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Filed pursuant to Rule 424(b)(3)
Registration No. 333-35931
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY
AND
THE TOLEDO EDISON COMPANY
OFFER TO EXCHANGE
7.19% SERIES B SECURED NOTES DUE 2000
FOR ALL OUTSTANDING 7.19% SERIES A SECURED NOTES DUE 2000
$220 MILLION AGGREGATE PRINCIPAL AMOUNT OUTSTANDING,
7.67% SERIES B SECURED NOTES DUE 2004
FOR ALL OUTSTANDING 7.67% SERIES A SECURED NOTES DUE 2004
$350 MILLION AGGREGATE PRINCIPAL AMOUNT OUTSTANDING AND
7.13% SERIES B SECURED NOTES DUE 2007
FOR ALL OUTSTANDING 7.13% SERIES A SECURED NOTES DUE 2007
$150 MILLION AGGREGATE PRINCIPAL AMOUNT OUTSTANDING
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M.,
NEW YORK CITY TIME, ON OCTOBER 27, 1997, UNLESS EXTENDED
------------------------
The Cleveland Electric Illuminating Company ("Cleveland Electric") and The
Toledo Edison Company ("Toledo Edison"), joint and several obligors and Ohio
corporations (together, the "Companies"), hereby offer (the "Exchange Offer"),
upon the terms and subject to the conditions set forth in this Prospectus and
the accompanying Letter of Transmittal (the "Letter of Transmittal"), to
exchange their 7.19% Series B Secured Notes due 2000 (the "New Notes due 2000"),
7.67% Series B Secured Notes due 2004 (the "New Notes due 2004") and 7.13%
Series B Secured Notes due 2007 (the "New Notes due 2007") (collectively, the
"New Notes"), which have been registered under the Securities Act of 1933, as
amended (the "Securities Act"), pursuant to a Registration Statement (as defined
herein) of which this Prospectus constitutes a part, for equal principal amounts
of their outstanding 7.19% Series A Secured Notes due 2000 (the "Old Notes due
2000" and together with the New Notes due 2000, the "Secured Notes due 2000"),
7.67% Series A Secured Notes due 2004 (the "Old Notes due 2004" and together
with the New Notes due 2004, the "Secured Notes due 2004") and 7.13% Series A
Secured Notes due 2007 (the "Old Notes due 2007" and together with the New Notes
due 2007, the "Secured Notes due 2007") (the Old Notes due 2000, the Old Notes
due 2004 and the Old Notes due 2007 are collectively referred to herein as the
"Old Notes"), of which $220 million, $350 million and $150 million aggregate
principal amount, respectively, are outstanding. The New Notes and the Old Notes
are collectively referred to herein as the "Secured Notes."
Subject to the terms and conditions set forth in this Prospectus and the
Letter of Transmittal, the Companies will accept for exchange any and all Old
Notes that are validly tendered and not withdrawn on or prior to 5:00 p.m., New
York City time, on October 27, 1997, unless the Exchange Offer is extended (the
"Expiration Date"). Tenders of Old Notes may be withdrawn at any time prior to
5:00 p.m., New York City time, on the Expiration Date. The Exchange Offer is not
conditioned upon any minimum principal amount of Old Notes being tendered for
exchange. However, the Exchange Offer is subject to certain conditions which may
be waived by the Companies and to the terms and provisions of the Registration
Agreement (as defined herein). Old Notes may be tendered only in denominations
of $1,000 and integral multiples thereof. The Companies have agreed to pay the
expenses of the Exchange Offer. See "The Exchange Offer."
The New Notes will evidence the same debt as the Old Notes for which they
are exchanged and will be obligations of the Companies entitled to the benefits
of the Note Indenture (as defined herein) relating to the Secured Notes. The
form and terms of the New Notes are identical in all material respects to the
form and terms of the Old Notes except that the New Notes have been registered
under the Securities Act, and, following the completion of the Exchange Offer
and during the effectiveness of any required Shelf Registration Statement (as
defined in the Registration Agreement), the holders of the Old Notes will not be
entitled to the contingent increase in the interest rate otherwise provided for
under
(cover continued on following pages)
------------------------
SEE "RISK FACTORS" FOR A DISCUSSION OF CERTAIN MATTERS THAT SHOULD BE
CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE NEW NOTES.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
The date of this Prospectus is September 25, 1997.
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(Continuation of cover page)
certain circumstances and will not be entitled to the benefit of certain
registration and exchange rights granted to the holders of the Old Notes under
the Registration Agreement. See "The Exchange Offer" and "Description of the New
Notes."
Each broker-dealer that receives New Notes for its own account pursuant to
the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. The Letter of Transmittal states
that by so acknowledging and by delivering a prospectus, a broker-dealer will
not be deemed to admit that it is an "underwriter" within the meaning of the
Securities Act. This Prospectus, as it may be amended or supplemented from time
to time, may be used by a broker-dealer in connection with resales of New Notes
received in exchange for Old Notes if such Old Notes were acquired by such
broker-dealer as a result of market-making activities or other trading
activities. The Companies have agreed that, for a period of 120 days after the
Expiration Date, they will make this Prospectus available to any broker-dealer
for use in connection with any such resale. See "Plan of Distribution."
New Notes of each series will bear interest at the same rate and on the
same terms as the Old Notes of the corresponding series. Under the Note
Indenture, interest on each Old Note ceases to accrue upon the exchange of such
Old Note for a New Note. Interest will accrue on each New Note from the date on
which it is authenticated and will be payable to the person in whose name such
New Note is registered at the close of business on the Regular Record Date (as
defined in the Note Indenture) for such interest, which will be the December 15
or June 15 (whether or not a business day), as the case may be, next preceding
the payment date for such interest. If, however, the New Note is authenticated
and delivered in exchange for an Old Note (i) between a record date for the
payment of interest on that Old Note and the related interest payment date, the
interest that accrues on the New Note from the date of authentication thereof to
that interest payment date shall be payable to the person in whose name such New
Note was issued on its issuance date or (ii) between an interest payment date
for the payment of interest on that Old Note and the record date for the next
succeeding interest payment date, the interest that accrues on the Old Note from
the earlier interest payment date to the date on which the Old Note is exchanged
for the New Note will be paid to the person in whose name the New Note is
registered on the record date for that next succeeding interest payment date.
The Companies intend to cause the New Notes to be authenticated on the date on
which the New Notes are exchanged for the Old Notes. Therefore, the exchange
will not result in the loss of interest income to holders of Old Notes exchanged
for New Notes. Interest on the Secured Notes is payable semiannually in cash in
arrears on January 1 and July 1 of each year, commencing July 1, 1997, and the
Secured Notes will bear interest and mature as follows: for the Secured Notes
due 2000, interest at 7.19% with a maturity date of July 1, 2000; for the
Secured Notes due 2004, interest at 7.67% with a maturity date of July 1, 2004;
and for the Secured Notes due 2007, interest at 7.13% with a maturity date of
July 1, 2007. See "The Exchange Offer -- Interest on the New Notes."
The obligations of Cleveland Electric and Toledo Edison under the Secured
Notes are joint and several. The Old Notes are, and the New Notes will be,
secured equally and ratably as to payment of principal and interest by first
mortgage bonds severally issued by Cleveland Electric and Toledo Edison and held
by the trustee under the indenture for the Secured Notes. See "Descriptions of
Cleveland Electric Bonds and Toledo Edison Bonds." Payment of the principal of
and interest on the Old Notes due 2007 is, and payment of principal and interest
on the New Notes due 2007 will be, insured by financial guaranty insurance
policies issued by Ambac Assurance Corporation. See "Credit Enhancement of
Secured Notes due 2007."
Old Notes of each series initially purchased by qualified institutional
buyers, as defined in Rule 144A under the Securities Act ("QIBs"), were
initially represented by a single, global Secured Note of each series in
registered form (each a "Global Note"), registered in the name of a nominee of
The Depository Trust Company ("DTC"), as depository. The New Notes of each
series exchanged for Old Notes represented by a Global Note will be represented
by a single, global New Note of that series in registered form (each a "Global
New Note"), registered in the name of Cede & Co., as nominee of DTC. Beneficial
interests in the Global New Notes will be shown on, and transfers thereof will
be effected only through, records maintained by DTC and its participants. See
"Description of the New Notes -- Book-Entry; Delivery and Form."
Based on no-action letters issued by the staff of the Securities and
Exchange Commission (the "SEC") to third parties, the Companies believe that the
New Notes issued pursuant to this Exchange Offer in exchange for the Old Notes
may be offered for resale, resold and otherwise transferred by any holder
thereof (other than (i) a broker-dealer who purchased such Old Notes directly
from the Companies to resell pursuant
i
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(Continuation of cover page)
to Rule 144A or any other available exemption under the Securities Act or (ii) a
person that is an "affiliate" of the Companies within the meaning of Rule 405
under the Securities Act) without compliance with the registration and
prospectus delivery provisions of the Securities Act, provided that the holder
is acquiring the New Notes in its ordinary course of business and is not
participating, and has no arrangement or understanding with any person to
participate, in a distribution of the New Notes. See Morgan Stanley & Co.
Incorporated, SEC No-Action Letter (available June 5, 1991) and Exxon Capital
Holdings Corporation, SEC No-Action Letter (available May 13, 1988). Holders of
Old Notes wishing to accept the Exchange Offer must represent to the Companies,
as required by the Registration Agreement, that such conditions have been met.
If the Companies' belief is inaccurate, holders of New Notes who transfer New
Notes in violation of the prospectus delivery provisions of the Securities Act
and without an exemption from registration thereunder may incur liability under
the Securities Act. The Companies do not assume, or indemnify holders against,
any such liability.
Proceeds from the offering of the Old Notes (the "Offering") were used by
the Companies, together with cash and approximately $155 million of short-term
borrowings, to refinance $873 million in high interest secured lease obligation
bonds issued by a special purpose funding corporation on behalf of lessors in
the Companies' sale and leaseback transaction for the Bruce Mansfield Generating
Plant (the "Mansfield Plant"). The Companies will not receive any proceeds from
the Exchange Offer, and no underwriter is being utilized in connection with the
Exchange Offer.
The exchange of Old Notes for New Notes will be a tax-free exchange. See
"Certain Tax Considerations."
After completion of the Exchange Offer, Old Notes which have not been
exchanged for New Notes will remain outstanding. See "Risk
Factors -- Consequences of Failure to Exchange."
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANIES ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF OLD NOTES IN ANY JURISDICTION IN WHICH
THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE WITH THE
SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION.
Prior to the Exchange Offer, there has been no public market for the Old
Notes. The Companies do not presently intend to list the New Notes on any stock
exchange or trading market. There can be no assurance that an active public
market for the New Notes will develop. If a market for the New Notes should
develop, the New Notes could trade at a discount from their principal amount.
See "Risk Factors -- Lack of Public Market for the Secured Notes."
The Companies have been advised by Morgan Stanley & Co. Incorporated,
Citicorp Securities, Inc., Credit Suisse First Boston and McDonald & Company
Securities, Inc., the placement agents of the Old Notes (the "Placement
Agents"), that, following completion of the Exchange Offer, each intends to make
a market in the New Notes; however, none of the Placement Agents are under any
obligation to do so and any market-making activities with respect to the New
Notes may be discontinued at any time.
ii
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THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF
AN OFFER TO BUY, ANY SECURED NOTE OFFERED HEREBY BY ANY PERSON IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL FOR SUCH PERSON TO MAKE SUCH AN OFFER OR
SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL UNDER ANY CIRCUMSTANCES IMPLY THAT THERE HAS BEEN NO CHANGE IN
THE AFFAIRS OF EITHER OF THE COMPANIES OR THAT THE INFORMATION SET FORTH HEREIN
IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
This Prospectus has been prepared by the Companies solely for use in
connection with the Exchange Offer. This Prospectus is personal to the offeree
to whom it has been delivered and does not constitute an offer to any other
person or to the public generally to subscribe for or otherwise acquire Secured
Notes. Distribution of this Prospectus to any person other than the offeree and
those persons, if any, retained to advise such offeree with respect thereto is
unauthorized.
This Prospectus incorporates by reference documents which are not presented
herein or delivered herewith. These documents are available upon request from
Janis T. Percio, Secretary, Centerior Energy Corporation, P.O. Box 94661,
Cleveland, Ohio 44101-4661, or telephone (216) 447-3100. In order to assure
timely delivery of the documents, any request should be made by October 20,
1997.
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None of Cleveland Electric, Toledo Edison or any of their respective
representatives makes any representation to any offeree or purchaser of the New
Notes offered hereby regarding the legality of an investment by such offeree or
purchaser under legal investment or similar laws. Each investor should consult
with its own advisors as to the legal, tax, business, financial and related
aspects of any purchase of the New Notes.
------------------------
THIS PROSPECTUS INCLUDES "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
THE SECURITIES LAWS. THE COMPANIES HAVE MADE FORWARD-LOOKING STATEMENTS
INCLUDING STATEMENTS ABOUT THEIR FINANCIAL CONDITION, RESULTS OF OPERATIONS AND
BUSINESS AND THE PENDING MERGER OF CENTERIOR ENERGY CORPORATION ("CENTERIOR
ENERGY") AND OHIO EDISON COMPANY ("OHIO EDISON") DISCUSSED HEREIN. THESE
STATEMENTS INVOLVE CERTAIN RISKS AND UNCERTAINTIES. FORWARD-LOOKING STATEMENTS
ARE STATEMENTS ABOUT FUTURE PERFORMANCE OR RESULTS, INCLUDING ANY STATEMENTS
USING THE WORDS "BELIEVE," "EXPECT," "ANTICIPATE" OR SIMILAR WORDS. FOR ALL OF
THOSE STATEMENTS, THE COMPANIES CLAIM THE PROTECTION OF THE SAFE HARBOR FOR
FORWARD-LOOKING STATEMENTS CONTAINED IN THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995. FACTORS THAT MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
THOSE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS INCLUDE, AMONG OTHERS,
THOSE IDENTIFIED UNDER "RISK FACTORS" HEREIN AND THE FOLLOWING POSSIBILITIES:
(1) EXPECTED COST SAVINGS FROM SUCH PENDING MERGER ARE NOT FULLY REALIZED; (2)
REGIONAL COMPETITIVE PRESSURE IN THE ELECTRIC UTILITY INDUSTRY INCREASES
SIGNIFICANTLY; (3) COSTS OR DIFFICULTIES RELATED TO THE INTEGRATION OF THE
BUSINESSES OF CENTERIOR ENERGY AND OHIO EDISON ARE GREATER THAN EXPECTED; (4)
STATE AND FEDERAL REGULATORY INITIATIVES ARE IMPLEMENTED THAT FURTHER INCREASE
COMPETITION, THREATEN COST AND INVESTMENT RECOVERY OR IMPACT RATE STRUCTURES;
AND (5) NATIONAL AND REGIONAL ECONOMIC CONDITIONS ARE LESS FAVORABLE THAN
EXPECTED. ALTHOUGH THE COMPANIES BELIEVE THAT THE EXPECTATIONS REFLECTED IN SUCH
FORWARD-LOOKING STATEMENTS ARE REASONABLE, THEY CAN GIVE NO ASSURANCE THAT SUCH
EXPECTATIONS WILL PROVE TO HAVE BEEN CORRECT. THESE FACTORS SHOULD BE TAKEN INTO
CONSIDERATION IN CONJUNCTION WITH THE FORWARD-LOOKING STATEMENTS INCLUDED IN
THIS PROSPECTUS.
2
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AVAILABLE INFORMATION
The Companies have filed with the SEC a Registration Statement on Form S-4
(together with all amendments, exhibits, schedules and supplements thereto, the
"Registration Statement") under the Securities Act with respect to the New Notes
offered hereby. This Prospectus, which forms a part of the Registration
Statement, does not contain all the information set forth in the Registration
Statement, certain parts of which have been omitted in accordance with the rules
and regulations of the SEC. For further information with respect to the
Companies and the New Notes offered hereby, reference is made to the
Registration Statement. Statements contained in this Prospectus as to the
contents of certain documents filed as exhibits to the Registration Statement
are not necessarily complete and, in each case, are qualified by reference to
the copy of the document so filed.
Cleveland Electric and Toledo Edison are each subject to the informational
requirements of the Securities Exchange Act of 1934 ("Exchange Act") and in
accordance therewith file reports and other information with the SEC. Such
reports, other information and the Registration Statement can be inspected and
copied at the public reference facilities maintained by the SEC at its principal
office located at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C.
20549-1004 and at its regional offices located at Suite 1400, Northwestern
Atrium, 500 West Madison Street, Chicago, IL 60661-2511 and 7 World Trade
Center, 13th Floor, New York, NY 10048. Copies of such material also can be
obtained at prescribed rates from the Public Reference Section of the SEC at its
principal office. The SEC also maintains a Web site that contains reports and
other information filed by the Companies. The SEC's Internet address is
http://www.sec.gov. Such material can also be inspected at the New York Stock
Exchange and, for Toledo Edison, also at the American Stock Exchange.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The Companies hereby incorporate in this Prospectus by reference the
following documents heretofore filed with the SEC, pursuant to the Exchange Act,
to which reference hereby is made:
1. Each Company's Annual Report on Form 10-K for the year ended
December 31, 1996 ("Form 10-K").
2. Each Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997 ("First Quarter 1997 Form 10-Q").
3. Each Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997 ("Second Quarter 1997 Form 10-Q").
4. Each Company's Current Reports on Form 8-K dated June 11, 1997 and
July 8, 1997 and Form 8-K/A dated August 27, 1997.
THE COMPANIES HEREBY UNDERTAKE TO PROVIDE WITHOUT CHARGE TO EACH PERSON TO
WHOM A COPY OF THIS PROSPECTUS HAS BEEN DELIVERED, ON THE WRITTEN OR ORAL
REQUEST OF SUCH PERSON, A COPY OF ANY OR ALL OF THE DOCUMENTS REFERRED TO ABOVE
WHICH HAVE BEEN INCORPORATED BY REFERENCE IN THIS PROSPECTUS, OTHER THAN
EXHIBITS TO SUCH DOCUMENTS UNLESS SUCH EXHIBITS ARE SPECIFICALLY INCORPORATED BY
REFERENCE INTO THE INFORMATION THAT THIS PROSPECTUS INCORPORATES. REQUESTS FOR
SUCH COPIES SHOULD BE DIRECTED TO JANIS T. PERCIO, SECRETARY, CENTERIOR ENERGY
CORPORATION, P.O. BOX 94661, CLEVELAND, OH 44101-4661, OR TELEPHONE (216)
447-3100.
3
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SUMMARY INFORMATION
The following material is qualified in its entirety by the information appearing
elsewhere in this Prospectus and in the documents incorporated herein by
reference. Holders of Old Notes are urged to read this Prospectus in its
entirety before exchanging their Old Notes for New Notes.
THE COMPANIES
Cleveland Electric, which was incorporated under the laws of the State of
Ohio in 1892, is a public utility engaged in the generation, purchase,
transmission, distribution and sale of electric energy in an area of
approximately 1,700 square miles in northeastern Ohio, including the City of
Cleveland. Cleveland Electric also provides electric energy at wholesale to
other electric utility companies and to two municipal electric systems (directly
and through American Municipal Power-Ohio ("AMP-Ohio")) in its service area.
Cleveland Electric serves approximately 741,000 customers and derives
approximately 77% of its total electric retail revenue from customers outside
the City of Cleveland. Principal industries served by Cleveland Electric include
those producing steel and other primary metals; automotive and other
transportation equipment; chemicals; electrical and nonelectrical machinery;
fabricated metal products; and rubber and plastic products. Nearly all of
Cleveland Electric's operating revenues are derived from the sale of electric
energy. At June 30, 1997, Cleveland Electric had 3,251 employees.
The mailing address of Cleveland Electric's principal offices is P.O. Box
5000, Cleveland, OH 44101, and its telephone number is (216) 622-9800.
Toledo Edison, which was incorporated under the laws of the State of Ohio
in 1901, is a public utility engaged in the generation, purchase, transmission,
distribution and sale of electric energy in an area of approximately 2,500
square miles in northwestern Ohio, including the City of Toledo. Toledo Edison
also provides electric energy at wholesale to other electric utility companies
and to 13 municipally owned distribution systems (through AMP-Ohio) and one
rural electric cooperative distribution system in its service area. Toledo
Edison serves approximately 293,000 customers and derives approximately 56% of
its total electric retail revenue from customers outside the City of Toledo.
Principal industries served by Toledo Edison include metal casting, forming and
fabricating; petroleum refining; automotive equipment and assembly; food
processing; and glass. Nearly all of Toledo Edison's operating revenues are
derived from the sale of electric energy. At June 30, 1997, Toledo Edison had
1,581 employees.
The mailing address of Toledo Edison's principal offices is 300 Madison
Avenue, Toledo, OH 43652-0001, and its telephone number is (419) 249-5000.
Cleveland Electric and Toledo Edison are wholly owned electric utility
subsidiaries of Centerior Energy. See "Pending Merger of Cleveland Electric and
Toledo Edison" for a discussion of the pending merger of Toledo Edison into
Cleveland Electric.
In September 1996, Centerior Energy and Ohio Edison entered into an
agreement and plan of merger to form a new holding company, FirstEnergy Corp.
("FirstEnergy"). Following the consummation of the pending merger of Centerior
Energy and Ohio Edison ("CEC-OE Merger"), FirstEnergy will directly hold all of
the issued and outstanding common stock of the Companies, Ohio Edison and the
other wholly owned subsidiaries of Centerior Energy. The Companies and Ohio
Edison have adjoining service areas and share a number of major generating
units. The Companies believe that the CEC-OE Merger will create a company that
is better positioned to compete in the increasingly competitive electric utility
industry than either Centerior Energy or Ohio Edison would be on a stand-alone
basis. If the CEC-OE Merger were completed today, FirstEnergy would be the 11th
largest investor-owned electric utility system in the U.S., based on combined
annual sales of approximately 64 billion kilowatt-hours, and would have assets
of over $18 billion, a customer base of 2.1 million and a service area of 13,200
square miles located within a 500-mile radius of one-half of the U.S.
population. In addition, the CEC-OE Merger is expected to result in significant
cost savings to the combined companies (approximately $1 billion over 10 years)
and to enable FirstEnergy to realize opportunities to maximize efficiencies and
increase management flexibility in order to enhance revenues, cash flow and
earnings. See "Pending Merger of Centerior Energy and Ohio Edison" and "Risk
Factors -- Consummation of the CEC-OE Merger."
4
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SUMMARY OF THE TERMS OF THE EXCHANGE OFFER
The Exchange Offer relates to the exchange of up to $220,000,000 aggregate
principal amount of New Notes due 2000 for an equal aggregate principal amount
of Old Notes due 2000, up to $350,000,000 aggregate principal amount of New
Notes due 2004 for an equal aggregate principal amount of Old Notes due 2004,
and up to $150,000,000 aggregate principal amount of New Notes due 2007 for an
equal aggregate principal amount of Old Notes due 2007. The New Notes are joint
and several obligations of the Companies entitled to the benefits of the Note
Indenture relating to the Secured Notes. The form and terms of the New Notes are
the same as the form and terms of the Old Notes except that the New Notes have
been registered under the Securities Act, and following the completion of the
Exchange Offer and during the effectiveness of any required Shelf Registration
Statement, the Old Notes will not be entitled to the contingent increase in the
interest rate otherwise provided for under certain circumstances and will not be
entitled to the benefit of certain registration and exchange rights granted to
the holders of the Old Notes under the Registration Agreement. See "The Exchange
Offer" and "Description of the New Notes."
THE EXCHANGE OFFER............ The Companies are offering to exchange $1,000
principal amount of each series of New Notes
for each $1,000 principal amount of the
corresponding series of Old Notes validly
tendered pursuant to the Exchange Offer. As of
the date hereof, there is $720 million
aggregate principal amount of Old Notes
outstanding. The Companies will issue the New
Notes to tendering holders of Old Notes on or
promptly after the Expiration Date. See "The
Exchange Offer -- Background" and "-- General."
RESALE OF THE NEW NOTES....... Based on interpretations by the staff of the
SEC set forth in no-action letters issued to
third parties, the Companies believe that New
Notes issued pursuant to the Exchange Offer in
exchange for Old Notes may be offered for
resale, resold and otherwise transferred by any
holder thereof (other than (i) a broker-dealer
who purchased such Old Notes directly from the
Companies for resale pursuant to Rule 144A or
any other available exemption under the
Securities Act or (ii) a person that is an
"affiliate" of the Companies within the meaning
of Rule 405 under the Securities Act) without
compliance with the registration and prospectus
delivery provisions of the Securities Act,
provided that the holder is acquiring the New
Notes in its ordinary course of business and is
not participating, and has no arrangement or
understanding with any person to participate,
in a distribution of the New Notes. If the
Companies' belief is inaccurate, holders of New
Notes who transfer New Notes in violation of
the prospectus delivery provisions of the
Securities Act and without an exemption from
registration thereunder may incur liability
under the Securities Act. The Companies do not
assume or indemnify holders against any such
liability.
Each broker-dealer that receives New Notes in
exchange for Old Notes held for its own
account, as a result of market-making or other
trading activities, must acknowledge that it
will deliver a prospectus in connection with
any resale of such New Notes. The Letter of
Transmittal states that by so acknowledging and
by delivering a prospectus, such broker-dealer
will not be deemed to admit that it is an
"underwriter" within the meaning of the
Securities Act. This Prospectus, as it may be
amended or supplemented from time to time, may
be used by any such broker-dealer in connection
with resales of New Notes received in exchange
for
5
<PAGE> 8
Old Notes. The Companies have agreed that, for
a period of 120 days after the Expiration Date,
they will make this Prospectus and any
amendment or supplement to this Prospectus
available to any such broker-dealer for use in
connection with any such resales. See "Plan of
Distribution." The Companies believe that no
registered holder of the Old Notes is an
"affiliate" (as such term is defined in Rule
405 of the Securities Act) of the Companies.
This Exchange Offer is not being made to, nor
will the Companies accept surrenders for
exchange from, holders of Old Notes in any
jurisdiction in which this Exchange Offer or
the acceptance thereof would not be in
compliance with the securities or blue sky laws
of such jurisdiction.
EXPIRATION OF EXCHANGE
OFFER......................... 5:00 p.m., New York City time, on October 27,
1997, unless the Exchange Offer is extended, in
which case the term "Expiration Date" means the
latest date and time to which the Exchange
Offer is extended. See "The Exchange
Offer -- Expiration Date; Extensions;
Amendments."
ACCRUED INTEREST ON THE NEW
NOTES AND THE OLD NOTES....... New Notes of each series will bear interest at
the same rate and on the same terms as the Old
Notes of the corresponding series. Under the
Note Indenture, interest on each Old Note
ceases to accrue upon the exchange of such Old
Note for a New Note. Interest will accrue on
each New Note from the date on which it is
authenticated and will be payable to the person
in whose name such New Note is registered at
the close of business on the Regular Record
Date for such interest, which will be the
December 15 or June 15 (whether or not a
business day), as the case may be, next
preceding the payment date for such interest.
If, however, the New Note is authenticated and
delivered in exchange for an Old Note (i)
between a record date for the payment of
interest on that Old Note and the related
interest payment date, the interest that
accrues on the New Note from the date of
authentication thereof to that interest payment
date shall be payable to the person in whose
name such New Note was issued on its issuance
date or (ii) between an interest payment date
for the payment of interest on that Old Note
and the record date for the next succeeding
interest payment date, the interest that
accrues on the Old Note from the earlier
interest payment date to the date on which the
Old Note is exchanged for the New Note will be
paid to the person in whose name the New Note
is registered on the record date for that next
succeeding interest payment date. The Companies
intend to cause the New Notes to be
authenticated on the date on which the New
Notes are exchanged for the Old Notes.
Therefore, the exchange will not result in the
loss of interest income to holders of Old Notes
exchanged for New Notes. Interest on the
Secured Notes is payable semiannually in cash
in arrears on January 1 and July 1 of each
year, commencing July 1, 1997, and the Secured
Notes will bear interest and mature as follows:
for the Secured Notes due 2000, interest at
7.19% with a maturity date of July 1, 2000; for
the Secured Notes due 2004, interest at 7.67%
with a maturity date of July 1, 2004; and for
the Secured Notes due 2007,
6
<PAGE> 9
interest at 7.13% with a maturity date of July
1, 2007. See "The Exchange Offer -- Interest on
the New Notes."
TERMINATION OF THE EXCHANGE
OFFER......................... The Exchange Offer is not subject to any
condition, other than (i) that the Exchange
Offer does not violate applicable law or any
applicable interpretation of the staff of the
SEC, (ii) that no action or proceeding shall
have been instituted or threatened in any court
or by or before any governmental agency or body
with respect to the Exchange Offer, and (iii)
that there shall not have been adopted or
enacted any law, statute, rule or regulation
that would render the Exchange Offer illegal.
There can be no assurance that any such
condition will not occur. Holders of Old Notes
will have certain rights against the Companies
under the Registration Agreement should the
Companies fail to consummate the Exchange
Offer. See "The Exchange Offer -- General" and
"-- Termination."
PROCEDURES FOR TENDERING OLD
NOTES......................... Each holder of Old Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof,
in accordance with the instructions contained
herein and therein, and mail or otherwise
deliver such Letter of Transmittal, or such
facsimile, together with any other required
documentation, to the Exchange Agent (as
defined herein), at the address set forth
herein and therein by 5:00 p.m., New York City
time, on the Expiration Date. See "The Exchange
Offer -- Procedures for Tendering."
By executing the Letter of Transmittal, each
holder will represent to the Companies that,
among other things, (i) it is acquiring the New
Notes pursuant to the Exchange Offer in the
ordinary course of business of the person
receiving such New Notes, whether or not such
person is the holder, (ii) neither the holder
nor any such other person is engaged in or
intends to engage in, or has an arrangement or
understanding with any person to participate
in, any distribution of such New Notes and
(iii) neither the holder nor any such other
person is an "affiliate," as defined in Rule
405 under the Securities Act, of the Companies
or, if an affiliate, such holder will comply
with the registration and prospectus delivery
requirements of the Securities Act to the
extent applicable. See "The Exchange
Offer -- General" and "-- Procedures for
Tendering."
SPECIAL PROCEDURES FOR
BENEFICIAL HOLDERS............ Any beneficial holder whose Old Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee
and who wishes to tender in the Exchange Offer
should contact such registered holder promptly
and instruct such registered holder to tender
on its behalf. If such beneficial holder wishes
to tender on his own behalf, such beneficial
holder must, prior to completing and executing
the Letter of Transmittal and delivering its
Old Notes, either make appropriate arrangements
to register ownership of the Old Notes in such
holder's name or obtain a properly completed
bond power from the registered holder. The
transfer of record ownership may take
considerable time. See "The Exchange
Offer -- Procedures for Tendering."
7
<PAGE> 10
GUARANTEED DELIVERY
PROCEDURES.................... Holders of Old Notes who wish to tender their
Old Notes and whose Old Notes are not
immediately available or who cannot deliver
their Old Notes (or who cannot complete the
procedure for book-entry transfer on a timely
basis) and a properly completed Letter of
Transmittal or any other documents required by
the Letter of Transmittal to the Exchange Agent
prior to the Expiration Date may tender their
Old Notes according to the guaranteed delivery
procedures set forth in "The Exchange
Offer -- Guaranteed Delivery Procedures."
WITHDRAWAL RIGHTS............. Tenders of Old Notes may be withdrawn at any
time prior to 5:00 p.m., New York City time, on
the Expiration Date. See "The Exchange
Offer -- Withdrawal of Tenders."
ACCEPTANCE OF OLD NOTES AND
DELIVERY OF NEW NOTES......... Subject to certain conditions (as summarized
above in "Termination of the Exchange Offer"
and described more fully under "The Exchange
Offer -- Termination") or waiver of such
conditions, the Companies will accept for
exchange any and all Old Notes which are
properly tendered in the Exchange Offer and not
validly withdrawn prior to 5:00 p.m., New York
City time, on the Expiration Date. The New
Notes issued pursuant to the Exchange Offer
will be delivered on or promptly after the
Expiration Date. See "The Exchange
Offer -- General."
CERTAIN TAX CONSIDERATIONS.... The exchange pursuant to the Exchange Offer
will not be a taxable event for federal income
tax purposes. See "Certain Tax Considerations."
REGISTRATION RIGHTS........... In connection with the sale of the Old Notes,
the Companies agreed to consummate the Exchange
Offer pursuant to an effective registration
statement or to cause resales of the Old Notes
to be registered under the Securities Act, and,
if neither such event occurs prior to December
15, 1997, interest payable on the Secured Notes
will increase by .50% per annum until one of
such events does occur. Holders who do not
participate in the Exchange Offer may
thereafter hold a less liquid security. See
"Risk Factors -- Consequences of Failure to
Exchange" and "The Exchange Offer."
EXCHANGE AGENT................ The Chase Manhattan Bank, the Trustee under the
Indenture, will serve as exchange agent (the
"Exchange Agent") in connection with the
Exchange Offer. The address of the Exchange
Agent is:
The Chase Manhattan Bank, 55 Water Street, Room
234, North Building, New York, NY 10041,
Attention: Carlos Esteves. For information with
respect to the Exchange Offer, the telephone
number for the Exchange Agent is (212) 638-0828
and the facsimile number for the Exchange Agent
is (212) 638-7375 or (212) 344-9367.
USE OF PROCEEDS............... There will be no cash proceeds payable to the
Companies from the issuance of the New Notes
pursuant to the Exchange Offer. The proceeds to
the Companies from the sale of the Old Notes
were approximately $720 million, net of
discounts and commissions. Such proceeds were
used, together with cash and approximately $155
million of short-term borrowings, to refinance
$873 million of
8
<PAGE> 11
high interest secured lease obligation bonds
issued by a special purpose funding corporation
on behalf of lessors in the Companies' sale and
leaseback transaction for the Mansfield Plant.
SUMMARY DESCRIPTION OF THE NEW NOTES
ISSUERS....................... Cleveland Electric and Toledo Edison.
SECURITIES TO BE OFFERED...... $220 million aggregate principal amount of New
Notes due 2000, $350 million aggregate
principal amount of New Notes due 2004 and $150
million aggregate principal amount of New Notes
due 2007.
MATURITY...................... July 1, 2000 for the New Notes due 2000, July
1, 2004 for the New Notes due 2004 and July 1,
2007 for the New Notes due 2007.
RECORD DATES.................. June 15 and December 15 of each year,
commencing with December 15, 1997.
INTEREST PAYMENT DATES........ Payable in cash in arrears on January 1 and
July 1 of each year, commencing on July 1,
1997.
REDEMPTION.................... The New Notes are not subject to redemption
prior to maturity. There will be no sinking
fund payments for the New Notes.
SECURITY...................... The Old Notes are, and the New Notes (together
with any Old Notes that remain outstanding
after the Exchange Offer is terminated) will
be, secured equally and ratably as to payment
of principal and interest by $575 million
aggregate principal amount of first mortgage
bonds of Cleveland Electric ("Cleveland
Electric Bonds") and $145 million aggregate
principal amount of first mortgage bonds of
Toledo Edison ("Toledo Edison Bonds") which
have been issued, pledged and delivered by the
Companies to the Note Trustee. The terms of the
Cleveland Electric Bonds and Toledo Edison
Bonds correspond to those of the Secured Notes.
See "Descriptions of Cleveland Electric Bonds
and Toledo Edison Bonds."
CREDIT ENHANCEMENT............ Ambac Assurance Corporation (formerly known as
AMBAC Indemnity Corporation) ("Ambac
Assurance") has issued a financial guaranty
insurance policy relating to the Old Notes due
2007 and has made a commitment to issue a
financial guaranty insurance policy relating to
the New Notes due 2007. The Secured Notes due
2000 and Secured Notes due 2004 are not
supported by such an insurance policy. See
"Credit Enhancement of Secured Notes due 2007."
For a discussion of certain factors that should be considered by holders of the
Old Notes in connection with an investment in the New Notes, see "Risk Factors."
9
<PAGE> 12
SUMMARY FINANCIAL INFORMATION FOR CLEVELAND ELECTRIC
<TABLE>
<CAPTION>
12 MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------------- 1997
1992 1993 1994 1995 1996 (UNAUDITED)
------ ------ ------ ------ ------ -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Operating Revenues........................ $1,743 $1,751 $1,698 $1,769 $1,790 $ 1,788
Operating Income.......................... $ 385 $ 222 $ 396 $ 398 $ 359 $ 354
Deferred Carrying Charges, Net(a)......... $ 59 $ (487) $ 25 $ 29 $ -- $ --
Write-off of Perry Nuclear Power Plant
Unit 2 ("Perry Unit 2")................. $ -- $ (351) $ -- $ -- $ -- $ --
Income (Loss) Before Interest Charges..... $ 448 $ (347) $ 427 $ 429 $ 357 $ 341
Interest Charges.......................... $ 243 $ 240 $ 242 $ 245 $ 240 $ 233
Earnings (Loss) Before Interest Charges,
Income Taxes, Depreciation and
Amortization ("EBITDA")(b).............. $ 722 $ (414) $ 708 $ 721 $ 636 $ 628
Net Income (Loss)......................... $ 205 $ (587) $ 185 $ 184 $ 117 $ 108
Ratio of Earnings to Fixed Charges(c)..... 1.89 --(d) 1.81 1.84 1.57 1.58
Ratio of EBITDA to Interest Charges....... 2.97 -- 2.93 2.94 2.65 2.70
BALANCE SHEET DATA (END OF PERIOD)
Total Assets.............................. $8,123 $7,159 $7,151 $7,152 $6,878 $ 7,337
Long-Term Debt............................ $2,515 $2,793 $2,543 $2,666 $2,441 $ 3,011(e)
Preferred Stock
With Mandatory Redemption Provisions.... $ 314 $ 285 $ 246 $ 215 $ 186 $ 172
Without Mandatory Redemption
Provisions........................... $ 144 $ 241 $ 241 $ 241 $ 238 $ 238
Common Stock Equity....................... $1,865 $1,040 $1,058 $1,127 $1,045 $ 1,010
Total Capitalization...................... $4,838 $4,359 $4,088 $4,249 $3,910 $ 4,431(e)
</TABLE>
- ---------------
(a) In 1993, Cleveland Electric wrote off $519 million of deferred carrying
charges. Deferrals under an October 1992 rate stabilization program for
Cleveland Electric ended in November 1995, and amortization of the deferrals
began in December 1995 (see Note 7(d) to Cleveland Electric's 1996 financial
statements in the Financial Statements Section, as hereinafter defined).
(b) EBITDA consists of income before interest charges, plus income taxes charged
to operating expenses and to other income, plus depreciation and
amortization. EBITDA is not a measure of operating results, but rather is a
measure of debt service ability. EBITDA should not be considered as an
alternative to net income or any other measure of performance required by
generally accepted accounting principles or as an indicator of Cleveland
Electric's operating performance.
(c) For the purpose of computing the ratio of earnings to fixed charges,
earnings consist of net income plus fixed charges and current and deferred
income taxes. Fixed charges consist of total interest charges (including
interest on first mortgage bonds, bank loans, commercial paper, pollution
control notes and other interest included in operation expenses;
amortization of net premium, discount and expense on debt; and capitalized
interest on nuclear fuel lease obligations) and an estimate of the interest
element of rentals (including the interest component of certain sale and
leaseback rentals, leased nuclear fuel in the reactor and other
miscellaneous rentals).
(d) Not meaningful due to a net loss. For the year ended December 31, 1993, the
net loss before taxes and fixed charges was $502 million. Fixed charges
during the period were $334 million. The net loss before income taxes and
fixed charges included write-offs of $986 million related to Cleveland
Electric's investment in Perry Unit 2 and phase-in plan deferred charges,
and other charges of $79 million attributable to an early retirement
program. Excluding these write-offs, the ratio of earnings to fixed charges
would have been 1.68.
(e) Includes Cleveland Electric's proportionate share of the Secured Notes ($575
million) which were issued on June 18, 1997.
10
<PAGE> 13
SUMMARY FINANCIAL INFORMATION FOR TOLEDO EDISON
<TABLE>
<CAPTION>
12 MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------------- 1997
1992 1993 1994 1995 1996 (UNAUDITED)
------ ------ ------ ------ ------ -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Operating Revenues(a)..................... $ 845 $ 871 $ 865 $ 874 $ 897 $ 915
Operating Income.......................... $ 150 $ 89 $ 180 $ 188 $ 156 $ 162
Deferred Carrying Charges, Net(b)......... $ 41 $ (161) $ 15 $ 14 $ -- $ --
Write-off of Perry Unit 2................. $ -- $ (232) $ -- $ -- $ -- $ --
Income (Loss) Before Interest Charges..... $ 192 $ (174) $ 197 $ 207 $ 152 $ 162
Interest Charges.......................... $ 121 $ 115 $ 115 $ 110 $ 95 $ 94
Earnings (Loss) Before Interest Charges,
Income Taxes, Depreciation and
Amortization ("EBITDA")(c).............. $ 303 $ (237) $ 315 $ 335 $ 277 $ 300
Net Income (Loss)......................... $ 71 $ (289) $ 82 $ 97 $ 57 $ 68
Ratio of Earnings to Fixed Charges(d)..... 1.43 --(e) 1.51 1.63 1.43 1.55
Ratio of EBITDA to Interest Charges....... 2.49 -- 2.74 3.05 2.92 3.19
BALANCE SHEET DATA (END OF PERIOD)
Total Assets.............................. $3,939 $3,510 $3,502 $3,474 $3,357 $ 3,572
Long-Term Debt............................ $1,178 $1,225 $1,154 $1,068 $1,003 $ 1,122(f)
Preferred Stock
With Mandatory Redemption Provisions.... $ 50 $ 28 $ 7 $ 5 $ 3 $ 2
Without Mandatory Redemption
Provisions........................... $ 210 $ 210 $ 210 $ 210 $ 210 $ 210
Common Stock Equity....................... $ 935 $ 623 $ 685 $ 763 $ 803 $ 817
Total Capitalization...................... $2,373 $2,086 $2,056 $2,046 $2,019 $ 2,151(f)
</TABLE>
- ---------------
(a) Includes revenues from all bulk power sales to Cleveland Electric of $130
million, $120 million, $111 million, $102 million and $105 million in 1992,
1993, 1994, 1995 and 1996, respectively, and $111 million for the 12 months
ended June 30, 1997.
(b) In 1993, Toledo Edison wrote off $186 million of deferred carrying charges.
Deferrals under an October 1992 rate stabilization program for Toledo Edison
ended in November 1995, and amortization of the deferrals began in December
1995 (see Note 7(d) to Toledo Edison's 1996 financial statements in the
Financial Statements Section).
(c) EBITDA consists of income before interest charges, plus income taxes charged
to operating expenses and to other income, plus depreciation and
amortization. EBITDA is not a measure of operating results, but rather is a
measure of debt service ability. EBITDA should not be considered as an
alternative to net income or any other measure of performance required by
generally accepted accounting principles or as an indicator of Toledo
Edison's operating performance.
(d) For the purpose of computing the ratio of earnings to fixed charges,
earnings consist of net income plus fixed charges and current and deferred
income taxes. Fixed charges consist of total interest charges (including
interest on first mortgage bonds, bank loans, commercial paper, pollution
control notes and other interest included in operation expenses;
amortization of net premium, discount and expense on debt; and capitalized
interest on nuclear fuel lease obligations) and an estimate of the interest
element of rentals (including the interest component of certain sale and
leaseback rentals, leased nuclear fuel in the reactor and other
miscellaneous rentals).
(e) Not meaningful due to a net loss. For the year ended December 31, 1993, the
net loss before taxes and fixed charges was $195 million. Fixed charges
during the period were $233 million. The net loss before income taxes and
fixed charges included write-offs of $473 million related to Toledo Edison's
investment in Perry Unit 2 and phase-in plan deferred charges, and other
charges of $56 million attributable to an early retirement program.
Excluding these write-offs, the ratio of earnings to fixed charges would
have been 1.42.
(f) Includes Toledo Edison's proportionate share of the Secured Notes ($145
million) which were issued on June 18, 1997.
11
<PAGE> 14
RISK FACTORS
Holders of the Secured Notes should consider carefully the factors set
forth below, as well as the other information contained in this Prospectus, in
evaluating an investment in the Secured Notes. The information below is
qualified in its entirety by reference to the information in the Companies'
financial statements included as part of this Prospectus and in the documents
incorporated in this Prospectus by reference and should be read in conjunction
with such information and the other information set forth in this Prospectus.
