FORM 10-Q/A
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 March 31, 2002
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.
----------- ----------------------------------- ------------------
1-3141 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
EXPLANATORY NOTE
Each of Jersey Central Power & Light Company ("JCP&L"), Metropolitan
Edison Company ("Met-Ed") and Pennsylvania Electric Company ("Penelec") is
filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002 solely to correct the review report letter of
PricewaterhouseCoopers LLP ("PwC ") accompanying its financial statements
contained in the original version of such report as filed with the Securities
and Exchange Commission on May 15, 2002.
To give effect to the above correction, each of JCP&L, Met-Ed and
Penelec is including in this filing only the following portions of Part I of
Item 1 of its report as originally filed:
(i) the Notes to Financial Statements (without changes) appearing on pages
1 through 8; and
(ii) its financial statements (without changes), the corrected letter of PwC
and Management's Discussion and Analysis of Results of Operations and
Financial Condition (without changes), appearing on pages 55 through 63
for JCP&L, pages 64 through 72 for MetEd and pages 73 through 81 for
Penelec.
Reference is made to such report as originally filed for the complete
text of all other portions of such report.
TABLE OF CONTENTS
Pages
Part I. Financial Information
Notes to Financial Statements.............................. 1-8
Jersey Central Power & Light Company
Consolidated Statements of Income.......................... 55
Consolidated Balance Sheets................................ 56-57
Consolidated Statements of Cash Flows...................... 58
Report of Independent Public Accountants................... 59
Management's Discussion and Analysis of Results
of Operations and Financial Condition.................... 60-63
Metropolitan Edison Company
Consolidated Statements of Income.......................... 64
Consolidated Balance Sheets................................ 65-66
Consolidated Statements of Cash Flows...................... 67
Report of Independent Public Accountants................... 68
Management's Discussion and Analysis of Results
of Operations and Financial Condition.................... 69-72
Pennsylvania Electric Company
Consolidated Statements of Income.......................... 73
Consolidated Balance Sheets................................ 74-75
Consolidated Statements of Cash Flows...................... 76
Report of Independent Public Accountants................... 77
Management's Discussion and Analysis of Results
of Operations and Financial Condition.................... 78-81
PART I. FINANCIAL INFORMATION
------------------------------
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 and
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.
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
1
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 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.
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 $133.6
million included in Accumulated Other Comprehensive Loss (AOCL) as of March 31,
2002, for derivative hedging activity, as compared to the December 31, 2001
balance of $169.4 million in AOCL, resulted from a $18.9 million increase
related to current hedging activity and a $16.9 million increase due to net
hedge losses included in earnings during the quarter. Approximately $7.1 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 $863
million (OE-$39 million, CEI-$57 million, TE-$27 million, Penn-$9 million,
JCP&L-$144 million, Met-Ed-$79 million, Penelec-$84 million, ATSI-$20 million,
FES-$261 million and other subsidiaries-$143 million) is applicable to 2002.
Investments for additional nuclear fuel during the 2002-2006 period are
estimated to be approximately $502 million (OE-$136 million, CEI-$166 million,
TE-$113 million and Penn-$87 million), of which approximately $35 million
(OE-$10 million, CEI-$12 million, TE-$8 million and Penn-$5 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 $27,500 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.
2
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 March 31, 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,
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 $58.2 million (JCP&L-$50.3 million,
CEI-$2.9 million, TE-$0.2 million, Met-Ed-$0.2 million, Penelec-$0.9 million and
other-$3.7 million) as of March 31, 2002. FirstEnergy does not believe
environmental remediation costs will have a material adverse effect on its
financial condition, cash flows or results of operations.
3
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."
In October 2001, FirstEnergy and Aquila, Inc. (formerly UtiliCorp
United) announced that Aquila made an offer to FirstEnergy 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 accepted the offer upon completion of its merger with GPU and
regulatory approvals for the transaction were received by Aquila. On March 18,
2002, FirstEnergy announced that the terms of the initial offer by Aquila were
modified such that Aquila would now acquire 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 will own all of the outstanding shares of Avon
through a jointly owned subsidiary, with each company having a 50-percent voting
interest. The transaction closed on May 8, 2002. In accordance with applicable
accounting guidance, the earnings of those foreign operations were capitalized
in advance of the sale and 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. In
addition, Avon's financial statements are no longer presented as "Assets Pending
Sale" and "Liabilities Related to Assets Pending Sale" in FirstEnergy's
Consolidated Balance Sheet at March 31, 2002.
GPU's former Argentina operations were also identified by FirstEnergy
for divestiture within twelve months of the merger date. FirstEnergy is actively
pursuing the sale of these operations. FirstEnergy determined the fair value of
the Argentina operations 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 the estimated fair value of the Argentina operations. 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 the current economic conditions in Argentina have not eroded
the fair value recorded for these operations, and as a result, an impairment
writedown of this investment is not warranted as of March 31, 2002. FirstEnergy
will continue to assess the potential impact of these and other related events
on the realizability of the value recorded for the Argentina operations. Other
international companies 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). The net after-tax
gain from the 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.
FirstEnergy also entered into a power purchase agreement (PPA) with NRG. Under
the terms of the PPA, NRG is obligated to sell FirstEnergy up to 10.5 billion
kilowatt-hours of electricity annually, similar to the average annual output of
the plants, through 2005. The sale is expected to close in mid-2002.
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.
4
EI Barranquilla, a wholly owned subsidiary of GPU Power, is an equity
investor in Termobarranquilla S.A., Empresa de Servicios Publicos (TEBSA), which
owns a Colombian independent power generation project. As of March 31, 2002, GPU
Power has an investment of approximately $113.7 million in TEBSA and 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 $301 million as of March 31,
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.
GPU had believed that various events of default had occurred under the
loan agreements relating to the TEBSA project. In addition, questions have been
raised as to the accuracy and completeness of information provided to various
parties to the project in connection with the project's formation. FirstEnergy
continues to discuss these issues and related matters with the project lenders,
CORELCA (the government owned Colombian electric utility with an ownership
interest in the project) and the Government of Colombia.
