UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
-------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the transition period from to
---------------- --------------
Commission Registrant, State of Incorporation, I.R.S. Employer
File Number Address and Telephone Number Identification No.
----------- ----------------------------------- ------------------
1-3522 Pennsylvania Electric Company 25-0718085
(a Pennsylvania corporation)
2800 Pottsville Pike
Reading, Pennsylvania 19640-0001
Telephone (610) 929-3601
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
The number of shares outstanding of each of the registrant's classes of
voting stock, as of November 13, 2001, was as follows:
Shares
Registrant Title Outstanding
----------------------------------- ---------------------------- -------------
Pennsylvania Electric Company Common Stock, $20 par value 5,290,596
Pennsylvania Electric Company
Quarterly Report on Form 10-Q
September 30, 2001
Table of Contents
-----------------
Page
----
PART I - Financial Information
Management's Discussion and Analysis
of Financial Condition and Results of
Operations 1
Consolidated Financial Statements:
Balance Sheets 10
Statements of Income 12
Statements of Cash Flows 13
Notes to Consolidated Financial Statements 14
PART II - Other Information 26
Signature 27
The financial statements (not examined by independent accountants) reflect
all adjustments (which consist of only normal recurring accruals), which are, in
the opinion of management, necessary for a fair statement of the results for the
interim periods presented.
This Quarterly Report on Form 10-Q is filed by Pennsylvania Electric
Company. This Form 10-Q supplements and updates the 2000 Annual Report on Form
10-K, filed by the registrant with the Securities and Exchange Commission, and
should be read in conjunction therewith.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
We caution you that this Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. They are statements about future
performance or results (such as statements including, but not limited to, the
terms "potential," "estimate," "believe," "expect" and "anticipate" and similar
words) when we discuss our financial condition, results of operations and
business. Forward-looking statements involve certain risks, assumptions and
uncertainties. They are not guarantees of future performance. Factors may cause
actual results to differ materially from those expressed in these
forward-looking statements. These factors include:
- changes in national and regional economic conditions;
- changes in markets for energy services;
- changing commodity market prices;
- the availability and cost of capital;
- inability to accomplish or realize anticipated benefits of strategic
goals;
- legislative and regulatory changes (including revised environmental
requirements);
- economic or weather conditions affecting future sales and margins;
- the speed and nature of increased competition and deregulation in
the electric utility industry; and
- outcomes of legal proceedings.
We believe that the expectations reflected in our forward-looking
statements are reasonable. However, we cannot assure you that these expectations
will prove to be correct. You should consider the factors we have noted above as
you read the forward-looking statements in this Form 10-Q. We undertake no
obligation to release publicly any revisions to such forward-looking statements
to reflect events or circumstances after the date of this document or to reflect
the occurrence of unanticipated events.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pennsylvania Electric Company (Penelec) is a wholly-owned electric utility
subsidiary of FirstEnergy Corp. (FirstEnergy), an Ohio corporation headquartered
in Akron, Ohio. Penelec conducts business under the name GPU Energy along with
its affiliates Metropolitan Edison Company (Met-Ed) and Jersey Central Power &
Light Company (JCP&L), which are also electric utility subsidiaries of
FirstEnergy.
In August 2000, FirstEnergy entered into an agreement to merge with
GPU, Inc., under which FirstEnergy would acquire all of the outstanding shares
of GPU, Inc.'s common stock for approximately $4.5 billion in cash and
FirstEnergy common stock. The merger became effective on November 7, 2001 and
is being accounted for by the purchase method. Prior to that time, Penelec was a
wholly-owned subsidiary of GPU, Inc.
RESULTS OF OPERATIONS
---------------------
Penelec's earnings for the third quarter 2001 were $14.4 million, compared
to a loss for the third quarter 2000 of $14 million. The increase in earnings
was primarily due to the Pennsylvania Public Utility Commission's (PaPUC) June
2001 order that allows Penelec to defer, for future rate recovery from
customers, energy costs in excess of its fixed generation tariff rates, starting
June 1, 2001, in connection with its provider of last resort (PLR) obligation.
For additional information on the PaPUC's order, see the Provider of Last Resort
section of the Supply Plan. As a result, in the third quarter 2001, Penelec was
able to defer approximately $91 million pre-tax of energy costs that it
otherwise would have had to expense.
For the nine months ended September 30, 2001, Penelec's earnings were
$19.5 million, compared to $17.5 million for the same period in 2000. Excluding
a non-recurring charge of $9.4 million after-tax for costs related to the
termination of a wholesale energy contract with AEC, and a non-recurring charge
of $5.3 million after-tax for costs related to Voluntary Enhanced Retirement
Programs (VERP) offered to certain bargaining unit employees, earnings for the
nine months ended September 30, 2001 would have been $34.2 million. The same
factors affecting the comparable quarterly results also affected the year to
date comparison on this basis. Also, there was a negative impact on year to date
2001 earnings prior to June 1, 2001, when Penelec did not defer its excess
energy costs incurred in connection with its PLR obligation.
OPERATING REVENUES:
-------------------
Operating revenues for the third quarter 2001 increased $28.9 million to
$265.6 million, as compared to the third quarter 2000. For the nine months ended
September 30, 2001, operating revenues increased $76.4 million to $740 million,
compared to the same period last year. The components of the changes are as
follows:
1
2001 vs. 2000 (in millions)
---------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
KWH revenues $25.3 $71.3
CTC revenues 1.9 3.1
Other revenues 1.7 2.0
---- ----
Increase in revenues $28.9 $76.4
==== ====
KWH revenues
------------
The increase in KWH revenues was primarily due to the return of numerous
shopping customers from alternate generation suppliers in 2001, partially offset
by a decrease of sales to other utilities. Starting June 1, 2001, there was no
impact on earnings associated with these returning customers since Penelec had a
deferral mechanism for its over/under-recovered energy costs in accordance with
the PaPUC's June 2001 order.
OPERATING INCOME:
-----------------
Operating income for the third quarter 2001 increased $48.5 million to
$37.5 million, as compared to the third quarter 2000. The increase was primarily
due to the PaPUC's June 2001 order that allows Penelec to defer, for future rate
recovery from customers, energy costs in excess of its fixed generation tariff
rates (approximately $91 million). Also contributing the increase was lower
operation and maintenance (O&M) expenses (approximately $8 million) resulting
primarily from lower pension costs.
For the nine months ended September 30, 2001, operating income increased
$8.7 million to $66 million, as compared to the same period last year. The
increase for the nine months ended September 30, 2001 reflects a non-recurring
charge of $16 million pre-tax, for costs related to the termination of the AEC
contract; and a non-recurring charge to other O&M of $9.1 million pre-tax, for
costs related to the VERP. In addition, the year to date comparison was
significantly impacted by the deferral of energy costs in excess of fixed
generation tariff rates (approximately $113 million, beginning June 1, 2001);
and lower O&M expense (approximately $20 million, excluding the VERP).
OTHER INCOME AND DEDUCTIONS:
----------------------------
Other income and deductions for the third quarter 2001 increased $5.1
million to $3.3 million, as compared to the third quarter 2000. For the nine
months ended September 30, 2001, other income and deductions increased $4.1
million to $7 million, versus the same period last year. The increase in the
third quarter was primarily due to the absence in 2001 of the write-down of
regulatory assets by $3.8 million for Three Mile Island Unit 2 (TMI-2)
decommissioning, representing the net realized gain previously recorded on the
accident-related portion of the TMI-2 decommissioning trust. The same factor
affecting the comparable quarterly results also affected the year to date
comparison. Partially offsetting the year to date increase was lower interest
income.
INTEREST CHARGES:
-----------------
Interest charges for the third quarter 2001 decreased $0.3 million to $11.8
million, as compared to the third quarter 2000. For the nine months ended
September 30, 2001, interest charges increased $3.6 million to $35.9 million,
2
versus the same period last year. The increase in the nine-month period was
primarily due to interest on the issuance of $93 million of senior notes during
2000.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Capital Expenditures and Investments
------------------------------------
Capital spending for the nine months ended September 30, 2001 was $38
million, and was used primarily to expand and improve existing transmission and
distribution facilities and for new customer connections. Penelec's remaining
capital expenditures for 2001 are estimated to be $23 million, primarily for
ongoing transmission and distribution system development. Management estimates
that a substantial portion of Penelec's 2001 capital spending will be supplied
through internally generated funds.