FINANCING CAPABILITY
At June 30, 1997, Cleveland Electric had long-term debt outstanding of
approximately $3,011 million (68% of total capitalization) and Toledo Edison had
long-term debt outstanding of approximately $1,122 million (52% of total
capitalization). Also at June 30, 1997, Cleveland Electric and Toledo Edison had
approximately $3,230 million and $1,262 million, respectively, in aggregate
principal amount of first mortgage bonds outstanding under their respective
mortgages. (The outstanding first mortgage bond amounts for Cleveland Electric
and Toledo Edison include $140.4 million principal amount and $210.6 million
principal amount, respectively, of first mortgage bonds pledged to secure
obligations to various bank creditors.) At June 30, 1997, neither Company was
able to issue a material amount of additional first mortgage bonds except in
connection with refinancings (see "The Companies -- Financing Capability" and
"Pending Merger of Centerior Energy and Ohio Edison -- Regulatory Matters").
Also at June 30, 1997, Cleveland Electric had fixed obligations for debt
other than first mortgage bonds and preferred stock with mandatory redemption
provisions of $229 million, and Toledo Edison had fixed obligations for debt
other than first mortgage bonds and preferred stock with mandatory redemption
provisions of $141 million. The Companies also have future minimum lease
payments of approximately $3,659 million for generation facility leases as of
June 30, 1997. See Note 2 to the 1996 financial statements in the Financial
Statements Section (as hereinafter defined).
As of June 30, 1997, debt and preferred stock maturities and sinking fund
requirements for the remainder of 1997 were $115.9 million (including $70.5
million of first mortgage bonds refinanced in August 1997) for Cleveland
Electric and $41.5 million (including $10.1 million of first mortgage bonds
refinanced in August 1997) for Toledo Edison. In August 1997, Cleveland Electric
and Toledo Edison refinanced $180.6 million aggregate principal amount and $10.1
million principal amount, respectively, of first mortgage bonds issued as
security for certain tax-exempt bonds issued by public authorities. Cleveland
Electric plans to refinance up to $550 million of outstanding first mortgage
bonds during the fourth quarter of 1997.
The Companies have $273 million in financing vehicles to support their
nuclear fuel leases, $83 million of which mature in 1997. Replacement financing
for the maturing issues may not be needed in 1997.
Under its articles of incorporation, Toledo Edison cannot issue preferred
stock unless certain earnings coverage requirements are met. Based on its
earnings for the 12 months ended June 30, 1997, Toledo Edison could not issue
additional preferred stock.
The availability and cost of capital to meet the Companies' external
financing needs depend upon such factors as financial market conditions and the
Companies' credit ratings. At the time of the Offering, credit ratings for the
Companies were as follows:
<TABLE>
<CAPTION>
STANDARD & POOR'S MOODY'S
----------------- -------------
<S> <C> <C>
First mortgage bonds.................................... BB Ba2
Unsecured notes of Cleveland Electric................... B+ Ba3
Unsecured notes of Toledo Edison........................ B+ B1
Preferred stock......................................... B b2
</TABLE>
12
<PAGE> 15
Current credit ratings for the Companies are as follows:
<TABLE>
<CAPTION>
STANDARD & POOR'S MOODY'S
----------------- -------------
<S> <C> <C>
First mortgage bonds.................................... BB+ Ba1
Unsecured notes......................................... BB- Ba3
Preferred stock......................................... BB- b1
</TABLE>
These ratings reflect recent upgrades by both Standard & Poor's Ratings
Group, a division of The McGraw-Hill Companies, Inc. ("Standard & Poor's") and
Moody's Investors Service, Inc. ("Moody's") and assume, among other things,
consummation of the CEC-OE Merger. See "-- Consummation of the CEC-OE Merger,"
"Pending Merger of Centerior Energy and Ohio Edison" and "The
Companies -- Financing Capability."
LACK OF PUBLIC MARKET FOR THE SECURED NOTES
The Old Notes currently have no trading market. There can be no assurance
that an active trading market for the New Notes will develop or be sustained.
The Companies do not presently intend to apply for listing of the New Notes on
any stock exchange or trading market. If the New Notes are traded after their
initial issuance, they may trade at a discount from their initial offering
price, depending upon prevailing interest rates, the market for similar
securities and other factors, including general economic conditions and the
financial condition and performance of, and prospects for, the Companies. The
Placement Agents have advised the Companies that they currently intend to make a
market in the New Notes. However, the Placement Agents are not obligated to do
so, and any market-making activity with respect to the New Notes may be
discontinued at any time without notice.
CONSEQUENCES OF FAILURE TO EXCHANGE
Old Notes that are not exchanged for New Notes pursuant to the Exchange
Offer will remain restricted securities and will not retain any rights under the
Registration Agreement, except in certain limited circumstances. The Old Notes
will continue to be subject to restrictions on transfer such that: (i) Old Notes
may be resold only if registered pursuant to the Securities Act or if an
exemption from registration is available thereunder, (ii) Old Notes will bear a
legend restricting transfer in the absence of registration or an exemption
therefrom and (iii) a holder of Old Notes who desires to sell or otherwise
dispose of all or any part of its Old Notes under an exemption from registration
under the Securities Act, if requested by the Companies, must deliver to the
Companies an opinion of independent counsel, reasonably satisfactory in form and
substance to the Companies, to the effect that such exemption is available.
CONSUMMATION OF THE CEC-OE MERGER
The consummation of the CEC-OE Merger remains subject to various conditions
and regulatory approvals, including the approval of the Federal Energy
Regulatory Commission ("FERC"). There can be no assurance that such conditions
will be satisfied or such approvals can be obtained on terms which Centerior
Energy and Ohio Edison will find acceptable. If the CEC-OE Merger is not
consummated, the benefits which are anticipated from the merger will not be
realized, and the recent upgrade in the ratings of the Companies' securities may
not be maintained. See "Pending Merger of Centerior Energy and Ohio Edison."
REGULATORY MATTERS
The Companies comply with the provisions of Statement of Financial
Accounting Standards 71 ("SFAS 71") which governs accounting for the effects of
certain types of rate regulation. The Companies continually monitor changes in
market and regulatory conditions and consider the effects of such changes in
assessing the continuing applicability of SFAS 71. Criteria that could give rise
to discontinuation of the application of SFAS 71 include: (1) increasing
competition which significantly restricts the Companies' ability to charge
prices which allow them to recover operating costs, earn a fair return on
invested capital and recover the amortization of regulatory assets and (2) a
significant change in the manner in which rates are set
13
<PAGE> 16
by The Public Utilities Commission of Ohio ("PUCO") from cost-based regulation
to some other form of regulation. In the event the Companies determine they no
longer meet the criteria for following SFAS 71, the Companies would be required
to record a before-tax charge to write off their regulatory assets which totaled
$1,334 million and $915 million at June 30, 1997 for Cleveland Electric and
Toledo Edison, respectively. In addition, the Companies would be required to
evaluate whether the changes in the competitive and regulatory environment which
led to discontinuing the application of SFAS 71 would also result in an
impairment of the net book values of the Companies' property, plant and
equipment.
Upon consummation of the CEC-OE Merger, the FirstEnergy Regulatory Plan (as
hereinafter defined) will go into effect. FirstEnergy believes that the
FirstEnergy Regulatory Plan will not provide for the full recovery of costs and
a fair return on the investment associated with the Companies' nuclear
operations. Pursuant to the PUCO's order approving the FirstEnergy Regulatory
Plan, FirstEnergy was required to submit to the PUCO staff the regulatory
accounting and cost recovery details for implementing the FirstEnergy Regulatory
Plan. Such details were submitted in July 1997. FirstEnergy expects that the
Companies will discontinue the application of SFAS 71 for their nuclear
operations if and when consummation of the CEC-OE Merger becomes probable. The
remainder of their business is expected to continue to comply with the
provisions of SFAS 71. At the time the CEC-OE Merger becomes probable, the
Companies would be required to write off certain of their regulatory assets for
financial reporting purposes. The write-off amounts would be determined at that
time. FirstEnergy estimates the write-off will total approximately $750 million.
This write-off is not expected to affect the Companies' first mortgage bond
capacities. For financial reporting purposes, the net book value of the
Companies' nuclear generating units is not expected to be impaired. If events
cause one or both Companies to conclude they no longer meet the criteria for
applying SFAS 71 for the remainder of their business, they would be required to
write off their remaining regulatory assets and measure all other assets for
impairment. See "Pending Merger of Centerior Energy and Ohio Edison" and also
"Management's Financial Analysis" and Note 15 which are contained in each
Company's 1996 financial statements included as a part of this Prospectus
("Financial Statements Section"). (The Financial Statements Section also
contains each Company's First Quarter 1997 Form 10-Q and Second Quarter 1997
Form 10-Q).
In the absence of consummation of the CEC-OE Merger, the PUCO's April 1996
rate order to the Companies remains in effect. In that order, the PUCO granted
price increases totaling $119 million in annualized revenues to the Companies.
The Companies intend to freeze rates at existing levels until at least 2002,
although they are not precluded from requesting further price increases. In the
order, the PUCO provided for recovery of all regulatory assets in the approved
rates, and the Companies continue to comply with the provisions of SFAS 71. In
connection with its order, the PUCO recommended that the Companies write down
certain assets for regulatory purposes by an aggregate of $1.25 billion through
2001. Consideration of whether to implement a plan responsive to the PUCO's
recommendation is pending the CEC-OE Merger.
Notwithstanding the CEC-OE Merger and discussions with regulators
concerning the effect of the FirstEnergy Regulatory Plan on the Companies'
nuclear generating assets, the Companies believe it is reasonable to expect that
rates will be set at levels that will recover all current and anticipated costs
associated with their nuclear operations, including all associated regulatory
assets, and such rates can be charged to and collected from customers. If there
is a change in the Companies' evaluation of the competitive environment,
regulatory framework or other factors, or if the PUCO significantly reduces the
value of their assets or reduces the approved return on common stock equity of
12.59% and overall rate of return of 10.06%, or both, for future regulatory
purposes, the Companies may be required to record material charges to earnings.
See "Management's Financial Analysis" in the Financial Statements Section.
COMPETITION
The Companies face competitive challenges due to regulatory and tax
constraints and their high retail cost structure.
Currently, the Companies' most pressing competition comes from municipal
electric systems in their service areas. Cleveland Electric's and Toledo
Edison's rates are generally higher than those of municipal
14
<PAGE> 17
systems due largely to such systems' exemption from taxation, the lower cost
financing available to them, the continued availability to them of lower cost
power through short-term power purchases and their access to cheaper
governmental power. The Companies face the threat that municipalities in their
service areas could establish new electric systems and continue expanding
existing systems. See "The Companies -- Competition" and "Pending Merger of
Centerior Energy and Ohio Edison -- Regulatory Matters."
Structural changes in the electric utility industry from actions by both
federal and state regulatory bodies are continuing to place downward pressure on
prices and to increase competition for customers. In 1996, the FERC adopted
rules relating to open-access transmission services. The open-access rules
require utilities to deliver power from other utilities or generation sources to
their wholesale customers at nondiscriminatory prices.
A number of states have enacted transition legislation which provides for
introduction of competition for retail electric business and recovery of
stranded investment. Several groups in Ohio are studying the possible
introduction of retail wheeling and stranded investment recovery. Retail
wheeling occurs when a customer obtains power from a utility company other than
its local utility. The term "stranded investment" generally refers to fixed
costs approved for recovery under traditional regulatory methods that would
become unrecoverable, or "stranded," as a result of legislative changes which
allow for widespread competition. The PUCO is sponsoring discussions among a
group of business, utility and consumer interests to explore ways of promoting
competitive options without unduly harming the interests of utility company
share owners or customers. The PUCO also has introduced two pilot projects, both
intended as initial steps to introduce competitive elements into the Ohio
electric utility business. A bill to restructure the electric utility industry
in Ohio has been introduced in the Ohio House of Representatives. A bipartisan
committee from both legislative houses has been formed to study the issue.
The Companies cannot predict when and to what extent retail wheeling or
other forms of competition will be allowed. The Companies believe that pure
competition (unrestricted retail wheeling for all customer classifications) is
at least several years away and that any transition to pure competition will be
in phases. The FERC and the PUCO have acknowledged the need to provide at least
partial recovery of stranded investment as greater competition is permitted and,
therefore, the Companies believe that there will be a mechanism developed for
the recovery of at least some stranded investment. However, due to the
uncertainty involved, there is a risk in connection with the introduction of
retail wheeling that some of the Companies' assets may not be fully recovered.
See "The Companies -- Competition" and "2. Conjunctive Electric Service ("CES")"
under "Part II. Other Information" of the Second Quarter 1997 Form 10-Q in the
Financial Statements Section.
NUCLEAR OPERATIONS
The Companies have interests in three nuclear generating units -- Beaver
Valley Power Station Unit 2 ("Beaver Valley Unit 2"), Davis-Besse Nuclear Power
Station ("Davis-Besse") and Perry Nuclear Power Plant Unit 1 ("Perry Unit 1").
Toledo Edison operates Davis-Besse and Cleveland Electric operates Perry Unit 1.
See "The Companies -- Nuclear Units."
The Companies' three nuclear units may be impacted by activities or events
beyond their control. Operating nuclear units have experienced unplanned outages
or extensions of scheduled outages because of equipment problems or new
regulatory requirements. A major accident at a nuclear facility anywhere in the
world could cause the United States Nuclear Regulatory Commission ("NRC") to
limit or prohibit the operation or licensing of any domestic nuclear unit. If
one of the Companies' nuclear units is taken out of service for an extended
period for any reason, including an accident at such unit or any other nuclear
facility, the Companies cannot predict whether regulatory authorities would
impose unfavorable rate treatment. Such treatment could include taking the
affected unit out of rate base, thereby not permitting the Companies to recover
their investment in and earn a return on that asset, or disallowing certain
construction or maintenance costs. An extended outage coupled with unfavorable
rate treatment could have a material adverse effect on each Company's financial
condition, cash flows and results of operations.
15
<PAGE> 18
SELECTED FINANCIAL INFORMATION FOR CLEVELAND ELECTRIC
<TABLE>
<CAPTION>
12 MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------- 1997
1992 1993 1994 1995 1996 (UNAUDITED)
------ ------ ------ ------ ------ -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Operating Revenues......................... $1,743 $1,751 $1,698 $1,769 $1,790 $ 1,788
Fuel and Purchased Power Expense........... $ 434 $ 423 $ 391 $ 413 $ 408 $ 418
Other Operation and Maintenance Expense.... $ 410 $ 598 $ 394 $ 418 $ 426 $ 415
Depreciation and Amortization Expense...... $ 179 $ 182 $ 195 $ 196 $ 210 $ 213
Operating Income........................... $ 385 $ 222 $ 396 $ 398 $ 359 $ 354
Deferred Carrying Charges, Net (a)......... $ 59 $ (487) $ 25 $ 29 $ -- $ --
Write-off of Perry Unit 2.................. $ -- $ (351) $ -- $ -- $ -- $ --
Income (Loss) Before Interest Charges...... $ 448 $ (347) $ 427 $ 429 $ 357 $ 341
Interest Charges........................... $ 243 $ 240 $ 242 $ 245 $ 240 $ 233
Earnings (Loss) Before Interest Charges,
Income Taxes, Depreciation and
Amortization ("EBITDA") (b).............. $ 722 $ (414) $ 708 $ 721 $ 636 $ 628
Net Income (Loss).......................... $ 205 $ (587) $ 185 $ 184 $ 117 $ 108
Preferred Dividend Requirements............ $ 41 $ 45 $ 45 $ 43 $ 39 $ 37
Earnings (Loss) Available for Common
Stock.................................... $ 164 $ (632) $ 140 $ 141 $ 78 $ 71
Ratio of Earnings to Fixed Charges (c)..... 1.89 --(d) 1.81 1.84 1.57 1.58
Ratio of EBITDA to Interest Charges........ 2.97 -- 2.93 2.94 2.65 2.70
OTHER DATA
Utility Plant Additions.................... $ 156 $ 175 $ 156 $ 155 $ 111 $ --(e)
BALANCE SHEET DATA (END OF PERIOD)
Total Assets............................... $8,123 $7,159 $7,151 $7,152 $6,878 $ 7,337
Current Portion of Long-Term Debt and
Preferred Stock.......................... $ 310 $ 70 $ 282 $ 177 $ 145 $ 135
Long-Term Debt............................. $2,515 $2,793 $2,543 $2,666 $2,441 $ 3,011(f)
Preferred Stock
With Mandatory Redemption Provisions..... $ 314 $ 285 $ 246 $ 215 $ 186 $ 172
Without Mandatory Redemption
Provisions............................. $ 144 $ 241 $ 241 $ 241 $ 238 $ 238
Common Stock Equity........................ $1,865 $1,040 $1,058 $1,127 $1,045 $ 1,010
Total Capitalization................ $4,838 $4,359 $4,088 $4,249 $3,910 $ 4,431(f)
</TABLE>
- ---------------
(a) In 1993, Cleveland Electric wrote off $519 million of deferred carrying
charges. Deferrals under an October 1992 rate stabilization program for
Cleveland Electric ended in November 1995, and amortization of the deferrals
began in December 1995 (see Note 7(d) to Cleveland Electric's 1996 financial
statements in the Financial Statements Section).
(b) EBITDA consists of income before interest charges, plus income taxes charged
to operating expenses and to other income, plus depreciation and
amortization. EBITDA is not a measure of operating results, but rather is a
measure of debt service ability. EBITDA should not be considered as an
alternative to net income or any other measure of performance required by
generally accepted accounting principles or as an indicator of Cleveland
Electric's operating performance.
(c) For the purpose of computing the ratio of earnings to fixed charges,
earnings consist of net income plus fixed charges and current and deferred
income taxes. Fixed charges consist of total interest charges (including
interest on first mortgage bonds, bank loans, commercial paper, pollution
control notes and other interest included in operation expenses;
amortization of net premium, discount and expense on debt; and capitalized
interest on nuclear fuel lease obligations) and an estimate of the interest
element of rentals (including the interest component of certain sale and
leaseback rentals, leased nuclear fuel in the reactor and other
miscellaneous rentals).
(d) Not meaningful due to a net loss. For the year ended December 31, 1993, the
net loss before taxes and fixed charges was $502 million. Fixed charges
during the period were $334 million. The net loss before income taxes and
fixed charges included write-offs of $986 million related to Cleveland
Electric's investment in Perry Unit 2 and phase-in plan deferred charges,
and other charges of $79 million attributable to an early retirement
program. Excluding these write-offs, the ratio of earnings to fixed charges
would have been 1.68.
(e) Not available for periods other than calendar year.
(f) Includes Cleveland Electric's proportionate share of the Secured Notes ($575
million) which were issued on June 18, 1997.
16
<PAGE> 19
SELECTED FINANCIAL INFORMATION FOR TOLEDO EDISON
<TABLE>
<CAPTION>
12 MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------- 1997
1992 1993 1994 1995 1996 (UNAUDITED)
------ ------ ------ ------ ------ -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Operating Revenues (a)..................... $ 845 $ 871 $ 865 $ 874 $ 897 $ 915
Fuel and Purchased Power Expense........... $ 169 $ 173 $ 167 $ 157 $ 169 $ 177
Other Operation and Maintenance Expense.... $ 236 $ 352 $ 229 $ 225 $ 231 $ 228
Depreciation and Amortization Expense...... $ 77 $ 76 $ 83 $ 84 $ 94 $ 95
Operating Income........................... $ 150 $ 89 $ 180 $ 188 $ 156 $ 162
Deferred Carrying Charges, Net (b)......... $ 41 $ (161) $ 15 $ 14 $ -- $ --
Write-off of Perry Unit 2.................. $ -- $ (232) $ -- $ -- $ -- $ --
Income (Loss) Before Interest Charges...... $ 192 $ (174) $ 197 $ 207 $ 152 $ 162
Interest Charges........................... $ 121 $ 115 $ 115 $ 110 $ 95 $ 94
Earnings (Loss) Before Interest Charges,
Income Taxes, Depreciation and
Amortization ("EBITDA") (c).............. $ 303 $ (237) $ 315 $ 335 $ 277 $ 300
Net Income (Loss).......................... $ 71 $ (289) $ 82 $ 97 $ 57 $ 68
Preferred Dividend Requirements............ $ 24 $ 23 $ 20 $ 18 $ 17 $ 17
Earnings (Loss) Available for Common
Stock.................................... $ 47 $ (312) $ 62 $ 79 $ 40 $ 51
Ratio of Earnings to Fixed Charges (d)..... 1.43 --(e) 1.51 1.63 1.43 1.55
Ratio of EBITDA to Interest Charges........ 2.49 -- 2.74 3.05 2.92 3.19
OTHER DATA
Utility Plant Additions.................... $ 44 $ 43 $ 41 $ 56 $ 49 $ --(f)
BALANCE SHEET DATA (END OF PERIOD)
Total Assets............................... $3,939 $3,510 $3,502 $3,474 $3,357 $ 3,572
Current Portion of Long-Term Debt and
Preferred Stock.......................... $ 58 $ 57 $ 83 $ 58 $ 51 $ 69
Long-Term Debt............................. $1,178 $1,225 $1,154 $1,068 $1,003 $ 1,122(g)
Preferred Stock
With Mandatory Redemption Provisions..... $ 50 $ 28 $ 7 $ 5 $ 3 $ 2
Without Mandatory Redemption
Provisions............................. $ 210 $ 210 $ 210 $ 210 $ 210 $ 210
Common Stock Equity........................ $ 935 $ 623 $ 685 $ 763 $ 803 $ 817
Total Capitalization................ $2,373 $2,086 $2,056 $2,046 $2,019 $ 2,151(g)
</TABLE>
- ---------------
(a) Includes revenues from all bulk power sales to Cleveland Electric of $130
million, $120 million, $111 million, $102 million and $105 million in 1992,
1993, 1994, 1995 and 1996, respectively, and $111 million for the 12 months
ended June 30, 1997.
(b) IN 1993, Toledo Edison wrote off $186 million of deferred carrying charges.
Deferrals under an October 1992 rate stabilization program for Toledo Edison
ended in November 1995, and amortization of the deferrals began in December
1995 (see note 7(d) to Toledo Edison's 1996 financial statements in the
Financial Statements section).
(c) EBITDA consists of income before interest charges, plus income taxes charged
to operating expenses and to other income, plus depreciation and
amortization. EBITDA is not a measure of operating results, but rather is a
measure of debt service ability. EBITDA should not be considered as an
alternative to net income or any other measure of performance required by
generally accepted accounting principles or as an indicator of Toledo
Edison's operating performance.
(d) For the purpose of computing the ratio of earnings to fixed charges,
earnings consist of net income plus fixed charges and current and deferred
income taxes. Fixed charges consist of total interest charges (including
interest on first mortgage bonds, bank loans, commercial paper, pollution
control notes and other interest included in operation expenses;
amortization of net premium, discount and expense on debt; and capitalized
interest on nuclear fuel lease obligations) and an estimate of the interest
element of rentals (including the interest component of certain sale and
leaseback rentals, leased nuclear fuel in the reactor and other
miscellaneous rentals).
(e) Not meaningful due to a net loss. For the year ended December 31, 1993, the
net loss before taxes and fixed charges was $195 million. Fixed charges
during the period were $233 million. The net loss before income taxes and
fixed charges included write-offs of $473 million related to Toledo Edison's
investment in Perry Unit 2 and phase-in plan deferred charges, and other
charges of $56 million attributable to an early retirement program.
Excluding these write-offs, the ratio of earnings to fixed charges would
have been 1.42.
(f) Not available for periods other than calendar year.
(g) Includes Toledo Edison's proportionate share of the secured notes ($145
million) which were issued on June 18, 1997.
17
<PAGE> 20
THE COMPANIES
GENERAL
Cleveland Electric, which was incorporated under the laws of the State of
Ohio in 1892, is a public utility engaged in the generation, purchase,
transmission, distribution and sale of electric energy in an area of
approximately 1,700 square miles in northeastern Ohio, including the City of
Cleveland. Cleveland Electric also provides electric energy at wholesale to
other electric utility companies and to two municipal electric systems (directly
and through AMP-Ohio) in its service area. Cleveland Electric serves
approximately 741,000 customers and derives approximately 77% of its total
electric retail revenue from customers outside the City of Cleveland. Principal
industries served by Cleveland Electric include those producing steel and other
primary metals; automotive and other transportation equipment; chemicals;
electrical and nonelectrical machinery; fabricated metal products; and rubber
and plastic products. Nearly all of Cleveland Electric's operating revenues are
derived from the sale of electric energy. At June 30, 1997, Cleveland Electric
had 3,251 employees of which 1,780 employees (about 55% of total employees) were
represented by one union.
On May 28, 1997, the collective bargaining agreement between Cleveland
Electric and the union expired without agreement on the terms of a new contract.
Cleveland Electric and the union are continuing to negotiate under the
supervision of a federal mediator. Both sides have agreed that there will be no
strike or lock-out while good faith negotiations are continuing. There is a risk
that such an event may occur if Cleveland Electric and the union do not reach an
agreement promptly. However, Cleveland Electric believes that it would be able
to continue to provide substantially normal electric service to its customers if
any such event were to occur. On September 5, 1997, union members voted to give
the union's negotiating committee authority to declare a strike.
Toledo Edison, which was incorporated under the laws of the State of Ohio
in 1901, is a public utility engaged in the generation, purchase, transmission,
distribution and sale of electric energy in an area of approximately 2,500
square miles in northwestern Ohio, including the City of Toledo. Toledo Edison
also provides electric energy at wholesale to other electric utility companies
and to 13 municipally owned distribution systems (through AMP-Ohio) and one
rural electric cooperative distribution system in its service area. Toledo
Edison serves approximately 293,000 customers and derives approximately 56% of
its total electric retail revenues from customers outside the City of Toledo.
Principal industries served by Toledo Edison include metal casting, forming and
fabricating; petroleum refining; automotive equipment and assembly; food
processing; and glass. Nearly all of Toledo Edison's operating revenues are
derived from the sale of electric energy. At June 30, 1997, Toledo Edison had
1,581 employees of which 967 employees (about 61% of total employees) were
represented by three unions having collective bargaining agreements with Toledo
Edison.
The Companies are wholly owned electric utility subsidiaries of Centerior
Energy, a holding company formed by them for the purpose of enabling them to
affiliate. The affiliation became effective in April 1986. Centerior Energy has
a third subsidiary, the Service Company, which furnishes certain administrative
and other services to the two utility subsidiaries and to Centerior Energy.
Cleveland Electric and Toledo Edison operate as separate companies, each
servicing the customers in its respective service area. In March 1994, Centerior
Energy announced a plan to merge Toledo Edison into Cleveland Electric. See
"Pending Merger of Cleveland Electric and Toledo Edison."
In September 1996, Centerior Energy and Ohio Edison entered into an
agreement and plan of merger to form a new holding company, FirstEnergy. See
"Pending Merger of Centerior Energy and Ohio Edison."
The Companies are members of the Central Area Power Coordination Group
("CAPCO Group"), which was created in 1967 by the Companies, Ohio Edison,
Duquesne Light Company ("Duquesne") and Ohio Edison's wholly owned subsidiary,
Pennsylvania Power Company ("Pennsylvania Power"). The CAPCO Group companies
have completed programs to construct larger, more efficient generating units and
to strengthen interconnections within the CAPCO Group. The CAPCO Group companies
have placed in service nine major generating units (four nuclear units and five
coal-fired units), of which the Companies have ownership or leasehold interests
in seven (three nuclear units and four coal-fired units). After the
18
<PAGE> 21
consummation of the CEC-OE Merger, FirstEnergy will have ownership or leasehold
interests in all nine CAPCO generating units.
COMPETITION
The Companies compete in their respective service areas with suppliers of
natural gas to satisfy customers' energy needs with regard to heating and
appliance usage. The Companies also are engaged in competition to a lesser
extent with suppliers of oil and liquefied natural gas for heating purposes and
with suppliers of cogeneration equipment. One competitor provides steam for
heating purposes and provides chilled water for cooling purposes in certain
areas of downtown Cleveland.
The Companies also compete with municipally owned electric systems within
their respective service areas. Several communities have evaluated
municipalization of electric service and decided to continue service from the
Companies. Officials in other communities have indicated an interest in
evaluating the municipalization issue.
The Companies face continuing competition from locations outside their
service areas which are promoted by governmental and private agencies in
attempts to influence potential and existing commercial and industrial customers
to locate in their respective areas.
The Companies also periodically compete with other producers of electricity
for sales to electric utilities which are in the market for bulk power
purchases. The Companies have interconnections with other electric utilities and
have a transmission system capable of transmitting ("wheeling") power between
the Midwest and the East.
In the future, the Companies will encounter an increasingly competitive
environment as a result of the structural changes taking place in the electric
utility industry. For a discussion of these changes, including open-access
transmission, retail wheeling and stranded investment considerations, see "Risk
Factors -- Competition" and "Outlook -- Competition" in Management's Financial
Analysis contained in the Financial Statements.
Cleveland Electric. Located within Cleveland Electric's service area are
two municipally owned electric systems. Cleveland Electric supplies a small
portion of those systems' power needs at wholesale rates.
One of those systems, Cleveland Public Power ("CPP"), is operated by the
City of Cleveland in competition with Cleveland Electric. CPP is primarily an
electric distribution system which currently supplies electric power in
approximately 60% of the City's geographical area and to approximately 33%
(about 72,000) of the electric consumers in the City -- equal to about 10% of
all customers served by Cleveland Electric. CPP's kilowatt-hour sales and
revenues are equal to about 6% of Cleveland Electric's kilowatt-hour sales and
revenues. Much of the area served by CPP overlaps that of Cleveland Electric.
For all classes of customers, Cleveland Electric's rates are higher than CPP's
rates due largely to CPP's exemption from taxation, the lower-cost financing
available to CPP, the continued availability to CPP of lower cost power through
short-term power purchases and CPP's access to cheaper governmental power.
Cleveland Electric makes power available to CPP on a wholesale basis,
subject to FERC regulation. In 1996, Cleveland Electric directly and through
AMP-Ohio provided a negligible amount of CPP's energy requirements. CPP's power
is purchased from other sources and wheeled over Cleveland Electric's
transmission systems. In cases currently pending, the FERC has ruled that
Cleveland Electric is obligated to provide an additional interconnection with
CPP but has not ruled on the terms and conditions thereof. Cleveland Electric
has asked the FERC to reconsider its order that Cleveland Electric provide CPP
with an additional interconnection. Also, the FERC has not ruled on Cleveland
Electric's request for an increase in rates for power and services provided to
CPP. Cleveland Electric believes that it is entitled to a higher level of
compensation for the power and the services it provides because the rates
currently paid by CPP do not adequately cover the cost of providing such power
and services.
CPP has constructed new transmission and distribution facilities extending
into eastern portions of Cleveland and plans to enhance its existing system in
western portions of Cleveland. CPP's expansion has
19
<PAGE> 22
resulted in a reduction in Cleveland Electric's annual net income by about $7
million in 1994, by an additional $1 million (for a total reduction of about $8
million) in 1995 and by an additional $3 million (for a total reduction of about
$11 million) in 1996. Cleveland Electric estimates that its net income will
continue to be reduced by an additional $1-$2 million each year in the
1997 - 2001 period because of CPP's expansion, with the exception of 1997 when
the reduction would be about $7 million including the loss of a commercial
customer, Medical Center Co., as discussed below.
Despite CPP's expansion efforts, Cleveland Electric has been successful in
retaining most of the large industrial and commercial customers in the expansion
areas by providing economic incentives in exchange for sole-supplier contracts.
During 1996, Cleveland Electric renewed and extended for as long as ten years
contracts with many of its large industrial customers, including the five
largest. Prior to these renewals, 61% of Cleveland Electric's industrial base
rate (nonfuel) revenues under contract was scheduled for renewal before 1999.
Following the renewals, only 18% of such revenues under contract is scheduled
for renewal by 1999. At year-end 1996, 51% of Cleveland Electric's industrial
base rate revenues was under long-term contracts. Also, in 1996, Cleveland
Electric reached agreements to serve a number of large commercial customers in
Cleveland, including some previously served by CPP. An increasing number of CPP
customers are converting back to Cleveland Electric service. However,
competition for such customers will continue.
In March 1995, one of Cleveland Electric's large commercial customers which
has provided annual net income to Cleveland Electric of approximately $6
million, Medical Center Co., signed a five-year contract with CPP for electric
service provided by another utility beginning in September 1996, when its
contract with Cleveland Electric terminated. Cleveland Electric believes that
the purchase of power by this customer is a direct purchase from another utility
in violation of Ohio's certified territory statute. After being denied a
rehearing on this matter by the PUCO, Cleveland Electric filed an appeal with
the Ohio Supreme Court. In August 1996, the Court granted Cleveland Electric's
request for rehearing and remanded the case back to the PUCO. Cleveland Electric
also filed a petition with the FERC on the grounds that such a transaction is a
violation of the Federal Power Act. However, in July 1996, the FERC ruled that
the transaction does not violate such Act. On September 18, 1996, the FERC
granted a rehearing to Cleveland Electric, which has agreed to begin providing
the requested transmission service to CPP.
For additional information on the effects of the CEC-OE Merger on Cleveland
Electric's competition with CPP, see "Pending Merger of Centerior Energy and
Ohio Edison -- Regulatory Matters."
Toledo Edison. Located wholly or partly within Toledo Edison's service area
are six rural electric cooperatives, five of which are supplied with power,
transmitted in some cases over Toledo Edison's facilities, by Buckeye Power,
Inc. (an affiliate of a number of Ohio rural electric cooperatives) and the
sixth of which is supplied by Toledo Edison.
Also located within Toledo Edison's service area are 16 municipally owned
electric distribution systems, three of which are supplied by other electric
systems. Toledo Edison provides a portion of the power purchased by the other 13
municipalities at wholesale rates through a contract with AMP-Ohio that expires
in 2009. Rates under this agreement are permitted to increase annually to
compensate for increased costs of operation. Less than 3% of Toledo Edison's
total electric operating revenues in 1996 was derived from sales under the
AMP-Ohio contract.
As does Cleveland Electric, Toledo Edison offers long-term contracts to
large industrial customers who might otherwise consider changing power
suppliers. During 1996, Toledo Edison renewed and extended from seven to ten
years contracts with many of its large industrial customers, including the six
largest. Prior to these renewals, 94% of Toledo Edison's industrial base rate
(nonfuel) revenues under contract was scheduled for renewal before 1999.
Following the renewals, only 19% of such revenues under contract is scheduled
for renewal by 1999. At year-end 1996, 61% of Toledo Edison's industrial base
rate revenues was under long-term contracts.
In October 1989, the City of Toledo ("Toledo") established an Electric
Franchise Review Committee to (i) study Toledo Edison's franchise agreement with
Toledo to determine whether alternate energy sources may be utilized and (ii)
investigate the feasibility of establishing a municipal electric system within
Toledo. In
20
<PAGE> 23
November 1993, Toledo approved a non-exclusive franchise with Toledo Edison
which runs through the end of 1998. In October 1995, the Toledo City Council
responded to a petition drive by appropriating funds to complete the Electric
Franchise Review Committee's study on whether to create a municipal electric
utility in Toledo. The Committee is also expected to look into the aggregating
of load to provide a conduit for retail wheeling to customers. A draft of the
consultant's report in connection with this study states that, if Centerior
Energy and Ohio Edison merge, a municipal system in Toledo could not compete
with Toledo Edison because of the rate reductions contained in the FirstEnergy
Regulatory Plan (see "Pending Merger of Centerior Energy and Ohio Edison" and
"Management's Financial Analysis" and Note 15 to Toledo Edison's financial
statements in the Financial Statements Section). The consultant's draft report
also states that, if the merger does not occur, a municipal system could be
competitive with Toledo Edison in one portion of Toledo. However, errors have
been found in the draft report which may change the content of the final
consultant's report. The final report will be considered by the Electric
Franchise Review Committee before making its recommendation to the Toledo City
Council later in 1997.
In January 1995, the City of Clyde ("Clyde"), which operates its own
municipal electric system, passed ordinances to force Toledo Edison to remove
most of its equipment from within Clyde's borders and to prevent any residential
and commercial customers within Clyde from obtaining service from Toledo Edison.
Clyde subsequently asked the PUCO to authorize the removal of Toledo Edison
equipment under the Miller Act. The Miller Act is an Ohio statute which provides
that a utility cannot be required to withdraw or abandon its facilities and
services in a city without a demonstration that such action is in the public
interest and without the approval of the PUCO. Toledo Edison challenged Clyde's
Miller Act proceeding before the PUCO and filed an action in the Court of
Appeals in Sandusky County, Ohio to challenge Clyde's ordinance prohibiting
customers from using Toledo Edison service. The Court of Appeals denied Toledo
Edison's challenge, and Toledo Edison appealed to the Ohio Supreme Court. In
August 1996, the Supreme Court ruled that Toledo Edison can continue to serve
customers who were customers prior to the establishment of the municipal system,
but Clyde has the exclusive right to serve new customers. The PUCO had
previously issued a ruling in April 1996 that Clyde cannot force Toledo Edison
to abandon service within Clyde. The ordinance that prevented Toledo Edison from
serving customers in Clyde was repealed in an initiative ballot issue in
November 1996. Toledo Edison currently serves approximately 345 customers within
Clyde.
In October 1995, Chase Brass & Copper Co., Inc. ("Chase Brass") terminated
its service with Toledo Edison and began to receive its electric service from a
consortium of four municipal electric systems and AMP-Ohio. Service is being
provided over a transmission line owned by AMP-Ohio. Although the Ohio
Constitution allows municipal electric systems to sell and deliver limited
amounts of power outside their municipal boundaries, Toledo Edison has filed two
lawsuits in Williams County (Ohio) Common Pleas Court against the four
municipalities and AMP-Ohio contending, in part, that this arrangement violates
the legal limits of such sales and that AMP-Ohio's system design for this
transaction raises certain safety issues. North Western Electric Cooperative,
whose certified territory is crossed by AMP-Ohio's transmission line, has also
filed suit to challenge this transaction. The loss of Chase Brass as a customer
reduced Toledo Edison's annual net income by about $1.6 million based on 1994
sales levels. As yet, no ruling has been issued by the Williams County Common
Pleas Court.
In addition, Chase Brass and other surrounding businesses and residences in
Jefferson Township continue to seek incorporation as a municipality to be named
the Village of Holiday City. The Williams County Board of Commissioners and the
Williams County Court of Common Pleas issued an order permitting the area to be
incorporated. Toledo Edison appealed the Court's order to the Sixth District
Court of Appeals, thereby staying the incorporation proceedings. The Court of
Appeals ruled against Toledo Edison, finding a lack of standing. Toledo Edison
then appealed to the Ohio Supreme Court, thereby staying the incorporation
proceedings again. On April 23, 1997, the Ohio Supreme Court denied Toledo
Edison's appeal. Toledo Edison does not plan to apply for reconsideration at the
Ohio Supreme Court.
The new municipality can negotiate with other utilities for electric power.
The other businesses in the proposed municipality previously terminated their
service with Toledo Edison and are receiving electric service from the Village
of Montpelier, one of the consortium now supplying Chase Brass.
21
<PAGE> 24
For additional information on the effects of the CEC-OE Merger on Toledo
Edison's relationship with AMP-Ohio, see "Pending Merger of Centerior Energy and
Ohio Edison -- Regulatory Matters."
SALES OF ELECTRICITY
Kilowatt-hour sales by the Companies follow a seasonal pattern marked by
increased customer usage in the summer for air conditioning and in the winter
for heating. Historically, Cleveland Electric has experienced its heaviest
demand for electric service during the summer months because of a significant
air conditioning load on its system and a relatively low amount of electric
heating load in the winter. Toledo Edison, although having a significant
electric heating load, has experienced in recent years its heaviest demand for
electric service during the summer months because of heavy air conditioning
usage.
Cleveland Electric's largest customer is a steel manufacturer which has two
major steel producing facilities. Sales to these facilities accounted for 3.3%
of Cleveland Electric's 1996 total electric operating revenues. The loss of
these facilities would reduce Cleveland Electric's annual net income by about
$16 million based on 1996 sales levels.
The largest customer served by Toledo Edison is a major automobile
manufacturer. Sales to this customer accounted for 3.9% of Toledo Edison's 1996
total electric operating revenues. The loss of this customer would reduce Toledo
Edison's annual net income by about $11 million based on 1996 sales levels.
FUEL SUPPLY
Generation by type of fuel for 1996 was 68% coal-fired and 32% nuclear for
Cleveland Electric and 48% coal-fired and 52% nuclear for Toledo Edison.
Coal. In 1996, Cleveland Electric and Toledo Edison burned 5.9 million tons
and 2.1 million tons of coal, respectively, for electric generation. Each
utility normally maintains a reserve supply of coal sufficient for about 20 days
of normal operations. On February 1, 1997, this reserve was about 20 days for
plants operated by Cleveland Electric, 16 days for the plant operated by Toledo
Edison and 35 days for the Mansfield Plant, which is operated by Pennsylvania
Power.
In 1996, about 45% of Cleveland Electric's coal requirements were purchased
under long-term contracts, with the longest remaining term being almost seven
years. In most cases, these contracts provide for adjusting the price of the
coal on the basis of changes in coal quality and mining costs. The sulfur
content of the coal purchased under these contracts ranges from less than 1% to
about 4%. Additionally, about 34% of Cleveland Electric's coal requirements were
purchased under short-term contracts (nine to twelve-month terms) with price
adjustments on the basis of coal quality. The sulfur content of the short-term
contracts ranged from 1.5% to 1.9%. The balance of Cleveland Electric's coal was
purchased on the spot market with sulfur content ranging from less than 1% to
4%.
In 1996, about 54% of Toledo Edison's coal requirements were purchased
under long-term contracts, with the longest remaining term being almost four
years. In most cases, these contracts provide for adjusting the price of the
coal on the basis of changes in coal quality and mining costs. The sulfur
content of the coal purchased under these contracts ranges from less than 1% to
4%. The balance of Toledo Edison's coal was purchased on the spot market with
sulfur content from less than 1% to 4%.
In May 1996, Cleveland Electric and The Ohio Valley Coal Company ("Ohio
Valley") terminated their existing coal supply agreement, which was scheduled to
continue until September 1997, and entered into a new coal supply agreement
scheduled to expire in September 1997. Under the prior agreement, Cleveland
Electric had agreed to pay Ohio Valley certain amounts to cover Ohio Valley's
costs, including amounts sufficient to service long-term debt and lease
obligations incurred by Ohio Valley. Cleveland Electric also agreed to assume
certain Ohio Valley costs and expenses, including mine closing costs, upon
termination of that agreement. However, under the new agreement, the terms and
conditions were revised whereby Cleveland Electric is only obligated to purchase
and pay Ohio Valley for a specified tonnage of coal during the term of the
agreement and has no responsibility for Ohio Valley's debt and lease obligations
and other expenses,
22
<PAGE> 25
including mine closing costs. The May 1996 agreement has been replaced by a new
agreement obligating Cleveland Electric to purchase at fixed prices a specified
tonnage of coal by the end of 1999.
The CAPCO Group companies have a long-term contract with Quarto Mining
Company ("Quarto") and Consolidation Coal Company for the supply of about
75%-85% of the annual coal needs of the Mansfield Plant. The contract is
scheduled to run through at least the end of 1999, and the price of coal is
adjustable to reflect changes in labor, materials, transportation and other
costs. The CAPCO Group companies have guaranteed, severally and not jointly, the
debt and lease obligations incurred by Quarto to develop, equip and operate two
of the mines which supply the Mansfield Plant. At December 31, 1996, the total
dollar amount of Quarto's debt and lease obligations guaranteed by Cleveland
Electric was $19.2 million and by Toledo Edison was $11.2 million. Cleveland
Electric and Toledo Edison expect that Quarto revenues from sales of coal to the
CAPCO Group companies will continue to be sufficient for Quarto to meet its debt
and lease obligations.
The Companies' least cost plan for complying with the Clean Air Act of 1970
and its 1990 Amendments, which was included in the agreement approved by the
PUCO in February 1993 in connection with the Companies' 1992 long-term forecast
and updated in 1995 proceedings, calls for compliance either through the use of
low-sulfur coal or the use of high sulfur-coal in combination with emission
allowances.
Nuclear. The acquisition and utilization of nuclear fuel involves six
distinct steps: (i) supply of uranium oxide raw material, (ii) conversion to
uranium hexafluoride, (iii) enrichment, (iv) fabrication into fuel assemblies,
(v) utilization as fuel in a nuclear reactor and (vi) storing or disposing of
spent fuel. The Companies have inventories of raw material sufficient to provide
nuclear fuel through 1997 for the operation of their nuclear generating units
and have contracts for fabrication services for all of that fuel. The CAPCO
Group companies have a contract with the United States Enrichment Corporation
("USEC") which will supply the needed enrichment services for their nuclear
units' fuel supply. However, the amount of enrichment services under the USEC
contract varies by CAPCO Group company, with Cleveland Electric's and Toledo
Edison's enrichment services reduced to 70% in 1997-1999 and reduced to 0% in
2000 and beyond. The additional required enrichment services are available.