Moreover, in September 2001, the DIAN (the Colombian national tax
authority) presented TEBSA with a statement of charges alleging that certain
lease payments made under the Lease Agreement with Los Amigos Leasing Company
(an indirect wholly owned subsidiary of GPU Power) violated Colombian foreign
exchange regulations and were, therefore, subject to substantial penalties. The
DIAN has calculated a statutory penalty amounting to approximately $200 million
and gave TEBSA two months to respond to the statement of charges. In November
2001, TEBSA filed a formal response to this statement of charges. TEBSA is
continuing to review the DIAN's position and has been advised by its Colombian
counsel that the DIAN's position is without substantial legal merit. FirstEnergy
is unable to predict the outcome of these matters.
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.
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
5
annualized shopping levels as of March 31, 2002, FirstEnergy believes the
maximum potential recovery reductions are approximately $55 million (OE-$48
million and TE-$7 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 rates after July 31, 2003 to be
determined in a rate case commencing in 2002. The Final Order had directed JCP&L
to make a filing, no later than August 1, 2002, as to the proposed level of all
unbundled rate components for the period commencing August 1, 2003. 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. FirstEnergy is unable to predict the outcome of this rate case. In
addition to basic electric industry deregulation provisions discussed above, the
Final Order also confirms the establishment of a non-bypassable societal
benefits charge 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. 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, JCP&L would need to record a
corresponding charge to income of approximately $25 million; there would be no
effect to FirstEnergy'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 March 31, 2002, the
accumulated deferred cost balance totaled approximately $320 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 provides for a
usage-based non-bypassable transition bond charge and for the transfer of the
bondable transition property to another entity. JCP&L plans to sell transition
bonds in the second quarter of 2002 which will be 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, Met-Ed and Penelec would then reduce
stranded costs by $12 million and $25 million, respectively, plus interest and
record a corresponding charge to income; similar to JCP&L, there would be no
effect to FirstEnergy's net income.
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.
6
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 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, the pretax write-offs as of
March 31, 2002 would be approximately $90.2 million for Met-Ed and $103.0
million for Penelec. FirstEnergy is unable to predict the outcome of these
matters. There would be no adverse effect to FirstEnergy'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 -- no impairment of goodwill is anticipated as a result of a preliminary
analysis. 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 first quarter of
2001 and the year 2001 of $98 million and $646 million, respectively, would have
been $111 million and $701 million, respectively, excluding goodwill
amortization.
In July 2001, the FASB issued SFAS 143, "Accounting for Asset
Retirement Obligations." The new statement provides accounting standards for
retirement obligations associated with tangible long-lived assets, with adoption
required by January 1, 2003. SFAS 143 requires that the fair value of a
liability for an asset retirement obligation be recorded in the period in which
it is incurred. The associated asset retirement costs are capitalized as part of
the carrying amount of the long-lived asset. Over time the capitalized costs are
depreciated and the present value of the asset retirement liability increases,
resulting in a period expense. Upon retirement, a gain or loss will be recorded
if the cost to settle the retirement obligation differs from the carrying
amount. FirstEnergy is currently assessing the new standard and has not yet
determined the impact on its financial statements.
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.
Segment Financial Information
-----------------------------
Regulated Competitive Reconciling
Services Services Other Adjustments Consolidated
-------- -------- ----- ----------- ------------
(In millions)
Three Months Ended:
-------------------
March 31, 2002
--------------
External revenues..................... $ 1,995 $ 678 $ 123 $ 6 (a) $ 2,802
Internal revenues..................... 355 410 117 (882) (b) --
Total revenues..................... 2,350 1,088 240 (876) 2,802
Depreciation and amortization......... 244 7 12 -- 263
Net interest charges.................. 161 10 103 (14) (b) 260
Income taxes.......................... 162 (41) (40) -- 81
Income before cumulative effect of a
change in accounting............... 198 (60) (53) -- 85
Net income (loss)..................... 198 (60) (22) -- 116
Total assets.......................... 29,147 2,706 6,288 (836) (b) 37,305
Property additions.................... 144 37 14 -- 195
March 31, 2001
--------------
External revenues..................... $ 1,309 $ 633 $ 1 $ 43 (a) $ 1,986
Internal revenues..................... 334 500 65 (899) (b) --
Total revenues..................... 1,643 1,133 66 (856) 1,986
Depreciation and amortization......... 215 4 8 -- 227
Net interest charges.................. 145 (4) 8 (23) (b) 126
Income taxes.......................... 67 13 4 -- 84
Income before cumulative effect of
a change in accounting............. 123 (24) 7 -- 106
Net income (loss)..................... 123 (32) 7 -- 98
Total assets.......................... 15,624 1,896 481 -- 18,001
Property additions.................... 53 94 4 -- 151
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.
8
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
-------------------------
2002 2001
--------- --------
(In thousands)
OPERATING REVENUES.............................................................. $450,713 | $461,682
-------- | --------
|
OPERATING EXPENSES AND TAXES: |
Fuel......................................................................... 1,176 | 1,338
Purchased power.............................................................. 210,985 | 215,666
Other operating costs........................................................ 68,517 | 63,644
-------- | --------
Total operation and maintenance expenses................................. 280,678 | 280,648
Provision for depreciation and amortization.................................. 63,903 | 61,749
General taxes................................................................ 17,003 | 15,573
Income taxes................................................................. 27,861 | 30,228
-------- | --------
Total operating expenses and taxes....................................... 389,445 | 388,198
-------- | --------
|
OPERATING INCOME................................................................ 61,268 | 73,484
|
OTHER INCOME.................................................................... 2,826 | 1,158
-------- | --------
|
INCOME BEFORE NET INTEREST CHARGES.............................................. 64,094 | 74,642
-------- | --------
|
NET INTEREST CHARGES: |
Interest on long-term debt................................................... 22,717 | 21,209
Allowance for borrowed funds used during construction........................ (482) | (434)
Deferred interest............................................................ 449 | (3,076)
Other interest expense (credit).............................................. (1,244) | 2,886
Subsidiaries' preferred stock dividend requirements.......................... 2,675 | 2,675
-------- | --------
Net interest charges..................................................... 24,115 | 23,260
-------- | --------
|
NET INCOME...................................................................... 39,979 | 51,382
|
PREFERRED STOCK DIVIDEND REQUIREMENTS........................................... 753 | 1,391
-------- | --------
|
EARNINGS ON COMMON STOCK........................................................ $ 39,226 | $ 49,991
======== | ========
The preceding Notes to Financial Statements as they relate to Jersey Central Power &
Light Company are an integral part of these statements.