Financing
---------
Upon the November 7, 2001 effective date of the FirstEnergy and GPU, Inc.
merger, Penelec's available short-term bank borrowing facilities (these included
a revolving credit agreement and various bank lines of credit) were terminated
by their terms and conditions. As a result, on this date all of Penelec's
outstanding borrowings from these facilities, totaling $75 million, were repaid
by FirstEnergy. In addition, Penelec had an outstanding loan payable to GPU,
Inc. in the amount of $40 million that became payable to FirstEnergy upon
consummation of the merger. FirstEnergy is in the process of establishing a new
$1.5 billion revolving credit facility to meet the short-term liquidity
requirements of the new combined company, including those requirements of
Penelec. Penelec is limited by SEC authorization to $150 million of short-term
debt outstanding at any one time.
Penelec has regulatory approval to issue senior notes through December 31,
2002 in the amount of $157 million. Penelec's senior notes are unsecured.
Penelec will not issue any additional FMBs other than as collateral for the
senior notes since the senior note indenture prohibits (subject to certain
exceptions) Penelec from issuing any debt which is senior to the senior notes.
In 2002, Penelec has scheduled long-term debt maturities totaling $50
million.
COMPETITIVE ENVIRONMENT AND RATE MATTERS
----------------------------------------
In March 2001, 106 Penelec employees accepted Voluntary Enhanced
Retirement Programs offered to certain bargaining unit employees in
Pennsylvania. As a result, Penelec has recorded a pre-tax charge $9.1 million in
2001 Operating Income for the cost of pension and other postretirement benefits.
Recent Regulatory Actions
-------------------------
With the transition to a competitive marketplace for generation service in
Pennsylvania, certain generation-related costs, which generally would be
recoverable in a regulated environment, may no longer be recoverable. These
costs are generally referred to as stranded costs.
3
Restructuring Orders
In 1998, the PaPUC issued amended Restructuring Orders approving
Settlement Agreements entered into by Penelec which, among other things, provide
for customer choice of electric generation supplier beginning January 1, 1999
and a one-year (1999) reduction in retail distribution rates for all consumers.
The Orders also provide for recovery of a substantial portion of what otherwise
would have become stranded costs, subject to Phase II proceedings following the
completion of Penelec's generating asset divestitures, to make a final
determination of the extent of that stranded cost recovery. In 2000, Penelec
submitted Phase II Reports to the PaPUC supporting their actual net divestiture
proceeds and providing a reconciliation of stranded costs pursuant to the 1998
Restructuring Orders.
In 2000, the PaPUC issued a Phase II Order which, among other things,
disallowed a portion of the requested additional stranded costs above those
amounts granted in the 1998 Orders. The Order requires Penelec to seek an IRS
ruling regarding the return of certain unamortized investment tax credits and
excess deferred income tax benefits to ratepayers. If the IRS ruling ultimately
supports returning these tax benefits to ratepayers, Penelec would then reduce
stranded costs by $23 million plus interest and record a corresponding charge to
income.
Provider of Last Resort ("PLR")
Penelec customers have been permitted to shop for their generation
supplier since January 1, 1999 under the 1998 PaPUC Restructuring Orders. The
PaPUC approved a competitive bid process designed to assign PLR service to
licensed generation suppliers, referred to as Competitive Default Service (CDS),
for 20% of Penelec's retail customers on June 1, 2000, 40% on June 1, 2001, 60%
on June 1, 2002 and 80% on June 1, 2003. Any retail customers assigned to CDS
may return to Penelec as the default PLR. Penelec may meet any remaining PLR
obligation at rates not less than the lowest rate charged by the winning CDS
provider, but no higher than Penelec's rate cap.
Due to the absence of acceptable bids in 2000, Penelec was required to
supply 300 megawatts (MW) of electric power more than it had planned. In
addition, customers requiring approximately 360 MW of power returned to Penelec
from their alternate suppliers for the peak Summer months. During that same
period, market prices at which Penelec was required to purchase electricity for
their retail supply customers at times substantially exceeded the amount Penelec
was allowed to charge for that electricity under its capped rates. This
situation resulted in Penelec's supply businesses recording after-tax losses for
2000 of approximately $14 million. Under the terms of its restructuring
settlement, in 2001 Penelec again sought alternative providers through a CDS
bidding process for 40% of its customers; however, the company did not receive
any bids in response to its request.
In November 2000, Penelec filed a petition with the PaPUC seeking
permission to defer for future recovery their energy costs in excess of amounts
reflected in its capped generation rates. In January 2001, the PaPUC
consolidated this petition with the FirstEnergy/GPU, Inc. merger proceeding for
consideration and resolution in accord with the merger procedural schedule.
In June 2001, Penelec, Met-Ed and FirstEnergy entered into a Settlement
Stipulation with all of the major intervenors in the combined merger and rate
relief proceedings, that, in addition to resolving certain issues concerning the
PaPUC's approval of the FirstEnergy/GPU, Inc. merger, also addressed
4
Penelec's request for PLR rate relief. On June 20, 2001, the PaPUC entered
orders approving the Settlement Stipulation, thus approving the merger and
providing Penelec PLR rate relief. Accordingly, Penelec is permitted to defer
for future recovery the difference between its actual energy costs and those
reflected in its capped generation rates, retroactive to January 1, 2001. These
"PLR deferrals" will continue through December 31, 2005. If energy costs
incurred by Penelec during this period are below its respective capped
generation rates, the difference would be used to reduce its PLR deferrals.
Penelec has established regulatory assets on its balance sheet for the
deferral of excess energy costs incurred during the period of January 1, 2001
through September 30, 2001. In the second quarter of 2001, Penelec had
established a reserve of $16 million against its PLR deferrals for the period of
January 1, 2001 through May 31, 2001, which would have been written off in
accordance with the Settlement Stipulation had the merger not been consummated.
Upon consummation of the merger, this reserve was reversed.
Under the Settlement Stipulation, Penelec's PLR obligations have been
extended through December 31, 2010. Penelec's Competitive Transition Charge
(CTC) revenues will be applied first to PLR costs, then to non-NUG stranded
costs and lastly to NUG stranded costs through December 31, 2010. Remaining PLR
deferrals not recovered as of December 31, 2010 would have to be written off.
The Settlement Stipulation also requires a revised calculation of NUG
stranded costs being recovered under the terms of Penelec's 1998 Restructuring
Orders, retroactive to January 1, 2001. In addition, the Settlement Stipulation
allows Penelec to access its NUG Trust to fund all costs payable under its NUG
agreements, retroactive to January 1, 2001.
Several parties have filed Petitions for Review with the Commonwealth
Court of Pennsylvania regarding the PaPUC's order. The Court has consolidated
these appeals, and has granted an expedited schedule. Oral arguments were held
in November 2001. There can be no assurance as to the outcome of these matters.
Supply Plan and Market Risk
---------------------------
As a result of the PaPUC's Restructuring Orders, Penelec is required to
act as provider of last resort (PLR) by supplying electricity to customers who
do not choose an alternate supplier. In 1999, Penelec completed the sales of its
electric generating stations. As a result, Penelec now has to supply electricity
to non-shopping customers almost entirely from contracted and open market
purchases.
Generation Agreements
Electricity supply planning is currently performed on a combined basis for
Penelec and its GPU Energy affiliates, with the goal of supplying all of the
energy requirements of their non-shopping customers at a reasonable cost. As of
September 30, 2001, Penelec and its GPU Energy affiliates had only 285 MW (none
of which is Penelec's) of owned generation capacity and related energy remaining
to meet customer needs. The companies also had contracts with nonutility
generators totaling 1,595 MW (of which Penelec's share is 396 MW) and agreements
with other parties to provide varying amounts of capacity through May 31, 2004.
