectively, for uncollectible accounts)............... 92,933 107,170
Associated companies.................................................... 62,119 40,203
Other................................................................... 16,815 14,842
Prepayments and other..................................................... 21,302 8,605
---------- ----------
213,480 209,853
---------- ----------
DEFERRED CHARGES:
Regulatory assets......................................................... 682,793 769,807
Goodwill.................................................................. 797,362 797,362
Other..................................................................... 27,469 27,703
---------- ----------
1,507,624 1,594,872
---------- ----------
$3,177,988 $3,300,269
========== ==========
80
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
---------- ------------
(In thousands)
CAPITALIZATION AND LIABILITIES
------------------------------
CAPITALIZATION:
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 1,188,190
Accumulated other comprehensive income.................................. 198 1,779
Retained earnings....................................................... 22,187 10,795
---------- ----------
Total common stockholder's equity................................... 1,316,387 1,306,576
Company-obligated trust preferred securities ............................. 92,107 92,000
Long-term debt............................................................ 471,444 472,400
---------- ----------
1,879,938 1,870,976
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt.......................................... 25,783 50,756
Accounts payable-
Associated companies.................................................... 122,110 126,390
Other................................................................... 44,092 38,720
Notes payable to associated companies..................................... 103,488 77,623
Accrued taxes............................................................. 9,430 29,255
Accrued interest.......................................................... 12,647 12,284
Other..................................................................... 8,267 10,993
---------- ----------
325,817 346,021
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 15,852 21,682
Accumulated deferred investment tax credits............................... 11,385 11,956
Nuclear plant decommissioning costs....................................... 135,999 135,483
Nuclear fuel disposal costs.............................................. 18,617 18,453
Power purchase contract loss liability.................................... 763,489 867,046
Other..................................................................... 26,891 28,652
---------- ----------
972,233 1,083,272
---------- ----------
COMMITMENTS, GUARANTEES AND CONTINGENCIES (Note 2)...........................
---------- ----------
$3,177,988 $3,300,269
========== ==========
<FN>
The preceding Notes to Financial Statements as they relate to Pennsylvania Electric Company are an integral part of these balance
sheets.
</FN>
81
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- ---------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: | |
Net income................................................ $ 11,245 | $ 7,190 $ 25,392 | $ 5,085
Adjustments to reconcile net income to net | |
cash from operating activities- | |
Provision for depreciation and amortization........ 14,814 | 12,660 29,645 | 25,814
Other amortization................................. (595) | 582 187 | 1,044
Deferred costs, net................................ (16,770) | (24,388) (27,185) | (34,755)
Deferred income taxes, net......................... 7,980 | 8,085 (1,651) | 8,882
Investment tax credits, net........................ (286) | (286) (571) | (571)
Receivables........................................ (21,455) | 6,619 (9,652) | 9,501
Accounts payable................................... 12,915 | 48,397 1,093 | 43,080
Accrued taxes ..................................... (35,087) | 4,620 (19,825) | (5,644)
Other.............................................. 15,248 | 3,321 (14,199) | (7,157)
-------- | -------- -------- | ---------
Net cash provided from (used for) operating | |
activities ..................................... (11,991) | 66,800 (16,766) | 45,279
-------- | -------- -------- | ---------
| |
| |
CASH FLOWS FROM FINANCING ACTIVITIES: | |
New Financing- | |
Short-term borrowings, net........................... 65,438 | 22,500 25,865 | 53,200
Contributions from parent............................ -- | 50,000 -- | 50,000
Redemptions and Repayments- | |
Long-term debt....................................... 24,973 | -- 24,973 | --
Dividend Payments- | |
Common stock......................................... 14,000 | -- 14,000 | --
-------- | -------- -------- | ---------
Net cash used for (provided from) financing | |
activities ..................................... (26,465) | (72,500) 13,108 | (103,200)
-------- | -------- -------- | ---------
| |
CASH FLOWS FROM INVESTING ACTIVITIES: | |
Property additions..................................... 12,623 | 15,149 22,817 | 29,372
Proceeds from non-utility generation trusts............ -- | (7,720) (34,208) | (16,185)
Decommissioning trust investments...................... -- | 3 -- | 15
Other.................................................. -- | 852 239 | 4,171
-------- | -------- -------- | ---------
Net cash used for (provided from) investing | |
activities ..................................... 12,623 | 8,284 (11,152) | 17,373
-------- | -------- -------- | ---------
| |
Net increase (decrease) in cash and cash equivalents...... 1,851 | 131,016 (18,722) | 131,106
Cash and cash equivalents at beginning of period.......... 18,460 | 670 39,033 | 580
-------- | -------- -------- | ---------
Cash and cash equivalents at end of period................ $ 20,311 | $131,686 $ 20,311 | $ 131,686
======== | ======== ======== | =========
<FN>
The preceding Notes to Financial Statements as they relate to Pennsylvania Electric Company are an integral part of these
statements.