55
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2002 2001
------------ ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $ 3,453,937 $ 3,431,823
Less--Accumulated provision for depreciation.............................. 1,341,659 1,313,259
----------- -----------
2,112,278 2,118,564
Construction work in progress - electric plant............................ 62,493 60,482
----------- -----------
2,174,771 2,179,046
----------- -----------
OTHER PROPERTY AND INVESTMENTS:
Nuclear plant decommissioning trusts...................................... 114,104 114,899
Nuclear fuel disposal trust............................................... 140,988 137,098
Long-term notes receivable from associated companies...................... 20,333 20,333
Other..................................................................... 17,360 6,643
----------- -----------
292,785 278,973
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 67,617 31,424
Receivables-
Customers (less accumulated provisions of $10,642,000 and $12,923,000
respectively, for uncollectible accounts).............................. 186,430 226,392
Associated companies.................................................... 475 6,412
Other .................................................................. 22,506 20,729
Materials and supplies, at average cost-.................................. 1,342 1,348
Prepayments and other..................................................... 10,313 16,569
----------- -----------
288,683 302,874
----------- -----------
DEFERRED CHARGES:
Regulatory assets......................................................... 3,291,456 3,324,804
Goodwill.................................................................. 1,926,526 1,926,526
Other..................................................................... 30,333 27,775
----------- -----------
5,248,315 5,279,105
----------- -----------
$ 8,004,554 $ 8,039,998
=========== ===========
The preceding Notes to Financial Statements as they relate to Jersey Central Power &
Light Company are an integral part of these balance sheets.
56
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, 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 income (loss)........................... 467 (472)
Retained earnings....................................................... 68,569 29,343
---------- ----------
Total common stockholder's equity................................... 3,203,866 3,163,701
Preferred stock-
Not subject to mandatory redemption..................................... 12,649 12,649
Subject to mandatory redemption......................................... 44,868 44,868
Company-obligated mandatorily redeemable preferred securities............. 125,250 125,250
Long-term debt............................................................ 1,221,114 1,224,001
---------- ----------
4,607,747 4,570,469
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock...................... 10,848 60,848
Accounts payable-
Associated companies.................................................... 165,618 171,168
Other................................................................... 90,323 89,739
Notes payable to associated companies..................................... -- 18,149
Accrued taxes............................................................. 70,353 35,783
Accrued interest.......................................................... 29,889 25,536
Other..................................................................... 107,669 79,589
---------- ----------
474,700 480,812
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 516,494 514,216
Accumulated deferred investment tax credits............................... 12,591 13,490
Power purchase contract loss liability.................................... 1,929,252 1,968,823
Nuclear fuel disposal costs............................................... 164,087 163,377
Nuclear plant decommissioning costs....................................... 137,424 137,424
Other..................................................................... 162,259 191,387
---------- ----------
2,922,107 2,988,717
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 2).......................................
---------- ----------
$8,004,554 $8,039,998
========== ==========
The preceding Notes to Financial Statements as they relate to Jersey Central Power &
Light Company are an integral part of these balance sheets.
57
JERSEY CENTRAL POWER & LIGHT COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
2002 2001
--------- --------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: |
Net income................................................................... $ 39,979 | $ 51,382
Adjustments to reconcile net income to net |
cash from operating activities- |
Provision for depreciation and amortization........................... 63,903 | 61,749
Other amortization.................................................... 511 | 9,052
Deferred costs, net................................................... (65,608) | (50,737)
Deferred income taxes, net............................................ 8,678 | 16,411
Investment tax credits, net........................................... (899) | (899)
Receivables........................................................... 44,122 | (67,651)
Materials and supplies................................................ 6 | (28)
Accounts payable...................................................... (4,966) | (77,164)
Other................................................................. 46,664 | 109,269
-------- | --------
Net cash provided from operating activities......................... 132,390 | 51,384
-------- | --------
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
New Financing- |
Short-term borrowings, net.............................................. -- | 63,100
Redemptions and Repayments- |
Long-term debt.......................................................... 50,000 | --
Short-term borrowings, net.............................................. 18,149 | --
Dividend Payments- |
Common stock............................................................ -- | 75,000
Preferred stock......................................................... 753 | 1,391
-------- | --------
Net cash used for financing activities.............................. 68,902 | 13,291
-------- | --------
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
Property additions........................................................ 25,902 | 33,113
Capital trust investments................................................. 101 | 294
Other..................................................................... 1,292 | 1,675
-------- | --------
Net cash used for investing activities.............................. 27,295 | 35,082
-------- | --------
|
Net increase in cash and cash equivalents.................................... 36,193 | 3,011
Cash and cash equivalents at beginning of period ............................ 31,424 | 2,021
-------- | --------
Cash and cash equivalents at end of period................................... $ 67,617 | $ 5,032
======== | ========
The preceding Notes to Financial Statements as they relate to Jersey Central Power &
Light Company are an integral part of these statements.
58
REPORT OF INDEPENDENT PUBLIC 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 March 31, 2002, and the related
consolidated statements of income and cash flows for the three-month period
ended March 31, 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
information for them to be in conformity with accounting principles generally
accepted in the United States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
May 15, 2002
59
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 distribution services. JCP&L also provides power to
those customers electing to retain them as their power supplier. JCP&L's
regulatory plan requires it to itemize, or unbundle, 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 $11.0 million or 2.4% in the first
quarter of 2002 compared to the first quarter of 2001. The sources of the
changes in operating revenues, as compared to the same period in 2001, are
summarized in the following table.
Sources of Operating Revenue Changes
-----------------------------------------------------------------------
Increase (Decrease) (In millions)
Change in kilowatt-hour sales due to level of retail
customers shopping for generation service.......... $ 27.0
Change in other retail kilowatt-hour sales............ (35.6)
All other changes..................................... (2.4)
-----------------------------------------------------------------------
Net Decrease in Operating Revenues.................... $(11.0)
=======================================================================
Electric Sales
In the first quarter of 2002, the majority of the decrease in
operating revenues was due to the mild weather compared to the first quarter of
2001, and a 2% rate reduction that was effective August 1, 2001. The effects of
these decreases more than offset an increase in generation sales to residential
customers. Sales to industrial customers also decreased due to a decline in
economic conditions, while sales to commercial customers increased slightly.