These capacity amounts from third parties vary from a monthly high of
approximately 4,500 MW in 2002 to 500 MW in May 2004. Based on the exercise of
call options, Penelec and its GPU Energy affiliates may take the energy
associated with up to 150 MW of this capacity through May
5
2003. The companies have also purchased all of the capacity and energy from
their previously owned Three Mile Island Unit 1 (TMI-1) and Oyster Creek nuclear
generating stations through December 31, 2001 and March 31, 2003, respectively.
In addition, through May 31, 2002, the companies have the right to 3,970 MW of
capacity associated with generating stations they sold in 1999. The remaining
capacity and energy needs of Penelec and its GPU Energy affiliates will be met
by short- to intermediate-term commitments (one month to three years), and any
residual needs will be purchased from the short-term market (one hour to one
month). Payments pursuant to these agreements, which include firm commitments as
well as certain assumptions regarding, among other things, call/put
arrangements, are estimated to be $282 million for the remainder of 2001, $781
million in 2002, $115 million in 2003, and $5 million in 2004.
Pursuant to the mandates of the Public Utility Regulatory Policies Act and
state regulatory directives, Penelec was required to enter into long-term power
purchase agreements with NUGs for the purchase of energy and capacity, which
agreements have remaining terms of up to 21 years. The PaPUC Restructuring
Orders provide Penelec full recovery of its above-market NUG costs and certain
NUG buyout costs. Penelec has recorded, on a present value basis, an estimated
liability of $551 million on its Consolidated Balance Sheets for above-market
NUG costs, which is offset by corresponding regulatory assets. Penelec is
continuing efforts to reduce the above-market costs of these agreements;
however, there can be no assurance as to the extent to which these efforts will
be successful.
Supply Market Risk
With the divestiture of its generating plants, Penelec is in a net short
position (load in excess of supply). Consequently, Penelec must manage its
purchase and sale of installed capacity and ancillary services to minimize
business risk associated with its reliability obligation in the PJM
Interconnection, LLC (PJM). As discussed above, Penelec currently manages its
electricity supply planning on a combined basis with its GPU Energy affiliates.
Supply/risk management transactions will be made based on the objective of
decreasing price uncertainty. Penelec will enter into supply/hedging market
arrangements for hedging purposes only.
Penelec is generally at risk of rising prices for electricity and
electricity-related products and services. These risks may differ during some
months of the year. To manage these risks, Penelec employs a portfolio approach
which primarily consists of two party forward purchases and options, but may
also include New York Mercantile Exchange PJM electricity futures and similar
instruments, as they become widely available. This portfolio includes
transactions of various durations ranging from one hour to greater than one
year.
Penelec's electricity market risks can be price-related, volume-related or
cost recovery-related as follows:
- Price-related risk refers to the price exposure associated with having to
purchase amounts of electricity, installed capacity and ancillary services
for load requirements from the PJM interchange spot market. To the extent
Penelec must rely on the PJM pool to satisfy load requirements, financial
exposure exists for the difference between the PJM energy and installed
capacity spot market prices and the fixed rates paid by customers.
- Volume-related risk refers to the uncertainty associated with the amount
of load Penelec is required to serve. Deregulation of the
6
electric utility industry has resulted in the ability of customers to
purchase electricity from other electric suppliers. This customer
shopping, combined with weather changes, which affect customer energy
usage, can affect Penelec's position.
- Cost recovery-related risk refers to the prudency risk associated with
future NUG cost recovery under the Restructuring Orders approved by the
PaPUC, which require continued mitigation of above-market NUG costs.
ENVIRONMENTAL MATTERS
---------------------
As a result of existing and proposed legislation and regulations, and
ongoing legal proceedings dealing with environmental matters including, but not
limited to, air and water quality, global warming, electromagnetic fields, and
storage and disposal of hazardous and/or toxic wastes, Penelec may be required
to incur substantial additional costs to construct new facilities; modify or
replace existing and proposed equipment; or remediate, decommission or clean up
waste disposal and other sites currently or formerly used by it, including coal
mine refuse piles and generation facilities. In addition, federal and state law
provide for payment by responsible parties for damage to natural resources.
Penelec records environmental liabilities (on an undiscounted basis) where
it is probable that a loss has been incurred and the amount of the loss can be
reasonably estimated, and adjusts these liabilities as required to reflect
changes in circumstances. At September 30, 2001, Penelec had liabilities
recorded on its Consolidated Balance Sheet for environmental remediation of $3
million.
For more information, see the Environmental Matters section of Note 1,
Commitments and Contingencies, of the Notes to Consolidated Financial
Statements.
LEGAL MATTERS - TMI-2 ACCIDENT CLAIMS
-------------------------------------
As a result of the 1979 Three Mile Island Unit 2 (TMI-2) accident,
individual claims for alleged personal injury (including claims for punitive
damages), which are material in amount, were asserted against Penelec, Met-Ed,
JCP&L and GPU, Inc. (the defendants). Approximately 2,100 of such claims were
filed in the US District Court for the Middle District of Pennsylvania. Some of
the claims also seek recovery for injuries from alleged emissions of
radioactivity before and after the accident.
In 1996, the District Court granted a motion for summary judgment filed by
the defendants, and dismissed the ten initial "test cases" which had been
selected for a test case trial, as well as all of the remaining 2,100 pending
claims. The Court ruled that there was no evidence which created a genuine issue
of material fact warranting submission of plaintiffs' claims to a jury. The
plaintiffs appealed the District Court's ruling to the Court of Appeals for the
Third Circuit. In November 1999, the Third Circuit affirmed the District Court's
dismissal of the ten "test cases," but set aside the dismissal of the additional
pending claims, remanding them to the District Court for further proceedings. In
remanding these claims, the Third Circuit held that the District Court had erred
in extending its summary judgment decision to the other plaintiffs and imposing
on these plaintiffs the District Court's finding that radiation exposures below
10 rems were too speculative to establish a causal link to cancer. The Court of
Appeals
7
stated that the non-test case plaintiffs should be permitted to present their
own individual evidence that exposure to radiation from the accident caused
their cancers. In June 2000, the US Supreme Court denied petitions for review
filed by the defendants and the plaintiffs.
In September 2000, the defendants filed a Motion for Summary Judgment in
the District Court. Meanwhile, the plaintiffs took an interlocutory appeal to
the Third Circuit seeking review of the District Court's determination that the
remaining plaintiffs should be allowed to advance causation theories based only
on the admissible evidence of record at the close of discovery in the case. On
April 30, 2001, the Third Circuit affirmed the District Court's decision. In
July 2001, the defendants renewed their motion for Summary Judgment of the
remaining 2,100 claims in the District Court.
There can be no assurance as to the outcome of this litigation.
Penelec believes that any liability to which it might be subject by reason
of the TMI-2 accident will not exceed its financial protection under the
Price-Anderson Act.