</FN>
82
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Pennsylvania
Electric Company:
We have reviewed the accompanying consolidated balance sheet of Pennsylvania
Electric Company and its subsidiaries as of June 30, 2002, and the related
consolidated statements of income and cash flows for each of the three-month and
six-month periods ended June 30, 2002. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
August 8, 2002
83
PENNSYLVANIA ELECTRIC COMPANY
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
Penelec is a wholly owned electric utility subsidiary of FirstEnergy.
Penelec conducts business in northern, western, and south central portions of
Pennsylvania, offering regulated electric transmission and distribution
services. Penelec also provides power to those customers electing to retain them
as their power supplier. Penelec's regulatory plan itemizes, or unbundles, the
price of electricity into its component elements - including generation,
transmission, distribution and transition charges. Penelec was formerly a wholly
owned subsidiary of GPU, Inc., which merged with FirstEnergy on November 7,
2001.
Results of Operations
- ---------------------
Operating revenues increased by $7.0 million or 3.0% in the second
quarter of 2002, and by $6.0 million or 1.3% in the first half of 2002, compared
to the same periods in 2001. The sources of the changes in operating revenues,
as compared to the same periods in 2001, are summarized in the following table.
Three Months Ended Six Months Ended
Sources of Operating Revenue Changes June 30, 2002 June 30, 2002
- --------------------------------------------------------------------------------
Increase (Decrease) (In millions)
Change in kilowatt-hour sales due to level
of retail customers shopping for
generation service ....................... $ 25.0 $ 60.4
Change in other retail kilowatt-hour sales.. (3.3) (8.8)
Change in wholesale sales................... (12.7) (40.6)
All other changes........................... (2.0) (5.0)
------- ------
Net Increase in Operating Revenues.......... $ 7.0 $ 6.0
======= ======
Electric Sales
In the first half of 2002, a significant reduction in the number of
customers receiving their power from alternate suppliers continued to have a
positive effect on operating revenues. During the first six months of 2001,
21.5% of kilowatt-hours delivered were to shopping customers, whereas only 4.9%
of kilowatt-hours delivered during the first six months of 2002 were to shopping
customers. Offsetting this increase in revenues from returning shopping
customers were lower sales to wholesale customers during the first half of 2002.
A decline in economic conditions resulted in a decrease in sales to industrial
customers during the six months ended June 30, 2002; however, conditions began
to improve in the quarter ended June 30, 2002, resulting in an increase in
industrial sales during that period. Changes in kilowatt-hour deliveries by
customer class during the three and six months periods ended June 30, 2002, as
compared to the same periods in 2001, are summarized in the following table:
Changes in Distribution Deliveries Three Months Ended Six Months Ended
and Wholesale Generation Sales June 30, 2002 June 30, 2002
- ------------------------------------------------------------------------------
Increase (Decrease)
Residential............................. 1.5% (1.5)%
Commercial.............................. 2.0% 0.9 %
Industrial.............................. 9.3% (4.9)%
----- -----
Total Retail............................ 4.2% (1.8)%
Wholesale............................... (56.9)% (71.9)%
----- -----
Total .................................. (2.5)% (10.7)%
----- -----
Operating Expenses and Taxes
Total operating expenses and taxes increased by $5.1 million in the
second quarter of 2002 compared to the same period in 2001, as a result of a
slight increase in operation and maintenance expenses, as well as higher general
taxes.