Continuing to have an effect on operating revenues was a significant reduction
in the number of customers who received their power from alternate suppliers.
During the first quarter of 2001, 11.6% of kilowatt-hour deliveries were from
shopping customers; whereas, only 0.3% of kilowatt-hour deliveries during the
first quarter of 2002 were from shopping customers. Changes in kilowatt-hour
deliveries by customer class during the first quarter of 2002, as compared to
the same period of 2001, are summarized in the following table:
Changes in Kilowatt-hour Deliveries
---------------------------------------------------------------------
Increase (Decrease)
Residential............................... (4.1)%
Commercial................................ 0.1%
Industrial................................ (6.8)%
----------------------------------------------------------------------
Total Retail.............................. (2.5)%
Wholesale................................. (65.8)%
----------------------------------------------------------------------
Total Deliveries.......................... (3.9)%
----------------------------------------------------------------------
Operating Expenses and Taxes
Total operating expenses and taxes increased $1.2 million in the first
quarter of 2002, compared to the first quarter of 2001. Fuel and purchased power
costs (net of deferrals) decreased $4.8 million during the three months ended
March 31, 2002, compared to the same three months of 2001, partly as a result of
the rate reduction mentioned above, which increased energy cost deferrals.
Higher other operating costs of $4.9 million were partially attributable to
greater employee-related costs. An increase of $2.2 million in depreciation and
amortization
60
expenses was mostly due to higher average depreciable plant balances in the
first quarter of 2002 versus the first quarter of 2001.
Net Interest Charges
Net interest charges increased by $0.9 million in the first three
months of 2002, compared to the same period in 2001. The increase was attributed
to the issuance of $150 million of senior notes in May 2001, partially offset by
the redemption of $50 million of notes in March 2002.
Capital Resources and Liquidity
-------------------------------
JCP&L has continuing cash requirements for planned capital
expenditures and maturing debt. During the remaining three quarters of 2002,
capital requirements for property additions are expected to be about $120
million. JCP&L also has sinking fund requirements for preferred stock of $10.8
million during the remainder of 2002. These requirements are expected to be
satisfied from internal cash and/or short-term credit arrangements. JCP&L also
plans to use proceeds from its upcoming sale of transition bonds (see New Jersey
Regulatory Matters) to redeem preferred stock and higher cost debt.
As of March 31, 2002, JCP&L had about $67.6 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
indentures prohibit (subject to certain exceptions) it from issuing any debt
which is senior to the senior notes. As of March 31, 2002, JCP&L had the
capability to issue $307 million of additional senior notes based upon FMB
collateral. Based upon applicable earnings coverage tests and its charter, JCP&L
could issue $4.6 billion of preferred stock (assuming no additional debt was
issued) based on earnings through March 31, 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 principally
for hedging purposes. The change in the fair value of commodity derivative
contracts related to energy production during the first quarter of 2002 is
summarized in the following table:
Change in the Fair Value of Commodity Derivative Contracts
----------------------------------------------------------------------
(In millions)
Outstanding as of December 31, 2001................. $ 1.5
Contract value when entered......................... 1.6
Increase in value of existing contracts............. 11.5
----------------------------------------------------------------------
Outstanding as of March 31, 2002.................... $14.6
======================================================================
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 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:
61
Source of Information - Fair Value by Contract Year
---------------------------------------------------
2002* 2003 2004 Thereafter Total
--------------------------------------------------------------------------------
(In millions)
Prices actively quoted... $4.1 $0.9 $0.9 $ -- $ 5.9
Prices based on models**. -- -- -- 8.7 8.7
--------------------------------------------------------------------------
Total.................. $4.1 $0.9 $0.9 $8.7 $14.6
===============================================================================
* For the remaining quarters 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 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 March 31, 2002.
New Jersey Regulatory Matters
-----------------------------
In March 2001, the NJBPU issued a Final Decision and Order in JCP&L's
restructuring proceedings under which JCP&L was directed to make a filing, no
later than August 1, 2002, as to the proposed level of all unbundled rate
components for the period commencing August 1, 2003. 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
NJBPU will review the unbundled rate components to establish the appropriate
level of rates after July 31, 2003.
On February 6, 2002, JCP&L received a Financing Order from the New
Jersey Board of Public Utilities with authorization to issue $320 million of
transition bonds to securitize the recovery of bondable stranded costs
associated with the previously divested Oyster Creek nuclear generating station.
The Order grants JCP&L the right to charge a usage-based, non-bypassable
transition bond charge (TBC) and provided for the transfer of the bondable
transition property relating to the TBC to JCP&L Transition Funding LLC
(Transition Funding), a wholly owned limited liability corporation. Subject to
the receipt of authorization from the Securities and Exchange Commission,
Transition Funding is expected to issue and sell $320 million of transition
bonds in the second quarter of 2002, which will be recognized on the
Consolidated Balance Sheet, with the TBC providing recovery of principal,
interest and related fees on the transition bonds.
Environmental Matters
---------------------
Various environmental liabilities have been recognized on the
Consolidated Balance Sheet as of March 31, 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 a non-bypassable societal
benefits charge. JCP&L has total accrued liabilities aggregating approximately
$50.3 million as of March 31, 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 its financial results. All of JCP&L's assets are subject
to their own specific risks and uncertainties and are periodically 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
62
(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. As of March 31, 2002, JCP&L had recorded goodwill
of approximately $1.9 billion related to the merger.
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 - $3.3 billion as of March 31, 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 activities, expectations, intentions, assumptions and estimates remain
valid. As part of its normal operations, JCP&L enters into commodities
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 have not
been billed through March 31, 2002. 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
Implementation of Recently Issued Accounting Standards
------------------------------------------------------
Under SFAS 142, "Goodwill and Other Intangible Assets," goodwill must
be tested for impairment at least on an annual basis. JCP&L did not have any
goodwill prior to its 2001 merger. Goodwill associated with the merger will not
be amortized, but will be reviewed for impairment at least annually under the
provisions of the new standard. JCP&L expects to have its goodwill impairment
analysis completed later this year.