8
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9
PENNSYLVANIA ELECTRIC COMPANY AND SUBSIDIARY COMPANIES
Consolidated Balance Sheets
---------------------------
In Thousands
---------------------------
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
ASSETS
Utility Plant:
Utility plant in service $1,817,409 $1,791,594
Accumulated depreciation (616,382) (588,377)
--------- ---------
Net utility plant in service 1,201,027 1,203,217
Construction work in progress 26,422 25,895
Other, net 2,306 2,665
--------- ---------
Net utility plant 1,229,755 1,231,777
--------- ---------
Other Property and Investments:
Nonutility generation trust, at market 182,803 190,710
Nuclear decommissioning trusts, at market (Note 1) 95,419 98,426
Other, net 19,085 833
--------- ---------
Total other property and investments 297,307 289,969
--------- ---------
Current Assets:
Cash and temporary cash investments 19,251 250
Special deposits 298 330
Accounts receivable:
Customers, less provision for doubtful accounts
of $14,565 for 2001 and $14,851 for 2000 77,000 78,001
Affiliates 41,507 9,558
Other 28,375 21,205
Unbilled revenues 34,672 39,514
Deferred income taxes 1,593 1,912
Prepayments 32,359 11,869
--------- ---------
Total current assets 235,055 162,639
--------- ---------
Deferred Debits and Other Assets:
Regulatory assets, net (Note 1) 427,790 614,182
Deferred income taxes 718,508 708,954
Other 37,756 34,829
--------- ---------
Total deferred debits and other assets 1,184,054 1,357,965
--------- ---------
Total Assets $2,946,171 $3,042,350
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
10
PENNSYLVANIA ELECTRIC COMPANY AND SUBSIDIARY COMPANIES
Consolidated Balance Sheets
---------------------------
In Thousands
---------------------------
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
LIABILITIES AND CAPITALIZATION
Capitalization:
Common stock $ 105,812 $ 105,812
Capital surplus 370,487 320,487
Retained earnings 62,977 43,515
Accumulated other comprehensive income/(loss) (Note 4) (1,201) 23
--------- ---------
Total common stockholder's equity 538,075 469,837
Company-obligated trust preferred securities (Note 5) 100,000 100,000
Long-term debt 492,937 517,813
--------- ---------
Total capitalization 1,131,012 1,087,650
--------- ---------
Current Liabilities:
Securities due within one year 25,015 14
Notes payable 65,000 55,800
Obligations under capital leases 523 485
Accounts payable:
Affiliates 102,915 29,788
Other 51,150 50,673
Taxes accrued 19,132 23,895
Interest accrued 17,511 11,582
Other 8,275 6,880
--------- ---------
Total current liabilities 289,521 179,117
--------- ---------
Deferred Credits and Other Liabilities:
Deferred income taxes 785,730 735,750
Unamortized investment tax credits 12,242 13,098
Power purchase contract loss liability (Note 1) 551,363 846,992
Three Mile Island Unit 2 future costs (Note 1) 131,929 128,820
Nuclear fuel disposal fee 18,344 17,728
Other 26,030 33,195
--------- ---------
Total deferred credits and other liabilities 1,525,638 1,775,583
--------- ---------
Commitments and Contingencies (Note 1)
Total Liabilities and Capitalization $2,946,171 $3,042,350
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
11
PENNSYLVANIA ELECTRIC COMPANY AND SUBSIDIARY COMPANIES
Consolidated Statements of Income
---------------------------------
(Unaudited)
In Thousands
----------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2001 2000 2001 2000
---- ---- ---- ----
Operating Revenues $265,603 $236,729 $740,030 $663,623
------- ------- ------- -------
Operating Expenses:
Power purchased and interchanged:
Affiliates 7,506 946 9,600 1,979
Others 252,686 198,961 596,738 469,097
Deferred costs, net (91,802) (19,488) (126,557) (63,793)
Other operation and maintenance 33,602 42,157 114,367 125,388
Depreciation and amortization 13,674 13,343 43,302 38,346
Taxes, other than income taxes 12,486 11,877 36,637 35,363
------- ------- ------- -------
Total operating expenses 228,152 247,796 674,087 606,380
------- ------- ------- -------
Operating Income/(Loss) 37,451 (11,067) 65,943 57,243
------- ------- ------- -------
Other Income and Deductions:
Other income/(expense), net 3,302 (1,748) 7,021 2,957
------- ------- ------- -------
Total other income and deductions 3,302 (1,748) 7,021 2,957
------- ------- ------- -------
Income/(Loss) Before Interest Charges 40,753 (12,815) 72,964 60,200
------- ------- ------- -------
Interest Charges:
Long-term debt and notes payable 9,395 10,494 29,056 26,895
Company-obligated trust
preferred securities 1,835 1,529 5,505 5,199
Other interest 297 331 1,374 938
Allowance for borrowed funds used
during construction 224 (215) (60) (714)
------- ------- ------- -------
Total interest charges 11,751 12,139 35,875 32,318
------- ------- ------- -------
Income/(Loss) Before Income Taxes 29,002 (24,954) 37,089 27,882
Income taxes 14,625 (10,945) 17,627 10,410
------- ------- ------- -------
Net Income/(Loss) $ 14,377 $(14,009) $ 19,462 $ 17,472
======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
12
PENNSYLVANIA ELECTRIC COMPANY AND SUBSIDIARY COMPANIES
Consolidated Statements of Cash Flows
-------------------------------------
(Unaudited)
In Thousands
----------------------
Nine Months
Ended September 30,
----------------------
2001 2000
---- ----
Operating Activities:
Net income $ 19,462 $ 17,472
Adjustments to reconcile income to cash provided:
Depreciation and amortization 40,294 41,006
Provision for doubtful accounts 10,257 11,148
Regulatory assets, net (7,518) 7,491
Voluntary enhanced retirement programs 9,077 -
Gain on sale of investment - 1,813
Deferred income taxes and investment tax
credits, net 42,356 58,360
Deferred costs, net (126,557) (63,793)
Allowance for other funds used during construction (60) (714)
Changes in working capital:
Receivables (11,584) (16,346)
Special deposits and prepayments (20,458) (48,938)
Payables and accrued liabilities 3,040 (95,504)
Due to/from affiliates 32,101 (41,458)
Nonutility generation contract buyout costs - (4,410)
Other, net (6,433) (7,381)
------- -------
Net cash required by operating activities (16,023) (141,254)
------- -------
Investing Activities:
Capital expenditures and investments (37,529) (48,356)
Proceeds from nonutility generation trust 18,339 62,116
Contributions to decommissioning trusts (15) (30)
Other, net (4,972) 2,047
------- -------
Net cash provided/(required) by investing activities (24,177) 15,777
------- -------
Financing Activities:
Increase in notes payable, net 9,200 55,700
Issuance of long-term debt - 118,000
Retirement of long-term debt - (25,000)
Contributions from parent corporation 50,000 -
Dividends paid on common stock - (55,000)
------- -------
Net cash provided by financing activities 59,200 93,700
------- -------
Net increase/(decrease) in cash and temporary cash
investments from above activities 19,000 (31,777)
Cash and temporary cash investments, beginning of year 250 32,250
------- -------
Cash and temporary cash investments, end of period $ 19,250 $ 473
======= =======
Supplemental Disclosure:
Interest and preferred dividends paid $ 21,919 $ 23,039
======= =======
Income taxes paid/(refunded) $ (9,148) $ 117,293
======= =======
New capital lease obligations incurred $ - $ -
======= =======
The accompanying notes are an integral part of the consolidated financial statements
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pennsylvania Electric Company (Penelec) is a wholly-owned electric
utility subsidiary of FirstEnergy Corp. (FirstEnergy), an Ohio corporation
headquartered in Akron, Ohio. Penelec conducts business under the name GPU
Energy along with its affiliates Metropolitan Edison Company (Met-Ed) and Jersey
Central Power & Light Company (JCP&L), which are also electric utility
subsidiaries of FirstEnergy.
In August 2000, FirstEnergy entered into an agreement to merge with
GPU, Inc., under which FirstEnergy would acquire all of the outstanding shares
of GPU, Inc.'s common stock for approximately $4.5 billion in cash and
FirstEnergy common stock. The merger became effective on November 7, 2001 and
is being accounted for by the purchase method. Prior to that time, Penelec was a
wholly-owned subsidiary of GPU, Inc.
1. COMMITMENTS AND CONTINGENCIES
COMPETITION AND THE CHANGING REGULATORY ENVIRONMENT
---------------------------------------------------
Stranded Costs and Regulatory Restructuring Orders:
--------------------------------------------------
With the transition to a competitive marketplace for generation service
in Pennsylvania, certain generation-related costs, which generally would be
recoverable in a regulated environment, may no longer be recoverable. These
costs are generally referred to as stranded costs.
In 1998, the Pennsylvania Public Utility Commission (PaPUC) issued
amended Restructuring Orders approving Settlement Agreements entered into by
Penelec which, among other things, provide for customer choice of electric
generation supplier beginning January 1, 1999 and a one-year (1999) reduction in
retail distribution rates for all consumers. The Orders also provide for
recovery of a substantial portion of what otherwise would have become stranded
costs, subject to Phase II proceedings following the completion of Penelec's
generating asset divestitures, to make a final determination of the extent of
that stranded cost recovery. In 2000, Penelec submitted Phase II Reports to the
PaPUC supporting their actual net divestiture proceeds and providing a
reconciliation of stranded costs pursuant to the 1998 Restructuring Orders.