Substantial additional fuel will have to be obtained in the future over the
remaining useful lives of the units. There is a plentiful supply of uranium
oxide raw material to meet the industry's nuclear fuel needs.
Oil. The Companies each have adequate supplies of fuel oil for their
oil-fired electric generating units which are used primarily as reserve and
peaking capacity.
NUCLEAR UNITS
The Companies' generating facilities include, among others, three nuclear
units owned or leased by the CAPCO Group -- Perry Unit 1, Beaver Valley Unit 2
and Davis-Besse. These three units are in commercial operation. Cleveland
Electric has responsibility for operating Perry Unit 1, Duquesne has
responsibility for operating Beaver Valley Unit 2 and Toledo Edison has
responsibility for operating Davis-Besse. Cleveland Electric and Toledo Edison
own, respectively, 31.11% and 19.91% of Perry Unit 1, 24.47% and 1.65% of Beaver
Valley Unit 2 and 51.38% and 48.62% of Davis-Besse. Cleveland Electric and
Toledo Edison also lease, as joint lessees, an additional 18.26% of Beaver
Valley Unit 2 as a result of a September 1987 sale and leaseback transaction
(see Note 2 to the 1996 financial statements in the Financial Statements
Section).
Davis-Besse was placed in commercial operation in 1977, and its operating
license expires in 2017. Perry Unit 1 and Beaver Valley Unit 2 were placed in
commercial operation in 1987, and their operating licenses expire in 2026 and
2027, respectively.
In 1989, the PUCO approved nuclear plant performance standards for the
Companies based on rolling three-year industry averages of availability for
pressurized water reactors and for boiling water reactors over the 1988-1998
period. Availability is the ratio of the number of hours a unit is available to
generate electricity (whether or not the unit is operated) to the number of
hours in the period, expressed as a percentage. The three-year availability
averages of the Companies' nuclear units are compared against the industry
averages for the same three-year period with a resultant penalty or banked
benefit. If the industry performance standards are not met, a penalty would be
incurred which would require the Companies to refund incremental
23
<PAGE> 26
replacement power costs to customers through the semiannual fuel cost rate
adjustment. However, if the performance of the Companies' nuclear units exceeds
the industry standards, a banked benefit results which can be used to offset
disallowances of incremental replacement power costs should future performance
be below industry standards.
The relevant industry standards for the 1994-1996 period are 80.7% for
pressurized water reactors such as Davis-Besse and Beaver Valley Unit 2 and
78.2% for boiling water reactors such as Perry Unit 1. The 1994-1996 combined
availability average for Davis-Besse and Beaver Valley Unit 2 was 87.7% and the
availability average for Perry Unit 1 was 72.2%. At December 31, 1996, the total
banked benefit for the Companies is estimated to be between $34 million and $37
million.
All three nuclear units have received generally favorable evaluations from
the NRC in their most recent Systematic Assessment of Licensee Performance
("SALP") reviews. Each of the functional areas evaluated is rated according to
three performance categories, with category 1 indicating performance
substantially exceeding regulatory requirements and that reduced NRC attention
may be appropriate; category 2 indicating performance above that needed to meet
regulatory requirements and that NRC attention may be maintained at normal
levels; and category 3 indicating performance does not significantly exceed that
needed to meet minimal regulatory requirements and that NRC attention should be
increased above normal levels.
The most recent review periods and SALP review scores for Beaver Valley
Unit 2, Perry Unit 1 and Davis-Besse are:
<TABLE>
<CAPTION>
BEAVER VALLEY UNIT 2 PERRY UNIT 1 DAVIS-BESSE
-------------------- --------------- ----------------
<S> <C> <C> <C>
SALP Review Period.................. 6/4/95-9/28/96 1/8/95-9/14/96 1/22/95-1/18/97
Operations.......................... 2 2 2
Engineering......................... 2 2 1
Maintenance......................... 1 2 1
Plant Support....................... 2 2 1
</TABLE>
In 1980, Congress passed the Low-Level Radioactive Waste Policy Act which
provides that the disposal of low-level radioactive waste is the responsibility
of the state where such waste is generated. The Act encourages states to form
compacts among themselves to develop regional disposal facilities. Failure by a
state or compact to begin implementation of a program could result in access
denial to the two facilities currently accepting low-level radioactive waste.
Ohio is part of the Midwest Compact and has responsibility for siting and
constructing a disposal facility. In June 1995, the Ohio legislature authorized
the siting, construction and operation of a disposal facility. In addition, the
South Carolina legislature voted to allow out-of-region generators (such as the
Companies' nuclear units) to resume shipments of low-level radioactive waste to
the Barnwell disposal facility. On June 26, 1997, the Midwest Compact Commission
voted to halt further siting activities in Ohio due to the availability of
disposal capacity at both the Barnwell facility and the Envirocare facility in
Utah. The Companies have also constructed interim storage facilities to house
the waste at each nuclear site. See "5. Ohio Abandons Nuclear Waste Project"
under "Part II. Other Information" of the Second Quarter 1997 Form 10-Q in the
Financial Statements Section.
Off-site disposal of spent nuclear fuel is unavailable, but the CAPCO Group
companies have contracts with the U.S. Department of Energy ("DOE") which
provide for the future acceptance of spent fuel for disposal by the federal
government. On December 17, 1996, the DOE notified the Companies that it would
be unable to begin acceptance of spent fuel for disposal by January 31, 1998 as
mandated by Section 302(a)(5)(B) of the Nuclear Waste Policy Act ("NWPA"). As a
result, the Companies along with 35 other nuclear utilities and 46 state
agencies have asked for federal court approval to stop payments into the Nuclear
Waste Fund and for an order requiring the DOE to take immediate action to comply
with NWPA. On-site storage capacity at Davis-Besse, Perry Unit 1 and Beaver
Valley Unit 2 should be sufficient through 2017, 2011 and 2013, respectively.
See "Risk Factors -- Nuclear Operations" and Note 5(a) to the 1996
financial statements and "Outlook -- Nuclear Operations" in Management's
Financial Analysis contained in the Financial Statements Section for a
discussion of potential risks facing the Companies as owners and lessees of
nuclear generating units.
24
<PAGE> 27
FINANCING CAPABILITY
At June 30, 1997, Cleveland Electric had long-term debt outstanding of
approximately $3,011 million (68% of total capitalization) and Toledo Edison had
long-term debt outstanding of approximately $1,122 million (52% of total
capitalization). Also at June 30, 1997, Cleveland Electric and Toledo Edison had
approximately $3,230 million and $1,262 million, respectively, in aggregate
principal amount of first mortgage bonds outstanding under their respective
mortgages. (The outstanding first mortgage bond amounts for Cleveland Electric
and Toledo Edison include $140.4 million principal amount and $210.6 million
principal amount, respectively, of first mortgage bonds pledged to secure
obligations to various bank creditors.) At June 30, 1997, neither Company was
able to issue a material amount of additional first mortgage bonds except in
connection with refinancings.
Also at June 30, 1997, Cleveland Electric had fixed obligations for debt
other than first mortgage bonds and preferred stock with mandatory redemption
provisions of $229 million, and Toledo Edison had fixed obligations for debt
other than first mortgage bonds and preferred stock with mandatory redemption
provisions of $141 million. The Companies also have future minimum lease
payments of approximately $3,659 million for generation facility leases as of
June 30, 1997. See Note 2 to the 1996 financial statements in the Financial
Statements Section. From 1994-1996, aggregate fixed obligations for debt,
preferred stock and the imputed principal portion of the Companies' generation
facility operating leases have been reduced by $523 million. The net proceeds
from the sale of the Old Notes were used by the Companies to refinance $720
million of the lessor debt related to their operating lease commitments for the
Mansfield Plant, resulting in a reduction of the aggregate principal amount of
the lessor debt by about $153 million after repayment of short-term financing
facilities and a reduction of the average life to maturity of the lessor debt
related to their Mansfield Plant operating lease commitments from approximately
11.8 years to approximately 7.0 years.
As of June 30, 1997, debt and preferred stock maturities and sinking fund
requirements for the remainder of 1997 were $115.9 million (including $70.5
million of first mortgage bonds refinanced in August 1997) for Cleveland
Electric and $41.5 million (including $10.1 million of first mortgage bonds
refinanced in August 1997) for Toledo Edison. In August 1997, Cleveland Electric
and Toledo Edison refinanced $180.6 million aggregate principal amount and $10.1
million principal amount, respectively, of first mortgage bonds issued as
security for certain tax-exempt bonds issued by public authorities. Cleveland
Electric plans to refinance up to $550 million of outstanding first mortgage
bonds during the fourth quarter of 1997.
The Companies have $273 million in financing vehicles to support their
nuclear fuel leases, $83 million of which mature in 1997. Replacement financing
for the maturing issues may not be needed in 1997. A $125 million revolving
credit facility which matured in May 1997 has been extended to May 1998. The
Companies expect to meet their remaining financing requirements with internal
cash generation, cash reserves and short-term borrowings.
Also, in June 1997, in connection with the lease refinancing discussed
above, Centerior Energy and the Companies arranged for $155 million of
short-term borrowings with variable interest rates (at that time, with a
weighted average interest rate of 6.8%). Of that amount, Centerior Energy
borrowed $30 million under the revolving credit facility which was renewed in
May 1997. The Companies also had unsecured borrowings totaling $100 million
guaranteed by Centerior Energy, and Centerior Energy had $25 million of
unsecured borrowings jointly and severally guaranteed by the Companies. While
the $25 million amount is outstanding, Centerior Energy has agreed not to use
$25 million of the revolving credit facility.
The Companies expect their foreseeable future cash needs to be satisfied
with internally generated cash and available credit facilities and, therefore,
that they will not need to issue first mortgage bonds, except in connection with
planned refinancings.
There are no restrictions on Cleveland Electric's ability to issue
preferred or preference stock, and there are no restrictions on Toledo Edison's
ability to issue preference stock. Under its articles of incorporation, Toledo
Edison cannot issue preferred stock unless certain earnings coverage
requirements are met. Based on its earnings for the 12 months ended June 30,
1997, Toledo Edison could not issue additional preferred stock.
25
<PAGE> 28
The availability and cost of capital to meet the Companies' external
financing needs depend upon such factors as financial market conditions and the
Companies' credit ratings. At the time of the Offering, credit ratings for the
Companies were as follows:
<TABLE>
<CAPTION>
STANDARD & POOR'S MOODY'S
----------------- -------------
<S> <C> <C>
First mortgage bonds.................................... BB Ba2
Unsecured notes of Cleveland Electric................... B+ Ba3
Unsecured notes of Toledo Edison........................ B+ B1
Preferred stock......................................... B b2
</TABLE>
Current credit ratings for the Companies are as follows:
<TABLE>
<CAPTION>
STANDARD & POOR'S MOODY'S
----------------- -------------
<S> <C> <C>
First mortgage bonds.................................... BB+ Ba1
Unsecured notes......................................... BB- Ba3
Preferred stock......................................... BB- b1
</TABLE>
These ratings reflect recent upgrades by both Standard & Poor's and Moody's
and assume, among other things, consummation of the CEC-OE Merger. See "Risk
Factors -- Consummation of the CEC-OE Merger" and "Pending Merger of Centerior
Energy and Ohio Edison."
Standard & Poor's has assigned the Secured Notes a rating of "BB+" and
Moody's has assigned the Secured Notes a rating of "Ba1." Any desired further
explanation of the significance of these ratings should be obtained from
Standard & Poor's or Moody's, respectively. The Companies furnished Standard &
Poor's and Moody's with certain information and materials with respect to the
Secured Notes and the Companies. Generally, rating agencies base their ratings
on the information and materials so furnished to them and on their own
investigations, studies and assumptions. There is no assurance that such ratings
will continue for any given period of time or that they will not be lowered or
withdrawn entirely if, in the judgment of the rating agencies, circumstances so
warrant. Any such change in or withdrawal of such ratings could have an adverse
effect on the market price of the Secured Notes. The Companies have not applied
for a rating with respect to the Secured Notes from any other credit rating
agency.
FirstEnergy plans to account for the CEC-OE Merger as a purchase in
accordance with generally accepted accounting principles. If FirstEnergy elects
to apply, or "push down," the effects of purchase accounting to the financial
statements of the Companies, Cleveland Electric would record adjustments to: (1)
reduce the carrying value of its nuclear generating plant by $880 million to
fair value; (2) recognize goodwill of $675 million; (3) reduce its common stock
equity by $258 million; (4) reset its retained earnings to zero; and (5) reduce
its related deferred federal income tax liability by $308 million; and Toledo
Edison would record adjustments to: (1) reduce the carrying value of its nuclear
generating plant by $370 million to fair value; (2) recognize goodwill of $307
million; (3) reduce its common stock equity by $124 million; (4) reset its
retained earnings to zero; and (5) reduce its related deferred federal income
tax liability by $130 million. These amounts reflect FirstEnergy's estimates of
the pro forma adjustments for the Companies as of December 31, 1996. The actual
adjustments to be recorded could be materially different from the estimates.
FirstEnergy has not decided whether to push down the effects of purchase
accounting to the financial statements of the Companies if the CEC-OE Merger is
completed.
If upon completion of the CEC-OE Merger FirstEnergy elects to apply
push-down accounting to the Companies, the available bondable property of each
Company would be reduced to below zero. However, each Company would still be
able to issue refundable bonds subject to certain limitations. See "Description
of Cleveland Electric Bonds and Toledo Edison Bonds," and "Pending Merger of
Centerior Energy and Ohio Edison -- Regulatory Matters." In addition, each
Company will also have the flexibility to issue cash-backed first mortgage bonds
or refinance on an unsecured basis, if necessary.
26
<PAGE> 29
CONSTRUCTION PROGRAM
The Companies carry on a continuous program of constructing transmission,
distribution and general facilities and modifying existing generating facilities
to meet anticipated demand for electric service and to comply with governmental
regulations. The Companies' 1996 long-term (20-year) forecast, as filed with the
PUCO, projects long-term annual growth rates in peak demand and kilowatt-hour
sales of 0.7% and 1.0%, respectively, after demand-side management
considerations. The Companies' integrated resource plan for the 1990s (which is
included in the long-term forecast) combines peak clipping demand-side
management programs with maximum utilization of existing generating capacity to
postpone the need for new generating units until the next decade. Cleveland
Electric's Lake Shore Plant ("Lake Shore") Unit 18, a 245,000-kilowatt unit
which was placed on cold standby status in October 1993, is scheduled to resume
active status in 2000.
According to the current long-term integrated resource plan, the Companies
do not plan to put into service any new generating capacity until 2008.
The following tables show, categorized by major components, the
construction expenditures by Cleveland Electric and Toledo Edison during 1994,
1995 and 1996 and the estimated cost of their construction programs for 1997
through 2001, in each case including allowance for funds used during
construction and excluding nuclear fuel (however, consummation of the CEC-OE
Merger is expected to reduce the Companies' cash construction expenditures from
those reported in the tables):
<TABLE>
<CAPTION>
ACTUAL ESTIMATED
------------------ ---------------------------------
1994 1995 1996 1997 1998 1999 2000 2001
----- ----- ---- ----- ----- ----- ----- -----
(MILLIONS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CLEVELAND ELECTRIC
Transmission, Distribution and General
Facilities................................. $ 53 $ 68 $ 79 $ 76 $ 81 $ 94 $ 96 $ 105
Renovation and Modification of Generating
Units
Nuclear.................................... 18 12 17 18 15 17 11 9
Nonnuclear................................. 61 63 19 18 12 18 16 17
Clean Air Act Amendments Compliance.......... 24 12 (4) 1 10 8 3 0
---- ---- ---- ---- ---- ---- ---- ----
Total.............................. $ 156 $ 155 $111 $ 113 $ 118 $ 137 $ 126 $ 131
==== ==== ==== ==== ==== ==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
ACTUAL ESTIMATED
------------------ ---------------------------------
1994 1995 1996 1997 1998 1999 2000 2001
----- ----- ---- ----- ----- ----- ----- -----
(MILLIONS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
TOLEDO EDISON
Transmission, Distribution and General
Facilities................................. $ 18 $ 37 $ 32 $ 38 $ 44 $ 34 $ 36 $ 25
Renovation and Modification of Generating
Units
Nuclear.................................... 10 6 12 14 12 14 10 6
Nonnuclear................................. 12 9 5 9 7 8 4 4
Clean Air Act Amendments Compliance.......... 1 3 0 1 6 6 2 0
---- ---- ---- ---- ---- ---- ---- ----
Total.............................. $ 41 $ 55 $ 49 $ 62 $ 69 $ 62 $ 52 $ 35
==== ==== ==== ==== ==== ==== ==== ====
</TABLE>
27
<PAGE> 30
Each company in the CAPCO Group is responsible for financing the portion of
the capital costs of nuclear fuel equivalent to its ownership and leased
interest in the unit in which the fuel will be utilized. See "The
Companies -- Fuel Supply -- Nuclear" for information regarding nuclear fuel
supplies and Note 6 in the Financial Statements regarding leasing arrangements
to finance nuclear fuel capital costs. Nuclear fuel capital costs incurred by
Cleveland Electric and Toledo Edison during 1994, 1995 and 1996 and their
estimated nuclear fuel capital costs for 1997 through 2001 are as follows:
<TABLE>
<CAPTION>
ACTUAL ESTIMATED
------------------ ---------------------------------
1994 1995 1996 1997 1998 1999 2000 2001
----- ----- ---- ----- ----- ----- ----- -----
(MILLIONS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cleveland Electric........................... $ 26 $ 19 $ 37 $ 25 $ 34 $ 40 $ 34 $ 40
Toledo Edison................................ $ 21 $ 12 $ 32 $ 22 $ 30 $ 30 $ 29 $ 32
</TABLE>
PROPERTIES
For a description of Cleveland Electric's properties, see "Descriptions of
Cleveland Electric Bonds and Toledo Edison Bonds -- Cleveland Electric
Bonds -- Title to Property," and for a description of Toledo Edison's
properties, see "Descriptions of Cleveland Electric Bonds and Toledo Edison
Bonds -- Toledo Edison Bonds -- Title to Property."
PENDING MERGER OF CENTERIOR ENERGY
AND OHIO EDISON
On September 16, 1996, Centerior Energy and Ohio Edison jointly announced
an agreement between them under which Centerior Energy would merge with Ohio
Edison in a stock-for-stock transaction to form FirstEnergy. Upon consummation
of the CEC-OE Merger, Centerior Energy common stock share owners will receive
0.525 share of FirstEnergy common stock for each share of Centerior Energy
common stock owned, and Ohio Edison share owners will receive one share of
FirstEnergy common stock for each share of Ohio Edison common stock owned.
Following the CEC-OE Merger, FirstEnergy will directly hold all of the issued
and outstanding common stock of Ohio Edison, Cleveland Electric, Toledo Edison,
the Service Company and the three other wholly owned subsidiaries of Centerior
Energy.
If the CEC-OE Merger were completed today, FirstEnergy would be the 11th
largest investor-owned electric utility system in the U.S., based on combined
annual sales of approximately 64 billion kilowatt-hours, and would have assets
of over $18 billion, a customer base of 2.1 million and a service area of 13,200
square miles located within a 500-mile radius of one-half of the U.S.
population. See "Management's Financial Analysis" and Note 15 to the 1996
financial statements in the Financial Statements Section and "Risk
Factors -- Consummation of the CEC-OE Merger."
Various aspects of the CEC-OE Merger remain subject to approval by the FERC
and the SEC and to certain other conditions. On July 16, 1997, the FERC issued
an order which delayed consummation of the CEC-OE Merger. The FERC gave the
Companies and Ohio Edison 15 days to elect one of two options: proceed to
concurrent trial-type hearings with the FERC and the PUCO, or revise the
screening analysis and propose appropriate mitigation measures. The FERC order
suggested that possible mitigation measures include: (1) divestiture of
generation assets, (2) creation of a regional independent system operator to
manage the two companies' combined transmission grids, (3) expansion of
transmission capacity and (4) commitment of internal transmission capacity to
alternative suppliers.
The order also directed the Companies and Ohio Edison to continue to
attempt to negotiate an adequate ratepayer protection mechanism with three
Pennsylvania municipalities which intervened but have not yet settled, and
report to the FERC within 30 days the results of those negotiations, whereupon
if no settlement is reached the FERC will decide the issue on the written record
or set it for hearing.
On July 30, 1997, the Companies and Ohio Edison formally notified the FERC
of their election to revise the screening analysis and propose appropriate
mitigation measures. On August 8, 1997, Ohio Edison and the Companies filed a
revised analysis, additional testimony and proposed mitigation measures fully
responsive to
28
<PAGE> 31
the FERC's July 16, 1997 order. While the revised analysis suggests potential
anticompetitive effects in certain markets under certain limited circumstances,
the Companies believe that the mitigation measures more than adequately address
these concerns through a variety of transmission solutions which are intended to
ensure that the proposed merger's effects are procompetitive. As a result of the
mitigation measures, municipal electric systems in Ohio Edison's and the
Companies' service areas will be able to take full advantage of additional third
party generation sources made available to them as a result of FirstEnergy's
open access transmission tariff. The comment period on the August 8, 1997
submissions expired on September 22, 1997. The Companies continue to believe the
FERC will approve the proposed merger prior to the end of 1997. See "1. Pending
Merger with Ohio Edison" under "Part II. Other Information" of the Second
Quarter 1997 Form 10-Q in the Financial Statements Section. However, there can
be no assurance that such approval can be obtained on terms which Centerior
Energy and Ohio Edison will find acceptable. See "Risk Factors -- Consummation
of the CEC-OE Merger."
REASONS FOR THE CEC-OE MERGER
The Companies believe that the CEC-OE Merger will create a company that is
better positioned to compete in the increasingly competitive electric utility
industry than either Centerior Energy or Ohio Edison would be on a stand-alone
basis. FirstEnergy expects to achieve this result through:
(a) improved coordination, control and operation of major generating
plants and transmission facilities;
(b) accelerated debt reduction;
(c) elimination of duplicative activities;
(d) reduced operating expenses and cost of capital;
(e) elimination or deferral of certain capital expenditures;
(f) development of opportunities for sales of energy-related products
and services;
(g) enhanced cash flow; and
(h) enhanced purchasing capabilities for goods and services.
The Companies believe the combination of Centerior Energy and Ohio Edison
is a natural alliance of companies with adjoining service areas who already
share ownership in many of their major generating assets. As a result of the
CEC-OE Merger, FirstEnergy expects to realize opportunities to eliminate
duplicative costs, maximize efficiencies and increase management flexibility in
order to enhance revenues, cash flow and earnings and be a more effective
competitor in the increasingly competitive electric utility industry.
REGULATORY MATTERS
On January 30, 1997, the PUCO approved a rate reduction and economic
development plan for the Companies to be effective upon the consummation of the
CEC-OE Merger and extending through 2006 ("FirstEnergy Regulatory Plan"). The
FirstEnergy Regulatory Plan provides for rate reductions, frozen fuel cost
factors, economic development incentive prices, an energy-efficiency program and
an earnings cap. The FirstEnergy Regulatory Plan requires, for regulatory
purposes, a revaluation of or an accelerated reduction in the Companies'
investment in nuclear plant and certain regulatory assets (excluding amounts due
from customers for future federal income taxes) by at least $2 billion by the
end of 2005. Only a portion of the $2 billion of accelerated costs is expected
to be charged against earnings for financial reporting purposes by 2005. To the
extent the revaluation or an accelerated reduction of assets required by the
FirstEnergy Regulatory Plan for Cleveland Electric and Toledo Edison is
reflected on the Companies' financial accounting books (which has not been
determined), and is also satisfied with physical plant rather than regulatory
assets (which also has not been determined), bondable property at each Company
will be reduced. If, in addition, some or all of the required reduction is
obtained by a change in depreciable life, Toledo Edison's (but not Cleveland
Electric's) net earnings would be reduced prospectively. Toledo Edison may issue
some refundable bonds without a net earnings certificate. See "Descriptions of
Cleveland Electric Bonds and Toledo Edison Bonds -- Toledo Edison
Bonds -- Issuance of Additional TE First Mortgage Bonds."
29
<PAGE> 32
FirstEnergy believes that the FirstEnergy Regulatory Plan will not provide
for the full recovery of costs and a fair return on the investment associated
with the Companies' nuclear operations. Pursuant to the order of the PUCO
approving the FirstEnergy Regulatory Plan, FirstEnergy was required to submit to
the PUCO staff the regulatory accounting and cost recovery details for
implementing the FirstEnergy Regulatory Plan. Such details were submitted in
July 1997. FirstEnergy expects that the Companies will discontinue the
application of SFAS 71 for their nuclear operations if and when consummation of
the CEC-OE Merger becomes probable. The remainder of their business is expected
to continue to comply with the provisions of SFAS 71. At the time the CEC-OE
Merger becomes probable, the Companies would be required to write off certain of
their regulatory assets for financial reporting purposes. The write-off amounts
would be determined at that time. FirstEnergy estimates the write-off will total
approximately $750 million. Under the FirstEnergy Regulatory Plan, some or all
of this write-off cannot be applied toward the $2 billion regulatory commitment
discussed above. For financial reporting purposes, the net book value of the
Companies' nuclear generating units is not expected to be impaired. If events
cause one or both Companies to conclude they no longer meet the criteria for
applying SFAS 71 for the remainder of their business, they would be required to
write off their remaining regulatory assets and measure all other assets for
impairment.
On June 11, 1997, an agreement was reached between FirstEnergy and the City
of Cleveland that provides the framework for resolving transmission and
distribution issues between Cleveland Electric and CPP. FirstEnergy believes
that the agreement will enable both Cleveland Electric and CPP to better serve
their customers while enhancing opportunities for economic development and
growth within their respective service areas. In a related development, an
agreement was also reached with AMP-Ohio that forms a framework for resolving
certain transmission and operating issues. As a result of the agreements, the
City of Cleveland and AMP-Ohio have withdrawn their opposition to the CEC-OE
Merger at both the federal and state levels and all pending litigation involving
the City of Cleveland or CPP and the Companies has been stayed to allow for
settlement discussions.
Reference is made to "Management's Financial Analysis" (specifically,
"Strategic Plan," "Pending Merger with Ohio Edison" and "FirstEnergy Rate Plan"
under "Management's Financial Analysis -- Outlook") and Note 15 to the 1996
financial statements in the Financial Statements Section for more information
concerning the CEC-OE Merger and the FirstEnergy Regulatory Plan. Also, see
"Risk Factors -- Consummation of the CEC-OE Merger" and "The
Companies -- Financing Capability."
PENDING MERGER OF
CLEVELAND ELECTRIC AND TOLEDO EDISON
In March 1994, Centerior Energy announced a plan to merge Toledo Edison
into Cleveland Electric. In June 1995, the preferred share owners of Cleveland
Electric and Toledo Edison approved actions necessary for the two companies to
merge. However, the merger agreement between Centerior Energy and Ohio Edison
requires the approval of Ohio Edison prior to the consummation of the Cleveland
Electric and Toledo Edison merger. Ohio Edison has not yet made a decision on
this matter. In the meantime, at the request of the NRC, pending Ohio Edison's
decision, both Cleveland Electric and Toledo Edison have withdrawn their request
for authorization to transfer certain NRC licenses to the merged entity. All
other regulatory approvals have been obtained.
EFFECT OF PENDING MERGER ON CEI FIRST MORTGAGE AND TE FIRST MORTGAGE
Substantially all of the fixed properties and the franchises of Cleveland
Electric ("CEI Mortgaged Property") are subject to the lien of the CEI First
Mortgage (as hereinafter defined), and substantially all of the fixed properties
and the franchises of Toledo Edison ("TE Mortgaged Property") are subject to the
lien of the TE First Mortgage (as hereinafter defined). If the merger of Toledo
Edison into Cleveland Electric is consummated, Cleveland Electric will acquire
all of the assets of Toledo Edison, including the TE Mortgaged Property, and the
TE Mortgaged Property will become subject to the lien of the CEI First Mortgage,
which lien will be junior to the lien of the TE First Mortgage.
30
<PAGE> 33
If the merger is consummated, the only assets of Cleveland Electric which
will be subject to the lien of the TE First Mortgage will be the TE Mortgaged
Property at the time of the merger and properties thereafter acquired by
Cleveland Electric which are betterments, extensions, improvements, additions,
repairs, renewals, replacements, substitutions and alterations to, upon, for and
of the TE Mortgaged Property and all property held or acquired for use or used
upon or in connection with or appertaining to the TE Mortgaged Property. The
lien of the CEI First Mortgage would, after the merger, continue to be a first
lien on the CEI Mortgaged Property. After the merger, the existing junior liens
of the subordinate mortgages of Cleveland Electric and Toledo Edison would be
junior to the liens of the CEI First Mortgage and the TE First Mortgage.
Cleveland Electric expects that, after the merger, it would enter into a
new indenture ("New Indenture") which will prohibit the issuance of any bonds
under the TE First Mortgage or the CEI First Mortgage, except to the trustee
under the New Indenture in the same principal amounts as, and as the basis for
the issuance of, bonds issued by Cleveland Electric under the New Indenture. The
New Indenture trustee would hold such TE First Mortgage bonds and CEI First
Mortgage bonds for the benefit of the holders of the New Indenture bonds, which
are thus expected to be rated the same as the TE First Mortgage bonds and the
CEI First Mortgage bonds.
A substantial portion of the properties owned by Cleveland Electric after
the merger, including some or all of the CEI Mortgaged Property and TE Mortgaged
Property, would be subject to the lien of the New Indenture, and such lien will
be junior to the liens of the CEI First Mortgage and the TE First Mortgage, but
senior to the existing liens of the subordinate mortgages of Cleveland Electric
and Toledo Edison.
At such time as the New Indenture trustee holds all of the outstanding CEI
First Mortgage bonds or TE First Mortgage bonds, such bonds will be canceled,
the indenture under which such bonds were issued will be discharged and the lien
of the New Indenture will become a first mortgage lien on the properties which
were subject to the first mortgage lien of the discharged indenture.
COMBINED PRO FORMA CONDENSED FINANCIAL STATEMENTS FOR CLEVELAND ELECTRIC AND
TOLEDO EDISON
The following pro forma condensed balance sheets and income statements give
effect to the agreement between Cleveland Electric and Toledo Edison to merge
Toledo Edison into Cleveland Electric. These statements are unaudited and based
on accounting for the merger on a method similar to a pooling of interests.
These statements combine the Companies' historical balance sheets at June 30,
1997, December 31, 1996 and December 31, 1995 and their historical income
statements for the 12 months ended June 30, 1997 and for each of the three years
ended December 31, 1996.
The following pro forma data is not necessarily indicative of the results
of operations or the financial condition which would have been reported had the
merger been in effect during those periods or which may be reported in the
future. The pro forma data does not reflect any potential effects related to the
consummation of the CEC-OE Merger. See "The Companies -- Financing Capability"
for a discussion of the effects on the Companies' financial statements if
FirstEnergy elects to apply push-down accounting to the Companies.
31
<PAGE> 34
COMBINED PRO FORMA CONDENSED BALANCE SHEETS
OF CLEVELAND ELECTRIC AND TOLEDO EDISON
(UNAUDITED)
(MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
AT JUNE 30, 1997
--------------------------------------------------
HISTORICAL
-------------------
CLEVELAND TOLEDO PRO FORMA
ELECTRIC EDISON ADJUSTMENTS TOTALS
--------- ------ ----------- ---------
<S> <C> <C> <C> <C>
ASSETS
Property, Plant and Equipment..................... $ 7,859 $3,527 $ -- $11,386
Less: Accumulated Depreciation and Amortization... 3,026 1,552 -- 4,578
------ ------ ----- -------
Net Property, Plant and Equipment............ 4,833 1,975 -- 6,808
Current Assets.................................... 443 240 (92)(a) 591
Regulatory and Other Assets....................... 2,061 1,357 (18)(a,b) 3,400
------ ------ ----- -------
Total Assets............................ $ 7,337 $3,572 $(110) $10,799
====== ====== ===== =======
CAPITALIZATION AND LIABILITIES
Capitalization:
Common Stock Equity............................. $ 1,010 $ 817 $ -- $ 1,827
Preferred Stock:
With Mandatory Redemption Provisions......... 172 2 -- 174
Without Mandatory Redemption Provisions...... 238 210 -- 448
Long-Term Debt.................................. 3,011 1,122 -- 4,133
------ ------ ----- -------
Total Capitalization.................... 4,431 2,151 -- 6,582
Current Liabilities............................... 794 364 (94)(a) 1,064
Deferred Credits and Other Liabilities............ 2,112 1,057 (16)(b,r) 3,153
------ ------ ----- -------
Total Capitalization and Liabilities.... $ 7,337 $3,572 $(110) $10,799
====== ====== ===== =======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
--------------------------------------------------
HISTORICAL
-------------------
CLEVELAND TOLEDO PRO FORMA
ELECTRIC EDISON ADJUSTMENTS TOTALS
--------- ------ ----------- ---------
<S> <C> <C> <C> <C>
ASSETS
Property, Plant and Equipment..................... $ 7,809 $3,504 $ -- $11,313
Less: Accumulated Depreciation and Amortization... 2,899 1,489 -- 4,388
------ ------ ----- -------
Net Property, Plant and Equipment............ 4,910 2,015 -- 6,925
Current Assets.................................... 498 308 (102)(a,r) 704
Regulatory and Other Assets....................... 1,470 1,034 (18)(a,b,r) 2,486
------ ------ ----- -------
Total Assets............................ $ 6,878 $3,357 $(120) $10,115
====== ====== ===== =======
CAPITALIZATION AND LIABILITIES
Capitalization:
Common Stock Equity............................. $ 1,045 $ 803 $ -- $ 1,848
Preferred Stock:
With Mandatory Redemption Provisions......... 186 3 -- 189
Without Mandatory Redemption Provisions...... 238 210 -- 448
Long-Term Debt.................................. 2,441 1,003 -- 3,444
------ ------ ----- -------
Total Capitalization.................... 3,910 2,019 -- 5,929
Current Liabilities............................... 878 278 (104)(a) 1,052
Deferred Credits and Other Liabilities............ 2,090 1,060 (16)(b,r) 3,134
------ ------ ----- -------
Total Capitalization and Liabilities.... $ 6,878 $3,357 $(120) $10,115
====== ====== ===== =======
</TABLE>
32
<PAGE> 35
COMBINED PRO FORMA CONDENSED BALANCE SHEETS
OF CLEVELAND ELECTRIC AND TOLEDO EDISON
(UNAUDITED)
(MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
AT DECEMBER 31, 1995
--------------------------------------------------
HISTORICAL
-------------------
CLEVELAND TOLEDO PRO FORMA
ELECTRIC EDISON ADJUSTMENTS TOTALS
--------- ------ ----------- ---------
<S> <C> <C> <C> <C>
ASSETS
Property, Plant and Equipment..................... $ 7,724 $3,485 $ -- $11,209
Less: Accumulated Depreciation and Amortization... 2,693 1,405 1(r) 4,099
------ ------ ----- -------
Net Property, Plant and Equipment............ 5,031 2,080 (1) 7,110
Current Assets.................................... 598 327 (24)(a) 901
Regulatory and Other Assets....................... 1,523 1,067 (11)(b) 2,579
------ ------ ----- -------
Total Assets............................ $ 7,152 $3,474 $ (36) $10,590
====== ====== ===== =======
CAPITALIZATION AND LIABILITIES
Capitalization:
Common Stock Equity............................. $ 1,127 $ 763 $ -- $ 1,890
Preferred Stock:
With Mandatory Redemption Provisions......... 215 5 -- 220
Without Mandatory Redemption Provisions...... 241 210 -- 451
Long-Term Debt.................................. 2,666 1,068 -- 3,734
------ ------ ----- -------
Total Capitalization.................... 4,249 2,046 -- 6,295
Current Liabilities............................... 796 329 (27)(a,r) 1,098
Deferred Credits and Other Liabilities............ 2,107 1,099 (9)(a,b) 3,197
------ ------ ----- -------
Total Capitalization and Liabilities.... $ 7,152 $3,474 $ (36) $10,590
====== ====== ===== =======
</TABLE>
33
<PAGE> 36
COMBINED PRO FORMA CONDENSED INCOME STATEMENTS
OF CLEVELAND ELECTRIC AND TOLEDO EDISON
(UNAUDITED)
(MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
12 MONTHS ENDED JUNE 30, 1997
--------------------------------------------------------
HISTORICAL
--------------------
CLEVELAND TOLEDO PRO FORMA
ELECTRIC EDISON ADJUSTMENTS TOTALS
--------- ------ ----------- ---------
<S> <C> <C> <C> <C>
Operating Revenues.......................... $ 1,788 $915 $(140)(c) $ 2,563
Operating Expenses.......................... 1,434 753 (140)(c,d) 2,047
------ ---- ----- ------
Operating Income.......................... 354 162 -- 516
Nonoperating (Loss)......................... (13) -- (4)(d,e,r) (17)
------ ---- ----- ------
Income Before Interest Charges............ 341 162 (4) 499
Interest Charges............................ 233 94 (5)(e,r) 322
------ ---- ----- ------
Net Income................................ 108 68 1 177
Preferred Dividend Requirements............. 37 17 -- 54
------ ---- ----- ------
Earnings Available for Common Stock......... $ 71 $ 51 $ 1 $ 123
====== ==== ===== ======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------------------
HISTORICAL
--------------------
CLEVELAND TOLEDO PRO FORMA
ELECTRIC EDISON ADJUSTMENTS TOTALS
--------- ------ ----------- ---------
<S> <C> <C> <C> <C>
Operating Revenues.......................... $ 1,790 $897 $(133)(c,r) $ 2,554
Operating Expenses.......................... 1,431 741 (134)(c,d,r) 2,038
------ ---- ----- ------
Operating Income.......................... 359 156 1 516
Nonoperating (Loss)......................... (2) (4) (2)(d,e) (8)
------ ---- ----- ------
Income Before Interest Charges............ 357 152 (1) 508
Interest Charges............................ 240 95 (1)(e) 334
------ ---- ----- ------
Net Income................................ 117 57 -- 174
Preferred Dividend Requirements............. 39 17 -- 56
------ ---- ----- ------
Earnings Available for Common Stock......... $ 78 $ 40 $ -- $ 118
====== ==== ===== ======
</TABLE>
34
<PAGE> 37
COMBINED PRO FORMA CONDENSED INCOME STATEMENTS
OF CLEVELAND ELECTRIC AND TOLEDO EDISON
(UNAUDITED)
(MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------------
HISTORICAL
--------------------
CLEVELAND TOLEDO PRO FORMA
ELECTRIC EDISON ADJUSTMENTS TOTALS
--------- ------ ----------- ---------
<S> <C> <C> <C> <C>
Operating Revenues.......................... $ 1,769 $874 $(127)(c,r) $ 2,516
Operating Expenses.......................... 1,371 686 (129)(c,d,r) 1,928
------ ---- ----- ------
Operating Income.......................... 398 188 2 588
Nonoperating Income......................... 31 19 (2)(d) 48
------ ---- ----- ------
Income Before Interest Charges............ 429 207 -- 636
Interest Charges............................ 245 110 -- 355
------ ---- ----- ------
Net Income................................ 184 97 -- 281
Preferred Dividend Requirements............. 43 18 -- 61
------ ---- ----- ------
Earnings Available for Common Stock......... $ 141 $ 79 $ -- $ 220
====== ==== ===== ======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1994
--------------------------------------------------------
HISTORICAL
--------------------
CLEVELAND TOLEDO PRO FORMA
ELECTRIC EDISON ADJUSTMENTS TOTALS
--------- ------ ----------- ---------
<S> <C> <C> <C> <C>
Operating Revenues.......................... $ 1,698 $865 $(141)(c) $ 2,422
Operating Expenses.......................... 1,302 685 (143)(c,d) 1,844
------ ---- ----- ------
Operating Income.......................... 396 180 2 578
Nonoperating Income......................... 31 17 (2)(d,e,r) 46
------ ---- ----- ------
Income Before Interest Charges............ 427 197 -- 624
Interest Charges............................ 242 115 (1)(e) 356
------ ---- ----- ------
Net Income................................ 185 82 1 268
Preferred Dividend Requirements............. 45 20 1(r) 66
------ ---- ----- ------
Earnings Available for Common Stock......... $ 140 $ 62 $ -- $ 202
====== ==== ===== ======
</TABLE>
- ---------------
NOTES TO COMBINED PRO FORMA CONDENSED BALANCE SHEETS AND INCOME STATEMENTS
(UNAUDITED)
The Pro Forma Financial Statements include the following adjustments:
(a) Elimination of intercompany accounts and notes receivable and accounts
and notes payable.
(b) Reclassification of prepaid pension costs.
(c) Elimination of intercompany operating revenues and operating expenses.
(d) Elimination of intercompany working capital transactions.
(e) Elimination of intercompany interest income and interest expense.
(r) Rounding adjustments.
35
<PAGE> 38
THE EXCHANGE OFFER
BACKGROUND
The Old Notes were issued and sold by the Companies to the Placement Agents
on June 18, 1997 (the "Old Note Issue Date"). Thereafter, the Old Notes were
resold by the Placement Agents to certain purchasers in reliance on one or more
exemptions from the registration requirements of the Securities Act. Pursuant to
the Registration Agreement entered into by the Companies and the Placement
Agents ("Registration Agreement") as a condition to the obligations of the
Placement Agents under the Placement Agreement among the Companies and the
Placement Agents, the Companies agreed that, unless the Exchange Offer is
prohibited by applicable law, they would (i) use their reasonable best efforts
to cause the Registration Statement to become effective no later than 150 days
after the Old Note Issue Date and (ii) upon effectiveness of Registration
Statement, commence the Exchange Offer, maintain the effectiveness of the
Registration Statement for at least 30 days (or a longer period if required by
law) and deliver to the Exchange Agent New Notes in the same aggregate principal
amount as the Old Notes that were tendered by the holders thereof pursuant to
the Exchange Offer. A copy of the Registration Agreement has been filed as an
exhibit to the Registration Statement of which this Prospectus is a part.
GENERAL
Subject to the terms and conditions described herein, all Old Notes validly
tendered and not withdrawn prior to the Expiration Date will be accepted for
exchange for New Notes.
The New Notes have terms identical to the terms of the Old Notes except
that the New Notes have been registered under the Securities Act and, following
the completion of the Exchange Offer and during the effectiveness of any
required Shelf Registration Statement, the holders of the Old Notes will not be
entitled to the contingent increase in the interest rate described below. The
New Notes will evidence the same debt as the Old Notes for which they are
exchanged and will be issued under, and be entitled to the benefits of, the Note
Indenture, which also authorized the issuance of the Old Notes.
If (a) the Companies determine that the Exchange Offer is not available or
may not be consummated as soon as practicable after the last date the Exchange
Offer is open because it would violate applicable law or the applicable
interpretations of the staff of the SEC; (b) the Exchange Offer is not
consummated by December 15, 1997; (c) the Placement Agents so request with
respect to the Old Notes not eligible to be exchanged for New Notes in the
Exchange Offer and held by them following consummation of the Exchange Offer; or
(d) any holder (other than an exchanging dealer) is not eligible to participate
in the Exchange Offer, or any holder (other than an exchanging dealer) that
participates in the Exchange Offer does not receive freely tradeable New Notes
on the date of the exchange for validly tendered (and not withdrawn) Old Notes,
the Companies will use all reasonable efforts to file a Shelf Registration
Statement, cause it to be declared effective and keep it effective for a period
of 120 days or such shorter period as may be necessary to allow for the resale
of all Old Notes. If the Exchange Offer is not consummated or a Shelf
Registration Statement with respect to resales of the Old Notes is not declared
effective by December 15, 1997, the interest rate borne by the Old Notes of each
series will be increased by .50% per annum until such time as such requirements
have been satisfied ("Additional Interest").
The Exchange Offer will be deemed to have been consummated upon the
Companies having exchanged New Notes for all outstanding Old Notes that have
been tendered and not withdrawn prior to the close of business on the Expiration
Date (other than Old Notes held by persons not eligible to participate in the
Exchange Offer) pursuant to the Exchange Offer. Upon consummation of the
Exchange Offer, holders of Old Notes seeking liquidity in their investment
(except, under certain circumstances, Participating Broker Dealers (as defined
in the Registration Agreement) and the Placement Agents) would have to rely on
exemptions to registration requirements under the securities laws, including the
Securities Act, and such holders will retain no rights under the Registration
Agreement except under certain limited circumstances. See "Risk Factors --
Consequences of Failure to Exchange."