In July 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 is currently
assessing its asset retirement obligations under the new standard and has not
yet determined the impact on its financial statements.
63
METROPOLITAN EDISON COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
-------------------------
2002 2001
-------- --------
(In thousands)
OPERATING REVENUES.............................................................. $245,790 | $221,020
-------- | --------
|
|
OPERATING EXPENSES AND TAXES: |
Purchased power.............................................................. 148,949 | 125,227
Other operating costs........................................................ 29,005 | 36,553
-------- | --------
Total operation and maintenance expenses................................. 177,954 | 161,780
Provision for depreciation and amortization.................................. 15,292 | 17,794
General taxes................................................................ 16,912 | 10,632
Income taxes................................................................. 9,556 | 6,413
-------- | --------
Total operating expenses and taxes....................................... 219,714 | 196,619
-------- | --------
|
OPERATING INCOME................................................................ 26,076 | 24,401
|
OTHER INCOME.................................................................... 5,131 | 4,685
-------- | --------
|
INCOME BEFORE NET INTEREST CHARGES.............................................. 31,207 | 29,086
-------- | --------
|
NET INTEREST CHARGES: |
Interest on long-term debt................................................... 10,455 | 9,154
Allowance for borrowed funds used during construction........................ (284) | (159)
Deferred interest............................................................ (193) | --
Other interest expense....................................................... 273 | 2,236
Subsidiaries' preferred stock dividend requirements.......................... 1,838 | 1,838
-------- | --------
Net interest charges..................................................... 12,089 | 13,069
-------- | --------
|
|
NET INCOME...................................................................... $ 19,118 | $ 16,017
======== | ========
The preceding Notes to Financial Statements as they relate to Metropolitan Edison
Company are an integral part of these statements.
64
METROPOLITAN EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2002 2001
----------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $1,618,998 $1,609,974
Less--Accumulated provision for depreciation.............................. 541,786 530,006
---------- ----------
1,077,212 1,079,968
Construction work in progress.............................................. 13,701 14,291
---------- ----------
1,090,913 1,094,259
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Nuclear plant decommissioning trusts...................................... 159,952 157,699
Long-term notes receivable from associated companies...................... 12,418 12,418
Other..................................................................... 33,490 13,391
---------- ----------
205,860 183,508
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 20,812 25,274
Receivables-
Customers (less accumulated provisions of $10,641,000 and $12,271,000
respectively, for uncollectible accounts)............................. 104,258 112,257
Associated companies.................................................... 1,628 8,718
Other................................................................... 18,850 16,675
Prepayments and other..................................................... 39,136 12,239
---------- ----------
184,684 175,163
---------- ----------
DEFERRED CHARGES:
Regulatory assets......................................................... 1,296,378 1,320,412
Goodwill.................................................................. 784,443 784,443
Other..................................................................... 52,802 49,402
---------- ----------
2,133,623 2,154,257
---------- ----------
$3,615,080 $3,607,187
========== ==========
The preceding Notes to Financial Statements as they relate to Metropolitan Edison
Company are an integral part of these balance sheets.
65
METROPOLITAN EDISON COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, 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)........................... (158) 11
Retained earnings....................................................... 33,735 14,617
---------- ----------
Total common stockholder's equity................................... 1,307,902 1,288,953
Company-obligated trust preferred securities.............................. 92,200 92,200
Long-term debt............................................................ 541,779 583,077
---------- ----------
1,941,881 1,964,230
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock...................... 40,029 30,029
Accounts payable-
Associated companies.................................................... 53,019 67,351
Other................................................................... 30,270 36,750
Notes payable to associated companies..................................... 127,558 72,011
Accrued taxes............................................................. 5,686 7,037
Accrued interest.......................................................... 10,635 17,468
Other..................................................................... 11,205 13,652
---------- ----------
278,402 244,298
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 304,907 300,438
Accumulated deferred investment tax credits............................... 13,098 13,310
Purchase power contract loss liability.................................... 721,812 730,662
Nuclear fuel disposal costs............................................... 37,066 36,906
Nuclear plant decommissioning costs....................................... 269,834 268,967
Other..................................................................... 48,080 48,376
---------- ----------
1,394,797 1,398,659
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 2).......................................
---------- ---------
$3,615,080 $3,607,187
========== ==========
The preceding Notes to Financial Statements as they relate to Metropolitan Edison
Company are an integral part of these balance sheets.
66
METROPOLITAN EDISON COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
---------------------------
2002 2001
-------- --------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: |
Net income................................................................... $ 19,118 | $ 16,017
Adjustments to reconcile net income to net |
cash from operating activities- |
Provision for depreciation and amortization........................... 15,292 | 17,794
Other amortization.................................................... (938) | 237
Deferred costs, net................................................... 5,889 | 296
Deferred income taxes, net............................................ 2,567 | 1,372
Investment tax credits, net........................................... (212) | (212)
Receivables........................................................... 12,914 | (173)
Accounts payable...................................................... (20,812) | (2,283)
Other................................................................. (51,331) | (40,473)
-------- | --------
Net cash used for operating activities.............................. (17,513) | (7,425)
-------- | --------
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
New Financing- |
Short-term borrowings, net.............................................. 55,547 | 40,300
Redemptions and Repayments- |
Long-term debt.......................................................... 30,000 | --
Dividend Payments- |
Common stock............................................................ -- | 15,000
-------- | --------
Net cash provided from financing activities......................... 25,547 | 25,300
-------- | --------
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
Property additions........................................................ 9,096 | 11,793
Capital trust investments................................................. 3,161 | 2,371
Other..................................................................... 239 | 2,991
-------- | --------
Net cash used for investing activities.............................. 12,496 | 17,155
-------- | --------
|
Net increase (decrease) in cash and cash equivalents......................... (4,462) | 720
Cash and cash equivalents at beginning of period ............................ 25,274 | 3,439
-------- | --------
Cash and cash equivalents at end of period................................... $ 20,812 | $ 4,159
======== | ========
The preceding Notes to Financial Statements as they relate Metropolitan Edison Company
are an integral part of these statements.