In 2000, the PaPUC issued a Phase II Order which, among other things,
disallowed a portion of the requested additional stranded costs above those
amounts granted in the 1998 Orders. The Order requires Penelec to seek an IRS
ruling regarding the return of certain unamortized investment tax credits and
excess deferred income tax benefits to ratepayers. If the IRS ruling ultimately
supports returning these tax benefits to ratepayers, Penelec would then reduce
stranded costs by $23 million plus interest and record a corresponding charge to
income.
14
Supply of Electricity:
---------------------
As a result of the PaPUC's Restructuring Orders, Penelec is required to
act as provider of last resort (PLR) by supplying electricity to customers who
do not choose an alternate supplier. Given that Penelec has exited the
generation business and will have to supply electricity to non-shopping
customers entirely from contracted and open market purchases, there will be
increased risks associated with supplying that electricity.
Penelec has been unable to recover energy costs in excess of amounts
reflected in its capped generation rates, which are in effect for varying
periods, under its 1998 Restructuring Orders. During 2000, market prices at
which Penelec was required to purchase electricity for its retail supply
customers at times substantially exceeded the amounts Penelec was allowed to
charge for that electricity under its capped rates. In November 2000, Penelec
filed a petition with the PaPUC seeking permission to defer for future recovery
its energy costs in excess of amounts reflected in its capped generation rates.
In January 2001, the PaPUC consolidated this petition with the FirstEnergy/GPU,
Inc. merger proceeding for consideration and resolution in accord with the
merger procedural schedule.
In June 2001, Penelec, Met-Ed and FirstEnergy entered into a Settlement
Stipulation with all of the major intervenors in the combined merger and rate
relief proceedings, that, in addition to resolving certain issues concerning the
PaPUC's approval of the FirstEnergy/GPU, Inc. merger, also addressed Penelec's
request for PLR rate relief. On June 20, 2001, the PaPUC entered orders
approving the Settlement Stipulation, thus approving the merger and providing
Penelec PLR rate relief. Accordingly, Penelec is permitted to defer for future
recovery the difference between its actual energy costs and those reflected in
its capped generation rates, retroactive to January 1, 2001. These "PLR
deferrals" will continue through December 31, 2005. If energy costs incurred by
Penelec during this period are below its respective capped generation rates, the
difference would be used to reduce its PLR deferrals.
Penelec has established regulatory assets on its balance sheet for the
deferral of excess energy costs incurred during the period of January 1, 2001
through September 30, 2001. In the second quarter of 2001, Penelec had
established a reserve of $16 million against its PLR deferrals for the period of
January 1, 2001 through May 31, 2001, which would have been written off in
accordance with the Settlement Stipulation had the merger not been consummated.
Upon consummation of the merger, this reserve was reversed.
Under the Settlement Stipulation, Penelec's PLR obligations have been
extended through December 31, 2010. Penelec's Competitive Transition Charge
(CTC) revenues will be applied first to PLR costs, then to non-NUG stranded
costs and lastly to NUG stranded costs through December 31, 2010. Remaining PLR
deferrals not recovered as of December 31, 2010 would have to be written off.
The Settlement Stipulation also requires a revised calculation of NUG
stranded costs being recovered under the terms of Penelec's 1998 Restructuring
Orders, retroactive to January 1, 2001. In addition, the Settlement Stipulation
allows Penelec to access its NUG Trust to fund all costs payable under its NUG
agreements, retroactive to January 1, 2001.
Several parties have filed Petitions for Review with the Commonwealth
Court of Pennsylvania regarding the PaPUC's orders. The Court has
15
consolidated these appeals, and has granted an expedited schedule. Oral
arguments were held in November 2001. There can be no assurance as to the
outcome of these matters.
Generation Agreements:
---------------------
The evolving competitive generation market has created uncertainty
regarding the forecasting of energy supply needs, which has caused the company
to seek shorter-term agreements offering more flexibility. Penelec currently
manages its electricity supply planning on a combined basis with its GPU Energy
affiliates. The current supply plan generally utilizes short- to
intermediate-term commitments (one month to three years), with any residual
needs being purchased from the short-term market (one hour to one month).
Penelec and its GPU Energy affiliates have entered into agreements with
third party suppliers to purchase capacity and energy through 2004. As of
September 30, 2001, payments pursuant to these agreements, which include firm
commitments as well as certain assumptions regarding, among other things,
call/put arrangements, are estimated to be $282 million for the remainder of
2001, $781 million in 2002, $115 million in 2003 and $5 million in 2004.
Pursuant to the mandates of the federal Public Utility Regulatory
Policies Act and state regulatory directives, Penelec was required to enter into
long-term power purchase agreements with NUGs for the purchase of energy and
capacity, which agreements have remaining terms of up to 21 years. The rates
under virtually all of these NUG agreements are substantially in excess of
current and projected prices from alternative sources, except for periods when
Penelec is required to meet high customer demand, typically during periods of
extremely hot weather or when power supplies are limited. The following table
shows Penelec's actual payments from 1999 through September 30, 2001, and
estimated payments thereafter through 2006:
Calendar Payments Under NUG Agreements
Year (in millions)
---- -------------
1999 $219
2000 217
2001 198
2002 191
2003 196
2004 202
2005 198
2006 201
The PaPUC Restructuring Orders provide Penelec assurance of full
recovery of its above-market NUG costs and certain NUG buyout costs. At
September 30, 2001, Penelec had recorded, on a present value basis, an estimated
liability of $551 million on its Consolidated Balance Sheet for above-market NUG
costs, which was offset by corresponding regulatory assets. Penelec is
continuing efforts to reduce the above-market costs of these agreements;
however, there can be no assurance as to the extent to which these efforts will
be successful.
ACCOUNTING MATTERS
------------------
In 1998, Penelec discontinued the application of Statement of
Financial Accounting Standards No. 71 (FAS 71), "Accounting for the Effects of
Certain Types of Regulation," and adopted the provisions of Statement of
Financial
16
Accounting Standards No. 101 (FAS 101), "Regulated Enterprises - Accounting for
the Discontinuation of Application of FASB Statement No. 71," and Emerging
Issues Task Force (EITF) Issue 97-4, "Deregulation of the Pricing of Electricity
- Issues Related to the Application of FAS 71 and FAS 101," with respect to its
electric generation operations. The transmission and distribution portion of
Penelec's operations continues to be subject to the provisions of FAS 71.
Regulatory assets, net as reflected in the September 30, 2001 and December 31,
2000 Consolidated Balance Sheets in accordance with the provisions of FAS 71 and
EITF Issue 97-4 were as follows:
In Thousands
---------------------------------
September 30, December 31,
2001 2000
------------- -------------
CTC $ 248,687 $ 439,446
Costs recoverable through distribution rates:
Income taxes recoverable through future rates, net 148,816 149,399
Three Mile Island Unit 2 decommissioning costs 24,222 18,479
Other, net 6,065 6,858
--------- ---------
Total regulatory assets, net $ 427,790 $ 614,182
========= =========
As of September 30, 2001, Regulatory assets, net shown above included
$(68) million of deferred energy-related costs plus interest (net of
collections). This deferred balance includes the under-recovered costs of
supplying electricity to customers who did not choose an alternate supplier, as
well as above-market NUG costs, but excludes the net generation asset
divestiture gains which were used to reduce stranded costs. For additional
information, see Competition and the Changing Regulatory Environment section.