36
<PAGE> 39
Upon the terms and subject to the conditions described in this Prospectus
and in the accompanying Letter of Transmittal, the Companies will accept all Old
Notes properly tendered and not withdrawn prior to 5:00 p.m., New York City
time, on the Expiration Date. The Companies will issue $1,000 principal amount
of each series of New Notes in exchange for each $1,000 principal amount of each
corresponding series of outstanding Old Notes accepted in the Exchange Offer.
Holders may tender some or all of their Old Notes pursuant to the Exchange Offer
in denominations of $1,000 and integral multiples thereof.
Based on no-action letters issued by the staff of the SEC to third parties,
the Companies believe that the New Notes issued pursuant to this Exchange Offer
in exchange for Old Notes may be offered for resale, resold and otherwise
transferred by any holder thereof (other than (i) a broker-dealer who purchased
such Old Notes directly from the Companies to resell pursuant to Rule 144A or
any other available exemption under the Securities Act or (ii) a person that is
an "affiliate" of the Companies within the meaning of Rule 405 under the
Securities Act) without compliance with the registration and prospectus delivery
requirements of the Securities Act, provided that the holder is acquiring the
New Notes in its ordinary course of business and is not participating, and has
no arrangement or understanding with any person to participate, in a
distribution of the New Notes. See Morgan Stanley & Co. Incorporated, SEC
No-Action Letter (available June 5, 1991) and Exxon Capital Holdings
Corporation, SEC No-Action Letter (available May 13, 1988). Holders of Old Notes
wishing to accept the Exchange Offer must represent to the Companies, as
required by the Registration Agreement, that such conditions have been met.
Each broker-dealer that receives New Notes in exchange for Old Notes held
for its own account, as a result of market-making or other trading activities,
must acknowledge that it will deliver a prospectus in connection with any resale
of such New Notes. The Letter of Transmittal states that by so acknowledging and
by delivering a prospectus, such broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act. This
Prospectus, as it may be amended or supplemented from time to time, may be used
by such broker-dealer in connection with resales of New Notes if such New Notes
were acquired by such broker-dealer as a result of market-making or other
trading activities. The Companies have agreed that, for a period of 120 days
after the Expiration Date, they will make this Prospectus and any amendment or
supplement to this Prospectus available to any such broker-dealer for use in
connection with any such resale. See "Plan of Distribution." No underwriter is
being used in connection with the Exchange Offer.
As of the date of this Prospectus, $720 million aggregate principal amount
of Old Notes is outstanding. In connection with the issuance of the Old Notes,
the Companies arranged for the Old Notes initially purchased by QIBs or in
offshore transactions in reliance on Regulation S under the Securities Act to be
issued and transferable in book-entry form through the facilities of DTC, acting
as depositary. The New Notes are also issuable and transferable in book-entry
form through DTC. See "Description of the New Notes -- Book-Entry Delivery and
Form."
The Companies will be deemed to have accepted validly tendered Old Notes
when, as and if the Companies have given oral or written notice thereof to the
Exchange Agent. See "--Exchange Agent." The Exchange Agent will act as agent for
the tendering holders of Old Notes for the purpose of receiving New Notes from
the Companies and delivering New Notes to such holders.
If any tendered Old Notes are not accepted for exchange because of an
invalid tender or the occurrence of certain other events set forth herein,
certificates for any such unaccepted Old Notes will be returned, without
expense, to the tendering holder thereof as promptly as practicable after the
Expiration Date.
Holders of the Old Notes do not have any appraisal or dissenters' rights
under the Note Indenture in connection with the Exchange Offer. The Companies
intend to conduct the Exchange Offer in accordance with the Registration
Agreement and the applicable requirements of the Securities Act, the Exchange
Act and the rules and regulations of the SEC thereunder.
Holders of Old Notes who tender in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Old Notes
pursuant to the Exchange Offer. The Companies will pay all reasonable charges
37
<PAGE> 40
and expenses, other than certain applicable taxes and counsel fees, incurred in
connection with the Exchange Offer. See "--Fees and Expenses."
EXPIRATION DATES; DELAYS; EXTENSIONS; AMENDMENTS
The term "Expiration Date" means the Expiration Date set forth on the cover
of this Prospectus, unless the Companies, in their sole discretion, extend the
Exchange Offer, in which case the term "Expiration Date" means the latest date
to which the Exchange Offer is extended.
The Companies will notify the Exchange Agent of any extension of the
Expiration Date by oral or written notice and will mail to the record holders of
Old Notes an announcement thereof, each prior to 9:00 a.m., New York City time,
on the next business day after the previously scheduled Expiration Date.
In the case of an extension, such announcement shall include disclosure of
the approximate number of Old Notes deposited to date and shall be made prior to
9:00 a.m., New York City time, on the next business day after the previously
scheduled Expiration Date.
The Companies reserve the right, in their sole discretion, (i) to delay
acceptance of any Old Notes, to extend the Exchange Offer or to terminate the
Exchange Offer and to refuse to accept Old Notes not previously accepted, if any
of the conditions set forth herein under "--Termination" shall have occurred and
shall not have been waived by the Companies (if permitted to be waived by the
Companies), by giving oral or written notice of such delay, extension or
termination to the Exchange Agent, and (ii) to amend the terms of the Exchange
Offer in any manner deemed by them to be advantageous to the holders of the Old
Notes. Any such delay in acceptance, extension, termination or amendment will be
followed as promptly as practicable by oral or written notice thereof to the
Exchange Agent. If the Exchange Offer is amended in a manner determined by the
Companies to constitute a material change, the Companies will promptly disclose
such amendment in a manner reasonably calculated to inform the holders of the
Old Notes of such amendment.
Without limiting the manner in which the Companies may choose to make
public announcements of any delay in acceptance, extension, termination or
amendment of the Exchange Offer, the Companies shall have no obligation to
publish, advertise or otherwise communicate any such public announcement, other
than by making a timely release to the Dow Jones News Service.
INTEREST ON THE SECURED NOTES
The New Notes of each series will bear interest at the same rate and on the
same terms as the Old Notes of the corresponding series. Under the Note
Indenture, interest on each Old Note ceases to accrue upon the exchange of such
Old Note for a New Note. Interest will accrue on each New Note from the date on
which it is authenticated and will be payable to the person in whose name such
New Note is registered at the close of business on the Regular Record Date for
such interest, which will be the December 15 or June 15 (whether or not a
business day), as the case may be, next preceding the payment date for such
interest. If, however, the New Note is authenticated and delivered in exchange
for an Old Note (i) between a record date for the payment of interest on that
Old Note and the related interest payment date, the interest that accrues on the
New Note from the date of authentication thereof to that interest payment date
shall be payable to the person in whose name such New Note was issued on its
issuance date or (ii) between an interest payment date for the payment of
interest on that Old Note and the record date for the next succeeding interest
payment date, the interest that accrues on the Old Note from the earlier
interest payment date to the date on which the Old Note is exchanged for the New
Note will be paid to the person in whose name the New Note is registered on the
record date for that next succeeding interest payment date. The Companies intend
to cause the New Notes to be authenticated on the date on which the New Notes
are exchanged for the Old Notes. Therefore, the exchange will not result in the
loss of interest income to holders of Old Notes exchanged for New Notes.
Interest on the Secured Notes is payable semiannually in cash in arrears on
January 1 and July 1 of each year, commencing July 1, 1997, and the Secured
Notes will bear interest and mature as follows: for the Secured Notes due 2000,
interest at 7.19% with a maturity date of July 1, 2000; for the Secured Notes
due 2004, interest at 7.67% with a maturity date of July 1, 2004; and for the
Secured Notes due 2007, interest at 7.13% with a maturity date of July 1, 2007.
38
<PAGE> 41
PROCEDURES FOR TENDERING
To tender in the Exchange Offer, a holder must properly complete, sign and
date the Letter of Transmittal, or a facsimile thereof, have the signatures
thereon guaranteed if required by the Letter of Transmittal, and mail or
otherwise deliver such Letter of Transmittal or such facsimile, together with
the Old Notes (unless such tender is being effected pursuant to the procedure
for book-entry transfer described below) and any other required documents, to
the Exchange Agent prior to 5:00 p.m., New York City time, on the Expiration
Date.
Any financial institution that is a participant in DTC's Book-Entry
Transfer Facility system may make book-entry delivery of the Old Notes by
causing DTC to transfer such Old Notes into the Exchange Agent's account in
accordance with DTC's procedures for such transfer. Although delivery of Old
Notes may be effected through book-entry transfer into the Exchange Agent's
account at DTC, the Letter of Transmittal (or facsimile thereof), with any
required signature guarantees and any other required documents, must, in any
case, be transmitted to and received or confirmed by the Exchange Agent at its
addresses set forth herein under "-- Exchange Agent" prior to 5:00 p.m., New
York City time, on the Expiration Date. DELIVERY OF DOCUMENTS TO DTC IN
ACCORDANCE WITH ITS PROCEDURES DOES NOT CONSTITUTE DELIVERY TO THE EXCHANGE
AGENT.
The tender by a holder of Old Notes will constitute an agreement between
such holder and the Companies in accordance with the terms and subject to the
conditions described herein and set forth in the Letter of Transmittal.
THE METHOD OF DELIVERY OF OLD NOTES AND THE LETTER OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK OF
THE HOLDERS. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE AN
OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE TIMELY DELIVERY. NO LETTER OF TRANSMITTAL OR OLD NOTES SHOULD
BE SENT TO THE COMPANIES. DELIVERY OF ALL DOCUMENTS MUST BE MADE TO THE EXCHANGE
AGENT AT ITS ADDRESS SET FORTH HEREIN. HOLDERS MAY ALSO REQUEST THAT THEIR
RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES OR NOMINEES
EFFECT SUCH TENDER FOR SUCH HOLDERS.
Only a holder of Old Notes may tender such Old Notes in the Exchange Offer.
The term "holder" with respect to the Exchange Offer means any person in whose
name Old Notes are registered in the Security Register (as defined herein) or
any other person who has obtained a properly completed bond power from the
registered holder, or any person whose Old Notes are held of record by DTC who
desires to deliver such Old Notes by book-entry transfer at DTC.
Any beneficial holder whose Old Notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender should contact such registered holder promptly and instruct such
registered holder to tender on such beneficial owner's behalf. If such
beneficial holder wishes to tender on its own behalf, such beneficial holder
must, prior to completing and executing the Letter of Transmittal and delivering
its Old Notes, either make appropriate arrangements to register ownership of the
Old Notes in such holder's name or obtain a properly completed bond power from
the registered holder which authorizes such owner to tender the Old Notes on
behalf of the registered holder, in each case signed by the registered holder as
the name of such registered holder appears on the Old Notes. The transfer of
record ownership may take considerable time.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed by a member firm of a registered national
securities exchange or of the National Association of Securities Dealers, Inc.,
a commercial bank or trust company having an office of correspondent in the
United States or an "eligible guarantor institution" within the meaning of Rule
17Ad-15 under the Exchange Act (an "Eligible Institution") unless the Old Notes
tendered pursuant thereto are tendered (i) by a registered holder who has
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not completed the box entitled "Special Issuance Instructions" or "Special
Delivery Instructions" on the Letter of Transmittal or (ii) for the account of
an Eligible Institution.
If the Letter of Transmittal is signed by a person other than the
registered holder of any Old Notes listed therein, such Old Notes must be
endorsed or accompanied by appropriate bond powers which authorize such person
to tender the Old Notes on behalf of the registered holder, in either case
signed as the name of the registered holder or holders appears on the Old Notes.
If the Letter of Transmittal or any Old Notes or bond powers are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Companies,
evidence satisfactory to the Companies of their authority to so act must be
submitted with the Letter of Transmittal.
The Exchange Agent and DTC have confirmed that any financial institution
that is a participant in DTC's system may utilize DTC's Automated Tender Offer
Program to tender Old Notes.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of the tendered Old Notes will be determined
by the Companies in their sole discretion, which determination will be final and
binding. The Companies reserve the absolute right to reject any and all Old
Notes not properly tendered or any Old Notes the Companies' acceptance of which
would, in the opinion of counsel for the Companies, be unlawful. The Companies
also reserve the absolute right to waive any irregularities or conditions of
tender as to particular Old Notes. The Companies' interpretation of the terms
and conditions of the Exchange Offer (including the instructions in the Letter
of Transmittal) will be final and binding on all parties. Unless waived, any
defects or irregularities in connection with tenders of Old Notes must be cured
within such time as the Companies shall determine. Neither the Companies, the
Exchange Agent nor any other person shall be under any duty to give notification
of defects or irregularities with respect to tenders of Old Notes nor shall any
of them incur any liability for failure to give such notification. Tenders of
Old Notes will not be deemed to have been made until such irregularities have
been cured or waived. Any Old Notes received by the Exchange Agent that are not
properly tendered and as to which the defects or irregularities have not been
cured or waived will be returned without cost by the Exchange Agent to the
tendering holder of such Old Notes unless otherwise provided in the Letter of
Transmittal, as soon as practicable following the Expiration Date.
While the Companies have no present plan to acquire any Old Notes which
have not been tendered in the Exchange Offer or to file a registration statement
to permit resales of Old Notes which are not tendered pursuant to the Exchange
Offer (except as may be required under the Registration Agreement), subject to
the terms of the Note Indenture, the Companies reserve the right in their sole
discretion to (a) purchase or make offers for any Old Notes that remain
outstanding subsequent to the Expiration Date, (b) as set forth under
"Termination," terminate the Exchange Offer with respect to such Old Notes or
(c) to the extent permitted by applicable law, purchase Old Notes in the open
market, in privately negotiated transactions or otherwise. The terms of any such
purchases or offers may differ from the terms of the Exchange Offer.
By tendering, each holder of Old Notes will represent to the Companies
that, among other things, the New Notes acquired pursuant to the Exchange Offer
are being obtained in the ordinary course of business of the person receiving
such New Notes, whether or not such person is the holder, that neither the
holder nor any other person has an arrangement or understanding with any person
to participate in a distribution of the New Notes and that neither the holder
nor any such other person is an "affiliate" of the Companies within the meaning
of Rule 405 under the Securities Act or, if an affiliate, such holder or such
other person will comply with the registration and prospectus delivery
requirements of the Securities Act to the extent applicable.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Old Notes and (i) whose Old Notes are not
lost but are not immediately available or (ii) who cannot deliver their Old
Notes, the Letter of Transmittal or any other
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required documents to the Exchange Agent prior to the Expiration Date, or who
cannot complete the procedure for book-entry transfer on a timely basis, may
effect a tender if:
(a) The tender is made through an Eligible Institution;
(b) Prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery (by facsimile transmission, mail or hand delivery)
setting forth the name and address of the holder of the Old Notes, the
certificate number or numbers of such Old Notes and the principal amount of
Old Notes tendered, stating that the tender is being made thereby, and
guaranteeing that, within three business days after the Expiration Date,
the Letter of Transmittal (or facsimile thereof), together with the
certificate(s) representing the Old Notes to be tendered in proper form for
transfer and any other documents required by the Letter of Transmittal,
will be deposited by the Eligible Institution with the Exchange Agent; and
(c) Such properly completed and executed Letter of Transmittal (or
facsimile thereof), together with the certificate(s) representing all
tendered Old Notes in proper form for transfer (or confirmation of a
book-entry transfer into the Exchange Agent's account at DTC of Old Notes
delivered electronically) and all other documents required by the Letter of
Transmittal are received by the Exchange Agent within three business days
after the Expiration Date.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Old Notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the Expiration Date.
To withdraw a tender of Old Notes in the Exchange Offer, a telegram, telex,
facsimile transmission or letter notice of withdrawal must be received by the
Exchange Agent at its address set forth herein prior to 5:00 p.m., New York City
time, on the Expiration Date. Any such notice of withdrawal must (i) specify the
name of the person having deposited the Old Notes to be withdrawn (the
"Depositor"), (ii) include a statement that the Depositor is withdrawing its
election to have Old Notes exchanged, and identify the Old Notes to be withdrawn
(including the certificate number or numbers and principal amount of such Old
Notes), (iii) be signed by the Depositor in the same manner as the original
signature on the Letter of Transmittal by which such Old Notes were tendered
(including any required signature guarantees) or be accompanied by documents of
transfer sufficient to permit the Trustee with respect to the Old Notes to
register the transfer of such Old Notes into the name of the Depositor
withdrawing the tender and (iv) specify the name in which any such Old Notes are
to be registered, if different from that of the Depositor. All questions as to
the validity, form and eligibility (including time of receipt) for such
withdrawal notices will be determined by the Companies, whose determination will
be final and binding on all parties. Any Old Notes so withdrawn will be deemed
not to have been validly tendered for purposes of the Exchange Offer and no New
Notes will be issued with respect thereto unless the Old Notes so withdrawn are
validly retendered. Any Old Notes which have been tendered but which are not
accepted for exchange will be returned to the holder thereof without cost to
such holder as soon as practicable after withdrawal, rejection of tender or
termination of the Exchange Offer. Properly withdrawn Old Notes may be
retendered by following one of the procedures described above under "--
Procedures for Tendering" at any time prior to the Expiration Date.
TERMINATION
The Exchange Offer is not subject to any condition, other than (i) that the
Exchange Offer does not violate applicable law or any applicable interpretation
of the staff of the SEC, (ii) that no action or proceeding shall have been
instituted or threatened in any court or by or before any governmental agency or
statute, rule or regulation that would render the Exchange Offer illegal and
(iii) that there shall not have been adopted or enacted any law, statute, rule
or regulation that would render the Exchange Offer illegal. There can be no
assurance that any such condition will not occur.
If the Companies determine that they may terminate the Exchange Offer, as
set forth above, the Companies may (i) refuse to accept any Old Notes and return
any Old Notes that have been tendered to the
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holders thereof, (ii) extend the Exchange Offer and retain all Old Notes
tendered prior to the Expiration of the Exchange Offer, subject to the rights of
such holders of tendered Old Notes to withdraw their tendered Old Notes or (iii)
waive such termination event with respect to the Exchange Offer and accept all
properly tendered Old Notes that have not been withdrawn. If such waiver
constitutes a material change in the Exchange Offer, the Companies will disclose
such change by means of a supplement to this Prospectus that will be distributed
to each registered holder of Old Notes, and the Companies will extend the
Exchange Offer for a period of five to ten business days, depending upon the
significance of the waiver and the manner of disclosure to the registered
holders of the Old Notes, if the Exchange Offer would otherwise expire during
such period.
EXCHANGE AGENT
The Chase Manhattan Bank, the Note Trustee under the Note Indenture, has
been appointed as Exchange Agent for the Exchange Offer. Questions and requests
for assistance and for additional copies of this Prospectus or of the Letter of
Transmittal should be directed to the Exchange Agent addressed as follows:
By Registered or Certified Mail or Hand or Overnight Delivery:
The Chase Manhattan Bank
55 Water Street
Room 234, North Building
New York, NY 10041
Attention: Carlos Esteves
Confirm by Telephone:
(212) 638-0828
Facsimile Transmissions:
(Eligible Institutions Only)
(212) 638-7375 or (212) 344-9367
FEES AND EXPENSES
The expenses of soliciting tenders pursuant to the Exchange Offer will be
borne by the Companies. The principal solicitation for tenders pursuant to the
Exchange Offer is being made by mail. Additional solicitations may be made by
officers and regular employees of the Companies and their affiliates in person,
by telegraph or telephone or other means.
The Companies will not make any payments to brokers, dealers or other
persons soliciting acceptances of the Exchange Offer. The Companies, however,
will pay the Exchange Agent reasonable and customary fees for its services and
will reimburse the Exchange Agent for its reasonable out-of-pocket expenses in
connection therewith. The Companies may also pay brokerage houses and other
custodians, nominees and fiduciaries the reasonable out-of-pocket expenses
incurred by them in forwarding copies of this Prospectus, Letters of Transmittal
and related documents to the beneficial owners of the Old Notes and in handling
or forwarding tenders for exchange.
Reasonable expenses incurred in connection with the Exchange Offer,
including expenses of the Exchange Agent and Note Trustee and accounting and
legal fees, other than certain applicable taxes and counsel fees, will be paid
by the Companies.
The Companies will pay all transfer taxes, if any, applicable to the
exchange of Old Notes pursuant to the Exchange Offer. If, however, certificates
representing New Notes or Old Notes for principal amounts not tendered or
accepted for exchange are to be delivered to, or are to be registered or issued
in the name of, any person other than the registered holder of the Old Notes
tendered, or if tendered Old Notes are registered in the name of any person
other than the person signing the Letter of Transmittal, or if a transfer tax is
imposed for any reason other than the exchange of Old Notes pursuant to the
Exchange Offer, then the amount of any such transfer taxes (whether imposed on
the registered holder or any other person) will be payable by the tendering
holder. If satisfactory evidence of payment of such taxes or exemption therefrom
is not submitted with the Letter of Transmittal, the amount of such transfer
taxes will be billed directly to such tendering holder.
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DESCRIPTION OF THE NEW NOTES
GENERAL
The Old Notes were, and the New Notes will be, issued pursuant to an
Indenture dated as of June 13, 1997 and a First Supplemental Indenture thereto
dated June 13, 1997 (as supplemented, "Note Indenture") between the Companies
and The Chase Manhattan Bank, as trustee ("Note Trustee"). The terms of the
Secured Notes include those stated in the Note Indenture and those made part of
the Note Indenture by reference to the Trust Indenture Act of 1939, as amended
("Trust Indenture Act"). Holders of Secured Notes are referred to the Note
Indenture and the Trust Indenture Act for a statement of all such terms. The
following summary of the material provisions of the Note Indenture does not
purport to be complete and is qualified in its entirety by reference to the Note
Indenture, including the definitions therein of certain terms used below. Copies
of the Note Indenture are available as set forth below under "Additional
Information."
The obligations of the Companies under the Secured Notes are joint and
several. The Secured Notes are secured equally and ratably as to payment of
principal and interest by $575 million aggregate principal amount of Cleveland
Electric Bonds and $145 million aggregate principal amount of Toledo Edison
Bonds.
The Secured Notes are denominated in United States currency in minimum
denominations of $1,000 and any integral multiple thereof.
PRINCIPAL, MATURITY AND INTEREST
The Secured Notes are limited to an aggregate amount of $720 million
consisting of $220 million aggregate principal amount of Secured Notes due 2000,
$350 million aggregate principal amount of Secured Notes due 2004 and $150
million aggregate principal amount of Secured Notes due 2007. New Notes of each
series will bear interest at the same rate and on the same terms as the Old
Notes of the corresponding series. Under the Note Indenture, interest on each
Old Note ceases to accrue upon the exchange of such Old Note for a new Note.
Interest will accrue on each new Note from the date on which it is authenticated
and will be payable to the person in whose name such New Note is registered at
the close of business on the Regular Record Date for such interest, which will
be the December 15 or June 15 (whether or not a business day), as the case may
be, next preceding the payment date for such interest. If, however, the New Note
is authenticated and delivered in exchange for an Old Note (i) between a record
date for the payment of interest on that Old Note and the related interest
payment date, the interest that accrues on the New Note from the date of
authentication thereof to that interest payment date shall be payable to the
person in whose name such New Note was issued on its issuance date or (ii)
between an interest payment date for the payment of interest on that Old Note
and the record date for the next succeeding interest payment date, the interest
that accrues on the Old Note from the earlier interest payment date to the date
on which the Old Note is exchanged for the New Note will be paid to the person
in whose name the New Note is registered on the record date for that next
succeeding interest payment date. The Companies intend to cause the New Notes to
be authenticated on the date on which the New Notes are exchanged for the Old
Notes. Therefore, the exchange will not result in the loss of interest income to
holders of Old Notes exchanged for New Notes. Interest on the Secured Notes is
payable semiannually in cash in arrears on January 1 and July 1 of each year,
commencing July 1, 1997, and the Secured Notes will bear interest and mature as
follows: for the Secured Notes due 2000, interest at 7.19% with a maturity date
of July 1, 2000; for the Secured Notes due 2004, interest at 7.67% with a
maturity date of July 1, 2004; and for the Secured Notes due 2007, interest at
7.13% with a maturity date of July 1, 2007. Interest will be computed on the
basis of a 360-day year comprised of twelve 30-day months. Principal, interest
and Additional Interest, if any, on the Secured Notes is payable at the office
or agency of the Companies maintained for such purpose within the City of New
York, State of New York or, at the option of the Companies, payment of interest
may be made by check mailed to the address of the person entitled thereto as
such address shall appear in the register of holders of Secured Notes ("Security
Register"); provided that all payments of principal, interest and Additional
Interest, if any, with respect to Secured Notes the holders of which have given
wire transfer instructions to the Companies will be required to be made by wire
transfer of immediately available funds to the accounts specified by the holders
thereof. Until otherwise designated by the
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Companies, the Companies' office or agency in the City of New York will be the
office of the Note Trustee maintained for such purpose.
SECURITY FOR THE SECURED NOTES
The Old Notes are, and the New Notes (together with any Old Notes that
remain outstanding after the Exchange Offer is terminated) will be, secured
equally and ratably as to payment of principal and interest by the Cleveland
Electric Bonds and the Toledo Edison Bonds, which were issued, pledged and
delivered by the Companies to the Note Trustee in connection with the Offering.
The Cleveland Electric Bonds and the Toledo Edison Bonds consist of three series
each of CEI First Mortgage Bonds and TE First Mortgage Bonds, respectively, all
of which are secured by a lien on certain property owned by Cleveland Electric
and Toledo Edison, respectively. See "Descriptions of Cleveland Electric Bonds
and Toledo Edison Bonds."
REDEMPTION PROVISIONS
The Secured Notes are not subject to redemption prior to maturity. There
are no sinking fund payments for the Secured Notes.
EVENTS OF DEFAULT AND REMEDIES
The Note Indenture describes "Events of Default" relating to the Secured
Notes of any series, which include: (i) default for 30 days in the payment when
due of interest on the Secured Notes of that series; (ii) default in payment
when due of the principal of the Secured Notes of that series; (iii) default for
60 days, after notice to the Companies by the Note Trustee or to the Companies
and the Note Trustee by the holders of a majority in principal amount of the
outstanding Secured Notes of that series, by the Companies in the performance,
or breach, of any covenant or warranty in the Note Indenture, (iv) default
relating to any of the Cleveland Electric Bonds or the Toledo Edison Bonds or
(v) certain events of bankruptcy or insolvency, whether voluntary or
involuntary, with respect to either Company.
If any Event of Default occurs and is continuing, the Note Trustee or the
holders of a majority in principal amount of the then outstanding Secured Notes
of any series may declare all the Secured Notes of such series to be due and
payable immediately. Notwithstanding the foregoing, in the case of an Event of
Default arising from certain events of bankruptcy or insolvency with respect to
either Company, all outstanding Secured Notes will become due and payable
without further action or notice. Holders of the Secured Notes may not enforce
the Note Indenture or the Secured Notes except as provided in the Note
Indenture. Subject to certain limitations, holders of a majority in principal
amount of the then outstanding Secured Notes of any series may direct the Note
Trustee in its exercise of any trust or power with respect to that series. The
Note Trustee may withhold from holders of the Secured Notes notice of any
continuing Event of Default (except an Event of Default relating to the payment
of principal or interest) if it determines that withholding notice is in their
interest.
The holders of a majority in principal amount of the Secured Notes then
outstanding of any series by notice to the Note Trustee may, on behalf of the
holders of all of the Secured Notes of such series, waive any past Event of
Default and its consequences under the Note Indenture except (i) a continuing
Event of Default in the payment of interest on or the principal of the Secured
Notes of such series or (ii) an Event of Default in respect of a covenant under
the Note Indenture which cannot be amended or modified without the consent of
the holders of each Secured Note of that series. In all circumstances in which
the Note Indenture requires the consent of the holders in connection with a
proposed action thereunder or grants to the holders the right to direct an
action thereunder, Ambac Assurance shall be considered the holder of the Secured
Notes due 2007.
The Companies are required to deliver to the Note Trustee annually an
officer's certificate stating whether or not the Companies are in default in the
performance and observance of the terms of the Note Indenture, and, if the
Companies shall be in default, a statement specifying the nature of such
default.
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DEFEASANCE AND COVENANT DEFEASANCE
The Companies may, at their option and at any time, elect to have all of
their respective obligations discharged with respect to the outstanding Secured
Notes ("Defeasance") except for (i) the rights of holders of outstanding Secured
Notes to receive, solely from the trust fund described below, payments in
respect of the principal of and interest on such Secured Notes when such
payments are due, (ii) the Companies' obligations with respect to the Secured
Notes concerning issuing temporary Secured Notes, registration of Secured Notes,
mutilated, destroyed, lost or stolen Secured Notes and the maintenance of an
office or agency for payment of money for security payments held in trust, (iii)
the rights, powers, trusts, duties and immunities of the Note Trustee, and the
Companies' obligations in connection therewith, (iv) the Defeasance provisions
of the Note Indenture and (v) that portion of the principal of and interest on
the Secured Notes due 2007 that is paid by Ambac Assurance pursuant to the
Financial Guaranty Insurance Policy (as defined herein). In addition, the
Companies may, at their option and at any time, elect to have the obligations of
the Companies released with respect to certain covenants that are described in
the Note Indenture ("Covenant Defeasance") and thereafter any omission to comply
with such obligations will not constitute an Event of Default with respect to
the Secured Notes. In the event Covenant Defeasance occurs, certain events (not
including non-payment, bankruptcy, receivership, rehabilitation and insolvency
events) described under "Events of Default" will no longer constitute an Event
of Default with respect to the Secured Notes.
In order to exercise either Defeasance or Covenant Defeasance, (i) the
Companies must irrevocably deposit with the Note Trustee, in trust, for the
benefit of the holders of the Secured Notes, cash in United States dollars, U.S.
Government Obligations (as hereinafter defined) or a combination thereof, in
such amounts as will be sufficient, in the opinion of a nationally recognized
firm of independent public accountants, to pay the principal of and interest on
the outstanding Secured Notes on the stated maturity; (ii) in the case of
Defeasance, the Companies shall have delivered to the Note Trustee an opinion of
counsel reasonably acceptable to the Note Trustee confirming that (A) the
Companies have received from, or there has been published by, the Internal
Revenue Service a ruling or (B) since the date of the Note Indenture, there has
been a change in the applicable federal income tax law, in either case to the
effect that, and based thereon such opinion of counsel shall confirm that, the
holders of the outstanding Secured Notes will not recognize gain or loss for
federal income tax purposes as a result of such deposit, Defeasance and
discharge and will be subject to federal income tax on the same amounts, in the
same manner and at the same times as would have been the case if such deposit,
Defeasance and discharge had not occurred; (iii) in the case of Covenant
Defeasance, the Companies shall have delivered to the Note Trustee an opinion of
counsel reasonably acceptable to the Note Trustee confirming that the holders of
the outstanding Secured Notes will not recognize gain or loss for federal income
tax purposes as a result of the deposit and Covenant Defeasance and will be
subject to federal income tax on the same amounts, in the same manner and at the
same times as would have been the case if such deposit and Covenant Defeasance
had not occurred; (iv) the Companies must deliver to the Note Trustee an
officer's certificate to the effect that such Secured Notes, if then listed on
any securities exchange, will not be delisted as a result of such deposit; (v)
no Event of Default shall have occurred and be continuing on the date of such
deposit (other than an Event of Default resulting from the borrowing of funds to
be applied to such deposit which will be cured upon such Defeasance or Covenant
Defeasance) or, insofar as Events of Default from bankruptcy or insolvency
events are concerned, at any time in the period ending on the 90th day after the
date of such deposit; (vi) such Defeasance or Covenant Defeasance shall not
cause the Note Trustee to have a conflicting interest within the meaning of the
Trust Indenture Act; (vii) such Defeasance or Covenant Defeasance will not
result in a breach or violation of, or constitute a default under any material
agreement or instrument to which the Companies are a party or by which the
Companies are bound; (viii) such Defeasance or Covenant Defeasance shall not
result in the trust arising from such deposit constituting an investment company
within the meaning of the Investment Company Act of 1940, as amended unless such
trust is registered thereunder; and (ix) the Companies must deliver to the Note
Trustee an officer's certificate and an opinion of counsel, each stating that
all conditions precedent provided for relating to the Defeasance or the Covenant
Defeasance have been complied with.
As used herein, "U.S. Government Obligation" means (x) any security which
is (i) a direct obligation of the United States of America for the payment of
which the full faith and credit of the United States of
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America is pledged or (ii) an obligation of a person controlled or supervised by
and acting as an agency or instrumentality of the United States of America the
payment of which is unconditionally guaranteed as a full faith and credit
obligation of the United States of America, which, in either case (i) or (ii),
is not callable or redeemable at the option of the issuer thereof, (y) any
depositary receipt issued by a bank (as defined in Section 3(a)(2) of the
Securities Act) as custodian with respect to any U.S. Government Obligation
which is specified in clause (x) above and held by such bank for the account of
the holder of such depositary receipt, or with respect to any specific payment
of principal of or interest on any U.S. Government Obligation which is so
specified and held, provided that (except as required by law) such custodian is
not authorized to make any deduction from the amount payable to the holder of
such depositary receipt from any amount received by the custodian in respect of
the U.S. Government Obligation or the specific payment of principal or interest
evidenced by such depositary receipt and (z) any certificates or other evidences
of ownership interest in obligations of the character described in either case
(i) or (ii) or in specified portions thereof, including without limitation,
portions consisting solely of the interest thereon provided that such
obligations are held in a bank or trust company acceptable to the Note Trustee
in a special account separate from the assets of such custodian.
TRANSFER AND EXCHANGE
A holder may transfer or exchange Secured Notes in accordance with the Note
Indenture. The Registrar (as defined in the Note Indenture) and the Note Trustee
may require a holder, among other things, to furnish appropriate endorsements
and transfer documents and the Companies may require a holder to pay any taxes
and fees required by law or permitted by the Note Indenture. See "-- Book Entry,
Delivery and Form."
The registered holder of a Secured Note will be treated as the owner of it
for all purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as described in the next two succeeding paragraphs, the Note
Indenture or the Secured Notes may be amended or supplemented with the consent
of the holders of at least a majority in principal amount of the Secured Notes
then outstanding of the series affected (including, without limitation, consents
obtained in connection with a purchase of, or tender offer or exchange offer
for, Secured Notes), and any existing default or compliance with any provision
of the Note Indenture or the Secured Notes may be waived with the consent of the
holders of a majority in principal amount of the Secured Notes then outstanding
of the series affected (including, without limitation, consents obtained in
connection with a purchase of, or tender offer or exchange offer for, Secured
Notes). Notwithstanding the foregoing, the Companies and the Note Trustee may
not, without the prior consent of Ambac Assurance, amend or supplement the Note
Indenture or the Secured Notes due 2007 if such amendment or supplement would
adversely affect the rights of Ambac Assurance to act as the holder of such
series.
Without the consent of each holder affected (and Ambac Assurance with
respect to the Secured Notes due 2007), an amendment or waiver may not (with
respect to any Secured Notes held by a non-consenting holder): (i) reduce the
principal amount of Secured Notes whose holders must consent to an amendment,
supplement or waiver, (ii) reduce the principal of or change the fixed maturity
of any Secured Note, (iii) reduce the rate of or change the time or place for
payment of interest on any Secured Note, (iv) waive an Event of Default in the
payment of principal of, interest on or Additional Interest, if any, on the
Secured Notes, (v) make any change in the provisions of the Note Indenture
relating to waivers of past defaults or the rights of holders of Secured Notes
to receive payments of principal of or interest on the Secured Notes or (vi)
make any change in the foregoing amendment and waiver provisions.
Notwithstanding the foregoing, without the consent of any holder of Secured
Notes, the Companies and the Note Trustee may amend or supplement the Note
Indenture or the Secured Notes to cure any ambiguity, defect or inconsistency,
to provide for uncertificated Secured Notes in addition to or in place of
certificated Secured Notes, to provide for the assumption of the Companies'
obligations to holders of Secured Notes in the case of a merger or consolidation
of either or both of the Companies, to make any change that would provide any
additional rights or benefits to the holders of Secured Notes or that does not
adversely affect the legal
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rights under the Note Indenture of any such holder, or to comply with
requirements of the SEC in order to effect or maintain the qualification of the
Note Indenture under the Trust Indenture Act or to provide for the acceptance of
appointment under the Note Indenture of a successor Note Trustee.
CONCERNING THE NOTE TRUSTEE
The Chase Manhattan Bank is the Note Trustee. The Note Trustee may resign
by giving written notice of its resignation as provided in the Note Indenture.
The resignation will take effect only upon the appointment of a successor
trustee. The holders of a majority of the then outstanding principal amount of
the Secured Notes may remove the Note Trustee at any time. The Companies may
appoint a successor trustee under the Note Indenture, subject to the right of
the holders to replace the successor trustee appointed by the Companies. Any
successor trustee must be eligible pursuant to the Trust Indenture Act and have
a combined capital and surplus of at least $50,000,000.
The Note Indenture contains certain limitations on the rights of the Note
Trustee, should it become a creditor of the Companies, to obtain payment of
claims in certain cases, or to realize on certain property received in respect
of any such claim as security or otherwise. The Note Trustee will be permitted
to engage in other transactions; however, if it acquires any conflicting
interest, it must eliminate such conflict within 90 days, and apply to the SEC
for permission to continue or resign.
The holders of a majority in principal amount of the then outstanding
Secured Notes have the right to direct the time, method and place of conducting
any proceeding for exercising any remedy available to the Note Trustee, subject
to certain exceptions. The Note Indenture provides that in case an Event of
Default shall occur (which shall not be cured), the Note Trustee is required, in
the exercise of its power, to use the degree of care of a prudent man in the
conduct of his own affairs. Subject to such provisions, the Note Trustee is
under no obligation to exercise any of its rights or powers under the Note
Indenture at the request of any holder of Secured Notes, unless such holder
shall have offered to the Note Trustee security and indemnity satisfactory to it
against any loss, liability or expense.
NO PERSONAL LIABILITY OF INCORPORATORS, STOCKHOLDERS, OFFICERS, DIRECTORS OR
EMPLOYEES
The Note Indenture provides that no recourse for the payment of the
principal of or interest on any of the Secured Notes or for any claim based
thereon or otherwise in respect thereof, and no recourse under or upon any
obligation, covenant or agreement of the Companies in the Note Indenture, or in
any of the Secured Notes or because of the creation of any indebtedness
represented thereby, shall be had against any incorporator, stockholder,
officer, director or employee of the Companies or of any successor thereof. Each
holder, by accepting the Secured Notes, waives and releases all such liability
and such waiver and release are part of the consideration for issuance of the
Secured Notes. It is the position of the SEC that, notwithstanding such waiver,
holders of the Secured Notes will continue to have all rights and remedies that
are otherwise available under the anti-fraud provisions of the federal
securities laws.
ADDITIONAL INFORMATION
Anyone who receives this Prospectus may obtain a copy of the Note Indenture
without charge by writing to Janis T. Percio, Secretary, Centerior Energy
Corporation, P.O. Box 94661, Cleveland, OH 44101-4661.
BOOK-ENTRY, DELIVERY AND FORM
The certificates representing the Old Notes were, and the certificates
representing the New Notes will be, issued in fully registered form and without
interest coupons. Each series of the New Notes will be represented by a Global
New Note.
Secured Notes sold in reliance on Rule 144A are represented by one or more
Global Notes in definitive, fully registered form and without interest coupons
and have been deposited with the Note Trustee, as custodian for, and registered
in the name of, a nominee of DTC.
The laws of some states require that certain persons take physical delivery
in definitive form of securities that they own. Consequently, the ability to
transfer beneficial interest in the Global Notes to such persons may
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be limited to that extent. Because DTC can act only on behalf of participants,
which in turn act on behalf of indirect participants and certain banks, the
ability of a person having a beneficial interest in the Global Notes to pledge
such interest to persons or entities that do not participate in the DTC system,
or otherwise take actions in respect of such interests, may be affected by the
lack of physical certificate evidencing such interests.
The Global Notes
Ownership of beneficial interests in a Global Note is and will be limited
to persons who have accounts with DTC ("participants") or persons who hold
interests through participants. Ownership of beneficial interests in a Global
Note is and will be shown on, and the transfer of that ownership is and will be
effected only through, records maintained by DTC or its nominee (with respect to
interests of participants) and the records of participants (with respect to
interests of persons other than participants). Qualified institutional buyers
may hold their interests in a Global Note directly through DTC if they are
participants in such system, or indirectly through organizations which are
participants in such system.
Investors may hold their interests in Old Notes sold in reliance on
Regulation S under the Securities Act (each a "Regulation S Global Note")
directly through Cedel Bank ("Cedel Bank") or Morgan Guaranty Trust Company of
New York, Brussels office, as operator of the Euroclear System ("Euroclear"), if
they are participants in such systems, or indirectly through organizations that
are participants in such systems. Beginning 40 days after the Closing Date but
not earlier, investors may also hold such interests through organizations other
than Cedel Bank or Euroclear that are participants in the DTC system. Cedel Bank
and Euroclear will hold interests in the Regulation S Global Notes on behalf of
their participants through DTC.
So long as DTC, or its nominee, is the registered owner or holder of a
Global Note, DTC or such nominee, as the case may be, will be considered the
sole owner or holder of the Secured Notes represented by such Global Note for
all purposes under the Note Indenture and the Secured Notes. No beneficial owner
of an interest in a Global Note is or will be able to transfer that interest
except in accordance with applicable procedures of DTC, in addition to those
provided for under the Note Indenture and, if applicable, those of Euroclear and
Cedel Bank.
Payments of the principal of, and interest on, the Global Notes are and
will be made to DTC or its nominee, as the case may be, as the registered owner
thereof. Neither the Companies nor the Note Trustee or any paying agent has any
responsibility or liability for any aspect of the records relating to or
payments made on account of beneficial ownership interests in the Global Notes
or for maintaining, supervising or reviewing any records relating to such
beneficial ownership interests.
The Companies expect that DTC or its nominee, upon receipt of any payment
of principal or interest in respect of a Global Note, will credit participants'
accounts with payments in amounts proportionate to their respective beneficial
interests in the principal amount of such Global Note, as shown on the records
of DTC or its nominee. The Companies also expect that payments by participants
to owners of beneficial interests in such Global Note held through such
participants will be governed by standing instructions and customary practices,
as is now the case with securities held for the accounts of customers registered
in the names of nominees for such customers. Such payments will be the
responsibility of such participants.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in same-day funds. Transfers
between participants in Euroclear and Cedel Bank will be effected in the
ordinary way in accordance with their respective rules and operating procedures.
If a holder requires physical delivery of a Certificated Note for any reason,
such holder must transfer its interest in the Global Note in accordance with
DTC's applicable procedures and, if applicable, those of Euroclear and Cedel
Bank.
The Companies expect that DTC will take any action permitted to be taken by
a holder of Secured Notes (including the presentation of Secured Notes for
exchange as described below) only at the direction of one or more participants
to whose account the DTC interests in the Global Notes are credited and only in
respect of such portion of the aggregate principal amount of Secured Notes as to
which such participant or participants
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has or have given such direction. However, if there is an Event of Default under
the Secured Notes, DTC will exchange the applicable Global Note for Certificated
Notes which it will distribute to its participants and which may be legended as
set forth under "Transfer Restrictions."
The Companies understand that DTC is a limited-purpose trust company
organized under the laws of the State of New York, a "banking organization"
within the meaning of New York Banking Law, a member of the Federal Reserve
System, a "clearing corporation" within the meaning of the Uniform Commercial
Code and a "Clearing Agency" registered pursuant to the provisions of Section
17A of the Exchange Act. DTC was created to hold securities for its participants
and facilitate the clearance and settlement of securities transactions between
participants through electronic book-entry changes in accounts of its
participants, thereby eliminating the need for physical movement of
certificates, and certain other organizations. Indirect access to the DTC system
is available to others such as banks, brokers, dealers and trust companies that
clear through or maintain a custodial relationship with a participant, either
directly or indirectly ("indirect participants").
Although DTC, Euroclear and Cedel Bank are expected to follow the foregoing
procedures in order to facilitate transfers of interests in the Global Notes
among participants of DTC, Euroclear and Cedel Bank, they are under no
obligation to perform or continue to perform such procedures, and such
procedures may be discontinued at any time. Neither the Companies nor the Note
Trustee will have any responsibility for the performance by DTC, Euroclear or
Cedel Bank or their respective participants or indirect participants of their
respective obligations under the rules and procedures governing their
operations.
Certificated Notes
If DTC is at any time unwilling or unable to continue as a depository for
the Global Notes and a successor depository is not appointed by the Companies
within 90 days, the Companies will issue Certificated Notes in exchange for the
Global Notes. Holders of an interest in a Global Note may receive a Certificated
Note in accordance with DTC's rules and procedures in addition to those provided
for under the Note Indenture.