84
Total operating expenses and taxes decreased by $11.0 million in the
first six months of 2002 compared to the same period in 2001. A $22.0 million
decrease in purchased power costs during this period was primarily due to the
absence in 2002 of a $16.0 million charge related to the termination of a
wholesale energy contract in 2001. A decrease of $8.5 million during the same
period was primarily attributable to the absence of costs related to early
retirement programs offered to certain bargaining unit employees during the
first quarter of 2001. These decreases were partially offset by an increase of
$5.3 million in general taxes in the first six months of 2002 compared to the
same period in 2001, as well as higher pension and other employee related costs.
Net Interest Charges
Net interest charges decreased by $2.8 million in the second quarter
of 2002, and $4.3 million in the first half of 2002, compared to the same
periods in 2001. The decreases reflect higher interest deferrals related to
Penelec's deferred provider of last resort costs, and reduced short-term
borrowing levels.
Capital Resources and Liquidity
- -------------------------------
Penelec has continuing cash requirements for planned capital
expenditures and maturing debt. During the remaining six months of 2002, capital
requirements for property additions and capital leases are expected to be about
$31.6 million. Penelec also has requirements for maturing long-term debt of
$25.2 million during the remainder of 2002. These requirements are expected to
be satisfied from internal cash and/or short-term credit arrangements.
As of June 30, 2002, Penelec had about $20.3 million of cash and
temporary investments and $103.5 million of short-term indebtedness. Penelec may
borrow from its affiliates on a short-term basis. Penelec will not issue first
mortgage bonds (FMBs) other than as collateral for senior notes, since its
senior note indenture prohibits (subject to certain exceptions) it from issuing
any debt which is senior to the senior notes. As of June 30, 2002, Penelec had
the capability to issue up to $463 million of additional FMBs on the basis of
property additions and retired bonds. Penelec has no restrictions on the
issuance of preferred stock.
Market Risk Information
- -----------------------
Penelec uses various market sensitive instruments, including
derivative contracts, primarily to manage the risk of price fluctuations.
Penelec's 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
Penelec is exposed to market risk primarily due to fluctuations in
electricity and natural gas prices. To manage the volatility relating to these
exposures, Penelec uses a variety of derivative instruments, including options
and futures contracts. The derivatives are used for hedging purposes. The change
in the fair value of commodity derivative contracts related to energy production
during the second quarter of 2002 is summarized in the following table:
Change in the Fair Value of Commodity Derivative Contracts
----------------------------------------------------------
(In millions)
Outstanding net asset as of March 31, 2002.......... $10.5
Settled contracts................................... (0.2)
Change in techniques/assumptions.................... --
Decrease in value of existing contracts............. (4.6)
-----
Outstanding net asset as of June 30, 2002........... $ 5.7
=====
The valuation of derivative contracts is based on observable market
information to the extent that such information is available. In cases where
such information is not available, Penelec relies on model-based information.
The model provides estimates of future regional prices for electricity and an
estimate of related price volatility. Penelec utilizes these results in
developing estimates of fair value for the later years of applicable electricity
contracts for both financial reporting purposes and for internal management
decision making. Sources of information for the valuation of derivative
contracts by year are summarized in the following table:
85
Source of Information - Fair Value by Contract Year
2002* 2003 2004 Thereafter Total
- -------------------------------------------------------------------------------
(In millions)
Prices actively quoted ..... $(0.1) $0.1 $ -- $ -- $ --
Prices based on models** ... -- -- -- 5.7 5.7
----- ---- ---- ---- ----
Total .................... $(0.1) $0.1 $ -- $5.7 $5.7
===== ==== ==== ==== ====
* For the last half of 2002.
** Relates to an embedded option that is offset by a regulatory liability
and does not affect earnings.
Penelec performs sensitivity analyses to estimate its exposure to the
market risk of its commodity position. A hypothetical 10% adverse shift in
quoted market prices and volatilities in the near term on derivative instruments
would not have had a material effect on Penelec's consolidated financial
position or cash flows as of June 30, 2002.