NUCLEAR FACILITIES
------------------
Investments:
-----------
In 1999, Penelec and its GPU Energy affiliates sold Three Mile Island
Unit 1 (TMI-1) to AmerGen Energy Company, LLC (AmerGen) for approximately $100
million. As part of the sale, AmerGen has assumed full responsibility for
decommissioning the plants, and Penelec and its GPU Energy affiliates have
transferred $320 million of TMI-1 decommissioning trust funds to AmerGen (of
which Penelec's share was $80 million). Three Mile Island Unit 2 (TMI-2), which
was damaged during a 1979 accident, is jointly owned by Penelec and its GPU
Energy affiliates, with Penelec having a 25% ownership percentage. Penelec's
remaining investment in TMI-2 was written off in 1998 after receiving the
PaPUC's Restructuring Orders.
TMI-2:
------
As a result of the 1979 TMI-2 accident, individual claims for alleged
personal injury (including claims for punitive damages), which are material in
amount, were asserted against Penelec, Met-Ed, JCP&L and GPU, Inc. (the
defendants). Approximately 2,100 of such claims were filed in the US District
Court for the Middle District of Pennsylvania. Some of the claims also seek
recovery for injuries from alleged emissions of radioactivity before and after
the accident.
At the time of the TMI-2 accident, as provided for in the
Price-Anderson Act, Penelec, Met-Ed and JCP&L had (a) primary financial
protection in the form of insurance policies with groups of insurance companies
17
providing an aggregate of $140 million of primary coverage, (b) secondary
financial protection in the form of private liability insurance under an
industry retrospective rating plan providing for up to an aggregate of $335
million in premium charges under such plan and (c) an indemnity agreement with
the Nuclear Regulatory Commission (NRC) for up to $85 million, bringing their
total financial protection up to an aggregate of $560 million. Under the
secondary level, Penelec, Met-Ed and JCP&L are subject to a retrospective
premium charge of up to $5 million per reactor, or a total of $15 million, of
which Penelec's share is $2.5 million.
In 1995, the US Court of Appeals for the Third Circuit ruled that the
Price-Anderson Act provides coverage under its primary and secondary levels for
punitive as well as compensatory damages, but that punitive damages could not be
recovered against the Federal Government under the third level of financial
protection. In so doing, the Court of Appeals referred to the "finite fund" (the
$560 million of financial protection under the Price- Anderson Act) to which
plaintiffs must resort to get compensatory as well as punitive damages.
The Court of Appeals also ruled that the standard of care owed by the
defendants to a plaintiff was determined by the specific level of radiation
which was released into the environment, as measured at the site boundary,
rather than as measured at the specific site where the plaintiff was located at
the time of the accident (as the defendants proposed). The Court of Appeals also
held that each plaintiff still must demonstrate exposure to radiation released
during the TMI-2 accident and that such exposure had resulted in injuries. In
1996, the US Supreme Court denied petitions filed by the defendants to review
the Court of Appeals' rulings.
In 1996, the District Court granted a motion for summary judgment filed
by the defendants, and dismissed the ten initial "test cases" which had been
selected for a test case trial, as well as all of the remaining 2,100 pending
claims. The Court ruled that there was no evidence which created a genuine issue
of material fact warranting submission of plaintiffs' claims to a jury. The
plaintiffs appealed the District Court's ruling to the Court of Appeals for the
Third Circuit. In November 1999, the Third Circuit affirmed the District Court's
dismissal of the ten "test cases," but set aside the dismissal of the additional
pending claims, remanding them to the District Court for further proceedings. In
remanding these claims, the Third Circuit held that the District Court had erred
in extending its summary judgment decision to the other plaintiffs and imposing
on these plaintiffs the District Court's finding that radiation exposures below
10 rems were too speculative to establish a causal link to cancer. The Court of
Appeals stated that the non-test case plaintiffs should be permitted to present
their own individual evidence that exposure to radiation from the accident
caused their cancers. In June 2000, the US Supreme Court denied petitions for
review filed by the defendants and the plaintiffs.
In September 2000, the defendants filed a Motion for Summary Judgment
in the District Court. Meanwhile, the plaintiffs took an interlocutory appeal to
the Third Circuit seeking review of the District Court's determination that the
remaining plaintiffs should be allowed to advance causation theories based only
on the admissible evidence of record at the close of discovery in the case. On
April 30, 2001, the Third Circuit affirmed the District Court's decision. In
July 2001, the defendants renewed their motion for Summary Judgment of the
remaining 2,100 claims in the District Court.
There can be no assurance as to the outcome of this litigation.
18
Penelec believes that any liability to which it might be subject by
reason of the TMI-2 accident will not exceed its financial protection under the
Price-Anderson Act.
NUCLEAR PLANT RETIREMENT COSTS
------------------------------
Retirement costs for nuclear plants include decommissioning the
radiological portions of the plants and the cost of removal of nonradiological
structures and materials. The disposal of spent nuclear fuel is covered
separately by contracts with the US Department of Energy (DOE).
In 1995, a consultant performed a site-specific study of TMI-2 that
considered various decommissioning methods and estimated the cost of
decommissioning the radiological portion and the cost of removal of the
nonradiological portion of the plant, using the prompt removal/dismantlement
method. Management has reviewed the methodology and assumptions used in this
study, is in agreement with them, and believes the results are reasonable. The
TMI-2 funding completion date is 2014, consistent with TMI-2 remaining in
long-term storage. Penelec's share of the estimated retirement costs under the
1995 site-specific study, assuming decommissioning of TMI-2 in 2014, is $115
million for radiological decommissioning and $8.9 million for non-radiological
removal costs (net of $3.1 million spent as of September 30, 2001)(in 2001
dollars).
Penelec and its GPU Energy affiliates are each responsible for
retirement costs in proportion to its respective ownership percentage. The
ultimate cost of retiring TMI-2 may be different from the cost estimate
contained in this site-specific study. The NRC has established a decommissioning
funding target which, while not an actual cost estimate, is a reference level
designed to assure that licensees demonstrate adequate financial responsibility
for decommissioning. The current NRC funding target exceeds the site-specific
study cost estimate by $10 million.
Penelec's estimated liability for future TMI-2 retirement costs
(reflected as Three Mile Island Unit 2 future costs on the Consolidated Balance
Sheet) as of September 30, 2001 was $132 million, and as of December 31, 2000
was $129 million. This liability is based upon the 1995 site-specific study
estimate (in 2001 and 2000 dollars, respectively) discussed above and an
estimate for remaining incremental monitored storage costs of $7 million, both
as of September 30, 2001 and December 31, 2000, as a result of TMI-2 entering
long-term monitored storage in 1993.
Offsetting the $132 million liability for future TMI-2 retirement costs
as of September 30, 2001 was $24 million which management believes is probable
of recovery from customers and included in Regulatory assets, net on the
Consolidated Balance Sheet, and $95 million in trust funds for TMI-2 and
included in Nuclear decommissioning trusts, at market on the Consolidated
Balance Sheet.
The PaPUC Restructuring Orders granted Penelec recovery of TMI-2
decommissioning costs as part of the CTC; however, Penelec has recovered these
costs through the divestiture of its generating assets. The 1996 Customer Choice
Act also allows Penelec to defer as a regulatory asset those amounts that are
above the level provided for in the CTC for future recovery.
As of September 30, 2001, the accident-related portion of TMI-2
radiological decommissioning costs was estimated to be $20 million for Penelec,
which is based on the 1995 site-specific study (in 2001 dollars).
19
In connection with rate case resolutions, Penelec made contributions to an
irrevocable external trust for its share of the accident-related portion of the
decommissioning liability in the amount of $20 million. This contribution was
not recoverable from customers and was expensed in 1991.
Penelec intends to seek recovery for any increases in TMI-2 retirement
costs, but recognizes that recovery cannot be assured.
Penelec and its GPU Energy affiliates own all of the common stock of
the Saxton Nuclear Experimental Corporation, which owns a small demonstration
nuclear reactor. Decommissioning of the plant is expected to be completed in
2002. Penelec's estimated liability for future Saxton decommissioning costs at
September 30, 2001 was $3 million, net of $10 million spent by Penelec through
September 30, 2001.
INSURANCE
---------
Penelec has insurance (subject to retentions and deductibles) for its
operations and facilities including coverage for property damage, liability to
employees and third parties, and loss of use and occupancy. There is no
assurance that Penelec will maintain all existing insurance coverages. Losses or
liabilities that are not completely insured, unless allowed to be recovered
through ratemaking, could have a material adverse effect on the financial
position of Penelec.