CREDIT ENHANCEMENT OF SECURED NOTES DUE 2007
PAYMENT PURSUANT TO FINANCIAL GUARANTY INSURANCE POLICY
At the closing of the issuance of the Old Notes, Ambac Assurance issued a
financial guaranty insurance policy relating to the Old Notes due 2007, and made
a commitment to issue an identical financial guaranty insurance policy relating
to the New Notes due 2007 ("Financial Guaranty Insurance Policy") effective as
of the date of issuance of the New Notes due 2007. Under the terms of the
Financial Guaranty Insurance Policy, Ambac Assurance will pay to the United
States Trust Company of New York, in New York, New York, or any successor
thereto ("Insurance Trustee") that portion of the principal of and interest on
the New Notes due 2007 which shall become Due for Payment but shall be unpaid by
reason of Nonpayment by the Issuer (as such terms are defined in the Financial
Guaranty Insurance Policy attached hereto as Appendix I). Ambac Assurance will
make such payments to the Insurance Trustee on the later of the date on which
such principal and interest become Due for Payment or within one business day
following the date on which Ambac Assurance shall have received notice of
Nonpayment from the Note Trustee. The insurance will extend for the term of the
New Notes due 2007 and, once issued, cannot be canceled by Ambac Assurance.
The Financial Guaranty Insurance Policy will insure payment only on stated
maturity dates. In the event of any acceleration of the principal of the New
Notes due 2007, the insured payments will be made at such times and in such
amounts as would have been made had there not been an acceleration.
In the event the Note Trustee has notice that any payment of principal of
or interest on a New Note due 2007 which has become Due for Payment and which is
made to a holder by or on behalf of the Companies has been deemed a preferential
transfer and theretofore recovered from its registered owner pursuant to the
United States Bankruptcy Code in accordance with a final, nonappealable order of
a court of competent jurisdiction,
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such registered owner will be entitled to payment from Ambac Assurance to the
extent of such recovery if sufficient funds are not otherwise available.
The Financial Guaranty Insurance Policy does not insure any risk other than
Nonpayment. Specifically, the Financial Guaranty Insurance Policy does not
cover:
1. Payment on acceleration, as a result of a call for redemption (other
than mandatory sinking fund redemption) or as a result of any other
advancement of maturity.
2. Payment of any redemption, prepayment or acceleration premium.
3. Nonpayment of principal or interest caused by the insolvency or
negligence of any trustee or paying agent, if any.
If it becomes necessary to call upon the Financial Guaranty Insurance Policy,
payment of principal requires the surrender of New Notes due 2007 to the
Insurance Trustee together with an appropriate instrument of assignment so as to
permit ownership of such New Notes due 2007 to be registered in the name of
Ambac Assurance to the extent of the payment under the Financial Guaranty
Insurance Policy. Payment of interest pursuant to the Financial Guaranty
Insurance Policy requires proof of holder entitlement to interest payments and
an appropriate assignment of the holders' right to payment to Ambac Assurance.
Upon payment of the insurance benefits, Ambac Assurance will become the
owner of the New Notes due 2007, appurtenant coupons, if any, or right to
payment of principal or interest on such New Notes due 2007 and will be fully
subrogated to the surrendering holder's right to payment.
AMBAC ASSURANCE CORPORATION
The information provided in this section and the following two sections was
provided to the Companies by Ambac Assurance.
Ambac Assurance is a Wisconsin-domiciled stock insurance corporation
regulated by the Office of the Commissioner of Insurance of the State of
Wisconsin and licensed to do business in 50 states, the District of Columbia,
the Territory of Guam, and the Commonwealth of Puerto Rico, with admitted assets
of approximately $2,736,000,000 (unaudited) and statutory capital of
approximately $1,548,000,000 (unaudited) as of June 30, 1997. Statutory capital
consists of Ambac Assurance's policyholders' surplus and statutory contingency
reserve. Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group,
Inc., a 100% publicly held company. Standard & Poor's, Moody's and Fitch
Investors Service, L.P. have each assigned a triple-A claims-paying ability
rating to Ambac Assurance.
Ambac Assurance has obtained a ruling from the Internal Revenue Service to
the effect that the insuring of an obligation by Ambac Assurance will not affect
the treatment for federal income tax purposes of interest on such obligation and
that insurance proceeds representing maturing interest paid by Ambac Assurance
under policy provisions substantially identical to those contained in its
Financial Guaranty Insurance Policy shall be treated for federal income tax
purposes in the same manner as if such payments were made by the issuer of the
obligation.
Ambac Assurance makes no representation regarding the New Notes due 2007 or
the advisability of investing in the New Notes due 2007 and makes no
representation regarding, nor has it participated in the preparation of, this
Prospectus other than the information supplied by Ambac Assurance and presented
under the heading "Credit Enhancement of Secured Notes due 2007."
AVAILABLE INFORMATION
The parent company of Ambac Assurance, Ambac Financial Group, Inc. ("Ambac
Financial"), is subject to the informational requirements of the Exchange Act,
and in accordance therewith files reports, proxy statements and other
information with the SEC. Such reports, proxy statements and other information
may be inspected and copied at the public reference facilities maintained by the
SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's regional
offices at 7 World Trade Center, New York, New York 10048, and Northwestern
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
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Copies of such material can be obtained from the public reference section of the
SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The
SEC also maintains a Web site that contains reports and other information filed
by Ambac Financial. The SEC's Internet address is http://www.sec.gov. In
addition, the aforementioned material may also be inspected at the offices of
the New York Stock Exchange, Inc. ("NYSE") at 20 Broad Street, New York, New
York 10005. Ambac Financial's Common Stock is listed on the NYSE.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by Ambac Financial with the SEC (File No.
1-10777) are incorporated by reference in this Prospectus.
1. Ambac Financial's Annual Report on Form 10-K for the fiscal year ended
December 31, 1996, filed on March 31, 1997;
2. Ambac Financial's Current Report on Form 8-K dated March 12, 1997,
filed on March 12, 1997;
3. Ambac Financial's Quarterly Report on Form 10-Q for the fiscal
quarterly period ended March 31, 1997, filed on May 15, 1997;
4. Ambac Financial's Quarterly Report on Form 10-Q for the fiscal
quarterly period ended June 30, 1997, filed on August 14, 1997.
All documents subsequently filed by Ambac Financial pursuant to the
requirements of the Exchange Act after the date of this Prospectus will be
available for inspection in the same manner as described above in "Available
Information."
Ambac Assurance has issued a commitment for financial guaranty insurance
relating to the New Notes due 2007. All tenders of the Secured Notes due 2007
may be conditioned upon the issuance effective as of the date on which the
Secured Notes due 2007 are issued, of a policy of insurance by Ambac Assurance,
insuring the payment when due of principal of and interest on the Secured Notes
due 2007. Each Secured Note due 2007 will bear a legend referring to the
insurance. The purchaser, holder or owner is not authorized to make any
statements concerning the insurance beyond those set out here and in the legend
on the Secured Notes due 2007 without the approval of Ambac Assurance.
DESCRIPTIONS OF CLEVELAND ELECTRIC BONDS AND
TOLEDO EDISON BONDS
The Old Notes are, and the New Notes, together with any Old Notes that
remain outstanding after the Exchange Offer is terminated, will be, secured
equally and ratably as to payment of principal and interest by the Cleveland
Electric Bonds and the Toledo Edison Bonds which were issued, pledged and
delivered by Cleveland Electric and Toledo Edison, respectively, to the Note
Trustee. The Cleveland Electric Bonds and the Toledo Edison Bonds were issued in
the aggregate principal amounts of $575 million and $145 million, respectively.
The Cleveland Electric Bonds and Toledo Edison Bonds held by the Note Trustee
provide, in the aggregate, for interest in an amount equal to the interest
payable on all Secured Notes outstanding. Satisfaction of Cleveland Electric's
and Toledo Edison's obligations with respect to principal of, and interest on,
the Secured Notes will satisfy the respective Company's obligations with respect
to principal of, and interest on, its Bonds.
CLEVELAND ELECTRIC BONDS
General
The Cleveland Electric Bonds were issued as three series of Cleveland
Electric's First Mortgage Bonds ("CEI First Mortgage Bonds") under Cleveland
Electric's Mortgage and Deed of Trust, dated July 1, 1940, from Cleveland
Electric to Guaranty Trust Company of New York as trustee, under which The Chase
Manhattan Bank is successor trustee ("CEI First Mortgage Trustee"), as
supplemented and modified by
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seventy-three supplemental indentures thereto and as further supplemented, for
the issuance of the Cleveland Electric Bonds, by a Seventy-Fourth Supplemental
Indenture ("Seventy-Fourth Supplemental Indenture") dated June 15, 1997 (the
Mortgage and Deed of Trust as so supplemented herein called the "CEI First
Mortgage"). The following summaries of certain provisions of the CEI First
Mortgage do not purport to be complete and are subject to, and qualified in
their entirety by, all of the provisions of the CEI First Mortgage. For a
discussion of the effect on the CEI First Mortgage of the proposed merger of
Toledo Edison into Cleveland Electric, see "Pending Merger of Cleveland Electric
and Toledo Edison -- Effect of Pending Merger on CEI First Mortgage and TE First
Mortgage." The Articles cited below refer to Articles of the CEI First Mortgage.
Security
The Cleveland Electric Bonds and all CEI First Mortgage Bonds of other
series currently outstanding and hereafter issued under the CEI First Mortgage
are, in the opinion of counsel for Cleveland Electric, secured equally and
ratably (except as to any sinking or analogous fund established for the CEI
First Mortgage Bonds of any particular series) by a valid and perfected first
lien, subject only to certain permitted liens and other encumbrances, on
substantially all the property owned and franchises held by Cleveland Electric,
except the following: (a) cash, receivables and contracts not pledged or
required to be pledged under the CEI First Mortgage and leases in which
Cleveland Electric is lessor; (b) securities not specifically pledged or
required to be pledged under the CEI First Mortgage; (c) property held for
consumption in operation or in advance of use for fixed capital purposes or for
resale or lease to customers; (d) electric energy and other materials or
products produced or purchased by Cleveland Electric for sale, distribution or
use in the ordinary conduct of its business; and (e) all the property of any
other corporation which may now or hereafter be wholly or substantially wholly
owned by Cleveland Electric. (Clauses preceding Article I) All property acquired
by Cleveland Electric after June 30, 1940, other than the property excepted from
the lien of the CEI First Mortgage, becomes subject to the lien thereof upon
acquisition. (Article I and granting and other clauses preceding Article I)
Under certain conditions, the CEI First Mortgage permits Cleveland Electric to
acquire property subject to a lien prior to the lien of the CEI First Mortgage.
(Article IV)
Property subject to the lien of the CEI First Mortgage will be released
from the lien upon the sale or transfer of such property if Cleveland Electric
deposits the fair value of the property with the CEI First Mortgage Trustee and
meets certain other conditions specified in the CEI First Mortgage. (Article
VII) Moneys received by the CEI First Mortgage Trustee for the release of
property will, under certain circumstances, be applied to redeem outstanding CEI
First Mortgage Bonds, be applied to satisfy other obligations of Cleveland
Electric or be paid over to Cleveland Electric from time to time based upon
property additions or refundable CEI First Mortgage Bonds. (Article VIII)
In the Nineteenth Supplemental Indenture, the CEI First Mortgage was
modified to permit Cleveland Electric without the vote or consent of the holders
of any CEI First Mortgage Bonds issued after November 1976 (a) to exclude
nuclear fuel from the lien of the CEI First Mortgage to the extent not excluded
therefrom by its existing provisions and (b) to revise the definition of
property additions which can constitute bondable property to include facilities
outside the State of Ohio ("State") even though they are not physically
connected with property of Cleveland Electric in the State and to clarify its
general scope.
Title to Property
The generating plants and other principal facilities of Cleveland Electric
are owned by Cleveland Electric, except as follows:
(a) Cleveland Electric and Toledo Edison jointly lease from others for
a term of about 29 1/2 years starting on October 1, 1987 undivided 6.5%,
45.9% and 44.38% tenant-in-common interests in Units 1, 2 and 3,
respectively, of the Mansfield Plant and also jointly lease from others for
the same term an 18.26% undivided tenant-in-common interest in Beaver
Valley Unit 2, all located in Shippingport, Pennsylvania. Cleveland
Electric owns another 24.47% interest in Beaver Valley Unit 2 as a
tenant-in-common.
(b) Most of the Lake Shore facilities are situated on artificially
filled land, extending beyond the natural shoreline of Lake Erie as it
existed in 1910. As of December 31, 1996, the cost of Cleveland
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Electric's facilities, other than water intake and discharge facilities,
located on such artificially filed land aggregated $97,081,000.
Title to land under the water of Lake Erie within the territorial
limits of the State (including artificially filled land) is in the State in
trust for the people of the State for the public uses to which it may be
adapted, subject to the powers of the United States, the public rights of
navigation, water commerce and fishery and the rights of upland owners to
wharf out or fill to make use of the water. The State is required by
statute, after appropriate proceedings, to grant a lease to an upland
owner, such as Cleveland Electric, which erected and maintained facilities
on such filled land prior to October 13, 1955. Cleveland Electric does not
have such a lease from the State with respect to the artificially filled
land on which its Lake Shore facilities are located, but Cleveland
Electric's position, on advice of counsel for Cleveland Electric, is that
the Lake Shore facilities and occupancy may not be disturbed because they
do not interfere with the free flow of commerce in navigable channels and
also constitute, at least in part, and are on land filled pursuant to, the
exercise by it of its property rights as owner of the land above the
shoreline adjacent to the filled land. Cleveland Electric does hold
permits, under federal statutes relating to navigation, to occupy such
artificially filled land.
(c) The facilities at the pumped-storage hydroelectric Seneca Power
Plant in Pennsylvania ("Seneca") are located on land owned by the United
States and occupied by Cleveland Electric and Pennsylvania Electric Company
pursuant to a license issued by the Federal Energy Regulatory Commission
for a 50-year period starting December 1, 1965 for the construction,
operation and maintenance of a pumped-storage hydroelectric plant.
(d) The water intake and discharge facilities at the electric
generating plants located along Lake Erie and the Ohio River are extended
into the lake and river under Cleveland Electric's property rights as owner
of the land above the water line and pursuant to permits under federal
statutes relating to navigation.
(e) The transmission system is located on land, easements or
rights-of-way owned by Cleveland Electric. The distribution system also is
located, in part, on land owned by Cleveland Electric, but, for the most
part, it is located on lands owned by others and on streets and highways.
In most cases, Cleveland Electric has obtained permission from the apparent
owner, or, if located on streets and highways, from the apparent owner of
the abutting property. The electric underground transmission and
distribution systems are located for the most part in public streets. The
Pennsylvania portions of the main transmission lines from Seneca, the
Mansfield Plant and Beaver Valley Unit 2 are not owned by Cleveland
Electric.
The fee title which Cleveland Electric has as a tenant-in-common owner, and
the leasehold interests it has as a joint lessee, of certain generating units do
not include the right to require a partition or sale for division of proceeds of
the units without the concurrence of all the other owners and their respective
mortgage trustees and the CEI First Mortgage Trustee.
Issuance of Additional CEI First Mortgage Bonds
In addition to the $3,230.0 million aggregate principal amount of CEI First
Mortgage Bonds outstanding at June 30, 1997 (which includes $140.4 million
principal amount of CEI First Mortgage Bonds pledged to secure Cleveland
Electric's obligations to various bank creditors), additional CEI First Mortgage
Bonds may be issued under Article III of the CEI First Mortgage, ranking equally
and ratably with such outstanding CEI First Mortgage Bonds and the Cleveland
Electric Bonds and without limit as to amount, on the basis of: (a) 70% of
bondable property (as described under "-- Cleveland Electric Bonds -- Security")
not previously used as the basis for issuance of CEI First Mortgage Bonds or
applied for some other purpose under the CEI First Mortgage; (b) the deposit of
cash (which may be withdrawn thereafter on the basis of bondable property or
refundable CEI First Mortgage Bonds); and (c) substitution for refundable CEI
First Mortgage Bonds. CEI First Mortgage Bonds become refundable CEI First
Mortgage Bonds when they are paid upon maturity, redemption or purchase out of
money deposited with the CEI First Mortgage Trustee for such payment or when
money for such payment is irrevocably deposited with the CEI First Mortgage
Trustee. (Articles I, III and VIII) In general, all property subject to the lien
of the CEI First Mortgage which is used or useful in
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Cleveland Electric's electric business (including property not located in the
State if it is physically connected with property of Cleveland Electric in the
State, either directly or through other property of Cleveland Electric), which
is not subject to an unfunded prior lien and as to which Cleveland Electric has
good title and corporate power to own and operate, is bondable property and as
such is available as a basis for the issuance of CEI First Mortgage Bonds.
(Article I) The facilities of Cleveland Electric on the artificially filled land
at Lake Shore will become bondable property only when Cleveland Electric
acquires, under conditions specified in the CEI First Mortgage, either good
title to such land or the right to occupy it; and the facilities of Cleveland
Electric on the land at Seneca are not now bondable property. See "-- Cleveland
Electric Bonds -- Title to Property." The tenant-in-common interests owned by
Cleveland Electric in certain generating units qualify as bondable property,
except that its interest in property located in Pennsylvania, including Beaver
Valley Unit 2, does not qualify because it is located outside the State and is
not physically connected with property of Cleveland Electric in the State.
(Article I) With certain exceptions, property which Cleveland Electric leases
from others is not bondable property. (Articles I and III)
Also, with certain exceptions, in order to issue additional CEI First
Mortgage Bonds based on bondable property, net earnings of Cleveland Electric
available for interest and property retirement appropriations for any 12
consecutive months within the 15 calendar months immediately preceding the month
in which application for authentication and delivery of such additional CEI
First Mortgage Bonds is made must be at least twice the annual interest charges
on all CEI First Mortgage Bonds outstanding and on the issue applied for.
(Article III)
At June 30, 1997, Cleveland Electric was not able to issue a material
amount of additional CEI First Mortgage Bonds except in connection with
refinancings. The amount of additional CEI First Mortgage Bonds which may be
issued in the future will fluctuate depending upon the amount of available
refundable CEI First Mortgage Bonds, available bondable property, earnings and
interest rates. FirstEnergy has not decided whether to apply, or push down, the
effects of purchase accounting to the financial statements of the Companies if
the CEC-OE Merger is completed. If such push-down accounting is applied,
Cleveland Electric's available bondable property would be reduced to below zero.
See "The Companies -- Financing Capability."
Covenant to Charge Earnings Not Applicable to the Cleveland Electric Bonds
The supplemental indentures applicable to CEI First Mortgage Bonds issued
prior to 1974 contain a covenant to the effect that, so long as any of those CEI
First Mortgage Bonds remain outstanding (which will be until November 15, 2005,
assuming no prior redemption), Cleveland Electric will charge against earnings,
and credit to reserves for depreciation and retirement of property, an amount
not less than 15% of gross operating revenues for each year (after deducting the
costs of purchased power and net electric energy received on interchange), less
the amounts expended for maintenance and repairs during the year. The
Seventy-Fourth Supplemental Indenture does not extend such covenant to the
Cleveland Electric Bonds.
Remedies in the Event of Default
Events of default under the CEI First Mortgage include the failure of
Cleveland Electric (a) to pay the principal of or premium, if any, on any CEI
First Mortgage Bond when due; (b) to pay any interest on or sinking fund
obligation of any CEI First Mortgage Bond within 30 days after it is due; (c) to
pay the principal of or interest on any prior lien bonds within any allowable
period; (d) to discharge, appeal or obtain the stay of any final judgment
against Cleveland Electric in excess of $100,000 within 30 days after it is
rendered; or (e) to perform any other covenant in the CEI First Mortgage within
60 days after notice to Cleveland Electric from the CEI First Mortgage Trustee
or the holders of not less than 15% in principal amount of the CEI First
Mortgage Bonds. Events of default also include certain events of bankruptcy,
insolvency or reorganization in bankruptcy or insolvency of Cleveland Electric.
(Article IX) Cleveland Electric is required to furnish periodically to the CEI
First Mortgage Trustee a certificate as to the absence of any default or as to
compliance with the terms of the CEI First Mortgage, and such a certificate is
also required in connection with the issuance of any additional CEI First
Mortgage Bonds and in certain other circumstances. (Article III) The CEI First
Mortgage provides that the CEI First Mortgage Trustee, within 90 days after
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notice of defaults under the CEI First Mortgage (60 days with respect to events
of default described in (e) above), is required to give notice of such defaults
to all holders of CEI First Mortgage Bonds, but, except in the case of a default
resulting from the failure to make any payment of principal of or interest on
the CEI First Mortgage Bonds or in the payment of any sinking or purchase fund
installments, the CEI First Mortgage Trustee may withhold such notice if it
determines in good faith that it is in the best interests of the holders of the
CEI First Mortgage Bonds to do so. (Article XIII)
Upon the occurrence of any event of default, the CEI First Mortgage Trustee
or the holders of not less than 25% in principal amount of the CEI First
Mortgage Bonds may declare the principal amount of all CEI First Mortgage Bonds
due, and, if Cleveland Electric cures all defaults before a sale of the
mortgaged property, the holders of a majority in principal amount of the CEI
First Mortgage Bonds may waive the default. If any event of default occurs, the
CEI First Mortgage Trustee also may (a) take possession of and operate the
mortgaged property for the purpose of paying the principal of and interest on
the CEI First Mortgage Bonds; (b) sell at public auction all of the mortgaged
property, or such parts thereof as the holders of a majority in principal amount
of the CEI First Mortgage Bonds may request or, in the absence of such request,
as the CEI First Mortgage Trustee may determine; (c) bring suit to enforce
payment of the principal of and interest on the CEI First Mortgage Bonds, to
foreclose the CEI First Mortgage or for the appointment of a receiver of the
mortgaged property; and (d) pursue any other remedy. (Article IX)
No holder of CEI First Mortgage Bonds may institute any action, suit or
proceeding for any remedy under the CEI First Mortgage unless he has previously
given the CEI First Mortgage Trustee written notice of a default by Cleveland
Electric, and in addition: (a) the holders of not less than 25% in principal
amount of the CEI First Mortgage Bonds have requested the CEI First Mortgage
Trustee and afforded it a reasonable opportunity to exercise its powers under
the CEI First Mortgage or to institute such action, suit or proceeding in its
own name; (b) such holder has offered to the CEI First Mortgage Trustee security
and indemnity satisfactory to it against the costs, expenses and liabilities to
be incurred thereby; and (c) the CEI First Mortgage Trustee has refused or
neglected to comply with such request within a reasonable time. The holders of a
majority in outstanding principal amount of the CEI First Mortgage Bonds, upon
furnishing the CEI First Mortgage Trustee with security and indemnification
satisfactory to it, may require the CEI First Mortgage Trustee to pursue any
available remedy, and any holder of the CEI First Mortgage Bonds has the
absolute and unconditional right to enforce the payment of the principal of and
interest on his CEI First Mortgage Bonds. (Article IX)
Modification of CEI First Mortgage and CEI First Mortgage Bonds
Certain modifications which do not in any manner impair any of the rights
of the holders of any series of CEI First Mortgage Bonds then outstanding or of
the CEI First Mortgage Trustee may be made without the vote of the holders of
the CEI First Mortgage Bonds by supplemental indenture entered into between
Cleveland Electric and the CEI First Mortgage Trustee. (Article XIV)
Modifications of the CEI First Mortgage or any indenture supplemental
thereto, and of the rights and obligations of Cleveland Electric and of holders
of all series of CEI First Mortgage Bonds outstanding, may be made with the
consent of Cleveland Electric by the vote of the holders of at least 80% in
principal amount of the outstanding CEI First Mortgage Bonds entitled to vote at
a meeting of the holders of the CEI First Mortgage Bonds or, if one or more, but
less than all, of the series of CEI First Mortgage Bonds outstanding under the
CEI First Mortgage are affected by any such modification, by the vote of the
holders of at least 80% in principal amount of the outstanding CEI First
Mortgage Bonds entitled to vote of each series so affected; but no such
modification may be made which will affect the terms of payment of the principal
of or premium, if any, or interest on any CEI First Mortgage Bond issued under
the CEI First Mortgage or to change the voting percentage described above to
less than 80% with respect to any CEI First Mortgage Bonds outstanding when such
modification becomes effective. CEI First Mortgage Bonds owned or held by or for
the account or benefit of Cleveland Electric or an affiliate of Cleveland
Electric (as defined in the CEI First Mortgage) are not entitled to vote.
(Article XV) In the Nineteenth Supplemental Indenture, the CEI First Mortgage
was modified, effective when none of the CEI First Mortgage Bonds of any series
issued prior to December 1976 are outstanding, so as to change the 80% voting
requirements discussed above to 60%. Based on the series of
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CEI First Mortgage Bonds outstanding at June 30, 1997, the 60% voting
requirement will become effective on May 1, 2009.
Defeasance and Discharge
The CEI First Mortgage provides that Cleveland Electric will be discharged
from any and all obligations under the CEI First Mortgage if Cleveland Electric
pays the principal, interest and premium, if any, due on all CEI First Mortgage
Bonds outstanding in accordance with the terms stipulated in each such Bond and
if Cleveland Electric has performed all other obligations under the CEI First
Mortgage. In the event of such discharge, Cleveland Electric has agreed to
continue to indemnify the CEI First Mortgage Trustee from any liability arising
out of the CEI First Mortgage. (Article XVI)
TOLEDO EDISON BONDS
General
The Toledo Edison Bonds were issued as three series of Toledo Edison's
First Mortgage Bonds ("TE First Mortgage Bonds") under Toledo Edison's Indenture
and Deed of Trust, dated as of April 1, 1947, from Toledo Edison to The Chase
National Bank of the City of New York (predecessor of The Chase Manhattan Bank),
as trustee ("TE First Mortgage Trustee"), as supplemented and modified by
forty-five supplemental indentures thereto and as further supplemented, for the
issuance of the Toledo Edison Bonds, by a Forty-sixth Supplemental Indenture
("Forty-sixth Supplemental Indenture") dated as of June 15, 1997 (the Indenture
and Deed of Trust as so supplemented herein called the "TE First Mortgage"). The
following summaries of certain provisions of the TE First Mortgage do not
purport to be complete and are subject to, and qualified in their entirety by,
all of the provisions of the TE First Mortgage. For a discussion of the effect
on the TE First Mortgage of the proposed merger of Toledo Edison into Cleveland
Electric, see "Pending Merger of Cleveland Electric and Toledo Edison -- Effect
of Pending Merger on CEI First Mortgage and TE First Mortgage." The Articles
cited below refer to Articles of the TE First Mortgage.
Security
The Toledo Edison Bonds and all TE First Mortgage Bonds of other series
currently outstanding and hereafter issued under the TE First Mortgage are, in
the opinion of counsel for Toledo Edison, secured equally and ratably (except as
to any sinking or analogous fund established for the TE First Mortgage Bonds of
any particular series) by a valid and perfected first lien, subject only to
certain permitted encumbrances, on substantially all the property owned and
franchises held by Toledo Edison, except the following: (a) cash, receivables,
contracts and leases in which Toledo Edison is lessor; (b) securities not
specifically pledged or required to be pledged under the TE First Mortgage; (c)
property held for sale or lease to customers or consumable in Toledo Edison's
operations; (d) transportation equipment; and (e) certain parcels of real estate
held for disposition. All property acquired by Toledo Edison after April 1, 1947
of the character initially subjected to the lien of the TE First Mortgage
becomes subject to the lien of the TE First Mortgage upon acquisition. (Granting
and other clauses preceding Article 1) Under certain conditions, the TE First
Mortgage permits Toledo Edison to acquire property subject to a lien prior to
the lien of the TE First Mortgage. (Article 4)
The TE First Mortgage provides that property subject to the lien of the TE
First Mortgage may be released from such lien under certain circumstances. The
following will be automatically released upon disposition by Toledo Edison: (a)
equipment which has become unnecessary for use; (b) property which has been
abandoned and the operation of which has become discontinued; (c) rights under
any leases, rights-of-way, contracts, franchises, licenses, authority or permit;
(d) real estate used solely for right-of-way if an easement over such real
estate is retained; and (e) real estate, the value of which together with the
value of all other real estate released in this manner within the preceding
twelve months does not exceed $25,000. Other property will be released upon
disposition by Toledo Edison subject to Toledo Edison's presentation to the TE
First Mortgage Trustee of documentation that the value received for the property
equals or exceeds the fair value of such property and that all conditions
contained in the TE First Mortgage relating to the release of property have been
complied with. Proceeds of the sale of any property subject to the lien of the
TE First
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Mortgage must be deposited with the TE First Mortgage Trustee and may be
withdrawn by Toledo Edison based upon property additions or refundable TE First
Mortgage Bonds, may be applied to the redemption of outstanding TE First
Mortgage Bonds or may be applied to pay federal or state taxes incurred by
Toledo Edison as a result of such sale. (Article 8)
Title to Property
The generating plants and other principal facilities of Toledo Edison are
owned by Toledo Edison, except as follows:
(a) Toledo Edison and Cleveland Electric lease from others for a term
of about 29 1/2 years starting on October 1, 1987 undivided 6.5%, 45.9% and
44.38% tenant-in-common interests in Units 1, 2 and 3, respectively, of the
Mansfield Plant and also jointly lease from others for the same term an
18.26% undivided tenant-in-common interest in Beaver Valley Unit 2, all
located in Shippingport, Pennsylvania. Toledo Edison owns about another
1.65% interest in Beaver Valley Unit 2 as a tenant-in-common.
(b) The water intake and discharge facilities at the generating plants
located along Lake Erie and the Maumee and Ohio Rivers are extended into
the lake and rivers under Toledo Edison's property rights as owner of the
land above the water line and pursuant to permits under federal statutes
relating to navigation.
(c) The transmission system is located on land, easements or
rights-of-way owned by Toledo Edison. The distribution system also is
located, in part, on land owned by Toledo Edison, but, for the most part,
it is located on lands owned by others and on streets and highways. In most
cases, Toledo Edison has obtained permission from the apparent owner or, if
located on streets and highways, from the apparent owner of the property.
The Pennsylvania portions of the main transmission lines from the Mansfield
Plant and Beaver Valley Unit 2 are not owned by Toledo Edison.
The fee title which Toledo Edison has as a tenant-in-common owner, and the
leasehold interests it has as a joint lessee, of certain generating units do not
include the right to require a partition or sale for division of proceeds of the
units without the concurrence of all the other owners and their respective
mortgage trustees and the TE First Mortgage Trustee.
Issuance of Additional TE First Mortgage Bonds
In addition to the $1,262.2 million aggregate principal amount of TE First
Mortgage Bonds outstanding at June 30, 1997 (which includes $210.6 million
principal amount of TE First Mortgage Bonds pledged to secure Toledo Edison's
obligations to various bank creditors), additional TE First Mortgage Bonds may
be issued under Article 3 of the TE First Mortgage, ranking equally and ratably
with such outstanding TE First Mortgage Bonds and the Toledo Edison Bonds and
without limit as to amount, on the basis of: (a) 60% of property additions not
previously used as the basis for issuance of TE First Mortgage Bonds or applied
for some other purpose under the TE First Mortgage; (b) the deposit of cash
(which may be withdrawn thereafter on the basis of property additions not
previously so used or refundable TE First Mortgage Bonds); and (c) substitution
for refundable TE First Mortgage Bonds. In general, all property subject to the
lien of the TE First Mortgage acquired by Toledo Edison after April 1, 1947
which is used or useful in Toledo Edison's electric business and located within
the State or any state adjacent thereto, which is not subject to the lien of any
outstanding prior lien bonds and as to which Toledo Edison has good title and
corporate power and governmental permission to own and operate constitutes
property additions and as such is available as a basis for the issuance of TE
First Mortgage Bonds. The tenant-in-common ownership interests of Toledo Edison
in certain generating units qualify as property additions. Property which Toledo
Edison leases from others does not qualify as property additions. With certain
exceptions, TE First Mortgage Bonds become refundable TE First Mortgage Bonds
when they are paid upon maturity, redemption or purchase out of money deposited
with the TE First Mortgage Trustee for such payment or when money for such
payment is irrevocably deposited with the TE First Mortgage Trustee. (Articles
1, 3 and 8)
Also, with certain exceptions, in order to issue additional TE First
Mortgage Bonds based on property additions, net earnings of Toledo Edison
available for interest for any 12 consecutive months within the 15 calendar
months immediately preceding the month in which application for authentication
and delivery of
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such additional TE First Mortgage Bonds is made must be at least twice the
annual interest charges on all TE First Mortgage Bonds outstanding and on the
issue applied for. (Article 3)
At June 30, 1997, Toledo Edison was not be able to issue a material amount
of additional TE First Mortgage Bonds except in connection with refinancings.
The amount of additional TE First Mortgage Bonds which may be issued in the
future will fluctuate depending upon the amount of available refundable TE First
Mortgage Bonds, property additions, earnings and interest rates. FirstEnergy has
not decided whether to apply, or push down, the effects of purchase accounting
to the financial statements of the Companies if the CEC-OE Merger is completed.
If such push-down accounting is applied, Toledo Edison's available bondable
property would be reduced to below zero. See "The Companies -- Financing
Capability."
Covenants to Pay into Maintenance and Replacement Fund and
Limiting Dividends Not Applicable to the Toledo Edison Bonds
The supplemental indentures relating to the TE First Mortgage Bonds issued
prior to October 15, 1987 contain the Maintenance and Replacement Fund and
Limitation on Dividends covenants described in the next two paragraphs. Those
covenants will continue in effect so long as any of those TE First Mortgage
Bonds remain outstanding (which will be until November 1, 2003, assuming no
prior redemption). The Forty-sixth Supplemental Indenture does not extend those
covenants to the Toledo Edison Bonds.
MAINTENANCE AND REPLACEMENT FUND. Under this covenant, Toledo Edison is
required to pay to the TE First Mortgage Trustee by May 1, annually, as a
Maintenance and Replacement Fund, an amount, called the Standard of Expenditure,
not less than 15% of gross electric operating revenues derived from the
mortgaged property during the prior calendar year after deducting the cost of
purchased power and net operating rentals paid. Toledo Edison may reduce this
payment by: (a) the amount of any expenditure during the prior year for repairs
and maintenance of the mortgaged property; (b) the cost of property additions
(with certain adjustments) acquired during the prior year equal to property
retirements during the prior year; (c) the principal amount of any TE First
Mortgage Bonds which have been retired and not used for any other purpose under
the TE First Mortgage; (d) the amount of any net property additions which might
otherwise be made the basis for the issuance of TE First Mortgage Bonds; and (e)
the principal amount of any TE First Mortgage Bonds delivered to the TE First
Mortgage Trustee for that purpose. Toledo Edison has been satisfying this
requirement by taking credits as described in clauses (a), (b) and (d) above.
Toledo Edison may elect to have any cash at any time remaining in the
Maintenance and Replacement Fund used, among other things, to purchase TE First
Mortgage Bonds at a price not in excess of the redemption price or to redeem
redeemable TE First Mortgage Bonds or to be paid to Toledo Edison against
funding of property additions not previously applied for any purpose under the
TE First Mortgage or against delivery of TE First Mortgage Bonds. (TE First
Mortgage Section 4.10 and Article IV of the First through Thirtieth Supplemental
Indentures)
LIMITATION ON DIVIDENDS. Under this covenant, Toledo Edison is prohibited
from declaring dividends, other than stock dividends, on common stock and from
making other distributions on or acquisitions of common stock, except out of
retained earnings accumulated after March 31, 1947, determined on the basis of
including in operating expenses for each year an aggregate amount for repairs,
maintenance and depreciation equal to the Standard of Expenditure for such year.
(TE First Mortgage Section 4.11 and Article IV of the First through Thirtieth
Supplemental Indentures)
Remedies in the Event of Default
Defaults under the TE First Mortgage include the failure of Toledo Edison:
(a) to pay the principal of or premium, if any, on any TE First Mortgage Bonds
when due; (b) to pay any interest on or sinking fund obligation of any TE First
Mortgage Bond within 60 days after it is due; (c) to pay the principal of or
interest on any prior lien bonds within any allowable period; or (d) to perform
any other covenant in the TE First Mortgage within 90 days after notice to
Toledo Edison from the TE First Mortgage Trustee or the holders of not less than
10% in principal amount of the TE First Mortgage Bonds. Defaults also include
certain events of bankruptcy, insolvency or reorganization in bankruptcy or
insolvency of Toledo Edison. The TE First Mortgage provides that the TE First
Mortgage Trustee, within 90 days after the occurrence of a default under
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the TE First Mortgage, is required to give the holders of the TE First Mortgage
Bonds notice of such default, unless cured or waived, but, except in the case of
default in the payment of principal of, or premium, if any, or interest on any
TE First Mortgage Bonds, the TE First Mortgage Trustee may withhold such notice
if it determines that it is in the interest of such holders to do so. (Article
9) A certificate regarding compliance with certain provisions of the TE First
Mortgage must be furnished to the TE First Mortgage Trustee annually. (Article 3
and Section 4.22)
If and so long as any default exists, the TE First Mortgage Trustee or the
holders of not less than 25% in principal amount of the TE First Mortgage Bonds
outstanding may declare the principal amount of all TE First Mortgage Bonds due,
and, if Toledo Edison cures all defaults before a sale of the mortgaged
property, the holders of a majority in principal amount of the TE First Mortgage
Bonds may waive the default. In certain circumstances, such a waiver occurs
automatically upon the curing of all defaults. If any default occurs, the TE
First Mortgage Trustee also may: (a) take possession of and operate the
mortgaged property for the purpose of paying the principal of and interest on
the TE First Mortgage Bonds; (b) sell at public auction all of the mortgaged
property or such parts as the TE First Mortgage Trustee may determine; (c) bring
suit to enforce its rights and the rights of the holders of the TE First
Mortgage Bonds to foreclose the TE First Mortgage or to appoint a receiver of
the mortgaged property; and (d) pursue any other remedy. (Article 9)
No holder of TE First Mortgage Bonds may institute any action, suit or
proceeding for any remedy under the TE First Mortgage unless he has previously
given the TE First Mortgage Trustee written notice of a default by Toledo Edison
and, in addition: (a) the holders of not less than a majority in principal
amount of the TE First Mortgage Bonds have requested the TE First Mortgage
Trustee in writing to act; (b) such holder has offered to the TE First Mortgage
Trustee security and indemnity satisfactory to it against the costs, expenses
and liabilities to be incurred thereby, without negligence or bad faith; and (c)
the TE First Mortgage Trustee has refused or neglected to comply with such
request within 60 days. The holders of a majority in principal amount of the TE
First Mortgage Bonds may require the TE First Mortgage Trustee to pursue any
available remedy, upon furnishing the TE First Mortgage Trustee with
indemnification satisfactory to it, if requested by the TE First Mortgage
Trustee, and any holder of the TE First Mortgage Bonds has the absolute and
unconditional right to enforce the payment of the principal of and interest on
his TE First Mortgage Bonds. (Article 9)
Modification of TE First Mortgage and TE First Mortgage Bonds
Certain modifications, which modifications do not in any manner impair any
of the rights of the holders of any series of TE First Mortgage Bonds or of the
TE First Mortgage Trustee, may be made without the vote of the holders of the TE
First Mortgage Bonds by supplemental indenture entered into between Toledo
Edison and the TE First Mortgage Trustee. (Article 14)
Modifications of the TE First Mortgage or any indenture supplemental
thereto, and of the rights and obligations of Toledo Edison and of holders of
all series of TE First Mortgage Bonds outstanding, may be made by the vote of
the holders of at least 75% in principal amount of the outstanding TE First
Mortgage Bonds entitled to vote at a meeting of the holders of the TE First
Mortgage Bonds or, if one or more, but less than all, of the series of
outstanding TE First Mortgage Bonds are affected by any such modification, by
the vote of the holders of at least 75% in principal amount of the outstanding
TE First Mortgage Bonds entitled to vote of any series so affected; but no such
modification may be made, without the consent of the holder of each TE First
Mortgage Bond affected, which will affect the terms of payment of the principal
of or premium, if any, or interest on any TE First Mortgage Bond (except changes
in any sinking fund), which will create any lien prior or equal to or deprive
any such holder of the benefit of the lien of the TE First Mortgage or which
will change the voting percentage described above to less than 75% with respect
to any TE First Mortgage Bonds outstanding when such modification becomes
effective. TE First Mortgage Bonds owned by Toledo Edison, any other obligor
thereon or an affiliate of Toledo Edison are not entitled to vote. (Article 15)
Defeasance and Discharge
The TE First Mortgage provides that Toledo Edison will be discharged from
any and all obligations under the TE First Mortgage if Toledo Edison pays the
principal of and interest and premium, if any, due and
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payable on all TE First Mortgage Bonds outstanding under the TE First Mortgage,
deposits with the TE First Mortgage Trustee cash sufficient to pay or redeem
such outstanding TE First Mortgage Bonds or delivers to the TE First Mortgage
Trustee for cancellation all TE First Mortgage Bonds outstanding under the TE
First Mortgage and if Toledo Edison has paid all other sums payable under the TE
First Mortgage. (Article 16)
CERTAIN TAX CONSIDERATIONS
The following is a summary of the taxation of the Secured Notes and of
certain anticipated United States federal income tax consequences resulting from
the ownership of the Secured Notes and the exchange of Old Notes for New Notes.
This summary does not cover all of the possible tax consequences relating to the
ownership of the Secured Notes and the receipt of interest thereon, and it is
not intended as tax advice to any person. It addresses only beneficial owners
who hold the Secured Notes as capital assets and does not address special
classes of beneficial owners such as dealers in securities or currencies, banks,
tax-exempt entities, life insurance companies, persons holding Secured Notes as
a hedge against interest rate or currency risks or as part of a straddle or
conversion transaction, or beneficial owners whose functional currency is not
the U.S. dollar. This summary is based upon the United States federal income tax
laws as currently in effect and as currently interpreted and does not include
any description of the tax laws of any non-U.S. government that may apply.
Prospective purchasers of Secured Notes should consult their own tax
advisors concerning the application of the United States federal income tax
laws, as well as the possible application of the tax laws of any other
jurisdiction, to their particular situation.
As used herein, the term "U.S. Holder" means a beneficial owner of a
Secured Note that is (for purposes of United States federal income tax) (i) a
citizen or resident of the United States, (ii) a corporation, partnership, or
other entity treated as a partnership organized in or under the laws of the
United States or of any political subdivisions thereof, or (iii) an estate or
trust that is treated as a "United States person" within the meaning of Section
7701(a)(30) of the Internal Revenue Code of 1986, as amended ("Code"). A "Non-
U.S. Holder" means any holder of a Secured Note other than a U.S. Holder.
The exchange of the Old Notes for the New Notes will be a tax-free exchange
for all holders and no gain or loss will be recognized by a holder as a result
of such exchange. A holder's tax basis for a New Note will be equal to the tax
basis of the Old Note exchanged therefor. A holder's holding period for a New
Note will include the period during which the holder held the Old Note exchanged
therefor.
U.S. FEDERAL INCOME TAXATION OF U.S. HOLDERS
General
Under general principles of current law, the interest paid on a Secured
Note will be includable in income by a U.S. Holder when the interest is received
or when it accrues in accordance with the U.S. Holder's regular method of tax
accounting.
Disposition or Retirement of a Secured Note
Upon the sale, exchange or other disposition of a Secured Note, or upon the
retirement of a Secured Note at maturity, a U.S. Holder will recognize gain or
loss equal to the difference, if any, between the amount realized upon the
disposition or retirement and the U.S. Holder's tax basis in the Secured Note. A
U.S. Holder's tax basis for determining gain or loss on the disposition or
retirement of a Secured Note will be the cost of that Secured Note to such U.S.
Holder, increased by the amount of original issue discount ("OID") and any
market discount includable in such U.S. Holder's gross income with respect to
that Secured Note, and decreased by the amount of any payments under the Secured
Note that are part of its stated redemption price at maturity and by the portion
of any premium applied to reduce interest payments as described above.
Gain or loss upon the disposition or retirement of a Secured Note will be
capital gain or loss, except to the extent the gain represents accrued OID not
previously included in gross income or accrued interest, to which
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extent such gain or loss would be treated as ordinary income. Any capital loss
will be long-term capital loss if at the time of disposition or retirement the
Secured Note has been held for more than one year. Any capital gain recognized
on the disposition or retirement of Secured Notes held for more than eighteen
months will be taxed at a maximum rate of 20 percent. Any capital gain
recognized on the disposition or retirement of Secured Notes held for more than
twelve months and less than eighteen months will be treated as mid-term gain and
taxed at a maximum rate of 28 percent.