Pennsylvania Regulatory Matters
- -------------------------------
In June 2001, Penelec 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 FirstEnergy's merger
with GPU, also addressed Penelec's request for PLR rate relief. Several parties
appealed the 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 Penelec's PLR
obligation, and denied Penelec's related request for rate relief. On March 25,
2002, Penelec filed a petition asking the Supreme Court of Pennsylvania to
review the Commonwealth Court decision denying Penelec the ability to defer
costs associated with its PLR obligation. Also on March 25, 2002, Citizens Power
filed a motion seeking an appeal of the Commonwealth Court's decision to affirm
the FirstEnergy and GPU merger with the Supreme Court of Pennsylvania. Penelec
is unable to predict the outcome of these matters.
Significant Accounting Policies
- -------------------------------
Penelec prepares its 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 financial results. All of Penelec's assets are subject
to their own specific risks and uncertainties and are regularly reviewed for
impairment. Assets related to the application of the policies discussed below
are similarly reviewed with their risks and uncertainties reflecting these
specific factors. Penelec's more significant accounting policies are described
below.
Purchase Accounting - Acquisition of GPU
On November 7, 2001, the merger between FirstEnergy and GPU became
effective, and Penelec 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 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 Penelec's 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. FirstEnergy's most recent
review was completed in June 2002. The results of that review indicate that no
impairment of Penelec's $797.4 million of goodwill is appropriate.
Regulatory Accounting
Penelec is subject to regulation that sets the prices (rates) it is
permitted to charge customers based on costs that regulatory agencies determine
Penelec is 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 - $682.8 million as of June 30, 2002.
Penelec regularly reviews these assets to assess their ultimate recoverability
within the approved regulatory guidelines. Impairment risk associated with these
assets relates to potentially adverse legislative, judicial or regulatory
actions in the future.
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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 SFAS 133, as amended, must be recorded at their fair value. Active market
prices are not always available to determine the fair value of the later years
of a contract, requiring that various assumptions and estimates be used in their
valuation. Penelec continually monitors its derivative contracts to determine if
its activities, expectations, intentions, assumptions and estimates remain
valid. As part of its normal operations, Penelec enters into commodity
contracts, which increase the impact of derivative accounting judgments.
Revenue Recognition
Penelec follows the accrual method of accounting for revenues,
recognizing revenue for kilowatt-hours that have been delivered but not yet
billed through the end of the accounting period. The determination of unbilled
revenues requires management to make various estimates including:
o Net energy generated or purchased for retail load
o Losses of energy over transmission and distribution lines
o Mix of kilowatt-hour usage by residential, commercial and industrial
customers
o Kilowatt-hour usage of customers receiving electricity from
alternative suppliers
Recently Issued Accounting Standards Not Yet Implemented
- --------------------------------------------------------
In June 2001, the Financial Accounting Standards Board 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 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 cost to settle
the retirement obligation differs from the carrying amount. Penelec has
identified various applicable legal obligations as defined under the new
standard and expects to complete an analysis of their financial impact in the
second half of 2002.
87
PART II. OTHER INFORMATION
- ---------------------------
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
(a) The annual meeting of FirstEnergy shareholders was held on
May 21, 2002.