67
REPORT OF INDEPENDENT PUBLIC 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 March 31, 2002, and the related
consolidated statements of income and cash flows for the three-month period
ended March 31, 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
information for them to be in conformity with accounting principles generally
accepted in the United States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
May 15, 2002
68
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 eastern and south central parts of Pennsylvania,
offering regulated electric distribution services. Met-Ed also provides power to
those customers electing to retain them as their power supplier. Met-Ed's
regulatory plan requires it to itemize, or unbundle, 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 $24.8 million or 11.2% in the first
quarter of 2002 compared to the first quarter of 2001. The sources of the
changes in operating revenues, as compared to the same period in 2001, are
summarized in the following table.
Sources of Operating Revenue Changes
----------------------------------------------------------------------
Increase (Decrease) (In millions)
Change in kilowatt-hour sales due to level of retail
customers shopping for generation service $ 35.5
Change in other retail kilowatt-hour sales............... (6.2)
Decrease in wholesale sales.............................. (1.0)
All other changes........................................ (3.5)
----------------------------------------------------------------------
Net Increase in Operating Revenues....................... $ 24.8
======================================================================
Electric Sales
In the first quarter of 2002, a significant reduction in the number of
customers who received their power from alternate suppliers continued to have an
effect on operating revenues. During the first quarter of 2001, 32.0% of
kilowatt-hour deliveries were to shopping customers; whereas, only 7.7% of
kilowatt-hour deliveries during the first quarter of 2002 were to shopping
customers. More than offsetting this increase in revenues from returning
shopping customers was lower kilowatt-hour sales to residential customers,
primarily due to milder weather during the first quarter of 2002 compared to the
first quarter of 2001. Sales to industrial customers also decreased due to a
decline in economic conditions. Changes in kilowatt-hour deliveries by customer
class during the first quarter of 2002, as compared to the same period of 2001,
are summarized in the following table:
Changes in Kilowatt-hour Deliveries
----------------------------------------------------------------
Increase (Decrease)
Residential............................... (7.1)%
Commercial................................ 0.7%
Industrial................................ (8.9)%
----------------------------------------------------------------
Total Retail.............................. (5.4)%
Wholesale................................. 7.4%
----------------------------------------------------------------
Total Deliveries.......................... (4.5)%
----------------------------------------------------------------
Operating Expenses and Taxes
Total operating expenses and taxes increased $23.1 million in the
first quarter of 2002 compared to the same period of 2001. Higher purchased
power costs accounted for the majority of the increase, as Met-Ed required more
power to satisfy its provider of last resort (PLR) obligation to customers who
returned from alternate suppliers in the first quarter of 2002. The $7.5 million
decrease in other operating costs in the first quarter of 2002 compared to the
same period of 2001 was primarily attributable to the absence of costs related
to early retirement programs offered to certain bargaining unit employees in
2001.
69
Net Interest Charges
Net interest charges decreased by $1.0 million in the first three
months of 2002, compared to the same period in 2001 due to the redemption of $30
million of long-term debt in the first quarter of 2002.
Capital Resources and Liquidity
-------------------------------
Met-Ed has continuing cash requirements for planned capital
expenditures and maturing debt. During the remaining three quarters of 2002,
capital requirements for property additions are expected to be about $69
million. These requirements are expected to be satisfied from internal cash
and/or short-term credit arrangements.
As of March 31, 2002, Met-Ed had about $20.8 million of cash and
temporary investments and $127.6 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 indentures prohibit (subject to certain exceptions) it from issuing
any debt which is senior to the senior notes. As of March 31, 2002, Met-Ed had
the capability to issue $112 million of additional senior notes based upon FMB
collateral. 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 principally for hedging
purposes. The change in the fair value of commodity derivative contracts related
to energy production during the first quarter of 2002 is summarized in the
following table:
Change in the Fair Value of Commodity Derivative Contracts
----------------------------------------------------------------------
(In millions)
Outstanding as of December 31, 2001................. $ 2.3
Contract value when entered......................... 0.2
Increase in value of existing contracts............. 18.8
----------------------------------------------------------------------
Outstanding as of March 31, 2002.................... $21.3
======================================================================
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:
Source of Information - Fair Value by Contract Year
---------------------------------------------------
2002* 2003 2004 Thereafter Total
-------------------------------------------------------------------------------
(In millions)
Prices actively quoted... $0.3 $1.8 $1.9 $ -- $ 4.0
Prices based on models**. -- -- -- 17.3 17.3
----------------------------------------------------------------------------
Total.................. $0.3 $1.8 $1.9 $17.3 $21.3
===============================================================================
* For the remaining quarters 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 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 March 31, 2002.
70
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. If the Commonwealth Court's decision is
affirmed by the Supreme Court of Pennsylvania, Met-Ed would have a pre-tax
write-off of approximately $90.2 million based on the March 31, 2002 PLR
deferred balance. 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 its financial results. All of Met-Ed's assets are
subject to their own specific risks and uncertainties and are periodically
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. As of March 31, 2002, Met-Ed
had recorded goodwill of approximately $784.4 million related to the merger.
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 March 31, 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.
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
71
and estimates remain valid. As part of its normal operations, Met-Ed enters into
commodities 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 have not
been billed through March 31, 2002. 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
Implementation of Recently Issued Accounting Standards
------------------------------------------------------
Under SFAS 142, "Goodwill and Other Intangible Assets," goodwill must
be tested for impairment at least on an annual basis. Met-Ed did not have any
goodwill prior to its 2001 merger. Goodwill associated with the merger will not
be amortized, but will be reviewed for impairment at least annually under the
provisions of the new standard. Met-Ed expects to have its goodwill impairment
analysis completed later this year.
In July 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 is currently
assessing its asset retirement obligations under the new standard and has not
yet determined the impact on its financial statements.