Secondary Market Purchasers -- Premium and Market Discount
A U.S. Holder who purchases a Secured Note subsequent to its original
issuance for an amount that is greater than its "adjusted issue price" (defined
as the sum of the issue price of the Secured Note and the portion of OID
previously includable, disregarding any reduction on account of acquisition
premium, as discussed below, in the gross income of any owners of the Secured
Note and reduced by the amount of any payment previously made on the Secured
Note other than a qualified periodic interest payment) and less than or equal to
its stated redemption price at maturity, reduced by the amount of any payment
previously made on the Secured Note other than a qualified periodic interest
payment, will be considered to have purchased such Secured Note at an
"acquisition premium." The amount of OID that such U.S. Holder must include in
its gross income with respect to such Secured Note for any taxable year is
generally reduced by the portion of such acquisition premium properly allocable
to such year. If a U.S. Holder purchases a Secured Note for a cost in excess of
its stated redemption price at maturity (reduced by the amount of any payment
made on the debt instrument prior to the purchase date other than a qualified
periodic interest payment), such Secured Note will have no OID and such U.S.
Holder may elect to amortize such premium, using a constant interest method,
generally over the remaining term of the Secured Note. Such premium generally
shall be deemed to be an offset to interest otherwise includable with respect to
the Secured Note. Premium on a Secured Note held by a U.S. Holder that does not
make such an election will decrease the gain or increase the loss otherwise
recognized on disposition of the Secured Note.
If a U.S. Holder purchases a Secured Note subsequent to its original
issuance for an amount that is less than, respectively, its stated redemption
price at maturity or its revised issue price (defined as the sum of the issue
price of the Secured Note and the aggregate amount of OID includable,
disregarding any reduction on account of acquisition premium, as discussed
above, in the gross income of all owners of the Secured Note), the amount of the
difference generally will be treated as "market discount" for federal income tax
purposes, unless such difference is less than a specified de minimis amount.
Under the market discount rules, a U.S. Holder will be required to treat any
principal payment on, or any gain on the sale, exchange, retirement or other
disposition of, a Secured Note as ordinary income to the extent of the market
discount that has accrued (and has not previously been included in income)
during the period such U.S. Holder held the Secured Note. In addition, the U.S.
Holder may be required to defer, until the maturity of the Secured Note or its
earlier disposition in a taxable transaction, the deduction of all or a portion
of the interest expense on any indebtedness incurred or continued to purchase or
carry such Secured Note.
Any market discount will be considered accrued ratably during the period
from the date of acquisition to the maturity date of the Secured Note, unless
the U.S. Holder elects to accrue on a constant interest basis. A U.S. Holder of
a Secured Note may elect to include market discount in income currently as it
accrues (on either a ratable or a constant interest basis with a corresponding
increase in the U.S. Holder's tax basis in the Secured Note), in which case the
rule described above regarding deferral of interest deductions will not apply.
This election to include market discount in income currently, once made, applies
to all market discount obligations acquired on or after the first taxable year
to which the election applies and may not be revoked without the consent of the
Internal Revenue Service.
Backup Withholding
In general, if a U.S. Holder fails to furnish a correct taxpayer
identification number or certification of exempt status, fails to report
dividend and interest income in full, or fails to certify that he has provided a
correct taxpayer identification number and that he is not subject to
withholding, the U.S. Holder may be subject to a 31 percent federal backup
withholding tax on certain amounts paid or deemed paid (including
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OID) to the U.S. Holder. An individual's taxpayer identification number is his
social security number. The backup withholding tax is not an additional tax and
may be credited against a U.S. Holder's regular federal income tax liability or
refunded by the Internal Revenue Service where applicable.
U.S. FEDERAL INCOME TAXATION OF NON-U.S. HOLDERS
General
A Non-U.S. Holder generally will not be subject to United States federal
withholding tax on interest paid on the Secured Notes as long as either (i) the
beneficial owner of the Secured Note, under penalties of perjury, provides the
Companies or their agent with such beneficial owner's name and address and
certifies on IRS Form W-8 (or a suitable substitute form) that it is not a U.S.
Holder or (ii) a securities clearing organization, bank, or other financial
institution that holds customers' securities in the ordinary course of its trade
or business ("financial institution") holds the Secured Note and provides a
statement to the Companies or their agent under penalties of perjury in which it
certifies that such an IRS Form W-8 (or a suitable substitute) has been received
by it from the beneficial owner of the Secured Note or qualifying intermediary
and furnishes the Companies or their agent a copy thereof. If the information
provided in such statement changes, the Non-U.S. Holder must so inform the payor
within 30 days of such change. The statement generally must be provided in the
year a payment occurs or in either of the two preceding years. A Non-U.S. Holder
is eligible to provide the statement referred to above in this paragraph if the
Non-U.S. Holder: (i) is not actually or constructively a "10 percent
shareholder" of either of the Companies within the meaning of the Code, (ii) is
not a "controlled foreign corporation" with respect to which either of the
Companies is a "related person" within the meaning of Section 881(c)(3)(C) of
the Code, and (iii) is not a bank described in Section 881(c)(3)(A) of the Code.
If the conditions described in the preceding paragraph are not satisfied,
then interest paid on the Secured Notes will be subject to United States
withholding tax at a rate of 30%, unless such rate is reduced or eliminated
pursuant to an applicable tax treaty.
Any capital gain realized by a Non-U.S. Holder on the sale, redemption,
retirement, or other taxable disposition of a Secured Note will be exempt from
United States federal income and withholding tax, provided that (i) the gain is
not effectively connected with the Non-U.S. Holder's conduct of a trade or
business in the United States, (ii) in the case of a Non-U.S. Holder that is an
individual, the holder is not present in the United States for 183 days or more
in the taxable year of the disposition, and (iii) the Non-U.S. Holder is not
subject to tax pursuant to the provisions of Section 877 of the Code applicable
to certain United States expatriates.
Effectively-Connected Income
If the interest, gain, or other income a Non-U.S. Holder recognizes on a
Secured Note is effectively connected with the Non-U.S. Holder's conduct of a
trade or business in the United States, the Non-U.S. Holder (although exempt
from the withholding tax previously discussed if an appropriate statement is
furnished) generally will be subject to United States federal income tax rates
applicable to United States persons. In addition, if the Non-U.S. Holder is a
foreign corporation, it may be subject to a branch profits tax equal to 30% of
its "effectively connected earnings and profits," as adjusted for certain items,
unless it qualifies for a lower rate under an applicable tax treaty.
Backup Withholding
A Non-U.S. Holder will generally be exempt from backup withholding and
information reporting requirements, provided it complies with the certification
and identification procedures as discussed above. The amount of any backup
withholding from a payment to a holder will be allowed as a credit against the
holder's federal income tax liability and may entitle such holder to a refund,
provided that the required information is furnished to the Internal Revenue
Service.
62
<PAGE> 65
PLAN OF DISTRIBUTION
A broker-dealer that is the holder of Old Notes that were acquired for the
account of such broker-dealer as a result of market-making or other trading
activities (other than Old Notes acquired directly from the Companies or any
affiliate of the Companies) may exchange such Old Notes for New Notes pursuant
to the Exchange Offer, provided that each broker-dealer that receives New Notes
for its own account in exchange for Old Notes, if such Old Notes were acquired
by such broker-dealer as a result of market-making or other trading activities,
must acknowledge that it will deliver a prospectus in connection with any resale
of such New Notes. This Prospectus, as it may be amended or supplemented from
time to time, may be used by any such broker-dealer in connection with resales
of New Notes received in exchange for Old Notes if such Old Notes were acquired
as a result of market-making activities or other trading activities. The
Companies have agreed that, for a period of 120 days after the Expiration Date,
they will make this Prospectus, as amended or supplemented, available to any
such broker-dealer for use in connection with any such resales. In addition,
until December 8, 1997, all dealers effecting transactions in the New Notes may
be required to deliver a prospectus.
The Companies will not receive any proceeds from any sale of New Notes by
broker-dealers. New Notes received by broker-dealers for their own account
pursuant to the Exchange Offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions, through
the writing of options on the New Notes or a combination of such methods of
resale, at market prices prevailing at the time of resale, at prices related to
such prevailing market prices or negotiated prices. Any such resale may be made
directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any such
broker-dealer or the purchasers of any such New Notes. Any broker-dealer that
resells New Notes that were received by it for its own account pursuant to the
Exchange Offer and any broker or dealer that participates in a distribution of
such New Notes may be deemed to be an "underwriter" within the meaning of the
Securities Act and any profit on any such resale of New Notes and any
commissions or concessions received by any such persons may be deemed to be
underwriting compensation under the Securities Act. The Letter of Transmittal
states that by acknowledging that it will deliver and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
For a period of 120 days after the Expiration Date, the Companies will
promptly send additional copies of this Prospectus, and any amendment or
supplement to this Prospectus, to any broker-dealer that requests those
documents in the Letter of Transmittal. The Companies have agreed to pay all
expenses incident to the Exchange Offer (including the expenses of one counsel
for the holders of the Secured Notes) other than commissions or concessions of
any broker or dealer and will indemnify the holders of the Secured Notes
(including any broker-dealer) against certain liabilities, including liabilities
under the Securities Act.
LEGAL MATTERS
Certain legal matters in connection with the Exchange Offer will be passed
upon for Cleveland Electric and Toledo Edison by Terrence G. Linnert, Mary E.
O'Reilly or Paul N. Edwards, counsel for each Company, and by Squire, Sanders &
Dempsey LLP, 4900 Key Tower, Cleveland, Ohio 44114, special counsel to the
Companies. Mr. Linnert is Vice President and Chief Financial Officer of each
Company, Senior Vice President, Chief Financial Officer and General Counsel of
Centerior Energy and Senior Vice President -- Corporate Administration Group,
Chief Financial Officer and General Counsel of the Service Company. Mrs.
O'Reilly is Managing Attorney of the Service Company and Mr. Edwards is
Principal Counsel of the Service Company.
EXPERTS
The financial statements of each Company as of December 31, 1996 and 1995
and for each of the three years in the period ended December 31, 1996, included
in the Form 10-K and included in or incorporated by reference in this
Prospectus, have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said reports.
63
<PAGE> 66
INDEX TO FINANCIAL STATEMENTS SECTION
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
CLEVELAND ELECTRIC FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1996
(Reprinted from Cleveland Electric's Annual Report to Share Owners)
Management's Financial Analysis............................................................. F-3
Report of Independent Public Accountants.................................................... F-10
Income Statement............................................................................ F-11
Retained Earnings........................................................................... F-11
Balance Sheet............................................................................... F-12
Cash Flows.................................................................................. F-14
Statement of Capitalization................................................................. F-15
Notes to the Financial Statements........................................................... F-17
Financial and Statistical Review............................................................ F-28
TOLEDO EDISON FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1996
(Reprinted from Toledo Edison's Annual Report to Share Owners)
Management's Financial Analysis............................................................. F-31
Report of Independent Public Accountants.................................................... F-38
Income Statement............................................................................ F-39
Retained Earnings........................................................................... F-39
Balance Sheet............................................................................... F-40
Cash Flows.................................................................................. F-42
Statement of Capitalization................................................................. F-43
Notes to the Financial Statements........................................................... F-45
Financial and Statistical Review............................................................ F-56
FIRST QUARTER 1997 FORM 10-Q
Notes to the Financial Statements (Unaudited)(a)............................................ F-61
Cleveland Electric Income Statement......................................................... F-64
Cleveland Electric Balance Sheet............................................................ F-65
Cleveland Electric Cash Flows............................................................... F-66
Cleveland Electric Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................................. F-67
Toledo Edison Income Statement.............................................................. F-69
Toledo Edison Balance Sheet................................................................. F-70
Toledo Edison Cash Flows.................................................................... F-71
Toledo Edison Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................. F-72
Part II. Other Information(a).............................................................. F-74
SECOND QUARTER 1997 FORM 10-Q
Notes to the Financial Statements (Unaudited)(a)............................................ F-82
Cleveland Electric Income Statement......................................................... F-85
Cleveland Electric Balance Sheet............................................................ F-86
Cleveland Electric Cash Flows............................................................... F-87
Cleveland Electric Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................................. F-88
Toledo Edison Income Statement.............................................................. F-91
Toledo Edison Balance Sheet................................................................. F-92
Toledo Edison Cash Flows.................................................................... F-93
Toledo Edison Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................. F-94
Part II. Other Information(a).............................................................. F-97
</TABLE>
- ---------------
(a) Combined in each 1997 Form 10-Q for Centerior Energy, Cleveland Electric and
Toledo Edison and relates to all three companies.
F-1
<PAGE> 67
CLEVELAND ELECTRIC
FINANCIAL STATEMENTS
FOR THE YEAR ENDED
DECEMBER 31, 1996
F-2
<PAGE> 68
MANAGEMENT'S FINANCIAL ANALYSIS
OUTLOOK
STRATEGIC PLAN
In early 1994, Centerior Energy Corporation (Centerior Energy), along with The
Cleveland Electric Illuminating Company (Company) and The Toledo Edison Company
(Toledo Edison), created a strategic plan to achieve the twin goals of
strengthening their financial conditions and improving their competitive
positions. The Company and Toledo Edison are the two wholly owned electric
utility subsidiaries of Centerior Energy. The plan's objectives relate to the
combined operations of all three companies. To meet these goals, we seek to
maximize share owner return on Centerior Energy common stock, achieve profitable
revenue growth, become a leader in customer satisfaction, build a winning
employee team and attain increasingly competitive supply costs. During 1996, the
third year of the eight-year plan, we made strong gains toward reaching some
plan objectives but need significant improvement on others.
A major step taken to reach the twin goals was Centerior Energy's agreement to
merge with Ohio Edison Company (Ohio Edison) to form a new holding company
called FirstEnergy Corp. (FirstEnergy). The proposed merger, combined with good
operating performance, a successful price increase and the accelerated paydown
of debt, resulted in a significant stock price gain, such that the total return
to Centerior Energy common stock share owners during 1996 was 33%. The merger is
expected to better position the merged companies to meet coming competitive
challenges.
Revenue growth is a key objective of the plan, from pricing actions as well as
market expansion.
In April 1996, The Public Utilities Commission of Ohio (PUCO) approved in full
the $119 million price increases requested by the Company and Toledo Edison ($84
million and $35 million, respectively). The primary purpose of the increases was
to provide additional revenues to recover all the costs of providing electric
service, including deferred costs, and provide a fair return to Centerior Energy
common stock share owners. The additional revenues also provided cash to
accelerate the redemption of debt and preferred stock.
For the second year in a row, the Company's total kilowatt-hour sales increased.
Although kilowatt-hour sales to our retail customers decreased by 1% compared to
1995 results, our wholesale sales increased by 27% from 1995 as a result of the
good availability of our generating units and a more aggressive bulk power
marketing effort. Adjusted for weather, kilowatt-hour sales to residential and
commercial customers increased by 1% and 0.8%, respectively, from 1995.
Another key element of our revenue strategy is to offer long-term contracts to
large industrial customers who might otherwise consider changing power
suppliers. During 1996, we renewed and extended for as long as ten years
contracts with many of our large industrial customers, including the five
largest. While this strategy has resulted in lower prices for these customers,
in the long run, it is expected to maximize share owner value by retaining our
customer base in a changing industry. Prior to these renewals, 61% of our
industrial base rate (nonfuel) revenues under contract was scheduled for renewal
before 1999. Following the renewals, the comparable percentage is 18%. At
year-end 1996, 51% of our industrial base rate revenues was under long-term
contracts.
Our continued emphasis on economic development activities is adding to our
opportunities for revenue growth. In 1996, we gained commitments on 24 economic
development projects, representing almost $6 million in new and retained annual
base rate revenues and nearly 4,000 new and retained jobs for Northeast Ohio.
Under the strategic plan, Centerior Energy and its subsidiaries are structured
in six strategic business groups to better focus on competitiveness. During
1996, the Company reduced employment from about 3,600 to 3,300. Further
reduction in our work force to about 3,100 is planned by year-end 1997. We also
plan to reduce expenditures for operation and maintenance activities (exclusive
of fuel and purchased power expenses) and capital projects from $593 million in
1996 to approximately $560 million in 1997 by continuing to streamline
operations. We will continue to reduce our unit cost of fuel used for generating
electricity, while safely improving the operating performance of our generation
facilities.
Reducing fixed financing costs is another primary objective in strengthening our
financial and competitive position. In 1996, we reduced our fixed obligations
for debt, preferred stock and generation facilities leases (partially offset by
the new accounts receivable securitization) by $145 million. See Notes 1(j) and
2. Interest expense and preferred dividends dropped $10 million. In the last
three years, fixed obligations were reduced by $246 million.
In 1996, we reported earnings available for common stock of $78 million compared
to $141 million in 1995. The decline in reported earnings is primarily
attributable to the delay in implementing our price increase until late April,
while we began at the end of 1995 to charge earnings for operating expenses and
amortization of deferrals which the price increase was designed to recover. The
price increase contributed approximately $33 million (after tax) more cash to
our earnings in 1996. The change in regulatory accounting measures resulted in
an $85 million decrease in reported earnings for 1996 versus 1995. In addition,
1996 results included a noncash charge against earnings of $11 million after tax
for the disposition of inventory. Excluding these factors, basic earnings from
operations in 1996 were the same as in 1995; however, the quality of reported
earnings improved. The full benefit of our $84 million price increase,
substantial reductions in operation and maintenance expenses and a continuing
decline in interest charges are expected to result in improvement in earnings
and cash flow from operations in 1997.
F-3
<PAGE> 69
PENDING MERGER WITH OHIO EDISON
On September 16, 1996, Centerior Energy announced its merger with Ohio Edison in
a stock-for-stock transaction. Centerior Energy share owners will receive 0.525
of a share of FirstEnergy common stock for each share of Centerior Energy common
stock owned, while Ohio Edison share owners will receive one share of
FirstEnergy common stock for each share of Ohio Edison common stock owned.
Following the merger, FirstEnergy will directly hold all of the issued and
outstanding common stock of the Company, Toledo Edison and Ohio Edison.
FirstEnergy plans to account for the merger as a purchase in accordance with
generally accepted accounting principles. If FirstEnergy elects to apply, or
"push down", the effects of purchase accounting to the financial statements of
the Company and Toledo Edison, the Company and Toledo Edison would record
adjustments to: (1) reduce the carrying value of nuclear generating plant by
$1.25 billion to fair value; (2) recognize goodwill of $865 million; (3) reduce
common stock equity by $401 million; (4) reset retained earnings of the Company
and Toledo Edison to zero; and (5) reduce the related deferred federal income
tax liability by $438 million. These amounts reflect FirstEnergy's estimates of
the pro forma combined adjustments for the Company and Toledo Edison as of
September 30, 1996. The actual adjustments to be recorded could be materially
different from these estimates. FirstEnergy has not decided whether to push down
the effects of purchase accounting to the financial statements of the Company
and Toledo Edison if the merger with Ohio Edison is completed, nor has
FirstEnergy estimated the allocations between the two companies if push-down
accounting is elected.
We believe that the merger will create a company that is better positioned to
compete in the electric utility industry than either Centerior Energy or Ohio
Edison could on a stand-alone basis, enhancing long-term share owner value and
providing customers with reliable service at more stable and competitive prices.
The combination of Centerior Energy and Ohio Edison is a natural alliance of two
companies with adjoining service areas who already share many major generating
units. FirstEnergy expects to reduce costs, maximize efficiencies and increase
management flexibility in order to enhance revenues, cash flows and earnings and
be a more effective competitor in the increasingly competitive electric utility
industry.
FirstEnergy anticipates the merger will result in net savings for the combined
companies of approximately $1 billion over ten years, in addition to the impact
of cost reduction programs underway at both companies. The additional savings,
which probably could not be achieved without the merger, will result primarily
from the reduction of duplicative functions and positions, joint dispatch of
generating facilities and procurement efficiencies. FirstEnergy expects
reductions in labor costs to comprise slightly over half the estimated savings.
In addition, FirstEnergy expects to reduce system-wide debt by at least $2.5
billion through the year 2000, yielding additional long-term savings in the form
of lower interest expense.
The Company's share of the $1 billion of savings will permit the Company to
reduce prices to its customers as discussed below under FirstEnergy Rate Plan.
Absent the merger, the Company plans to achieve savings as well, but at a lower
level, which is expected to allow prices to be frozen at current levels until at
least 2002 despite inflationary pressures.
Various aspects of the merger are subject to the approval of the Federal Energy
Regulatory Commission (FERC) and other regulatory authorities. Common stock
share owners of Centerior Energy and Ohio Edison are expected to vote on
approval of the merger agreement on March 27, 1997. The merger must be approved
by the affirmative votes of the share owners of at least two-thirds of the
outstanding shares of Ohio Edison common stock and a majority of the outstanding
shares of Centerior Energy common stock. The merger is expected to be effective
in late 1997.
FIRSTENERGY RATE PLAN
On January 30, 1997, the PUCO approved a Rate Reduction and Economic Development
Plan (Plan) for the Company and Toledo Edison to be effective upon the
consummation of the Centerior Energy and Ohio Edison merger. The Plan would be
null and void if the merger is not consummated. The rate order granting the
April 1996 price increase will remain in full force and effect during the
pendency of the merger or if the merger is not consummated.
The Plan calls for a base rate freeze through 2005 (except to comply with any
significant changes in environmental, regulatory or tax laws), followed by an
immediate $310 million (which represents a decrease of approximately 15% from
current levels) base rate reduction in 2006 (the Company's share is expected to
be $217 million); interim reductions beginning seven months after consummation
of the merger of $3 per month increasing to $5 per month per residential
customer by July 1, 2001; $105 million for economic development and energy
efficiency programs (the Company's share is expected to be $70 million);
earnings caps for regulatory purposes for the Company and Toledo Edison; a
commitment by FirstEnergy for a reduction, for regulatory accounting purposes,
in nuclear and regulatory assets by the end of 2005 of at least $2 billion more
than it otherwise would be, through revaluing facilities or accelerating
depreciation and amortization; and a freeze in fuel cost factors until December
31, 2005, subject to PUCO review at year-end 2002 and annual inflation
adjustments. The Plan permits the Company and Toledo Edison to dispose of
generating assets subject to notice and possible PUCO approval, and to enter
into associated power purchase arrangements.
F-4
<PAGE> 70
Total price savings for the Company's customers of about $280 million are
anticipated over the term of the Plan, as summarized below, excluding potential
economic development benefits and assuming that the merger takes place on
December 31, 1997. The total price savings for customers of the Company and
Toledo Edison are expected to be about $391 million.
<TABLE>
<CAPTION>
Year Amount
- ---------------------------------------------- ------------
(millions of
dollars)
<S> <C>
1998________________________________________ $ 15
1999________________________________________ 27
2000________________________________________ 31
2001________________________________________ 39
2002________________________________________ 42
2003________________________________________ 42
2004________________________________________ 42
2005________________________________________ 42
--------
Total___________________________________ $280
========
</TABLE>
Under the Plan's earnings cap, the Company and Toledo Edison will be permitted
to earn up to an 11.5% return on common stock equity for regulatory purposes
during calendar years prior to 2000, 12% during calendar years 2000 and 2001,
and 12.59% during calendar years 2001 through 2005. The regulatory return on
equity is generally expected to be lower than the return on equity calculated
for financial reporting purposes due to the calculation methodology defined by
the Plan and, as discussed in the next paragraph, anticipated differences in
accounting for the Plan for financial reporting versus regulatory purposes. If
for any calendar year the regulatory return on equity exceeds the specified
level, the excess will be credited to customers, first through a reduction in
Percentage of Income Payment Plan (PIPP) arrearages and then as a credit to base
rates. PIPP is a deferred payment program for low-income residential customers.
The Plan requires, for regulatory purposes, a revaluation of or an accelerated
reduction in the investment in nuclear plant and certain regulatory assets of
the Company and Toledo Edison (excluding amounts due from customers for future
federal income taxes) by at least $2 billion by the end of 2005. FirstEnergy has
not yet determined each company's estimated share of the $2 billion. Only a
portion of the $2 billion of accelerated costs is expected to be charged against
the two companies' earnings for financial reporting purposes by 2005.
FirstEnergy believes that the Plan will not provide for the full recovery of
costs and a fair return on investment associated with the nuclear operations of
the Company and Toledo Edison. Pursuant to the PUCO's order, FirstEnergy is
required to submit to the PUCO staff the regulatory accounting and cost recovery
details for implementing the Plan. After approval of such details by the PUCO
staff, FirstEnergy expects that the Company and Toledo Edison will discontinue
the application of Statement of Financial Accounting Standards (SFAS) 71 for
their nuclear operations if and when consummation of the merger becomes
probable. The remainder of their business is expected to continue to comply with
the provisions of SFAS 71. At the time the merger is probable, the Company and
Toledo Edison would be required to write off certain of their regulatory assets
for financial reporting purposes. The write-off amounts would be determined at
that time. FirstEnergy estimates the write-off amounts for the Company and
Toledo Edison will total approximately $750 million. The Company's share of the
write-off is expected to be about two-thirds of this amount. Under the Plan,
some or all of this write-off cannot be applied toward the $2 billion regulatory
commitment discussed above. For financial reporting purposes, nuclear generating
units are not expected to be impaired. If events cause either the Company or
Toledo Edison or both companies to conclude they no longer meet the criteria for
applying SFAS 71 for the remainder of their business, they would be required to
write off their remaining regulatory assets and measure all other assets for
impairment. For a discussion of the criteria for complying with SFAS 71, see
Note 7(a).
APRIL 1996 RATE ORDER
In its April 1996 order, the PUCO granted price increases of $84 million and $35
million in annualized revenues to the Company and Toledo Edison, respectively.
The Company and Toledo Edison intend to freeze rates at existing levels until at
least 2002, although they are not precluded from requesting further price
increases. In the order, the PUCO provided for recovery of all regulatory assets
in the approved rates, and the Company and Toledo Edison continue to comply with
the provisions of SFAS 71.
In connection with its order, the PUCO recommended that the Company and Toledo
Edison write down certain assets for regulatory purposes by an aggregate of
$1.25 billion through 2001. If the merger is consummated, the Company and Toledo
Edison believe acceleration of $2 billion of costs under the Plan would fully
satisfy this recommendation. The Company and Toledo Edison agree with the
concept of accelerating the recognition of costs and the recovery of assets as
such concept is consistent with the strategic objective to become more
competitive. However, the Company and Toledo Edison believe that such
acceleration must also be consistent with the reduction of debt and the
opportunity for Centerior Energy common stock share owners to receive a fair
return on their investment. Consideration of whether to implement a plan
responsive to the PUCO's recommendation to revalue assets by $1.25 billion is
pending the merger with Ohio Edison.
Notwithstanding the pending merger with Ohio Edison and discussions with
regulators concerning the effect of the Plan on the Company's nuclear generating
assets, we believe it is reasonable to expect that rates will be set at levels
that will recover all current and anticipated costs associated with the
Company's nuclear operations, including all associated regulatory assets, and
such rates can be charged to and collected from customers. If there is a change
in our evaluation of the competitive environment, regulatory framework or other
factors, or if the PUCO significantly reduces the value of the Company's assets
or reduces the approved return on common stock
F-5
<PAGE> 71
equity of 12.59% and overall rate of return of 10.06%, or both, for future
regulatory purposes, the Company may be required to record material charges to
earnings.
MERGER OF TOLEDO EDISON INTO THE COMPANY
In October 1996, the FERC authorized the merger of Toledo Edison into the
Company. The merger agreement between Centerior Energy and Ohio Edison requires
the approval of Ohio Edison prior to consummation of the proposed merger of
Toledo Edison into the Company. Ohio Edison has not yet made a decision. See
Note 16.
COMPETITION
Structural changes in the electric utility industry from actions by both federal
and state regulatory bodies are continuing to place downward pressure on prices
and increase competition for customers. The Company's nuclear plant licenses
have required open-access transmission for its wholesale customers for 20 years.
More recently, the Federal Energy Policy Act of 1992 initiated broader access to
utility transmission systems and, in 1996, the FERC adopted rules relating to
open-access transmission services. The open-access rules require utilities to
deliver power from other utilities or generation sources to their wholesale
customers at nondiscriminatory prices.
A number of states have enacted transition legislation which provides for
introduction of competition for retail electric business and recovery of
stranded investment. Several groups in Ohio are studying the possible
introduction of retail wheeling and stranded investment recovery. Retail
wheeling occurs when a customer obtains power from a utility company other than
its local utility. The term "stranded investment" generally refers to fixed
costs approved for recovery under traditional regulatory methods that would
become unrecoverable, or "stranded", as a result of legislative changes which
allow for widespread competition. The PUCO is sponsoring discussions among a
group of business, utility and consumer interests to explore ways of promoting
competitive options without unduly harming the interests of utility company
share owners or customers. The PUCO also has introduced two pilot projects, both
intended as initial steps to introduce competitive elements into the Ohio
electric utility business.
A bill to restructure the electric utility industry in Ohio has been introduced
in the Ohio House of Representatives. A bipartisan committee from both
legislative houses has been formed to study the issue. Centerior Energy
presented the Company's model for customer choice, called Energy Choice, to the
PUCO discussion group in August 1996. Under this model, full retail competition
should be introduced by 2002, but two essential elements, recovery of stranded
investment and levelization of tax burdens among energy suppliers, must be
resolved in the interim to assure share owners' recovery of and a fair return on
their investments.
Although competitive pressures are increasing, the traditional regulatory
framework remains in place and is expected to continue for the foreseeable
future. We cannot predict when and to what extent retail wheeling or other forms
of competition will be allowed. We believe that pure competition (unrestricted
retail wheeling for all customer classifications) is at least several years away
and that any transition to pure competition will be in phases. The FERC and the
PUCO have acknowledged the need to provide at least partial recovery of stranded
investment as greater competition is permitted and, therefore, we believe that
there will be a mechanism developed for the recovery of at least some stranded
investment. However, due to the uncertainty involved, there is a risk in
connection with the introduction of retail wheeling that some of the Company's
assets may not be fully recovered.
Competition from municipal electric suppliers for retail business in our service
area is producing both favorable and unfavorable results in our business.
Through aggressive door-to-door campaigns, we have been successful in limiting
the number of conversions of our customers to Cleveland Public Power (CPP) under
its ongoing expansion plan. CPP is the largest municipal supplier in our service
area. In 1996, we reached agreements to serve a number of large Cleveland
commercial customers, including some previously served by CPP. We continue to
pursue legal remedies to halt illegal municipal expansion in our service area.
The merger with Ohio Edison and the benefits of the Plan to our customers are
expected to better position us to deal with the structural changes taking place
in the industry and to improve our competitive position with respect to
municipalization.
NUCLEAR OPERATIONS
The Company has interests in three nuclear generating units -- Davis-Besse
Nuclear Power Station (Davis-Besse), Perry Nuclear Power Plant Unit 1 (Perry
Unit 1) and Beaver Valley Power Station Unit 2 (Beaver Valley Unit 2). Toledo
Edison operates Davis-Besse and the Company operates Perry Unit 1.
All three units were out of service temporarily for refueling during 1996; thus,
plant availability factors for Davis-Besse, Perry Unit 1 and Beaver Valley Unit
2 were 85%, 76% and 70%, respectively, for 1996. The 1994-1996 availability
factors for the units were 91%, 72%, and 85%, for Davis-Besse, Perry Unit 1 and
Beaver Valley Unit 2, respectively. The comparable industry averages for a
three-year period (as of August 31, 1996) are 82% for pressurized water reactors
such as Davis-Besse and Beaver Valley Unit 2 and 78% for boiling water reactors
such as Perry Unit 1. Davis-Besse established a plant record with its 509-day
continuous run at or near full capacity before shutting down for its scheduled
refueling outage in April 1996.
A significant part of the strategic plan involves ongoing efforts to increase
the availability and lower the cost of
F-6
<PAGE> 72
production of our nuclear units. In 1996, we continued our progress toward
increasing long-term unit availability while continuing to lower production
costs. The goal of our nuclear improvement program is to replicate Davis-Besse's
operational excellence and cost reduction gains at Perry Unit 1, while improving
performance ratings.
Our nuclear units may be impacted by activities or events beyond our control.
Operating nuclear units have experienced unplanned outages or extensions of
scheduled outages because of equipment problems or new regulatory requirements.
A major accident at a nuclear facility anywhere in the world could cause the
Nuclear Regulatory Commission (NRC) to limit or prohibit the operation or
licensing of any domestic nuclear unit. If one of our nuclear units is taken out
of service for an extended period for any reason, including an accident at such
unit or any other nuclear facility, we cannot predict whether regulatory
authorities would impose unfavorable rate treatment. Such treatment could
include taking our affected unit out of rate base, thereby not permitting us to
recover our investment in and earn a return on it, or disallowing certain
construction or maintenance costs. An extended outage coupled with unfavorable
rate treatment could have a material adverse effect on our financial condition,
cash flows and results of operations. Premature plant closings could also have a
material adverse effect on our financial condition, cash flows and results of
operations because the estimated cost to decommission a plant exceeds the
current funding in the decommissioning trust.
HAZARDOUS WASTE DISPOSAL SITES
The Company has been named as a "potentially responsible party" (PRP) for three
sites listed on the Superfund National Priorities List (Superfund List) and is
aware of its potential involvement in the cleanup of several other sites.
Allegations that the Company disposed of hazardous waste at these sites, and the
amount 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. If the Company were held liable for 100% of the cleanup costs of
all the sites referred to above, the cost could be as high as $300 million.
However, we believe that the actual cleanup costs will be substantially lower
than $300 million, that the Company's share of any cleanup costs will be
substantially less than 100% and that most of the other PRPs are financially
able to contribute their share. The Company has accrued a liability totaling $7
million at December 31, 1996 based on estimates of the costs of cleanup and its
proportionate responsibility for such costs. We believe that the ultimate
outcome of these matters will not have a material adverse effect on our
financial condition, cash flows or results of operations.
A new Statement of Position issued by the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants, Inc.
effective January 1, 1997 provides guidance on the recognition and disclosure of
environmental remediation liabilities. Adoption of the statement in 1997 is not
expected to have a material adverse effect on our financial condition or results
of operations.
COMMON STOCK DIVIDENDS
Centerior Energy's common stock dividend has been funded in recent years
primarily by common stock dividends paid by the Company. The declaration and
payment of future common stock dividends is at the discretion of the Company's
Board of Directors, subject to applicable legal restrictions. In 1994, Centerior
Energy lowered its common stock dividend which reduced its cash outflow by over
$110 million annually. This action, in turn, reduced the common stock cash
dividend demand on the Company. The Company used the increased retained cash to
redeem debt and preferred stock more quickly than would otherwise be the case.
In 1996, Centerior Energy increased its common stock cash dividend demand on the
Company to fund its common stock dividend and other corporate activities. See
Capital Resources and Liquidity-Liquidity below.
CAPITAL RESOURCES AND LIQUIDITY
1994-1996 CASH REQUIREMENTS
We need cash for normal corporate operations (including the payment of
dividends), retirement of maturing securities, and an ongoing program of
constructing and improving facilities to meet demand for electric service and to
comply with government regulations. Our cash construction expenditures totaled
$164 million in 1994, $148 million in 1995 and $104 million in 1996. Our debt
and preferred stock maturities and sinking fund requirements totaled $62 million
in 1994, $282 million in 1995 and $176 million in 1996. In addition, we
optionally redeemed $341 million of securities in the 1994-1996 period,
including $143 million of tax-exempt issues refunded in 1995.
In July 1996, Centerior Funding Corporation (Centerior Funding), the Company's
wholly owned subsidiary, issued $150 million in AAA-rated accounts receivable-
backed investor certificates due in 2001 with an interest rate of 7.2%. The
Company's share of the net proceeds from the accounts receivable securitization
was used to redeem higher-cost securities and for general corporate purposes.
As a result of these activities, the embedded cost of the Company's debt at the
end of 1996 declined to 8.83% versus 8.88% in 1995 and 8.96% in 1994.
The Company also utilized short-term borrowings to help meet its cash needs. The
Company had $112 million of notes payable to affiliates at December 31, 1996.
The Company is a party to a $125 million revolving credit facility which was
renewed in May 1996 for a one-year term. In 1996, portions of the nuclear fuel
lease financing vehicles for the Company and Toledo Edison matured: $84 million
of intermediate-term notes in September and a $150 million letter of credit
supporting short-term borrowing in October. These facilities were replaced by
$100 million of intermediate-term notes and a $100 million two-year letter of
credit. The net reduction in the
F-7
<PAGE> 73
facility size results from lower nuclear fuel financing requirements.
1997 AND BEYOND CASH REQUIREMENTS
Our anticipated 1997 cash requirements for construction are $110 million. Debt
and preferred stock maturities and sinking fund requirements are $145 million.
Of this amount, $70 million are for a tax-exempt issue secured by first mortgage
bonds and subject to optional tender by the owners on November 1, 1997, which we
expect to replace with a similar issue at a substantially lower interest rate.
We expect to meet remaining requirements with internal cash generation and cash
reserves. We also expect to be able to optionally redeem more debt and preferred
stock in 1997 than we did in 1996.
We expect to meet all of our 1998-2001 cash requirements with internal cash
generation. Estimated cash requirements for our construction program during this
period total $496 million. Debt and preferred stock maturities and sinking fund
requirements total $445 million for the same period. If economical, additional
securities may be redeemed with funding expected to be provided through internal
cash generation.
Consummation of the merger with Ohio Edison is expected to reduce the Company's
cash construction requirements and improve its ability to redeem fixed
obligations.
LIQUIDITY
Net cash flow from operating activities in 1996 was significantly increased from
1995 by implementation of the price increase effective in April 1996. Most of
the net proceeds from our accounts receivable securitization of $65 million were
used to redeem other higher-cost securities, producing net savings in our
overall cost of borrowing. In 1996, we reduced our fixed obligations for debt,
preferred stock and generation facilities leases (partially offset by the new
accounts receivable securitization) by $145 million. At year-end 1996, we had
$30 million in cash and temporary cash investments, down from $70 million at
year-end 1995.
Additional first mortgage bonds may be issued by the Company under its mortgage
on the basis of property additions, cash or refundable first mortgage bonds. If
the applicable interest coverage test is met, the Company may issue first
mortgage bonds on the basis of property additions and, under certain
circumstances, refundable bonds. At December 31, 1996, the Company would have
been permitted to issue approximately $666 million of additional first mortgage
bonds. If FirstEnergy elects to apply purchase accounting to the Company if the
merger with Ohio Edison is completed, the Company's first mortgage bond capacity
would be adversely affected.
The Company also is able to raise funds through the sale of preferred and
preference stock. There are no restrictions on the Company's ability to issue
preferred or preference stock.
The Company and Toledo Edison have $273 million in financing vehicles to support
their nuclear fuel leases, $83 million of which mature in 1997. Replacement
financing for the maturing issues may not be needed in 1997. The Company is a
party to a $125 million revolving credit facility which is expected to be
renewed when it matures in May 1997.
Current credit ratings for the Company are as follows:
<TABLE>
<CAPTION>
Standard Moody's
& Poor's Investors
Corporation Service, Inc.
----------- -------------
<S> <C> <C>
First mortgage bonds__________________ BB Ba2
Subordinate debt______________________ B+ Ba3
Preferred stock_______________________ B b2
</TABLE>
Following the FirstEnergy merger announcement, both rating agencies placed the
Company's securities on credit watch with positive implications.
Federal law prohibits the Company from paying dividends out of capital accounts.
The Company has since 1993 declared and paid preferred and common stock
dividends out of appropriated current net income included in retained earnings.
At the times of such declarations and payments, the Company had a deficit in its
retained earnings. At December 31, 1996, the Company had $130 million of
appropriated retained earnings for the payment of dividends.
As part of a routine audit, the FERC is considering statements which it
requested and received from the Company and Toledo Edison supporting the payment
of dividends out of appropriated current net income included in retained
earnings while total retained earnings were a deficit. At December 31, 1996, the
Company's retained earnings deficit was $276 million. The final disposition of
this issue is a factor expected to be considered by FirstEnergy in deciding
whether to apply purchase accounting to the Company and Toledo Edison, one
effect of which would be to reset deficit retained earnings to zero. If the
merger is not consummated or if FirstEnergy determines not to apply purchase
accounting to the two companies, the Company and Toledo Edison intend to
continue to support their position and pursue all available alternatives to
allow them to continue the declaration and payment of dividends.
RESULTS OF OPERATIONS
1996 VS. 1995
Factors contributing to the 1.2% increase in 1996 operating revenues are as
follows:
<TABLE>
<CAPTION>
Millions
Increase (Decrease) in Operating Revenues of Dollars
- -------------------------------------------------- -----------
<S> <C>
Base Rates______________________________________ $ 51
KWH Sales Volume and Mix________________________ (41)
Wholesale Revenues______________________________ 14
Fuel Cost Recovery Revenues_____________________ (9)
Miscellaneous Revenues__________________________ 6
-----
Total_______________________________________ $ 21
=====
</TABLE>
The increase in 1996 base rates revenues resulted primarily from the April 1996
rate order issued by the PUCO
F-8
<PAGE> 74
for the Company as discussed under Outlook-April 1996 Rate Order and in Note
7(b). Renegotiated contracts for certain large industrial customers resulted in
a decrease in base revenues which partially offset the effect of the general
price increase. For the second year in a row, total kilowatt-hour sales
increased. Total sales increased 1.3% because of a 27% increase in wholesale
sales, the result of the good availability of our generating units and a more
aggressive bulk power marketing effort. Residential and commercial kilowatt-hour
sales decreased 2.1% and 0.6%, respectively, primarily because of the cooler
summer weather in 1996. On a weather-normalized basis, residential and
commercial sales increased 1% and 0.8%, respectively. Industrial kilowatt-hour
sales decreased 0.2% primarily because of fewer sales to large automotive
manufacturers. Lower 1996 fuel cost recovery revenues resulted from favorable
changes in the fuel cost factors. The weighted average of these fuel cost
factors decreased approximately 3%. Miscellaneous revenues increased in 1996
primarily because of new revenues relating to a generating plant lease agreement
in effect for four months during the year. The parties canceled the agreement
because the FERC insisted on terms which were not economic to the parties.
For 1996, operating revenues were 32% residential, 32% commercial, 29%
industrial and 7% other, and kilowatt-hour sales were 23% residential, 28%
commercial, 37% industrial and 12% other. The average prices per kilowatt-hour
for residential, commercial and industrial customers were 11.34, 9.67 and 6.57
cents, respectively.
Operating expenses increased 4.4% in 1996. The cessation of the Rate
Stabilization Program deferrals and the commencement of their amortization in
December 1995 resulted in the increase in the net amortization of deferred
operating expenses. See Note 7(d). Depreciation and amortization expenses
increased primarily because of a $7 million net increase in depreciation related
to changes in depreciation rates, as discussed in Note 1(e), and the cessation
of the accelerated amortization of unrestricted investment tax credits under the
Rate Stabilization Program, which was reported in 1995 as a $6 million reduction
of depreciation. Other operation and maintenance expenses in 1996 included a $17
million one-time charge for the disposition of inventory as part of a
reengineering of the supply chain process. Reengineering the supply chain
process increases the use of technology, consolidates warehousing and uses
just-in-time purchase and delivery. Federal income taxes decreased as a result
of lower pretax operating income.
A nonoperating loss resulted in 1996 primarily from costs related to the
accounts receivable securitization, as discussed in Note 1(j), and the Company's
share of merger-related expenses. The deferral of carrying charges related to
the Rate Stabilization Program ended in November 1995. The federal income tax
credit for nonoperating income increased in 1996 accordingly.
Interest charges and preferred dividend requirements decreased in 1996 because
of the redemption of securities and refundings at favorable terms in 1996 and
1995.
1995 VS. 1994
Factors contributing to the 4.2% increase in 1995 operating revenues are as
follows:
<TABLE>
<CAPTION>
Millions
Increase (Decrease) in Operating Revenues of Dollars
- --------------------------------------------------- ----------
<S> <C>
KWH Sales Volume and Mix_________________________ $ 52
Wholesale Revenues_______________________________ 11
Fuel Cost Recovery Revenues______________________ 19
Miscellaneous Revenues___________________________ (11)
----
Total________________________________________ $ 71
====
</TABLE>
Industrial kilowatt-hour sales increased 0.3% in 1995, but sales grew 2.4%
excluding reductions at two low-margin steel producers (representing 7.6% of
industrial revenues). Residential and commercial kilowatt-hour sales increased
2.8% and 3%, respectively, primarily because of the hot summer weather, although
there was about 2% nonweather-related growth in commercial kilowatt-hour sales.