Penelec and its GPU Energy affiliates have purchased property and
decontamination insurance coverage for TMI-2 totaling $150 million.
The Price-Anderson Act limits an owner's liability to third parties
resulting from a nuclear incident to approximately $9.5 billion. Coverage for
the first $200 million of such liability is provided by private insurance. The
remaining coverage, or secondary financial protection, is provided by
retrospective premiums payable by all nuclear reactor owners. Although TMI-2 is
exempt from retrospective premium assessments, the plant is still covered by the
provisions of the Price-Anderson Act. In addition, Penelec and its GPU Energy
affiliates are subject to other retrospective premium assessments related to
policies applicable to TMI-1 prior to its sale to AmerGen.
ENVIRONMENTAL MATTERS
---------------------
As a result of existing and proposed legislation and regulations, and
ongoing legal proceedings dealing with environmental matters including, but not
limited to, air and water quality, global warming, electromagnetic fields, and
storage and disposal of hazardous and/or toxic wastes, Penelec may be required
to incur substantial additional costs to construct new facilities; modify or
replace existing and proposed equipment; or remediate, decommission or clean up
waste disposal and other sites currently or formerly used by it, including coal
mine refuse piles and generation facilities. In addition, federal and state laws
provide for payment by responsible parties for damage to natural resources.
At September 30, 2001, Penelec had liabilities recorded on its
Consolidated Balance Sheet for environmental remediation of $3 million, as
discussed below.
Penelec has been formally notified by the US Environmental Protection
Agency (EPA) and state environmental authorities that it is among the
20
potentially responsible parties (PRPs) who may be jointly and severally liable
to pay for the costs associated with the investigation and remediation at two
hazardous and/or toxic waste sites.
In addition, Penelec has been requested to participate in the
remediation or supply information to the EPA and state environmental authorities
on several other sites for which it has not been formally named as a PRP,
although the EPA and/or state authorities may nevertheless consider it a PRP.
Penelec has also been named in lawsuits requesting damages (which are material
in amount) for hazardous and/or toxic substances allegedly released into the
environment. As of September 30, 2001, a liability of approximately $0.2 million
had been recorded for PRP sites where it is probable that a loss has been
incurred and the amount could be reasonably estimated.
The ultimate cost of remediation of all these and other hazardous waste
sites will depend upon changing circumstances as site investigations continue,
including (a) the existing technology required for site cleanup, (b) the
remedial action plan chosen and (c) the extent of site contamination and the
portion attributed to Penelec.
OTHER COMMITMENTS AND CONTINGENCIES
-----------------------------------
In March 1999, Penelec and New York State Electric & Gas Corporation
(NYSEG) each sold their 50% undivided ownership interests in the Homer City
Station to a subsidiary of Edison Mission Energy (EME) for a total of $1.9
billion. In connection with the sale, Penelec and NYSEG indemnified the buyer
with respect to certain contingent liabilities. In 1998, the EPA conducted
inspections at Homer City with regard to the plant's compliance with New Source
Performance Standards, Prevention of Significant Deterioration and New Source
Review regulations under the Clean Air Act. On October 30, 2000, EME notified
Penelec and NYSEG that the EPA had concluded that these regulations applied to
Homer City prior to the sale to EME and that Homer City was operating in
violation of these Clean Air Act regulations. If it is ultimately determined
that these regulations were applicable to Homer City, the EPA might seek to
assess substantial monetary penalties and require capital modifications to the
plant, the costs of which would be material. If it is determined that Penelec
and NYSEG are obligated to indemnify EME for any of these costs, they would each
be severally liable for a 50% share. There can be no assurance as to the outcome
of this matter.
In accordance with the Nuclear Waste Policy Act of 1982 (NWPA), Penelec
has entered into contracts with, and paid fees to, the DOE for the future
disposal of spent nuclear fuel in a repository or interim storage facility. In
1996, the DOE notified Penelec and other Standard Contract holders that it would
be unable to begin acceptance of spent nuclear fuel for disposal by January 31,
1998, as mandated by the NWPA. The DOE requested recommendations from contract
holders for handling the delay. In June 1997, a consortium of electric
utilities, including GPU Nuclear, Inc. (GPUN), the former operator of the
nuclear plants previously owned by Penelec and its GPU Energy affiliates, filed
a license application with the NRC seeking permission to build an interim
above-ground storage facility for spent nuclear fuel in Utah.
At September 30, 2001, Penelec had recorded a liability of $18 million
owed to the Nuclear Waste Fund, related to spent nuclear fuel generated prior
21
to the sale of TMI-1 to AmerGen. AmerGen has assumed all liability for disposal
costs related to spent nuclear fuel generated following its purchase of the
plant.
On July 26, 2000, GPUN filed suit in the United States Court of Federal
Claims seeking to recover damages as a result of the DOE's failure to commence
disposal of GPUN's spent nuclear fuel by January 31, 1998, as required by the
terms of the Standard Contracts between GPUN and DOE. The complaint seeks
damages from the Government in an amount to be determined at trial. GPUN has
alleged that it is entitled to damages attributable to operations at TMI-1. In
an August 20, 2001 pleading, the Government acknowledged that the DOE's
inability to begin providing the services required by the Standard Contract by
January 31, 1998 constituted a partial breach of the Standard Contract. In the
same pleading, the Government stated that GPUN may lack standing to maintain its
suit because it assigned its Standard Contracts and title to its spent nuclear
fuel to the buyer of TMI-1. By order dated September 24, 2001, the Court stated
that it would hold in abeyance any final determination on standing until the
completion of discovery, which is currently underway. There can be no assurance
as to the outcome of this matter.
During the normal course of the operation of its business, in addition
to the matters described above, Penelec is, from time to time, involved in
disputes, claims and, in some cases, as a defendant in litigation in which
compensatory and punitive damages are sought by the public, customers,
contractors, vendors and other suppliers of equipment and services and by
employees alleging unlawful employment practices. While management does not
expect that the outcome of these matters will have a material effect on
Penelec's financial position or results of operations, there can be no assurance
that this will continue to be the case.
2. ACCOUNTING FOR NON-RECURRING ITEMS
In March 2001, 106 Penelec employees accepted Voluntary Enhanced
Retirement Programs offered to certain bargaining unit employees in
Pennsylvania. As a result, in the quarter ended March 31, 2001, a pre-tax charge
of $9.1 million ($5.3 million after-tax) was recorded in Operating Income for
the cost of pension and other postretirement benefits.
In February 2001, Penelec paid Allegheny Electric Cooperative (AEC), a
wholesale customer, $16 million pre-tax ($9.4 million after-tax), for costs
related to the termination of a wholesale energy contract. The $16 million
payment was recorded in Operating Income in the quarter ended March 31, 2001.
3. NEW ACCOUNTING STANDARDS
Penelec's use of derivative instruments is intended to manage the risk
of price and interest rate fluctuations. Penelec does not hold or issue
derivative instruments for trading purposes.
Effective January 1, 2001, Penelec adopted Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by FAS 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB
22
Statement No. 133" and FAS 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities - An Amendment of FASB Statement No. 133"
(collectively, FAS 133). FAS 133 establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities.
In general, FAS 133 requires that companies recognize all derivatives
as either assets or liabilities on the balance sheet, measured at their fair
value. Derivatives not designated as hedges must be adjusted to fair value with
an offset to income. If the derivative is designated as a hedge, depending on
the nature of the hedge, changes in fair value of the derivative are either
offset against the change in fair value of the asset or liability through
income, or recognized in accumulated other comprehensive income until the hedged
item is recognized in income. To the extent the hedge is determined to be
ineffective, that portion of the derivative's change in fair value is
immediately recognized in income. FAS 133 provides an exemption for certain
contracts that qualify as "normal purchases and sales." To qualify for this
exclusion, certain criteria, including that it must be probable that the
contract will result in physical delivery, must be met.