72
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
-------------------------
March 31,
2002 2001
--------- --------
(In thousands)
OPERATING REVENUES.............................................................. $242,820 | $243,827
-------- | --------
|
OPERATING EXPENSES AND TAXES: |
Purchased power.............................................................. 146,148 | 169,064
Other operating costs........................................................ 33,800 | 43,083
-------- | --------
Total operation and maintenance expenses................................. 179,948 | 212,147
Provision for depreciation and amortization.................................. 14,831 | 14,529
General taxes................................................................ 15,030 | 11,690
Income taxes (benefit)....................................................... 9,172 | (3,336)
-------- | --------
Total operating expenses and taxes....................................... 218,981 | 235,030
-------- | --------
|
OPERATING INCOME................................................................ 23,839 | 8,797
|
OTHER INCOME.................................................................... 298 | 605
-------- | --------
|
INCOME BEFORE NET INTEREST CHARGES.............................................. 24,137 | 9,402
-------- | --------
|
NET INTEREST CHARGES: |
Interest on long-term debt................................................... 8,421 | 8,241
Allowance for borrowed funds used during construction........................ (120) | (144)
Deferred interest............................................................ (751) | --
Other interest expense ...................................................... 605 | 1,575
Subsidiaries' preferred stock dividend requirements.......................... 1,835 | 1,835
-------- | --------
Net interest charges..................................................... 9,990 | 11,507
-------- | --------
|
NET INCOME (LOSS)............................................................... $ 14,147 | $ (2,105)
======== | ========
The preceding Notes to Financial Statements as they relate to the Pennsylvania Electric
Company are an integral part of these statements.
73
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2002 2001
----------- ------------
(In thousands)
ASSETS
------
UTILITY PLANT:
In service................................................................ $1,851,968 $1,845,187
Less--Accumulated provision for depreciation.............................. 644,012 630,957
---------- ----------
1,207,956 1,214,230
Construction work in progress-
Electric plant.......................................................... 15,578 12,857
---------- ----------
1,223,534 1,227,087
---------- ----------
OTHER PROPERTY AND INVESTMENTS:
Non-utility generation trusts............................................. 121,686 154,067
Nuclear plant decommissioning trusts...................................... 96,293 96,610
Long-term notes receivable from associated companies...................... 15,515 15,515
Other..................................................................... 11,410 2,265
---------- ----------
244,904 268,457
---------- ----------
CURRENT ASSETS:
Cash and cash equivalents................................................. 18,460 39,033
Receivables-
Customers (less accumulated provisions of $12,215,000 and $14,719,000
respectively, for uncollectible accounts)............................ 95,093 107,170
Associated companies.................................................... 40,493 40,203
Other................................................................... 14,825 14,842
Prepayments and other..................................................... 37,449 8,605
---------- ----------
206,320 209,853
---------- ----------
DEFERRED CHARGES:
Regulatory assets......................................................... 752,791 769,807
Goodwill.................................................................. 797,362 797,362
Other..................................................................... 27,664 27,703
---------- ----------
1,577,817 1,594,872
---------- ----------
$3,252,575 $3,300,269
========== ==========
The preceding Notes to Financial Statements as they relate to the Pennsylvania Electric
Company are an integral part of these balance sheets.
74
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, 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.................................. 929 1,779
Retained earnings....................................................... 24,942 10,795
---------- ----------
Total common stockholder's equity................................... 1,319,873 1,306,576
Company-obligated trust preferred securities ............................. 92,000 92,000
Long-term debt............................................................ 471,918 472,400
---------- ----------
1,883,791 1,870,976
---------- ----------
CURRENT LIABILITIES:
Currently payable long-term debt and preferred stock...................... 50,769 50,756
Accounts payable-
Associated companies.................................................... 114,706 126,390
Other................................................................... 38,582 38,720
Notes payable to associated companies..................................... 38,050 77,623
Accrued taxes............................................................. 44,517 29,255
Accrued interest.......................................................... 18,373 12,284
Other..................................................................... 7,600 10,993
---------- ----------
312,597 346,021
---------- ----------
DEFERRED CREDITS:
Accumulated deferred income taxes......................................... 4,490 21,682
Accumulated deferred investment tax credits............................... 11,671 11,956
Nuclear plant decommissioning costs....................................... 135,795 135,483
Nuclear fuel disposal costs.............................................. 18,533 18,453
Power purchase contract loss liability.................................... 855,759 867,046
Other..................................................................... 29,939 28,652
---------- ----------
1,056,187 1,083,272
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 2).......................................
---------- ----------
$3,252,575 $3,300,269
========== ==========
The preceding Notes to Financial Statements as they relate to the Pennsylvania Electric
Company are an integral part of these balance sheets.
75
PENNSYLVANIA ELECTRIC COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
---------------------------
2002 2001
-------- --------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: |
Net income (loss)............................................................ $ 14,147 | $ (2,105)
Adjustments to reconcile net income (loss) to net |
cash from operating activities- |
Provision for depreciation and amortization........................... 14,831 | 13,154
Other amortization.................................................... 782 | 462
Deferred costs, net................................................... (10,415) | (10,367)
Deferred income taxes, net............................................ (9,631) | 797
Investment tax credits, net........................................... (285) | (285)
Receivables........................................................... 11,803 | 2,882
Accounts payable...................................................... (11,822) | (5,317)
Other................................................................. (14,185) | (20,742)
-------- | --------
Net cash used for operating activities.............................. (4,775) | (21,521)
-------- | --------
CASH FLOWS FROM FINANCING ACTIVITIES: |
New Financing- |
Short-term borrowings, net.............................................. -- | 30,700
Redemptions and Repayments- |
Short-term borrowings, net.............................................. 39,573 | --
-------- | --------
Net cash used for (provided from) financing activities.................... 39,573 | (30,700)
-------- | --------
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
Property additions........................................................ 10,194 | 14,223
Proceeds from non-utility generation trusts............................... (34,208) | (8,465)
Contributions to decommissioning trusts................................... -- | 12
Other..................................................................... 239 | 3,319
-------- | --------
Net cash used for (provided from) investing activities.............. (23,775) | 9,089
-------- | --------
|
Net increase (decrease) in cash and cash equivalents......................... (20,573) | 90
Cash and cash equivalents at beginning of period ............................ 39,033 | 580
-------- | --------
Cash and cash equivalents at end of period................................... $ 18,460 | $ 670
======== | ========
The preceding Notes to Financial Statements as they relate to the Pennsylvania Electric
Company are an integral part of these statements.
76
REPORT OF INDEPENDENT PUBLIC 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 March 31, 2002, and the related
consolidated statements of income and cash flows for the three-month period
ended March 31, 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
information for them to be in conformity with accounting principles generally
accepted in the United States of America.