Other sales increased 36% because of a 58% increase in wholesale sales due
principally to the hot summer and good availability of our generating units.
Weather accounted for approximately $24 million of the $41 million increase in
1995 base rate revenues. Higher 1995 fuel cost recovery revenues resulted from
an increase in the fuel cost factors. The weighted average of these fuel cost
factors increased approximately 7%. Miscellaneous revenues decreased in 1995
primarily because the 1994 amount included the billings to other utility owners
and lessees for overhead expenses related to the 1994 refueling and maintenance
outage of the jointly owned Perry Unit 1.
For 1995, operating revenues were 32% residential, 32% commercial, 29%
industrial and 7% other, and kilowatt-hour sales were 24% residential, 28%
commercial, 38% industrial and 10% other. The average prices per kilowatt-hour
for residential, commercial and industrial customers were 11.04, 9.47 and 6.54
cents, respectively. The changes from 1994 were not significant.
Operating expenses increased 5.3% in 1995. Fuel and purchased power expenses
increased as higher fuel expense was partially offset by lower purchased power
expense. The higher fuel expense was attributable to increased generation and
more amortization of previously deferred fuel costs than the amount amortized in
1994. The higher other operation and maintenance expenses resulted primarily
from charges for an ongoing inventory reduction program and the recognition of
costs associated with preliminary engineering studies. Federal income taxes
increased as a result of higher pretax operating income. Taxes, other than
federal income taxes, increased primarily due to property tax increases
resulting from plant additions, real estate valuation increases and a
nonrecurring tax credit recorded in 1994.
F-9
<PAGE> 75
REPORT OF INDEPENDENT
PUBLIC ACCOUNTANTS
To the Share Owners and
Board of Directors of
The Cleveland Electric Illuminating Company:
We have audited the accompanying consolidated balance sheet and consolidated
statement of capitalization of The Cleveland Electric Illuminating Company (a
wholly owned subsidiary of Centerior Energy Corporation) and subsidiaries as of
December 31, 1996 and 1995, and the related consolidated statements of income,
retained earnings and cash flows for each of the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of The Cleveland Electric
Illuminating Company and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Cleveland, Ohio
February 14, 1997
F-10
<PAGE> 76
INCOME STATEMENT The Cleveland Electric Illuminating Company and Subsidiaries
<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------
1996 1995 1994
------ ------ ------
(millions of dollars)
<S> <C> <C> <C>
OPERATING REVENUES_________________________________________________ $1,790 $1,769 $1,698
------ ------ ------
OPERATING EXPENSES
Fuel and purchased power (1)_____________________________________ 408 413 391
Other operation and maintenance__________________________________ 426 418 394
Generation facilities rental expense, net________________________ 56 56 56
------ ------ ------
Total operation and maintenance_______________________________ 890 887 841
Depreciation and amortization____________________________________ 210 196 195
Taxes, other than federal income taxes___________________________ 230 230 218
Amortization of deferred operating expenses, net_________________ 26 (36) (34)
Federal income taxes_____________________________________________ 75 94 82
------ ------ ------
1,431 1,371 1,302
------ ------ ------
OPERATING INCOME___________________________________________________ 359 398 396
------ ------ ------
NONOPERATING INCOME (LOSS)
Allowance for equity funds used during construction______________ 2 2 4
Other income and deductions, net_________________________________ (10) 2 6
Deferred carrying charges________________________________________ -- 29 25
Federal income taxes--credit (expense)___________________________ 6 (2) (4)
------ ------ ------
(2) 31 31
------ ------ ------
INCOME BEFORE INTEREST CHARGES_____________________________________ 357 429 427
------ ------ ------
INTEREST CHARGES
Debt interest____________________________________________________ 242 248 247
Allowance for borrowed funds used during construction____________ (2) (3) (5)
------ ------ ------
240 245 242
------ ------ ------
NET INCOME_________________________________________________________ 117 184 185
PREFERRED DIVIDEND REQUIREMENTS____________________________________ 39 43 45
------ ------ ------
EARNINGS AVAILABLE FOR COMMON STOCK________________________________ $ 78 $ 141 $ 140
====== ====== ======
</TABLE>
- ---------------
(1) Includes purchased power expense of $105 million, $102 million and $111
million in 1996, 1995 and 1994, respectively, for all purchases from Toledo
Edison.
RETAINED EARNINGS
<TABLE>
<CAPTION>
For the years ended
December 31,
-------------------------
1996 1995 1994
----- ----- -----
(millions of dollars)
<S> <C> <C> <C>
RETAINED EARNINGS (DEFICIT) AT BEGINNING OF YEAR___________________ $(193) $(262) $(280)
----- ----- -----
ADDITIONS
Net income_______________________________________________________ 117 184 185
DEDUCTIONS
Dividends declared:
Common stock__________________________________________________ (161) (74) (122)
Preferred stock_______________________________________________ (39) (41) (45)
----- ----- -----
Net Increase (Decrease)_____________________________________ (83) 69 18
----- ----- -----
RETAINED EARNINGS (DEFICIT) AT END OF YEAR_________________________ $(276) $(193) $(262)
===== ===== =====
</TABLE>
The accompanying notes are an integral part of these statements.
F-11
<PAGE> 77
BALANCE SHEET
<TABLE>
<CAPTION>
December 31,
----------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C>
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Utility plant in service_________________________________________________________ $6,938 $6,872
Less: accumulated depreciation and amortization_______________________________ 2,252 2,094
------- -------
4,686 4,778
Construction work in progress____________________________________________________ 57 73
------- -------
4,743 4,851
Nuclear fuel, net of amortization________________________________________________ 113 122
Other property, less accumulated depreciation____________________________________ 54 58
------- -------
4,910 5,031
------- -------
CURRENT ASSETS
Cash and temporary cash investments______________________________________________ 30 70
Amounts due from customers and others, net_______________________________________ 181 152
Amounts due from affiliates______________________________________________________ 6 5
Unbilled revenues________________________________________________________________ 9 79
Materials and supplies, at average cost
Owned_________________________________________________________________________ 52 101
Under consignment_____________________________________________________________ 24 --
Taxes applicable to succeeding years_____________________________________________ 182 184
Other____________________________________________________________________________ 14 7
------- -------
498 598
------- -------
REGULATORY AND OTHER ASSETS
Regulatory assets________________________________________________________________ 1,350 1,398
Nuclear plant decommissioning trusts_____________________________________________ 76 61
Other____________________________________________________________________________ 44 64
------- -------
1,470 1,523
------- -------
Total Assets________________________________________________________________ $6,878 $7,152
======= =======
</TABLE>
The accompanying notes are an integral part of this statement.
F-12
<PAGE> 78
The Cleveland Electric Illuminating Company and Subsidiaries
<TABLE>
<CAPTION>
December 31,
----------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C>
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common stock equity______________________________________________________________ $1,045 $1,127
Preferred stock
With mandatory redemption provisions__________________________________________ 186 215
Without mandatory redemption provisions_______________________________________ 238 241
Long-term debt___________________________________________________________________ 2,441 2,666
------ ------
3,910 4,249
------ ------
CURRENT LIABILITIES
Current portion of long-term debt and preferred stock____________________________ 145 177
Current portion of nuclear fuel lease obligations________________________________ 52 55
Accounts payable_________________________________________________________________ 83 89
Accounts and notes payable to affiliates_________________________________________ 171 64
Accrued taxes____________________________________________________________________ 316 296
Accrued interest_________________________________________________________________ 52 59
Other____________________________________________________________________________ 59 56
------ ------
878 796
------ ------
DEFERRED CREDITS AND OTHER LIABILITIES
Unamortized investment tax credits_______________________________________________ 176 184
Accumulated deferred federal income taxes________________________________________ 1,306 1,298
Unamortized gain from Bruce Mansfield Plant sale_________________________________ 296 311
Accumulated deferred rents for Bruce Mansfield Plant_____________________________ 99 92
Nuclear fuel lease obligations___________________________________________________ 74 86
Retirement benefits______________________________________________________________ 73 65
Other____________________________________________________________________________ 66 71
------ ------
2,090 2,107
------ ------
Total Capitalization and Liabilities________________________________________ $6,878 $7,152
====== ======
</TABLE>
F-13
<PAGE> 79
CASH FLOWS The Cleveland Electric Illuminating Company and Subsidiaries
<TABLE>
<CAPTION>
For the years ended
December 31,
-------------------------
1996 1995 1994
----- ----- -----
(millions of dollars)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES (1)
Net Income________________________________________________________________ $ 117 $ 184 $ 185
------ ------ ------
Adjustments to Reconcile Net Income to Cash from Operating Activities:
Depreciation and amortization__________________________________________ 210 196 195
Deferred federal income taxes__________________________________________ 25 56 50
Unbilled revenues______________________________________________________ 5 (7) 27
Deferred fuel__________________________________________________________ 7 9 (20)
Deferred carrying charges______________________________________________ -- (29) (25)
Leased nuclear fuel amortization_______________________________________ 46 71 55
Amortization of deferred operating expenses, net_______________________ 26 (36) (34)
Allowance for equity funds used during construction____________________ (2) (2) (4)
Changes in amounts due from customers and others, net__________________ (4) (6) 10
Net proceeds from accounts receivable securitization___________________ 65 -- --
Changes in materials and supplies______________________________________ 25 10 2
Changes in accounts payable____________________________________________ (6) 1 (34)
Changes in working capital affecting operations________________________ 11 (17) 3
Other noncash items____________________________________________________ (7) -- 4
------ ------ ------
Total Adjustments____________________________________________________ 401 246 229
------ ------ ------
Net Cash from Operating Activities________________________________ 518 430 414
------ ------ ------
CASH FLOWS FROM FINANCING ACTIVITIES (2)
Notes payable to affiliates_______________________________________________ 107 (53) 58
First mortgage bond issues________________________________________________ -- 443 46
Maturities, redemptions and sinking funds_________________________________ (290) (460) (116)
Nuclear fuel lease obligations____________________________________________ (52) (58) (60)
Dividends paid____________________________________________________________ (200) (117) (142)
Premiums, discounts and expenses__________________________________________ (1) (11) (1)
------ ------ ------
Net Cash from Financing Activities________________________________ (436) (256) (215)
------ ------ ------
CASH FLOWS FROM INVESTING ACTIVITIES (2)
Cash applied to construction______________________________________________ (104) (148) (164)
Interest capitalized as allowance for borrowed funds used during
construction___________________________________________________________ (2) (3) (5)
Contributions to nuclear plant decommissioning trusts_____________________ (12) (13) (14)
Other cash applied________________________________________________________ (4) (6) (27)
------ ------ ------
Net Cash from Investing Activities________________________________ (122) (170) (210)
------ ------ ------
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS___________________________ (40) 4 (11)
------ ------ ------
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF YEAR____________________ 70 66 77
------ ------ ------
CASH AND TEMPORARY CASH INVESTMENTS AT END OF YEAR__________________________ $ 30 $ 70 $ 66
====== ====== ======
- ---------------
(1) Interest paid (net of amounts capitalized)______________________________ $ 237 $ 214 $ 208
====== ====== ======
Federal income taxes paid______________________________________________ $ 30 $ 66 $ 15
====== ====== ======
(2) Increases in Nuclear Fuel and Nuclear Fuel Lease Obligations in the Balance
Sheet resulting from the noncash capitalizations under nuclear fuel
agreements are excluded from this statement.
</TABLE>
The accompanying notes are an integral part of this statement.
F-14
<PAGE> 80
STATEMENT OF CAPITALIZATION
The Cleveland Electric Illuminating Company and Subsidiaries
<TABLE>
<CAPTION>
December 31,
-----------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C> <C> <C> <C> <C>
COMMON STOCK EQUITY:
Common shares, without par value: 105 million authorized; 79.6 million outstanding in 1996
and 1995________________________________________________________________________________ $1,241 $1,241
Other paid-in capital_____________________________________________________________________ 80 79
Retained earnings (deficit)_______________________________________________________________ (276) (193)
------ ------
Total Common Stock Equity_____________________________________________________________ 1,045 1,127
------ ------
</TABLE>
<TABLE>
<CAPTION>
Current
1996 Shares Call Price
Outstanding Per Share
----------- ----------
<S> <C> <C> <C> <C> <C> <C>
PREFERRED STOCK:
Without par value, 4,000,000 preferred shares authorized
Subject to mandatory redemption:
$ 7.35 Series C___________________________ 120,000 $ 101.00 12 13
88.00 Series E___________________________ 12,000 1,011.48 12 15
9.125 Series N___________________________ 150,000 100.00 15 30
91.50 Series Q___________________________ 53,572 1,000.00 54 64
88.00 Series R___________________________ 50,000 -- 50 50
90.00 Series S___________________________ 74,000 -- 73 73
------ ------
216 245
Less: Current maturities 30 30
------ ------
Total Preferred Stock, with Mandatory Redemption
Provisions_____________________________________________ 186 215
------ ------
Not subject to mandatory redemption:
$ 7.40 Series A___________________________ 500,000 101.00 50 50
7.56 Series B___________________________ 450,000 102.26 45 45
Adjustable Series L___________________________ 474,000 100.00 46 49
42.40 Series T___________________________ 200,000 -- 97 97
------ ------
Total Preferred Stock, without Mandatory Redemption
Provisions_____________________________________________ 238 241
------ ------
LONG-TERM DEBT:
First mortgage bonds:
7.625% due 2002_______________________________________________________________________ 195 245
7.375% due 2003_______________________________________________________________________ 100 100
9.500% due 2005_______________________________________________________________________ 300 300
8.750% due 2005_______________________________________________________________________ 75 75
10.880% due 2006_______________________________________________________________________ -- 50
9.250% due 2009_______________________________________________________________________ 50 50
8.375% due 2011_______________________________________________________________________ 125 125
8.375% due 2012_______________________________________________________________________ 75 75
9.375% due 2017_______________________________________________________________________ 300 300
10.000% due 2020_______________________________________________________________________ 100 100
9.000% due 2023_______________________________________________________________________ 150 150
------ ------
1,470 1,570
------ ------
Tax-exempt issues secured by first mortgage bonds:
7.000% due 2006-2009__________________________________________________________________ 64 64
6.000% due 2011**_____________________________________________________________________ 6 6
6.000% due 2011**_____________________________________________________________________ 2 2
6.200% due 2013_______________________________________________________________________ 48 48
8.000% due 2013_______________________________________________________________________ 79 79
3.500% due 2015**_____________________________________________________________________ 40 40
6.000% due 2017**_____________________________________________________________________ 1 1
3.500% due 2018**_____________________________________________________________________ 73 73
6.000% due 2020**_____________________________________________________________________ 41 41
6.000% due 2020**_____________________________________________________________________ 9 9
9.750% due 2022***____________________________________________________________________ 70 70
6.850% due 2023_______________________________________________________________________ 30 30
8.000% due 2023_______________________________________________________________________ 73 73
7.625% due 2025_______________________________________________________________________ 54 54
7.750% due 2025_______________________________________________________________________ 45 45
7.700% due 2025_______________________________________________________________________ 44 44
------ ------
679 679
------ ------
</TABLE>
The accompanying notes are an integral part of this statement.
F-15
<PAGE> 81
STATEMENT OF CAPITALIZATION (CONTINUED)
<TABLE>
<CAPTION>
December 31,
---------------------
1996 1995
------ ------
(millions of dollars)
<S> <C> <C> <C>
LONG-TERM DEBT: (CONTINUED)
Medium-term notes secured by first mortgage bonds:
8.700% due 1996_________________________________________________________________________ -- 20
9.100% due 1996_________________________________________________________________________ -- 32
9.110% due 1996_________________________________________________________________________ -- 13
9.000% due 1996_________________________________________________________________________ -- 13
9.140% due 1996_________________________________________________________________________ -- 12
9.050% due 1996_________________________________________________________________________ -- 10
8.950% due 1996_________________________________________________________________________ -- 40
9.450% due 1997_________________________________________________________________________ 43 43
9.000% due 1998_________________________________________________________________________ 5 5
8.870% due 1998_________________________________________________________________________ 10 10
8.260% due 1998_________________________________________________________________________ 2 2
8.330% due 1998_________________________________________________________________________ 25 25
8.170% due 1998_________________________________________________________________________ 11 11
8.150% due 1998_________________________________________________________________________ 8 8
8.160% due 1998_________________________________________________________________________ 5 5
9.250% due 1999_________________________________________________________________________ 52 52
9.300% due 1999_________________________________________________________________________ 25 25
7.670% due 1999_________________________________________________________________________ 3 3
7.250% due 1999_________________________________________________________________________ 12 12
7.850% due 1999_________________________________________________________________________ 25 25
7.770% due 1999_________________________________________________________________________ 17 17
8.290% due 1999_________________________________________________________________________ 10 10
9.200% due 2001_________________________________________________________________________ 15 15
7.420% due 2001_________________________________________________________________________ 10 20
9.050% due 2001_________________________________________________________________________ 5 5
8.680% due 2001_________________________________________________________________________ 15 15
8.540% due 2001_________________________________________________________________________ 3 3
8.560% due 2001_________________________________________________________________________ 4 4
8.550% due 2001_________________________________________________________________________ 5 5
7.850% due 2002_________________________________________________________________________ 5 5
8.130% due 2002_________________________________________________________________________ 28 28
7.750% due 2003_________________________________________________________________________ 15 15
9.520% due 2021_________________________________________________________________________ 8 8
------ ------
366 516
------ ------
Tax-exempt notes:
6.500% due 1996_________________________________________________________________________ -- 3
5.500% due 1997_________________________________________________________________________ * *
6.700% due 2006_________________________________________________________________________ 20 21
5.700% due 2008_________________________________________________________________________ 7 8
6.700% due 2011_________________________________________________________________________ 6 6
5.875% due 2012_________________________________________________________________________ 14 14
------ ------
47 52
------ ------
Bank loans secured by subordinate mortgage:
7.500% due 1996_________________________________________________________________________ -- 2
------ ------
Unamortized premium (discount), net_________________________________________________________ (6) (6)
------ ------
2,556 2,813
Less: Current maturities__________________________________________________________________ 115 147
------ ------
Total Long-Term Debt____________________________________________________________________ 2,441 2,666
------ ------
TOTAL CAPITALIZATION________________________________________________________________________ $3,910 $4,249
====== ======
</TABLE>
- ---------------
* Denotes debt of less than $1 million.
** Denotes variable rate issue with December 31, 1996 interest rate shown.
*** Subject to optional tender by the owners on November 1, 1997.
F-16
<PAGE> 82
NOTES TO THE FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
(a) GENERAL
The Company is an electric utility serving Northeast Ohio and a wholly owned
subsidiary of Centerior Energy. The Company's financial statements have
historically included the accounts of the Company's wholly owned subsidiaries,
which in the aggregate were not material. In 1995, the Company formed a wholly
owned subsidiary, Centerior Funding, to serve as the transferor in connection
with an accounts receivable securitization completed in 1996 as discussed in
Note 1(j). In 1994, the Company transferred its investments in three wholly
owned subsidiaries to Centerior Energy at cost ($26 million) via property
dividends. All significant intercompany items have been eliminated in
consolidation.
The Company follows the Uniform System of Accounts prescribed by the FERC and
adopted by the PUCO. Rate-regulated utilities are subject to SFAS 71 which
governs accounting for the effects of certain types of rate regulation. Pursuant
to SFAS 71, certain incurred costs are deferred for recovery in future rates.
See Note 7(a).
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses, and
the disclosure of contingent assets and liabilities. The estimates are based on
an analysis of the best information available. Actual results could differ from
those estimates.
The Company is a member of the Central Area Power Coordination Group (CAPCO).
Other members are Toledo Edison, Duquesne Light Company, Ohio Edison and its
wholly owned subsidiary, Pennsylvania Power Company. The members have
constructed and operate generation and transmission facilities for their joint
use.
(b) RELATED PARTY TRANSACTIONS
Operating revenues, operating expenses and interest charges include those
amounts for transactions with affiliated companies in the ordinary course of
business operations.
The Company's transactions with Toledo Edison are primarily for firm power,
interchange power, transmission line rentals and jointly owned power plant
operations and construction. See Notes 2 and 3. As discussed in Note 1(j),
beginning in May 1996, Centerior Funding began serving as the transferor in
connection with the accounts receivable securitization for the Company and
Toledo Edison.
Centerior Service Company (Service Company), a wholly owned subsidiary of
Centerior Energy, provides management, financial, administrative, engineering,
legal and other services at cost to the Company and other affiliated companies.
The Service Company billed the Company $149 million, $141 million and $136
million in 1996, 1995 and 1994, respectively, for such services.
(c) REVENUES
Customers are billed on a monthly cycle basis for their energy consumption based
on rate schedules or contracts authorized by the PUCO. An accrual is made at the
end of each month to record the estimated amount of unbilled revenues for
kilowatt-hours sold in the current month but not billed by the end of that
month.
A fuel factor is added to the base rates for electric service. This factor is
designed to recover from customers the costs of fuel and most purchased power.
It is reviewed and adjusted semiannually in a PUCO proceeding. See Management's
Financial Analysis -- Outlook-FirstEnergy Rate Plan.
(d) FUEL EXPENSE
The cost of fossil fuel is charged to fuel expense based on inventory usage. The
cost of nuclear fuel, including an interest component, is charged to fuel
expense based on the rate of consumption. Estimated future nuclear fuel disposal
costs are being recovered through base rates.
The Company defers the differences between actual fuel costs and estimated fuel
costs currently being recovered from customers through the fuel factor. This
matches fuel expenses with fuel-related revenues.
Owners of nuclear generating plants are assessed by the federal government for
the cost of decontamination and decommissioning of nuclear enrichment facilities
operated by the United States Department of Energy. The assessments are based
upon the amount of enrichment services used in prior years and cannot be imposed
for more than 15 years (to 2007). The Company has accrued a liability for its
share of the total assessments. These costs have been recorded as a regulatory
asset since the PUCO is allowing the Company to recover the assessments through
its fuel cost factors. See Note 7(a).
(e) DEPRECIATION AND DECOMMISSIONING
The cost of property, plant and equipment is depreciated over their estimated
useful lives on a straight-line basis. In its April 1996 rate order, the PUCO
approved changes
F-17
<PAGE> 83
in depreciation rates for the Company. An increase in the depreciation rate for
nuclear property from 2.5% to 2.88% increased annual depreciation expense
approximately $13 million. A reduction in the composite depreciation rate for
nonnuclear property from 3.34% to 3.23% decreased annual depreciation expense by
approximately $3 million. The changes in depreciation rates were effective in
April 1996 and resulted in a $7 million net increase in 1996 depreciation
expense.
The Company accrues the estimated costs of decommissioning its three nuclear
generating units. The accruals are required to be funded in an external trust.
The PUCO requires that the expense and payments to the external trusts be
determined on a levelized basis by dividing the unrecovered decommissioning
costs in current dollars by the remaining years in the licensing period of each
unit. This methodology requires that the net earnings on the trusts be
reinvested therein with the intent of having net earnings offset inflation. The
PUCO requires that the estimated costs of decommissioning and the funding level
be reviewed at least every five years.
In April 1996, pursuant to the PUCO rate order, the Company decreased its annual
decommissioning expense accruals to $12 million from the $13 million level in
1995. The accruals are reflected in current rates. The accruals are based on
adjustments to updated, site-specific studies for each of the units completed in
1993 and 1994. These estimates reflect the DECON method of decommissioning
(prompt decontamination), and the locations and cost characteristics specific to
the units, and include costs associated with decontamination and dismantlement
for each of the units. The estimate for Davis-Besse also includes the cost of
site restoration. The adjustments to the updated studies which reduced the
annual accruals beginning in April 1996 were attributable to changed assumptions
on radioactive waste burial cost estimates and the exclusion of site restoration
costs for Perry Unit 1 and Beaver Valley Unit 2. After the decommissioning of
these units in the future, the two plant sites may be usable for new power
production facilities or other industrial purposes.
The revised estimates for the units in current dollars and in dollars at the
time of license expiration, assuming a 4% annual inflation rate, are as follows:
<TABLE>
<CAPTION>
License
Expiration Future
Generating Unit Year Amount Amount
- ---------------------------- ---------- ------ ------
(millions of
dollars)
<S> <C> <C> <C>
Davis-Besse_________________ 2017 $176 $ 451
Perry Unit 1________________ 2026 132 482
Beaver Valley Unit 2________ 2027 54 203
---- ------
Total_________________ $362 $1,136
==== ======
</TABLE>
The classification, Accumulated Depreciation and Amortization, in the Balance
Sheet at December 31, 1996 includes $85 million of decommissioning costs
previously expensed and the earnings on the external trust funding. This amount
exceeds the Balance Sheet amount of the external Nuclear Plant Decommissioning
Trusts because the reserve began prior to the external trust funding. The trust
earnings are recorded as an increase to the trust assets and the related
component of the decommissioning reserve (included in Accumulated Depreciation
and Amortization).
The staff of the Securities and Exchange Commission
has questioned certain of the current accounting practices of the electric
utility industry, including those of the Company, regarding the recognition,
measurement and classification of decommissioning costs for nuclear generating
stations in the financial statements. In response to these questions, the
Financial Accounting Standards Board (FASB) is reviewing the accounting for
removal costs, including decommissioning. If current accounting practices are
changed, the annual provision for decommissioning could increase; the estimated
cost for decommissioning could be recorded as a liability rather than as
accumulated depreciation; and trust fund income from the external
decommissioning trusts could be reported as investment income rather than as a
reduction to decommissioning expense. The FASB issued an exposure draft on the
subject on February 7, 1996 and continues to review the subject.
(f) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at original cost less amounts
disallowed by the PUCO. Construction costs include related payroll taxes,
retirement benefits, fringe benefits, management and general overheads and
allowance for funds used during construction (AFUDC). AFUDC represents the
estimated composite debt and equity cost of funds used to finance construction.
This noncash allowance is credited to income. The AFUDC rate was 10.32% in 1996,
10.33% in 1995 and 9.68% in 1994.
Maintenance and repairs for plant and equipment are charged to expense as
incurred. The cost of replacing plant and equipment is charged to the utility
plant accounts. The cost of property retired plus removal costs, after deducting
any salvage value, is charged to the accumulated provision for depreciation.
F-18
<PAGE> 84
(g) DEFERRED GAIN FROM SALE OF UTILITY PLANT
The sale and leaseback transaction discussed in Note 2 resulted in a net gain
for the sale of the Bruce Mansfield Generating Plant (Mansfield Plant). The net
gain was deferred and is being amortized over the term of the leases. The
amortization and the lease expense amounts are reported in the Income Statement
as Generation Facilities Rental Expense, Net.
(h) INTEREST CHARGES
Debt Interest reported in the Income Statement does not include interest on
obligations for nuclear fuel under construction. That interest is capitalized.
See Note 6.
Losses and gains realized upon the reacquisition or redemption of long-term debt
are deferred, consistent with the regulatory rate treatment. See Note 7(a). Such
losses and gains are either amortized over the remainder of the original life of
the debt issue retired or amortized over the life of the new debt issue when the
proceeds of a new issue are used for the debt redemption. The amortizations are
included in debt interest expense.
(i) FEDERAL INCOME TAXES
The Company uses the liability method of accounting for income taxes in
accordance with SFAS 109. See Note 8. This method requires that deferred taxes
be recorded for all temporary differences between the book and tax bases of
assets and liabilities. The majority of these temporary differences are
attributable to property-related basis differences. Included in these basis
differences is the equity component of AFUDC, which will increase future tax
expense when it is recovered through rates. Since this component is not
recognized for tax purposes, the Company must record a liability for its tax
obligation. The PUCO permits recovery of such taxes from customers when they
become payable. Therefore, the net amount due from customers through rates has
been recorded as a regulatory asset and will be recovered over the lives of the
related assets. See Note 7(a).
Investment tax credits are deferred and amortized over the lives of the
applicable property as a reduction of depreciation expense.
(j) ACCOUNTS RECEIVABLE SECURITIZATION
In May 1996, the Company and Toledo Edison began to sell on a daily basis
substantially all of their retail customer accounts receivable and unbilled
revenue receivables to Centerior Funding pursuant to a five-year asset-backed
securitization agreement.
In July 1996, Centerior Funding completed a public sale of $150 million of
receivables-backed investor certificates in a transaction that qualifies for
sale accounting treatment for financial reporting purposes. Costs associated
with the sale totaling $5 million in 1996 are included in Other Income and
Deductions, Net in the Income Statement. These costs are expected to be $11
million annually over the remaining period.
(k) MATERIALS AND SUPPLIES
In December 1996, the Company sold substantially all of its materials and
supplies and fossil fuel inventories for certain generating units and other
storage locations to an independent entity at book value. The buyer now provides
all of these inventories under a consignment arrangement. In accordance with
SFAS 49 accounting for product financing arrangements, the inventories continue
to be reported as assets in the Balance Sheet even though the buyer owns the
inventories since the Company has guaranteed to be a buyer of last resort.
(2) UTILITY PLANT SALE AND LEASEBACK TRANSACTIONS
The Company and Toledo Edison are co-lessees of 18.26% (150 megawatts) of Beaver
Valley Unit 2 and 6.5% (51 megawatts), 45.9% (358 megawatts) and 44.38% (355
megawatts) of Units 1, 2 and 3 of the Mansfield Plant, respectively. These
leases extend through 2017 and are the result of sale and leaseback transactions
completed in 1987.
Under these leases, the Company and Toledo Edison are responsible for paying all
taxes, insurance premiums, operation and maintenance expenses, and all other
similar costs for their interests in the units sold and leased back. They may
incur additional costs in connection with capital improvements to the units. The
Company and Toledo Edison have options to buy the interests back at certain
times at a premium and at the end of the leases for the fair market value at
that time or to renew the leases. The leases include conditions for mandatory
termination (and possible repurchase of the leasehold interests) upon certain
events of default.
As co-lessee with Toledo Edison, the Company is also obligated for Toledo
Edison's lease payments. If Toledo Edison is unable to make its payments under
the Beaver Valley Unit 2 and Mansfield Plant leases, the Company would be
obligated to make such payments. No such payments have been made on behalf of
Toledo Edison.
F-19
<PAGE> 85
Future minimum lease payments under the operating leases at December 31, 1996
are summarized as follows:
<TABLE>
<CAPTION>
For For
the Toledo
Year Company Edison
- --------------------------------------- ------- -------
(millions of
dollars)
<S> <C> <C>
1997_________________________________ $ 63 $ 102
1998_________________________________ 63 102
1999_________________________________ 70 108
2000_________________________________ 76 111
2001_________________________________ 75 111
Later Years__________________________ 1,170 1,696
------ ------
Total Future Minimum Lease
Payments_____________________ $1,517 $2,230
====== ======
</TABLE>
Rental expense is accrued on a straight-line basis over the terms of the leases.
The amount recorded in 1996, 1995 and 1994 as annual rental expense for the
Mansfield Plant leases was $70 million. See Note 1(g). Amounts charged to
expense in excess of the lease payments are classified as Accumulated Deferred
Rents in the Balance Sheet.
The Company is buying 150 megawatts of Toledo Edison's Beaver Valley Unit 2
leased capacity entitlement. Purchased power expense for this transaction was
$99 million, $98 million and $108 million in 1996, 1995 and 1994, respectively.
We anticipate that this purchase will continue indefinitely. The future minimum
lease payments through 2017 associated with Beaver Valley Unit 2 aggregate
$1.265 billion.
(3) PROPERTY OWNED WITH OTHER UTILITIES AND INVESTORS
The Company owns, as a tenant in common with other utilities and those investors
who are owner-participants in various sale and leaseback transactions (Lessors),
certain generating units as listed below. Each owner owns an undivided share in
the entire unit. Each owner has the right to a percentage of the generating
capability of each unit equal to its ownership share. Each utility owner is
obligated to pay for only its respective share of the construction costs and
operating expenses. Each Lessor has leased its capacity rights to a utility
which is obligated to pay for such Lessor's share of the construction costs and
operating expenses. The Company's share of the operating expenses of these
generating units is included in the Income Statement. The Balance Sheet
classification of Property, Plant and Equipment at December 31, 1996 includes
the following facilities owned by the Company as a tenant in common with other
utilities and Lessors:
<TABLE>
<CAPTION>
Property,
Plant and
Ownership Equipment
Megawatts (Exclusive of Accumulated
Generating Unit (% Share) Nuclear Fuel) Depreciation
- ------------------------ ---------- ------------- -----------
(millions of dollars)
<S> <C> <C> <C>
Seneca Pumped Storage___ 351 (80.00%) $ 65 $ 24
Eastlake Unit 5_________ 411 (68.80) 161 --
Davis-Besse_____________ 454 (51.38) 711 250
Perry Unit 1____________ 371 (31.11) 1,774 392
Beaver Valley Unit 2 and
Common Facilities (Note
2)_____________________ 201 (24.47) 1,279 319
------ ------
Total_____________ $ 3,990 $ 985
====== ======
</TABLE>
Depreciation for Eastlake Unit 5 has been accumulated with all other nonnuclear
depreciable property rather than by specific units of depreciable property.
(4) CONSTRUCTION AND CONTINGENCIES
(a) CONSTRUCTION PROGRAM
The estimated cost of the Company's construction program for the 1997-2001
period is $624 million, including AFUDC of $17 million and excluding nuclear
fuel.
The Clean Air Act Amendments of 1990 (Clean Air Act) require, among other
things, significant reductions in the emission of sulfur dioxide and nitrogen
oxides by fossil-fueled generating units. Our strategy provides for compliance
primarily through greater use of low-sulfur coal at some of our units and the
use of emission allowances. Total capital expenditures from 1994 through 1996 in
connection with Clean Air Act compliance amounted to $32 million. The plan will
require additional capital expenditures over the 1997-2006 period of
approximately $25 million for nitrogen oxide control equipment and other plant
process modifications. In addition, higher fuel and other operation and
maintenance expenses will be incurred. Recently proposed particulate and ozone
ambient standards have the potential to increase future compliance costs.
(b) HAZARDOUS WASTE DISPOSAL SITES
The Company is aware of its potential involvement in the cleanup of three sites
listed on the Superfund List and several other sites. The Company has accrued a
liability totaling $7 million at December 31, 1996 based on estimates of the
costs of cleanup and its proportionate responsibility for such costs. We believe
that the ultimate outcome of these matters will not have a material adverse
effect on our financial condition, cash flows or results of operations. See
Management's Financial Analysis -- Outlook-Hazardous Waste Disposal Sites.
F-20
<PAGE> 86
(5) NUCLEAR OPERATIONS AND CONTINGENCIES
(a) OPERATING NUCLEAR UNITS
The Company's three nuclear units may be impacted by activities or events beyond
our control. An extended outage of one of our nuclear units for any reason,
coupled with any unfavorable rate treatment, could have a material adverse
effect on our financial condition, cash flows and results of operations. See the
discussion of these and other risks in Management's Financial
Analysis -- Outlook-Nuclear Operations.
(b) NUCLEAR INSURANCE
The Price-Anderson Act limits the public liability of the owners of a nuclear
power plant to the amount provided by private insurance and an industry
assessment plan. In the event of a nuclear incident at any unit in the United
States resulting in losses in excess of the level of private insurance
(currently $200 million), the Company's maximum potential assessment under that
plan would be $85 million per incident. The assessment is limited to $11 million
per year for each nuclear incident. These assessment limits assume the other
CAPCO companies contribute their proportionate share of any assessment for the
generating units that they have an ownership or leasehold interest in.
The utility owners and lessees of Davis-Besse, Perry and Beaver Valley also have
insurance coverage for damage to property at these sites (including leased fuel
and cleanup costs). Coverage amounted to $1.3 billion for Davis-Besse and $2.75
billion for each of the Perry and Beaver Valley sites as of January 1, 1997.
Damage to property could exceed the insurance coverage by a substantial amount.
If it does, the Company's share of such excess amount could have a material
adverse effect on its financial condition, cash flows and results of operations.
In addition, the Company can be assessed a maximum of $12 million under these
policies during a policy year if the reserves available to the insurer are
inadequate to pay claims arising out of an accident at any nuclear facility
covered by the insurer.
The Company also has extra expense insurance coverage. It includes the
incremental cost of any replacement power purchased (over the costs which would
have been incurred had the units been operating) and other incidental expenses
after the occurrence of certain types of accidents at our nuclear units. The
amounts of the coverage are 100% of the estimated extra expense per week during
the 52-week period starting 21 weeks after an accident and 80% of such estimate
per week for the next
104 weeks. The amount and duration of extra expense could substantially exceed
the insurance coverage.
(6) NUCLEAR FUEL
Nuclear fuel is financed for the Company and Toledo Edison through leases with a
special-purpose corporation. The total amount of financing currently available
under these lease arrangements is $273 million ($173 million from
intermediate-term notes and $100 million from bank credit arrangements). The
intermediate-term notes mature in the 1997 through 2000 period. The bank credit
arrangements terminate in October 1998. The special-purpose corporation may not
need alternate financing in 1997 to replace $83 million of maturing
intermediate-term notes. At December 31, 1996, $129 million of nuclear fuel was
financed for the Company. The Company and Toledo Edison severally lease their
respective portions of the nuclear fuel and are obligated to pay for the fuel as
it is consumed in a reactor. The lease rates are based on various
intermediate-term note rates, bank rates and commercial paper rates.
The amounts financed include nuclear fuel in the Davis-Besse, Perry Unit 1 and
Beaver Valley Unit 2 reactors with remaining lease payments for the Company of
$49 million, $51 million and $18 million, respectively, at December 31, 1996.
The nuclear fuel amounts financed and capitalized also included interest charges
incurred by the lessors amounting to $3 million in 1996, $4 million in 1995 and
$7 million in 1994. The estimated future lease amortization payments for the
Company based on projected consumption are $52 million in 1997, $40 million in
1998, $38 million in 1999, $35 million in 2000 and $34 million in 2001.
(7) REGULATORY MATTERS
(a) REGULATORY ACCOUNTING REQUIREMENTS AND REGULATORY ASSETS
The Company is subject to the provisions of SFAS 71 and has complied with its
provisions. SFAS 71 provides, among other things, for the deferral of certain
incurred costs that are probable of future recovery in rates. We monitor changes
in market and regulatory conditions and consider the effects of such changes in
assessing the continuing applicability of SFAS 71. Criteria that could give rise
to discontinuation of the application of SFAS 71 include: (1) increasing
competition which significantly restricts the Company's ability to charge prices
which allow it to recover operating costs, earn a fair return on invested
capital and recover the amortization of regulatory assets and (2) a significant
change in the manner in which rates are set by the PUCO from cost-based
regulation to some other form of regulation. Regulatory assets
F-21
<PAGE> 87
represent probable future revenues to the Company associated with certain
incurred costs, which it will recover from customers through the rate-making
process.
Effective January 1, 1996, the Company adopted SFAS 121 which imposes stricter
criteria for carrying regulatory assets than SFAS 71 by requiring that such
assets be probable of recovery at each balance sheet date. The criteria under
SFAS 121 for plant assets require such assets to be written down if the book
value exceeds the projected net future undiscounted cash flows.
Regulatory assets in the Balance Sheet are as follows:
<TABLE>
<CAPTION>
December 31,
---------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C>
Amounts due from customers for future federal
income taxes, net__________________________ $ 634 $ 651
Unamortized loss on reacquired debt__________ 58 61
Pre-phase-in deferrals*______________________ 320 331
Rate Stabilization Program deferrals_________ 300 313
Other________________________________________ 38 42
------ ------
Total____________________________________ $1,350 $1,398
====== ======
</TABLE>
* Represent deferrals of operating expenses and carrying charges for Perry Unit
1 and Beaver Valley Unit 2 in 1987 and 1988 which are being amortized over the
lives of the related property.
As of December 31, 1996, customer rates provide for recovery of all the above
regulatory assets. The remaining recovery periods for about $1.2 billion of the
regulatory assets approximate 30 years. The remaining recovery periods for the
rest of the regulatory assets generally range from about two to 20 years.
Regulatory liabilities in the Balance Sheet at December 31, 1996 and 1995
totaled $24 million and $17 million, respectively.
(b) RATE ORDER
On April 11, 1996, the PUCO issued an order for the Company and Toledo Edison
granting price increases aggregating $119 million in annualized revenues ($84
million for the Company and $35 million for Toledo Edison). The PUCO rate order
provided for recovery of all costs to provide regulated services, including
amortization of regulatory assets, in the approved prices. The new prices were
implemented in late April 1996. The average price increase for the Company's
customers was 4.9% with the actual percentage increase depending upon the
customer class. The Company and Toledo Edison intend to freeze prices through at
least 2002, although they are not precluded from requesting further price
increases.
The PUCO also recommended that the Company and Toledo Edison reduce the value of
their assets for regulatory purposes by an aggregate $1.25 billion through 2001.
This represents an incremental reduction beyond the normal level in nuclear
plant and regulatory assets. Implementation of the price increases was not
contingent upon a revaluation of assets. The PUCO invited the Company and Toledo
Edison to file a proposal to effectuate the PUCO's recommendation and expressed
a willingness to consider alternatives to its recommendation. The PUCO stated in
its order that failure by the Company and Toledo Edison to follow the
recommendation could result in a PUCO-ordered write-down of assets for
regulatory purposes. The PUCO approved a return on common stock equity of 12.59%
and an overall rate of return of 10.06% for both companies. However, the PUCO
also indicated the authorized return could be lowered by the PUCO if the Company
and Toledo Edison do not implement the recommendation. In August 1996, various
intervenors appealed the PUCO rate order to the Ohio Supreme Court. The Company
and Toledo Edison did not appeal the order to the Ohio Supreme Court. In
connection with the PUCO order discussed in Management's Financial
Analysis -- Outlook-FirstEnergy Rate Plan, certain parties agreed to request a
stay of their appeals until completion of the pending merger with Ohio Edison.
(c) ASSESSMENT
The Company and Toledo Edison agree with the concept of accelerating the
recognition of costs and recovery of assets as such concept is consistent with
the strategic objective to become more competitive. However, the Company and
Toledo Edison believe that such acceleration must also be consistent with the
reduction of debt and the opportunity for Centerior Energy common stock share
owners to receive a fair return on their investment. Consideration of whether to
implement a plan responsive to the PUCO's recommendation to revalue assets by
$1.25 billion is pending the merger with Ohio Edison.
We have evaluated the Company's markets, regulatory conditions and ability to
bill and collect the approved prices, and conclude that the Company continues to
comply with the provisions of SFAS 71 and its regulatory assets remain probable
of recovery. If there is a change in our evaluation of the competitive
environment, regulatory framework or other factors, or if the PUCO significantly
reduces the value of the Company's assets or reduces the approved return on
common stock equity of 12.59% and overall rate of return of 10.06%, or both, for
future regulatory purposes, the Company may be required to record material
charges to earnings. In particular, if we determine that the Company no longer
meets the criteria for SFAS 71, the Company would be required to record a
before-tax charge to write off the regulatory assets shown above. In the more
likely event that only a portion of operations (such as nuclear operations) no
longer meets the criteria of SFAS 71, a write-off would be limited to regulatory
assets that are not reflected in the Company's cost-based prices established for
the remaining regulated
F-22
<PAGE> 88
operations. In addition, we would be required to evaluate whether the changes in
the competitive and regulatory environment which led to discontinuing the
application of SFAS 71 to some or all of the Company's operations would also
result in a write-down of property, plant and equipment pursuant to SFAS 121.
See Management's Financial Analysis -- Outlook-FirstEnergy Rate Plan for a
discussion of a regulatory plan for the Company and Toledo Edison and its effect
on their compliance with SFAS 71.
(d) RATE STABILIZATION PROGRAM
The Rate Stabilization Program that the PUCO approved in October 1992 allowed
the Company to defer and subsequently amortize and recover certain costs not
being recovered in rates at that time. Recovery of both the costs no longer
being deferred and the amortization of the 1992-1995 deferrals began in late
April 1996 with the implementation of the price increase granted by the PUCO as
discussed above. The cost deferrals recorded in 1995 and 1994 pursuant to the
Rate Stabilization Program were $76 million and $70 million, respectively. The
amortization of the deferrals began in December 1995. The total amortization was
$12 million and $1 million in 1996 and 1995, respectively.
The regulatory accounting measures under the Rate Stabilization Program also
provided for the accelerated amortization of certain benefits during the
1992-1995 period. The total annual amount of such accelerated benefits was $28
million in both 1995 and 1994.