The adoption of FAS 133 on January 1, 2001 resulted in the recognition
of derivative assets on the Consolidated Balance Sheet at January 1, 2001 in the
amount of $26 million, with an offsetting amount, net of tax, recorded in
Regulatory assets, net, of $25.9 million. As of January 1, 2001, Penelec also
recorded derivative liabilities in the amount of $1 million as a result of
adopting FAS 133, with a substantially offsetting amount recorded in Accumulated
other comprehensive income, of $0.5 million. As of January 1, 2001, a cumulative
effect of accounting change was recognized as an expense in Other income, net on
the Consolidated Statement of Income in the amount of $0.8 million.
Penelec uses Over-the-Counter forward contracts and options on forward
contracts to manage the risk of fluctuations in the market price of electricity.
The majority of the forward commodity contracts are considered "normal purchases
and sales," as defined by FAS 133, and therefore are excluded from the scope of
FAS 133.
The energy options and forward contracts determined to be derivatives
under FAS 133 are accounted for as cash flow hedges and expire on various dates
through November 2002. These contracts are recorded at fair value on Penelec's
September 30, 2001 Consolidated Balance Sheet in the amount of $0.2 million. The
offset of the change in fair value is recorded in Accumulated other
comprehensive income, net of tax, and subsequently recognized as a component of
Power purchased and interchanged on the Consolidated Statement of Income when
the underlying power being hedged is purchased. The ineffective portion of these
commodity contracts was immaterial for the quarter ended September 30, 2001.
When Penelec and its GPU Energy affiliates sold TMI-1 to AmerGen, the
parties entered into an agreement which calls for an adjustment to the purchase
price of TMI-1 in the event of future energy price increases. If the future
price of energy exceeds the strike price during the contract year as defined per
the agreement, Penelec and its GPU Energy affiliates will receive payments from
AmerGen, subject to a market price cap. However, if the future price of energy
is less than the strike price during a contract year, a credit is applied
against future contract payments that would be received from AmerGen. This
agreement qualifies as a derivative as defined by FAS 133, and its value is
recorded on the Consolidated Balance Sheet based
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on the present value of the contract's projected future cash flows. As of
September 30, 2001, Penelec's share of this amount was $13.7 million and was
included in Other Property and Investments - Other, net on the Consolidated
Balance Sheet. An offsetting regulatory liability in the amount of $12.9 million
was recorded against Regulatory assets, net, representing the obligation to
treat the retail portion of payments received as stranded cost revenues when
received. The non-retail portion is recorded on the Consolidated Statement of
Income in Other income, net. This amount was immaterial for the quarter ended
September 30, 2001.
Penelec uses interest rate swap agreements to manage the risk of
increases in variable interest rates. The interest rate swap agreements, which
were entered into to convert variable rate debt to fixed rate debt, are
accounted for as cash flow hedges under FAS 133 and are recorded at fair value
on the Consolidated Balance Sheet in Deferred Credits and Other Liabilities -
Other in the amount of $2 million as of September 30, 2001. The offset of the
change in fair value is recorded in Accumulated other comprehensive income, net
of tax, and subsequently recognized as a component of Interest expense when the
related interest payments being hedged are recognized. Of the $1.2 million
recorded in Accumulated other comprehensive income as of September 30, 2001,
Penelec expects a pre-tax loss of approximately $2 million to be recognized in
income within the next twelve months. The ineffective portion of the interest
rate swaps was immaterial for the quarter ended September 30, 2001.
As of September 30, 2001, the interest rate swap agreements covered
approximately $50 million of debt, and were scheduled to expire on various dates
through 2002. For the quarter ended September 30, 2001, the amount by which
fixed rate interest expense exceeded variable rate interest was immaterial.
In June 2001, the Financial Accounting Standards Board (FASB) approved
Statement of Financial Accounting Standards No. 141 (FAS 141), "Business
Combinations," and Statement of Financial Accounting Standards No. 142 (FAS
142), "Goodwill and Other Intangible Assets". These new standards are effective
beginning July 1, 2001. FAS 141 requires all business combinations initiated
after June 30, 2001, to be accounted for using purchase accounting. Under FAS
142, amortization of existing goodwill will cease on January 1, 2002 and instead
goodwill will be tested for impairment at least on an annual basis. As of
September 30, 2001, Penelec did not have any goodwill on its balance sheet,
however, as a result of the merger of FirstEnergy and GPU, Inc. which became
effective on November 7, 2001, there will be goodwill associated with this
merger applied to Penelec. The amount of goodwill to be applied to Penelec has
not yet been determined.
In July 2001, the FASB issued Statement of Financial Accounting
Standards No. 143 (FAS 143), "Accounting for Asset Retirement Obligations." FAS
143 provides the accounting requirements for retirement obligations associated
with tangible long-lived assets. FAS 143 is effective for fiscal years beginning
after June 15, 2002, with early adoption encouraged. Penelec is currently
assessing the new standard and has not yet determined the impact on its
financial statements.
In September 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 (FAS 144), "Accounting for the Impairment or Disposal of
Long-Lived Assets." FAS 144 supersedes Statement of Financial Accounting
Standards No. 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 Accounting Principles Board Opinion
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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." FAS 144 is effective for fiscal years beginning after
June 15, 2001, with early adoption encouraged. Penelec is currently assessing
the new standard and has not yet determined the impact on its financial
statements.
4. COMPREHENSIVE INCOME
For the nine months ended September 30, 2001 and 2000, comprehensive
income is summarized below.
In Thousands
----------------------
Nine months
Ended September 30,
-----------------------
2001 2000
---- ----
Net income/(loss) $ 19,462 $ 17,472
------- -------
Other comprehensive income/(loss), net of tax:
Net unrealized gain/(loss) on investments (19) (10,609)
Cumulative effect of change in accounting
for derivative instruments at 1/1/01 (535) -
Net unrealized loss on derivative instruments (670) -
------- -------
Total other comprehensive income/(loss) (1,224) (10,609)
------- -------
Comprehensive income $ 18,238 $ 6,863
======= =======
5. COMPANY-OBLIGATED TRUST PREFERRED SECURITIES
In 1999, Penelec Capital Trust, a wholly-owned subsidiary of Penelec,
issued $100 million of trust preferred securities (Penelec Trust Preferred
Securities) at 7.34%, due 2039. The sole assets of Penelec Capital Trust are the
7.34% Cumulative Preferred Securities of Penelec Capital II, L.P. (Penelec
Partnership Preferred Securities) and its only revenues are the quarterly cash
distributions it receives on the Penelec Partnership Preferred Securities. Each
Penelec Trust Preferred Security represents a Penelec Partnership Preferred
Security. Penelec Capital II, L.P. is a wholly-owned subsidiary of Penelec and
the sponsor of Penelec Capital Trust. The sole assets of Penelec Capital II,
L.P. are Penelec's 7.34% Subordinated Debentures, Series A, due 2039, which have
an aggregate principal amount of $103.1 million. Penelec has fully and
unconditionally guaranteed the Penelec Partnership Preferred Securities, and,
therefore, the Penelec Trust Preferred Securities.
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PART II
ITEM 1 - LEGAL PROCEEDINGS
-----------------
Information concerning the current status of certain legal
proceedings instituted against Penelec discussed in Part I of this
report in the Notes to Consolidated Financial Statements is
incorporated herein by reference and made a part hereof.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
(12) Statements Showing Computation of Ratio of Earnings to
Fixed Charges Based on SEC Regulation S-K, Item 503
(b) Reports on Form 8-K
Dated September 28, 2001, under Item 5 (Other Events)
Dated October 30, 2001, under Item 5 (Other Events)
Dated November 9, 2001, under Item 1 (Changes in Control
of Registrant) and under Item 4 (Changes in Registrant's
Certifying Accountant)
26
Signature
---------
Pursuant to the requirements of the Securities Exchange Act of 1934,the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
November 14, 2001
PENNSYLVANIA ELECTRIC COMPANY
-----------------------------
Registrant
/s/ Harvey L. Wagner
---------------------------------
Harvey L. Wagner
Vice President and Controller
(Principal Accounting Officer)
27