PricewaterhouseCoopers LLP
Cleveland, Ohio
May 15, 2002
77
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 parts of
Pennsylvania, offering regulated electric distribution services. Penelec also
provides power to those customers electing to retain them as their power
supplier. Penelec's regulatory plan requires it to itemize, or unbundle, 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 decreased by $1.0 million or 0.4% in the first
quarter of 2002 compared to the first quarter of 2001. The sources of the
changes in operating revenues, as compared to the same period in 2001, are
summarized in the following table.
Sources of Operating Revenue Changes
--------------------------------------------------------------------------
Increase (Decrease) (In millions)
Change in kilowatt-hour sales due to level of retail
customers shopping for generation service $ 35.4
Change in other retail kilowatt-hour sales............... (5.5)
Decrease in wholesale sales.............................. (27.9)
Provision for rate refunds............................... (0.8)
All other changes........................................ (2.2)
---------------------------------------------------------------------------
Net Decrease in Operating Revenues....................... $ (1.0)
===========================================================================
Electric Sales
In the first quarter of 2002, a significant reduction in the number of
customers who received their power from alternate suppliers continued to have an
effect on operating revenues. During the first quarter of 2001, 25.9% of
kilowatt-hour deliveries were from shopping customers, whereas only 4.4% of
kilowatt-hour deliveries during the first quarter of 2002 were from shopping
customers. More than offsetting this increase in revenues from returning
shopping customers was lower kilowatt-hour deliveries to residential customers,
primarily due to milder weather during the first quarter of 2002 compared to the
first quarter of 2001. Sales to industrial customers also decreased due to a
decline in economic conditions; lower sales to wholesale customers in the first
quarter of 2002 also reduced operating revenues. Changes in kilowatt-hour
deliveries by customer class during the first quarter of 2002, as compared to
the same period of 2001, are summarized in the following table:
Changes in Kilowatt-hour Deliveries
----------------------------------------------------------------------
Increase (Decrease)
Residential............................... (3.8)%
Commercial................................ (0.1)%
Industrial................................ (16.5)%
----------------------------------------------------------------------
Total Retail.............................. (10.8)%
Wholesale................................. (81.4)%
----------------------------------------------------------------------
Total Deliveries.......................... (20.4)%
----------------------------------------------------------------------
Operating Expenses and Taxes
Total operating expenses and taxes decreased $16.0 million in the
first quarter of 2002 compared to the same period of 2001. Purchased power costs
decreased $22.9 million in the first quarter of 2002 compared to the first
quarter of 2001 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 $9.3
million decrease in other operating costs in the first quarter of 2002
78
compared to the same period of 2001 was primarily attributable to the absence of
costs related to early retirement programs offered to certain bargaining unit
employees in 2001.
Net Interest Charges
Net interest charges decreased by $1.5 million in the first three
months of 2002, compared to the same period in 2001. The decrease was attributed
to higher deferred interest related to Penelec's deferred energy costs and lower
short-term borrowing levels.
Capital Resources and Liquidity
-------------------------------
Penelec has continuing cash requirements for planned capital
expenditures and maturing debt. During the remaining three quarters of 2002,
capital requirements for property additions and capital leases are expected to
be about $75 million. Penelec also has sinking fund requirements for maturing
long-term debt of $50.2 million during the remainder of 2002. These requirements
are expected to be satisfied from internal cash and/or short-term credit
arrangements.
As of March 31, 2002, Penelec had about $18.5 million of cash and
temporary investments and $38.1 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 indentures prohibit (subject to certain exceptions) it from issuing
any debt which is senior to the senior notes. As of March 31, 2002, Penelec had
the capability to issue $450 million of additional senior notes based upon FMB
collateral. 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 principally for hedging
purposes. The change in the fair value of commodity derivative contracts related
to energy production during the first quarter of 2002 is summarized in the
following table:
Change in the Fair Value of Commodity Derivative Contracts
----------------------------------------------------------------------
(In millions)
Outstanding as of December 31, 2001................. $1.3
Contract value when entered......................... 0.2
Increase in value of existing contracts............. 9.0
----------------------------------------------------------------------
Outstanding as of March 31, 2002.................... $10.5
======================================================================
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:
79
Source of Information - Fair Value by Contract Year
---------------------------------------------------
2002* 2003 2004 Thereafter Total
------------------------------------------------------------------------------
(In millions)
Prices actively quoted... $ -- $0.9 $0.9 $ -- $ 1.8
Prices based on models**. -- -- -- 8.7 8.7
----------------------------------------------------------------------------
Total.................. $ -- $0.9 $0.9 $ 8.7 $10.5
==============================================================================
* For the remaining quarters 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 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 March 31, 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. If the Commonwealth Court's decision
is affirmed by the Supreme Court of Pennsylvania, Penelec would have a pre-tax
write-off of approximately $103.0 million based on the March 31, 2002 PLR
deferred balance. 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 its financial results. All of Penelec's assets are
subject to their own specific risks and uncertainties and are periodically
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. As of March 31, 2002, Penelec
had recorded goodwill of approximately $797.4 million related to the merger.
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 - $752.8 million as of March 31, 2002.
Penelec regularly reviews these assets to assess their ultimate recoverability
80
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. 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 commodities
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 have not
been billed through March 31, 2002. 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
Implementation of Recently Issued Accounting Standards
------------------------------------------------------
Under SFAS 142, "Goodwill and Other Intangible Assets," goodwill must
be tested for impairment at least on an annual basis. Penelec did not have any
goodwill prior to its 2001 merger. Goodwill associated with the merger will not
be amortized, but will be reviewed for impairment at least annually under the
provisions of the new standard. Penelec expects to have its goodwill impairment
analysis completed later this year.
In July 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 is currently
assessing its asset retirement obligations under the new standard and has not
yet determined the impact on its financial statements.
81
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.
June 3, 2002
JERSEY CENTRAL POWER & LIGHT COMPANY
------------------------------------
Registrant
METROPOLITAN EDISON COMPANY
---------------------------
Registrant
PENNSYLVANIA ELECTRIC COMPANY
-----------------------------
Registrant
/s/ Harvey L. Wagner
---------------------------------------
Harvey L. Wagner
Vice President and Controller
Principal Accounting Officer
83