(b) At this meeting, the following persons were elected to
FirstEnergy's Board of Directors:
Number of Votes
------------------------------
For Withheld
----------- ---------
Anthony J. Alexander 249,064,230 3,900,177
H. Peter Burg 249,016,232 3,948,175
Russell W. Maier 248,971,447 3,992,960
Robert N. Pokelwaldt 248,926,056 4,038,351
Jesse T. Williams, Sr. 249,446,265 3,518,142
(c) At this meeting, an amendment to the Executive and Director
Incentive Compensation Plan was approved (passage required a
majority of votes cast):
Number of Votes
----------------------------------------------
For Against Abstentions
----------- ---------- -----------
211,599,033 37,047,370 4,318,004
(d) At this meeting, a shareholder proposal designed to result in
the election of the entire Board of Directors each year was
rejected (passage required 80% of the 297,636,276 common shares
outstanding):
Number of Votes
----------------------------------------------------------------
Broker
For Against Abstentions Non-Votes
----------- ---------- ----------- ---------
127,437,897 87,573,561 5,452,837 32,500,112
(e) At this meeting, a shareholder proposal to reinstate
simple-majority vote on all issues that are submitted to
shareholder vote was rejected (passage required 80% of the
297,636,276 common shares outstanding):
Number of Votes
-----------------------------------------------------------------
Broker
For Against Abstentions Non-Votes
----------- ---------- ----------- ---------
135,678,057 79,163,575 5,626,478 32,496,297
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
Exhibit
Number
-------
Met-Ed
------
12 Fixed charge ratios
99.1 Certification letter from chief executive officer
99.2 Certification letter from chief financial officer
Penelec
-------
12 Fixed charge ratios
15 Letter from independent public accountants
99.1 Certification letter from chief executive officer
99.2 Certification letter from chief financial officer
88
JCP&L
-----
12 Fixed charge ratios
15 Letter from independent public accountants
99.2 Certification letter from chief financial officer
99.3 Certification letter from chief executive officer
FirstEnergy, OE and Penn
------------------------
15 Letter from independent public accountants
99.1 Certification letter from chief executive officer
99.2 Certification letter from chief financial officer
CEI and TE
----------
99.1 Certification letter from chief executive officer
99.2 Certification letter from chief financial officer
Pursuant to paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K,
neither FirstEnergy, OE, CEI, TE, Penn, JCP&L, Met-Ed nor Penelec
have filed as an exhibit to this Form 10-Q any instrument with
respect to long-term debt if the respective total amount of
securities authorized thereunder does not exceed 10% of their
respective total assets of FirstEnergy and its subsidiaries on a
consolidated basis, or respectively, OE, CEI, TE, Penn, JCP&L, Met-Ed
or Penelec but hereby agree to furnish to the Commission on request
any such documents.
(b) Reports on Form 8-K
FirstEnergy
-----------
Four reports on Form 8-K were filed since March 31, 2002. A report
dated April 18, 2002 reported a change in the registrant's certifying
accountant. A report dated May 9, 2002 reported the completion of the
Avon Energy Partners Holdings sale. A report dated May 24, 2002
reported the purchase of an unused replacement reactor vessel head
for the Davis-Besse Nuclear Power Station. A report dated August 1,
2002 reported two JCP&L rate filings with the New Jersey Board of
Public Utilities.
OE, Penn, Met-Ed and Penelec
----------------------------
OE, Penn, Met-Ed and Penelec each filed one report on Form 8-K since
March 31, 2002. A report dated April 18, 2002 reported a change in
the registrant's certifying accountant.
CEI and TE
----------
CEI and TE each filed two reports on Form 8-K since March 31, 2002. A
report dated April 18, 2002 reported a change in the registrant's
certifying accountant. A report dated May 24, 2002 reported the
purchase of an unused replacement reactor vessel head for the
Davis-Besse Nuclear Power Station.
JCP&L
-----
JCP&L filed two reports on Form 8-K since March 31, 2002. A report
dated April 18, 2002 reported a change in the registrant's certifying
accountant. A report dated August 1, 2002 reported two JCP&L rate
filings with the New Jersey Board of Public Utilities.
89
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
each Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
August 8, 2002
FIRSTENERGY CORP.
-----------------
Registrant
OHIO EDISON COMPANY
-------------------
Registrant
THE CLEVELAND ELECTRIC
----------------------
ILLUMINATING COMPANY
--------------------
Registrant
THE TOLEDO EDISON COMPANY
-------------------------
Registrant
PENNSYLVANIA POWER COMPANY
--------------------------
Registrant
JERSEY CENTRAL POWER & LIGHT COMPANY
------------------------------------
Registrant
METROPOLITAN EDISON COMPANY
---------------------------
Registrant
PENNSYLVANIA ELECTRIC COMPANY
-----------------------------
Registrant
/s/ Harvey L. Wagner
-------------------------------------
Harvey L. Wagner
Vice President,Controller
and Chief Accounting Officer
90