(8) FEDERAL INCOME TAX
The components of federal income tax expense recorded in the Income Statement
were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Operating Expenses:
Current______________________________ $ 55 $49 $ 53
Deferred_____________________________ 20 45 29
---- ---- ----
Total Charged to Operating
Expenses_________________________ 75 94 82
---- ---- ----
Nonoperating Income:
Current______________________________ (11) (9) (17)
Deferred_____________________________ 5 11 21
---- ---- ----
Total Expense (Credit) to
Nonoperating Income______________ (6) 2 4
---- ---- ----
Total Federal Income Tax Expense_______ $ 69 $96 $ 86
==== ==== ====
</TABLE>
The deferred federal income tax expense results from the temporary differences
that arise from the different years when certain expenses are recognized for tax
purposes as opposed to financial reporting purposes. Such temporary differences
relate principally to depreciation and deferred operating expenses and carrying
charges.
Federal income tax, computed by multiplying income before taxes by the 35%
statutory rate, is reconciled to the amount of federal income tax recorded on
the books as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Book Income Before Federal Income Tax__ $186 $280 $271
---- ---- ----
Tax on Book Income at Statutory Rate___ $ 65 $ 98 $ 95
Increase (Decrease) in Tax:
Depreciation_________________________ 8 8 6
Rate Stabilization Program___________ -- (18) (18)
Other items__________________________ (4) 8 3
---- ---- ----
Total Federal Income Tax Expense_______ $ 69 $ 96 $ 86
==== ==== ====
</TABLE>
The Company joins in the filing of a consolidated federal income tax return with
its affiliated companies. The method of tax allocation reflects the benefits and
burdens realized by each company's participation in the consolidated tax return,
approximating a separate return result for each company.
For tax reporting purposes, the Perry Nuclear Power Plant Unit 2 (Perry Unit 2)
abandonment was recognized in 1994 and resulted in a $204 million loss with a
corresponding $71 million reduction in federal income tax liability. Because of
the alternative minimum tax (AMT), $40 million of the $71 million was realized
in 1994. The remaining $31 million will not be realized until 1999.
Additionally, a repayment of approximately $29 million of previously allowed
investment tax credits was recognized in 1994.
Under SFAS 109, temporary differences and carryforwards resulted in deferred tax
assets of $420 million and deferred tax liabilities of $1.726 billion at
December 31, 1996 and deferred tax assets of $425 million and deferred tax
liabilities of $1.723 billion at December 31, 1995. These are summarized as
follows:
<TABLE>
<CAPTION>
December 31,
---------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C>
Property, plant and equipment________________ $1,482 $1,468
Deferred carrying charges and operating
expenses___________________________________ 134 139
Net operating loss carryforwards_____________ (26) (67)
Investment tax credits_______________________ (95) (99)
Sale and leaseback transactions______________ (121) (123)
Other________________________________________ (68) (20)
------ ------
Net deferred tax liability_______________ $1,306 $1,298
====== ======
</TABLE>
For tax purposes, net operating loss (NOL) carryforwards of approximately $74
million are available to reduce future taxable income and will expire in 2009.
The 35% tax effect of the NOLs is $26 million. Additionally, AMT credits of $174
million that may be carried forward indefinitely are available to reduce future
tax.
F-23
<PAGE> 89
(9) RETIREMENT BENEFITS
(a) RETIREMENT INCOME PLAN
Centerior Energy sponsors jointly with its subsidiaries a noncontributing
pension plan (Centerior Pension Plan) which covers all employee groups. The
amount of retirement benefits generally depends upon the length of service.
Under certain circumstances, benefits can begin as early as age 55. The funding
policy is to comply with the Employee Retirement Income Security Act of 1974
guidelines.
Pension costs (credits) for Centerior Energy and its subsidiaries for 1994
through 1996 were comprised of the following components:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Service cost for benefits earned during
the period___________________________ $ 13 $ 10 $ 13
Interest cost on projected benefit
obligation___________________________ 28 26 26
Actual return on plan assets___________ (50) (53) (2)
Net amortization and deferral__________ 2 9 (34)
--- --- ---
Net costs (credits)__________________ $ (7) $ (8) $ 3
=== === ===
</TABLE>
Pension costs (credits) for the Company and its pro rata share of the Service
Company's costs were $(5) million for both 1996 and 1995, and $2 million for
1994.
The following table presents a reconciliation of the funded status of the
Centerior Pension Plan. The Company's share of the Centerior Pension Plan's
total projected benefit obligation approximates 50%.
<TABLE>
<CAPTION>
December 31,
-------------
1996 1995
---- ----
(millions of
dollars)
<S> <C> <C>
Actuarial present value of benefit
obligations:
Vested benefits___________________________ $326 $304
Nonvested benefits________________________ 16 2
---- ----
Accumulated benefit obligation__________ 342 306
Effect of future compensation levels______ 53 54
---- ----
Total projected benefit obligation______ 395 360
Plan assets at fair market value____________ 421 394
---- ----
Funded status___________________________ 26 34
Unrecognized net gain from variance between
assumptions and experience________________ (56) (68)
Unrecognized prior service cost_____________ 14 15
Transition asset at January 1, 1987 being
amortized over 19 years___________________ (32) (36)
---- ----
Net accrued pension liability___________ $(48) $(55)
==== ====
</TABLE>
A September 30 measurement date was used for 1996 and 1995 reporting. At
December 31, 1996, the settlement (discount) rate and long-term rate of return
on plan assets assumptions were 7.75% and 11%, respectively. The long-term rate
of annual compensation increase assumption was 3.5% for 1997 and 4% thereafter.
At December 31, 1995, the settlement rate and long-term rate of return on plan
assets assumptions were 8% and 11%, respectively. The long-term rate of annual
compensation increase assumption was 3.5% for 1996 and 1997 and 4% thereafter.
At December 31, 1996 and 1995, the Company's net prepaid pension cost included
in Regulatory and Other Assets -- Other in the Balance Sheet was $15 million and
$11 million, respectively.
Plan assets consist primarily of investments in common stock, bonds, guaranteed
investment contracts, cash equivalent securities and real estate.
(b) OTHER POSTRETIREMENT BENEFITS
Centerior Energy sponsors jointly with its subsidiaries a postretirement benefit
plan which provides all employee groups certain health care, death and other
postretirement benefits other than pensions. The plan is contributory, with
retiree contributions adjusted annually. The plan is not funded. Under SFAS 106,
the accounting standard for postretirement benefits other than pensions, the
expected costs of such benefits are accrued during the employees' years of
service.
The components of the total postretirement benefit costs for 1994 through 1996
were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Service cost for benefits earned during
the period___________________________ $ 1 $ 1 $ 1
Interest cost on accumulated
postretirement benefit obligation____ 12 11 11
Amortization of transition obligation
at January 1, 1993 of $104 million
over 20 years________________________ 5 5 5
Amortization of gain___________________ -- (1) --
--- --- ---
Total costs $18 $16 $17
=== === ===
</TABLE>
These amounts included costs for the Company and its pro rata share of the
Service Company's costs.
The accumulated postretirement benefit obligation and accrued postretirement
benefit cost for the Company and its share of the Service Company's obligation
are as follows:
<TABLE>
<CAPTION>
December 31,
-------------
1996 1995
----- -----
(millions of
dollars)
<S> <C> <C>
Accumulated postretirement benefit obligation
attributable to:
Retired participants_______________________ $(108) $(124)
Fully eligible active plan participants____ (3) (2)
Other active plan participants_____________ (21) (19)
----- -----
Accumulated postretirement benefit
obligation_____________________________ (132) (145)
Unrecognized net gain from variance between
assumptions and experience_________________ (31) (12)
Unamortized transition obligation____________ 74 79
----- -----
Accrued postretirement benefit cost______ $ (89) $ (78)
===== =====
</TABLE>
The Balance Sheet classification of Retirement Benefits at December 31, 1996 and
1995 includes only the Company's accrued postretirement benefit cost of $73
million and $65 million, respectively, and excludes the Service Company's
portion since the Service Company's total accrued cost is carried on its books.
A September 30 measurement date was used for 1996 and 1995 reporting. At
December 31, 1996 and 1995, the settlement rate and the long-term rate of annual
compen-
F-24
<PAGE> 90
sation increase assumptions were the same as those discussed for pension
reporting in Note 9(a). At December 31, 1996, the assumed annual health care
cost trend rates (applicable to gross eligible charges) were 7.5% for medical
and 7% for dental in 1997. Both rates reduce gradually to a fixed rate of 4.75%
by 2003. Elements of the obligation affected by contribution caps are
significantly less sensitive to the health care cost trend rate than other
elements. If the assumed health care cost trend rates were increased by one
percentage point in each future year, the accumulated postretirement benefit
obligation as of December 31, 1996 would increase by $3 million and the
aggregate of the service and interest cost components of the annual
postretirement benefit cost would increase by $0.3 million.
(10) GUARANTEES
The Company has guaranteed certain loan and lease obligations of a coal supplier
under a long-term coal supply contract. At December 31, 1996, the principal
amount of the loan and lease obligations guaranteed by the Company under the
contract was $19 million.
The prices under the contract which includes certain minimum payments are
sufficient to satisfy the loan and lease obligations and mine closing costs over
the life of the contract. If the contract is terminated early for any reason,
the Company would attempt to reduce the termination charges and would ask the
PUCO to allow recovery of such charges from customers through the fuel factor.
See Management's Financial Analysis -- Outlook-FirstEnergy Rate Plan.
(11) CAPITALIZATION
(a) CAPITAL STOCK TRANSACTIONS
Preferred stock shares retired during the three years ended December 31, 1996
are listed in the following table.
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(thousands of shares)
<S> <C> <C> <C>
Subject to Mandatory Redemption:
$ 7.35 Series C___________________ (10) (10) (10)
88.00 Series E___________________ (3) (3) (3)
Adjustable Series M_______________ -- (100) (100)
9.125 Series N__________________ (150) (111) (189)
91.50 Series Q___________________ (11) (11) --
90.00 Series S___________________ -- (1) --
Not Subject to Mandatory
Redemption:
Adjustable Series L_______________ (26) -- --
---- ---- -----
Total___________________________ (200) (236) (302)
==== ==== =====
</TABLE>
(b) EQUITY DISTRIBUTION RESTRICTIONS
Federal law prohibits the Company from paying dividends out of capital accounts.
The Company has since 1993 declared and paid preferred and common stock
dividends out of appropriated current net income included in retained earnings.
At the times of such declarations and payments, the Company had a deficit in its
retained earnings. At December 31, 1996, the Company had $130 million of
appropriated retained earnings for
the payment of dividends. See Management's Financial Analysis -- Capital
Resources and Liquidity-Liquidity.
(c) PREFERRED AND PREFERENCE STOCK
Amounts to be paid for preferred stock which must be redeemed during the next
five years are $30 million in 1997, $15 million in 1998, $33 million in both
1999 and 2000, and $80 million in 2001.
The annual preferred stock mandatory redemption provisions are as follows:
<TABLE>
<CAPTION>
Shares Price
To Be Beginning Per
Redeemed in Share
-------- --------- ------
<S> <C> <C> <C>
$ 7.35 Series C__________________ 10,000 1984 $ 100
88.00 Series E__________________ 3,000 1981 1,000
9.125 Series N_________________ 150,000 1993 100
91.50 Series Q__________________ 10,714 1995 1,000
88.00 Series R__________________ 50,000 2001* 1,000
90.00 Series S__________________ 18,750 1999 1,000
</TABLE>
* All outstanding shares to be redeemed on December 1, 2001.
In 1995, the Company purchased 1,000 shares of Serial Preferred Stock, $90.00
Series S, which reduces the 2002 redemption requirement shown in the above
table.
The annualized preferred dividend requirement at December 31, 1996 was $38
million.
The preferred dividend rate on the Company's Series L fluctuates based on
prevailing interest rates and market conditions. The dividend rate for this
issue was 7% in 1996.
Preference stock authorized for the Company is 3,000,000 shares without par
value. No preference shares are currently outstanding.
With respect to dividend and liquidation rights, the Company's preferred stock
is prior to its preference stock and common stock, and its preference stock is
prior to its common stock.
(d) LONG-TERM DEBT AND OTHER BORROWING ARRANGEMENTS
Long-term debt which matures or is subject to put options during the next five
years is as follows: $115 million in 1997, $68 million in 1998, $149 million in
1999, $5 million in 2000 and $62 million in 2001.
The Company's mortgage constitutes a direct first lien on substantially all
property owned and franchises held by the Company. Excluded from the lien, among
other things, are cash, securities, accounts receivable, fuel and supplies.
Certain credit agreements of the Company contain covenants relating to fixed
charge coverage ratios and limitations on secured financing other than through
first
F-25
<PAGE> 91
mortgage bonds or certain other transactions. The Company was in compliance with
all such covenants as of December 31, 1996. The Company and Toledo Edison have
letters of credit in connection with the sale and leaseback of Beaver Valley
Unit 2 that expire in June 1999. The letters of credit are in an aggregate
amount of approximately $225 million and are secured by first mortgage bonds of
the Company and Toledo Edison in the proportion of 40% and 60%, respectively.
(12) SHORT-TERM BORROWING ARRANGEMENTS
Centerior Energy has a $125 million revolving credit facility through May 1997.
Centerior Energy and the Service Company may borrow under the facility, with all
borrowings jointly and severally guaranteed by the Company and Toledo Edison.
Centerior Energy plans to transfer any of its borrowed funds to the Company and
Toledo Edison. The credit agreement is secured with first mortgage bonds of the
Company and Toledo Edison in the proportion of 40% and 60%, respectively. The
credit agreement also provides the participating banks with a subordinate
mortgage security interest on the properties of the Company and Toledo Edison.
The banks' fee is 0.625% per annum payable quarterly in addition to interest on
any borrowings. There were no borrowings under the facility at December 31,
1996. Also, the Company and Toledo Edison may borrow from each other on a
short-term basis. At December 31, 1996, the Company had total short-term
borrowings of $112 million from its affiliates with a weighted average interest
rate of 6.18%.
(13) FINANCIAL INSTRUMENTS
The estimated fair values at December 31, 1996 and 1995 of financial instruments
that do not approximate their carrying amounts in the Balance Sheet are as
follows:
<TABLE>
<CAPTION>
December 31,
----------------------------------
1996 1995
---------------- ----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- ------
(millions of dollars)
<S> <C> <C> <C> <C>
Capitalization and Liabilities:
Preferred Stock, with
Mandatory Redemption
Provisions_________________ $ 216 $ 220 $ 245 $ 232
Long-Term Debt_______________ 2,562 2,630 2,819 2,824
</TABLE>
Noncash investments in the Nuclear Plant Decommissioning Trusts are summarized
in the following table. In 1996, the Company and Toledo Edison transferred the
bulk of their investment assets in existing trusts into Centerior Energy pooled
trust funds for the two companies. The December 31, 1996 amounts in the table
represent the Company's pro rata share of the fair value of such noncash
investments.
<TABLE>
<CAPTION>
December 31,
--------------
1996 1995
---- ----
(millions of
dollars)
<S> <C> <C>
Type of Securities:
Debt Securities:
Federal Government_____________________ $14 $26
Municipal______________________________ -- 14
Other__________________________________ 5 --
--- ---
19 40
Equity Securities________________________ 56 --
--- ---
Total________________________________ $75 $40
=== ===
Maturities of Debt Securities:
Due within one year______________________ $-- $ 1
Due in one to five years_________________ 10 12
Due in six to 10 years___________________ 4 13
Due after 10 years_______________________ 5 14
--- ---
Total________________________________ $19 $40
=== ===
</TABLE>
The fair value of these trusts is estimated based on the quoted market prices
for the investment securities and approximates the carrying value. The fair
value of the Company's preferred stock, with mandatory redemption provisions,
and long-term debt is estimated based on the quoted market prices for the
respective or similar issues or on the basis of the discounted value of future
cash flows. The discounted value used current dividend or interest rates (or
other appropriate rates) for similar issues and loans with the same remaining
maturities.
The estimated fair values of all other financial instruments approximate their
carrying amounts in the Balance Sheet at December 31, 1996 and 1995 because of
their short-term nature.
(14) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of operations
for the two years ended December 31, 1996.
<TABLE>
<CAPTION>
Quarters Ended
----------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
--------- -------- --------- --------
(millions of dollars)
<S> <C> <C> <C> <C>
1996
Operating Revenues______ $428 $434 $506 $422
Operating Income________ 76 86 121 76
Net Income______________ 17 25 59 16
Earnings Available for
Common Stock__________ 7 15 49 6
1995
Operating Revenues______ $410 $424 $ 526 $408
Operating Income________ 85 91 145 77
Net Income______________ 34 38 90 23
Earnings Available for
Common Stock__________ 23 27 80 12
</TABLE>
Earnings for the quarter ended September 30, 1996 were decreased by $11 million
as a result of a $17 million charge for the disposition of materials and
supplies inventory. The sale and disposal of inventory was part of the
reengineering of the supply chain process.
(15) PENDING MERGER OF CENTERIOR ENERGY AND OHIO EDISON
On September 13, 1996, Centerior Energy and Ohio Edison entered into an
agreement and plan of merger to
F-26
<PAGE> 92
form a new holding company, FirstEnergy. Following the merger, FirstEnergy will
directly hold all of the issued and outstanding common stock of the Company,
Toledo Edison and Ohio Edison. As a result of the merger, the common stock share
owners of Centerior Energy and Ohio Edison will own all of the issued and
outstanding shares of FirstEnergy common stock. Centerior Energy share owners
will receive 0.525 of a share of FirstEnergy common stock for each share of
Centerior Energy common stock owned. Ohio Edison share owners will receive one
share of FirstEnergy common stock for each share of Ohio Edison common stock
owned.
FirstEnergy plans to account for the merger as a purchase in accordance with
generally accepted accounting principles. If FirstEnergy elects to apply, or
"push down", the effects of purchase accounting to the financial statements of
the Company and Toledo Edison, the Company and Toledo Edison would record
adjustments to: (1) reduce the carrying value of nuclear generating plant by
$1.25 billion to fair value; (2) recognize goodwill of $865 million; (3) reduce
common stock equity by $401 million; (4) reset retained earnings of the Company
and Toledo Edison to zero; and (5) reduce the related deferred federal income
tax liability by $438 million. These amounts reflect FirstEnergy's estimates of
the pro forma combined adjustments for the Company and Toledo Edison as of
September 30, 1996. The actual adjustments to be recorded could be materially
different from these estimates. FirstEnergy has not decided whether to push down
the effects of purchase accounting to the financial statements of the Company
and Toledo Edison if the merger with Ohio Edison is completed, nor has
FirstEnergy estimated the allocations between the two companies if push-down
accounting is elected.
In addition to the approvals by the share owners of Centerior Energy and Ohio
Edison common stock, various aspects of the merger are subject to the approval
of the FERC and other regulatory authorities. A rate reduction and economic
development plan for the Company and Toledo Edison has been approved by the
PUCO. From the date of consummation of the merger through 2006, the plan
provides for rate reductions, frozen fuel cost factors, economic development
incentive prices, an energy-efficiency program, an earnings cap and an
accelerated reduction in nuclear and regulatory assets for regulatory purposes.
The plan will require the Company and Toledo Edison to write off certain
regulatory assets at the time the merger becomes probable, which is expected to
be after obtaining the aforementioned approvals of the merger. The write-off
amounts for the Company and Toledo Edison to be charged against earnings,
estimated by FirstEnergy to total approximately $750 million, will be determined
based upon the plan's regulatory accounting and cost recovery details to be
submitted by FirstEnergy to the PUCO staff for approval. The Company's share of
the write-off is expected to be about two-thirds of this amount.
If the merger is not consummated, the plan would be null and void. See
Management's Financial Analysis -- Outlook-Pending Merger with Ohio Edison and
- -FirstEnergy Rate Plan for a discussion of the proposed merger and the plan.
(16) PENDING MERGER OF TOLEDO EDISON INTO THE COMPANY
In March 1994, Centerior Energy announced a plan to merge Toledo Edison into the
Company. The merger agreement between Centerior Energy and Ohio Edison requires
the approval of Ohio Edison prior to consummation of the proposed merger of
Toledo Edison into the Company. Ohio Edison has not yet made a decision. All
necessary regulatory approvals have been obtained, except the NRC's approval.
This application was withdrawn at the NRC's request pending Ohio Edison's
decision whether to complete this merger.
In June 1995, share owners of Toledo Edison's preferred stock approved the
merger and share owners of the Company's preferred stock approved the
authorization of additional shares of preferred stock. If and when the merger
becomes effective, share owners of Toledo Edison's preferred stock will exchange
their shares for preferred stock shares of the Company having substantially the
same terms. Debt holders of the merging companies will become debt holders of
the Company.
For the merging companies, the combined pro forma operating revenues were $2.554
billion, $2.516 billion and $2.422 billion and the combined pro forma net income
was $174 million, $281 million and $268 million for the years 1996, 1995 and
1994, respectively. The pro forma data is based on accounting for the merger on
a method similar to a pooling of interests. The pro forma data is not
necessarily indicative of the results of operations which would have been
reported had the merger been in effect during those years or which may be
reported in the future. The pro forma data does not reflect any potential
effects related to the consummation of the Centerior Energy and Ohio Edison
merger. The pro forma data should be read in conjunction with the audited
financial statements of both the Company and Toledo Edison.
F-27
<PAGE> 93
FINANCIAL AND STATISTICAL REVIEW
OPERATING REVENUES (millions of dollars)
<TABLE>
<CAPTION>
Total Total Steam
Year Residential Commercial Industrial Other Retail Wholesale Electric Heating
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1996 --------- $ 562 571 524 88 1 745 45 1 790 --
1995 --------- 559 563 523 93 1 738 31 1 769 --
1994 --------- 531 541 508 98 1 678 20 1 698 --
1993 --------- 539 536 510 98 1 683 68 1 751 --
1992 --------- 517 531 530 101 1 679 64 1 743 --
1986 --------- 410 383 461 61 1 315 8 1 323 13
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
Total
Operating
Year Revenues
- --------------------------------------------
<S> <C>
1996 --------- $ 1 790
1995 --------- 1 769
1994 --------- 1 698
1993 --------- 1 751
1992 --------- 1 743
1986 --------- 1 336
- --------------------------------------------
</TABLE>
OPERATING EXPENSES (millions of dollars)
<TABLE>
<CAPTION>
Other Generation Amortization of
Fuel & Operation Facilities Depreciation Taxes, Deferred Federal
Purchased & Rental & Other Than Operating Income
Year Power Maintenance Expense, Net Amortization FIT Expenses, Net Taxes
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1996 --------- $ 408 426 56 210 230 26 75
1995 --------- 413 418 56 196 230 (36) 94
1994 --------- 391 394 56 195 218 (34) 82
1993 --------- 423 598(a) 56 182 221 27(b) 22
1992 --------- 434 410 55 179 226 (35) 89
1986 --------- 372 388 -- 103 144 -- 97
- ---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Total
Operating
Year Expenses
- ----------------------------------------------------------
<S> <<C>
1996 --------- $ 1 431
1995 --------- 1 371
1994 --------- 1 302
1993 --------- 1 529
1992 --------- 1 358
1986 --------- 1 104
- ----------------------------------------------------------
</TABLE>
INCOME (LOSS) (millions of dollars)
<TABLE>
<CAPTION>
Federal Income
Other Deferred Income (Loss)
Income & Carrying Taxes-- Before
Operating AFUDC-- Deductions, Charges, Credit Interest
Year Income Equity Net Net (Expense) Charges
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996 --------- $ 359 2 (10) -- 6 $ 357
1995 --------- 398 2 2 29 (2) 429
1994 --------- 396 4 6 25 (4) 427
1993 --------- 222 4 (356)(c) (487)(b) 270 (347)
1992 --------- 385 1 8 59 (5) 448
1986 --------- 232 179 (7) -- 65 469
- ---------------------------------------------------------------------------------------------------
</TABLE>
INCOME (LOSS) (millions of dollars)
<TABLE>
<CAPTION>
Earnings
Preferred & (Loss)
Net Preference Available for
Debt AFUDC-- Income Stock Common
Year Interest Debt (Loss) Dividends Stock
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1996 --------- $ 242 (2) 117 39 $ 78
1995 --------- 248 (3) 184 43 141
1994 --------- 247 (5) 185 45 140
1993 --------- 244 (4) (587) 45 (632)
1992 --------- 243 -- 205 41 164
1986 --------- 232 (63) 300 40 260
- -----------------------------------------------------------------------------------
</TABLE>
(a) Includes early retirement program expenses and other charges of $165
million.
(b) Includes write-off of phase-in deferrals of $636 million, consisting of $117
million of deferred operating expenses and $519 million of deferred carrying
charges.
F-28
<PAGE> 94
The Cleveland Electric Illuminating Company and Subsidiaries
<TABLE>
<CAPTION>
ELECTRIC SALES (millions of KWH) ELECTRIC CUSTOMERS
(thousands at year end)
Industrial
Year Residential Commercial Industrial Wholesale Other Total Residential Commercial & Other
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------- ------------------- ------------------------------------------
1996 --- 4 958 5 908 7 977 2 155 522 21 520 663 71 7
1995 --- 5 063 5 946 7 994 1 694 550 21 247 670 72 7
1994 --- 4 924 5 770 7 970 1 073 575 20 312 668 72 7
1993 --- 4 934 5 634 7 911 2 290 532 21 301 669 71 8
1992 --- 4 725 5 467 7 988 1 989 533 20 702 670 71 8
1986 --- 4 586 4 744 7 927 121 460 17 838 651 63 9
- -------------------------------------------------------------------- ------------------- ------------------------------------------
<CAPTION>
ELECTRIC CUSTOMERS RESIDENTIAL USAGE
(thousands at year end)
Average Average
Average Price Revenue
KWH Per Per Per
Year Total Customer KWH Customer
<S> <C> <C> <C> <C>
- --------------------- ----------------------------------
1996 --- 741 7 451 11.34cent $845.12
1995 --- 749 7 570 11.04 835.40
1994 --- 747 7 370 10.79 795.11
1993 --- 748 7 373 10.93 805.68
1992 --- 749 7 071 10.94 773.77
1986 --- 723 6 810 8.94 611.34
- --------------------- ----------------------------------
</TABLE>
<TABLE>
<CAPTION>
LOAD (MW & %) ENERGY (millions of KWH) FUEL
Net Company Generated
Seasonal Peak Capacity Load ----------------------------- Purchased Fuel Cost
Year Capability Load Margin Factor Fossil(d) Nuclear Total Power Total Per KWH
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------- ----------------------------------------------------------- ----------
1996 ------ 3 922 3 938 (0.4)% 60.6% 14 411 6 829 21 240 1 640 22 880 1.35cent
1995 ------ 4 273 4 049 5.2 58.8 12 684 8 175 20 859 1 673 22 532 1.42
1994 ------ 4 500 3 740 16.9 62.4 12 840 6 405 19 245 2 022 21 267 1.35
1993 ------ 4 500 3 862 14.2 59.9 15 557 5 644 21 201 1 454 22 655 1.37
1992 ------ 4 704 3 605 23.4 63.0 12 715 7 521 20 236 1 649 21 885 1.47
1986 ------ 3 775 3 601 4.6 62.2 16 151 12 16 163 2 984 19 147 1.78
- ----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
FUEL
BTU Per
Year KWH
<S> <C>
- -------------------------
1996 ------ 10 357
1995 ------ 10 504
1994 ------ 10 538
1993 ------ 10 339
1992 ------ 10 456
1986 ------ 10 464
- -------------------------
</TABLE>
<TABLE>
<CAPTION>
INVESTMENT (millions of dollars)
Construction
Utility Work In Total
Plant Accumulated Progress Nuclear Property, Utility
In Depreciation & Net & Perry Fuel and Plant and Plant Total
Year Service Amortization Plant Unit 2 Other Equipment Additions Assets
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------- ----------- -------
1996 ------ $6 938 2 252 4 686 57 167 $ 4 910 $ 111 $6 878
1995 ------ 6 872 2 094 4 778 73 180 5 031 155 7 152
1994 ------ 6 871 2 014 4 857 99 195 5 151 156 7 151
1993 ------ 6 734 1 889 4 845 141 243 5 229 175 7 159
1992 ------ 6 602 1 728 4 874 501 261 5 636 156 8 123
1986 ------ 3 197 952 2 245 3 013 384 5 642 671 6 155
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CAPITALIZATION (millions of dollars & %)
Preferred &
Preference Preferred
Stock, with Stock, without
Mandatory Mandatory
Common Stock Redemption Redemption
Year Equity Provisions Provisions Long-Term Debt Total
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1996 ------ $1 045 27% 186 5% 238 6% 2 441 62% $3 910
1995 ------ 1 127 26 215 5 241 6 2 666 63 4 249
1994 ------ 1 058 26 246 6 241 6 2 543 62 4 088
1993 ------ 1 040 24 285 7 241 5 2 793 64 4 359
1992 ------ 1 865 39 314 6 144 3 2 515 52 4 838
1986 ------ 1 844 40 339 7 144 3 2 311 50 4 638
- -------------------------------------------------------------------------------------------------------
</TABLE>
(c) Includes write-off of Perry Unit 2 of $351 million.
(d) Reduced by net energy used by the Seneca Pumped Storage Plant for pumping.
F-29
<PAGE> 95
TOLEDO EDISON
FINANCIAL STATEMENTS
FOR THE YEAR ENDED
DECEMBER 31, 1996
F-30
<PAGE> 96
MANAGEMENT'S FINANCIAL ANALYSIS
OUTLOOK
STRATEGIC PLAN
In early 1994, Centerior Energy Corporation (Centerior Energy), along with The
Toledo Edison Company (Company) and The Cleveland Electric Illuminating Company
(Cleveland Electric), created a strategic plan to achieve the twin goals of
strengthening their financial conditions and improving their competitive
positions. The Company and Cleveland Electric are the two wholly owned electric
utility subsidiaries of Centerior Energy. The plan's objectives relate to the
combined operations of all three companies. To meet these goals, we seek to
maximize share owner return on Centerior Energy common stock, achieve
profitable revenue growth, become a leader in customer satisfaction, build a
winning employee team and attain increasingly competitive supply costs. During
1996, the third year of the eight-year plan, we made strong gains toward
reaching some plan objectives but need significant improvement on others.
A major step taken to reach the twin goals was Centerior Energy's agreement to
merge with Ohio Edison Company (Ohio Edison) to form a new holding company
called FirstEnergy Corp. (FirstEnergy). The proposed merger, combined with good
operating performance, a successful price increase and the accelerated paydown
of debt, resulted in a significant stock price gain, such that the total return
to Centerior Energy common stock share owners during 1996 was 33%. The merger
is expected to better position the merged companies to meet coming competitive
challenges.
Revenue growth is a key objective of the plan, from pricing actions as well as
market expansion.
In April 1996, The Public Utilities Commission of Ohio (PUCO) approved in full
the $119 million price increases requested by the Company and Cleveland
Electric ($35 million and $84 million, respectively). The primary purpose of
the increases was to provide additional revenues to recover all the costs of
providing electric service, including deferred costs, and provide a fair return
to Centerior Energy common stock share owners. The additional revenues also
provided cash to accelerate the redemption of debt and preferred stock.
Kilowatt-hour sales to the Company's retail customers increased by 1.6%
compared to 1995 results as sales to industrial and commercial customers
increased by 3% and 2.4%, respectively. Adjusted for weather, kilowatt-hour
sales to commercial and residential customers increased by 4.7% and 1%,
respectively.
Another key element of our revenue strategy is to offer long-term
contracts to large industrial customers who might otherwise consider changing
power suppliers. During 1996, we renewed and extended for seven to ten years
contracts with many of our large industrial customers, including the six
largest. While this strategy has resulted in lower prices for these customers,
in the long run, it is expected to maximize share owner value by retaining our
customer base in a changing industry. Prior to these renewals, 94% of our
industrial base rate (nonfuel) revenues under contract was scheduled for
renewal before 1999. Following the renewals, the comparable percentage is 19%.
At year-end 1996, 61% of our industrial base rate revenues was under long-term
contracts.
Northwest Ohio is recognized as one of the nation's leading areas in job
creation and economic growth. New and expanded operations at businesses such as
Delafoil/Phillips and Alcoa, as well as the development surrounding a new,
major North Star BHP Steel facility, are adding to our opportunities for
revenue growth. In 1996, we gained commitments on 23 economic development
projects, representing almost $5 million in new and retained annual base rate
revenues and over 3,000 new and retained jobs for Northwest Ohio.
Under the strategic plan, Centerior Energy and its subsidiaries are structured
in six strategic business groups to better focus on competitiveness. During
1996, the Company reduced employment from about 1,800 to 1,600. Further
reduction in our work force to about 1,400 is planned by year-end 1997. We also
plan to reduce expenditures for operation and maintenance activities (exclusive
of fuel and purchased power expenses) and capital projects from $384 million in
1996 to approximately $360 million in 1997 by continuing to streamline
operations. We will continue to reduce our unit cost of fuel used for
generating electricity, while safely improving the operating performance of our
generation facilities.
Reducing fixed financing costs is another primary objective in strengthening
the Company's financial and competitive position. In 1996, we reduced our fixed
obligations for debt, preferred stock and generation facilities leases by $82
million. See Note 2. Interest expense and preferred dividends dropped $16
million. In the last three years, fixed obligations were reduced by $277
million.
In 1996, we reported earnings available for common stock of $40 million
compared to $79 million in 1995. The reported decrease masks a $5 million
increase in basic earnings from operations and a significant improvement in the
quality of reported earnings. The decline in reported earnings is primarily
attributable to the delay in implementing our price increase until late April,
while we began at the end of 1995 to charge earnings for operating expenses and
amortization of deferrals which the price increase was designed to recover. The
price increase contributed approximately $14 million (after tax) more cash to
our earnings in 1996. The change in regulatory accounting measures resulted in
a $47 million decrease in reported earnings for 1996 versus 1995. In addition,
1996 results included noncash charges against earnings of $11 million after tax
for the disposition of inventory and write-down of inactive production
facilities. The full benefit of our $35 million price increase, substantial
reductions in operation and maintenance expenses and a continuing decline in
interest charges are expected to result in improvement in earnings and cash
flow from operations in 1997.
F-31
<PAGE> 97
PENDING MERGER WITH OHIO EDISON
On September 16, 1996, Centerior Energy announced its merger with Ohio Edison in
a stock-for-stock transaction. Centerior Energy share owners will receive 0.525
of a share of FirstEnergy common stock for each share of Centerior Energy common
stock owned, while Ohio Edison share owners will receive one share of
FirstEnergy common stock for each share of Ohio Edison common stock owned.
Following the merger, FirstEnergy will directly hold all of the issued and
outstanding common stock of the Company, Cleveland Electric and Ohio Edison.
FirstEnergy plans to account for the merger as a purchase in accordance with
generally accepted accounting principles. If FirstEnergy elects to apply, or
"push down", the effects of purchase accounting to the financial statements of
the Company and Cleveland Electric, the Company and Cleveland Electric would
record adjustments to: (1) reduce the carrying value of nuclear generating plant
by $1.25 billion to fair value; (2) recognize goodwill of $865 million; (3)
reduce common stock equity by $401 million; (4) reset retained earnings of the
Company and Cleveland Electric to zero; and (5) reduce the related deferred
federal income tax liability by $438 million. These amounts reflect
FirstEnergy's estimates of the pro forma combined adjustments for the Company
and Cleveland Electric as of September 30, 1996. The actual adjustments to be
recorded could be materially different from these estimates. FirstEnergy has not
decided whether to push down the effects of purchase accounting to the financial
statements of the Company and Cleveland Electric if the merger with Ohio Edison
is completed, nor has FirstEnergy estimated the allocations between the two
companies if push-down accounting is elected.
We believe that the merger will create a company that is better positioned to
compete in the electric utility industry than either Centerior Energy or Ohio
Edison could on a stand-alone basis, enhancing long-term share owner value and
providing customers with reliable service at more stable and competitive prices.
The combination of Centerior Energy and Ohio Edison is a natural alliance of two
companies with adjoining service areas who already share many major generating
units. FirstEnergy expects to reduce costs, maximize efficiencies and increase
management flexibility in order to enhance revenues, cash flows and earnings and
be a more effective competitor in the increasingly competitive electric utility
industry.
FirstEnergy anticipates the merger will result in net savings for the combined
companies of approximately $1 billion over ten years, in addition to the impact
of cost reduction programs underway at both companies. The additional savings,
which probably could not be achieved without the merger, will result primarily
from the reduction of duplicative functions and positions, joint dispatch of
generating facilities and procurement efficiencies. FirstEnergy expects
reductions in labor costs to comprise slightly over half the estimated savings.
In addition, FirstEnergy expects to reduce system-wide debt by at least $2.5
billion through the year 2000, yielding additional long-term savings in the form
of lower interest expense.
The Company's share of the $1 billion of savings will permit the Company to
reduce prices to its customers as discussed below under FirstEnergy Rate Plan.
Absent the merger, the Company plans to achieve savings as well, but at a lower
level, which is expected to allow prices to be frozen at current levels until at
least 2002 despite inflationary pressures.
Various aspects of the merger are subject to the approval of the Federal Energy
Regulatory Commission (FERC) and other regulatory authorities. Common stock
share owners of Centerior Energy and Ohio Edison are expected to vote on
approval of the merger agreement on March 27, 1997. The merger must be approved
by the affirmative votes of the share owners of at least two-thirds of the
outstanding shares of Ohio Edison common stock and a majority of the outstanding
shares of Centerior Energy common stock. The merger is expected to be effective
in late 1997.
FIRSTENERGY RATE PLAN
On January 30, 1997, the PUCO approved a Rate Reduction and Economic Development
Plan (Plan) for the Company and Cleveland Electric to be effective upon the
consummation of the Centerior Energy and Ohio Edison merger. The Plan would be
null and void if the merger is not consummated. The rate order granting the
April 1996 price increase will remain in full force and effect during the
pendency of the merger or if the merger is not consummated.
The Plan calls for a base rate freeze through 2005 (except to comply with any
significant changes in environmental, regulatory or tax laws), followed by an
immediate $310 million (which represents a decrease of approximately 15% from
current levels) base rate reduction in 2006 (the Company's share is expected to
be $93 million); interim reductions beginning seven months after consummation of
the merger of $3 per month increasing to $5 per month per residential customer
by July 1, 2001; $105 million for economic development and energy efficiency
programs (the Company's share is expected to be $35 million); earnings caps for
regulatory purposes for the Company and Cleveland Electric; a commitment by
FirstEnergy for a reduction, for regulatory accounting purposes, in nuclear and
regulatory assets by the end of 2005 of at least $2 billion more than it
otherwise would be, through revaluing facilities or accelerating depreciation
and amortization; and a freeze in fuel cost factors until December 31, 2005,
subject to PUCO review at year-end 2002 and annual inflation adjustments. The
Plan permits the Company and Cleveland Electric to dispose of generating assets
subject to notice and possible PUCO approval, and to enter into associated power
purchase arrangements.
Total price savings for the Company's customers of about $111 million are
anticipated over the term of the Plan, as summarized below, excluding potential
economic devel-
F-32
<PAGE> 98
opment benefits and assuming that the merger takes place
on December 31, 1997. The total price savings for customers of the Company and
Cleveland Electric are expected to be about $391 million.
<TABLE>
<CAPTION>
Year Amount
- -------------------------------------------------- ------------
(millions of
dollars)
<S> <C>
1998______________________________________________ $ 6
1999______________________________________________ 10
2000______________________________________________ 12
2001______________________________________________ 15
2002______________________________________________ 17
2003______________________________________________ 17
2004______________________________________________ 17
2005______________________________________________ 17
--------
Total_________________________________________ $111
========
</TABLE>
Under the Plan's earnings cap, the Company and Cleveland Electric will be
permitted to earn up to an 11.5% return on common stock equity for regulatory
purposes during calendar years prior to 2000, 12% during calendar years 2000 and
2001, and 12.59% during calendar years 2001 through 2005. The regulatory return
on equity is generally expected to be lower than the return on equity calculated
for financial reporting purposes due to the calculation methodology defined by
the Plan and, as discussed in the next paragraph, anticipated differences in
accounting for the Plan for financial reporting versus regulatory purposes. If
for any calendar year the regulatory return on equity exceeds the specified
level, the excess will be credited to customers, first through a reduction in
Percentage of Income Payment Plan (PIPP) arrearages and then as a credit to base
rates. PIPP is a deferred payment program for low-income residential customers.
The Plan requires, for regulatory purposes, a revaluation of or an accelerated
reduction in the investment in nuclear plant and certain regulatory assets of
the Company and Cleveland Electric (excluding amounts due from customers for
future federal income taxes) by at least $2 billion by the end of 2005.
FirstEnergy has not yet determined each company's estimated share of the $2
billion. Only a portion of the $2 billion of accelerated costs is expected to be
charged against the two companies' earnings for financial reporting purposes by
2005.
FirstEnergy believes that the Plan will not provide for the full recovery of
costs and a fair return on investment associated with the nuclear operations of
the Company and Cleveland Electric. Pursuant to the PUCO's order, FirstEnergy is
required to submit to the PUCO staff the regulatory accounting and cost recovery
details for implementing the Plan. After approval of such details by the PUCO
staff, FirstEnergy expects that the Company and Cleveland Electric will
discontinue the application of Statement of Financial Accounting Standards
(SFAS) 71 for their nuclear operations if and when consummation of the merger
becomes probable. The remainder of their business is expected to continue to
comply with the provisions of SFAS 71. At the time the merger is probable, the
Company and Cleveland Electric would be required to write off certain of their
regulatory assets for financial reporting purposes. The write-off amounts would
be determined at that time. FirstEnergy estimates the write-off amounts for the
Company and Cleveland Electric will total approximately $750 million. The
Company's share of the write-off is expected to be about one-third of this
amount. Under the Plan, some or all of this write-off cannot be applied toward
the $2 billion regulatory commitment discussed above. For financial reporting
purposes, nuclear generating units are not expected to be impaired. If events
cause either the Company or Cleveland Electric or both companies to conclude
they no longer meet the criteria for applying SFAS 71 for the remainder of their
business, they would be required to write off their remaining regulatory assets
and measure all other assets for impairment. For a discussion of the criteria
for complying with SFAS 71, see Note 7(a).
APRIL 1996 RATE ORDER
In its April 1996 order, the PUCO granted price increases of $35 million and $84
million in annualized revenues to the Company and Cleveland Electric,
respectively. The Company and Cleveland Electric intend to freeze rates at
existing levels until at least 2002, although they are not precluded from
requesting further price increases. In the order, the PUCO provided for recovery
of all regulatory assets in the approved rates, and the Company and Cleveland
Electric continue to comply with the provisions of SFAS 71.
In connection with its order, the PUCO recommended that the Company and
Cleveland Electric write down certain assets for regulatory purposes by an
aggregate of $1.25 billion through 2001. If the merger is consummated, the
Company and Cleveland Electric believe acceleration of $2 billion of costs under
the Plan would fully satisfy this recommendation. The Company and Cleveland
Electric agree with the concept of accelerating the recognition of costs and the
recovery of assets as such concept is consistent with the strategic objective to
become more competitive. However, the Company and Cleveland Electric believe
that such acceleration must also be consistent with the reduction of debt and
the opportunity for Centerior Energy common stock share owners to receive a fair
return on their investment. Consideration of whether to implement a plan
responsive to the PUCO's recommendation to revalue assets by $1.25 billion is
pending the merger with Ohio Edison.
Notwithstanding the pending merger with Ohio Edison and discussions with
regulators concerning the effect of the Plan on the Company's nuclear generating
assets, we believe it is reasonable to expect that rates will be set at levels
that will recover all current and anticipated costs associated with the
Company's nuclear operations, including all associated regulatory assets, and
such rates can be charged to and collected from customers. If there is a change
in our evaluation of the competitive environment, regulatory framework or other
factors, or if the PUCO significantly reduces the value of the Company's assets
or reduces the approved return on common stock equity of 12.59% and overall rate
of return of 10.06%, or both, for future regulatory purposes, the Company may be
required to record material charges to earnings.
F-33
<PAGE> 99
MERGER OF THE COMPANY INTO CLEVELAND ELECTRIC
In October 1996, the FERC authorized the merger of the Company into Cleveland
Electric. The merger agreement between Centerior Energy and Ohio Edison requires
the approval of Ohio Edison prior to consummation of the proposed merger of the
Company into Cleveland Electric. Ohio Edison has not yet made a decision. See
Note 16.
COMPETITION
Structural changes in the electric utility industry from actions by both federal
and state regulatory bodies are continuing to place downward pressure on prices
and increase competition for customers. The Company's nuclear plant licenses
have required open-access transmission for its wholesale customers for 20 years.
More recently, the Federal Energy Policy Act of 1992 initiated broader access to
utility transmission systems and, in 1996, the FERC adopted rules relating to
open-access transmission services. The open-access rules require utilities to
deliver power from other utilities or generation sources to their wholesale
customers at nondiscriminatory prices.
A number of states have enacted transition legislation which provides for
introduction of competition for retail electric business and recovery of
stranded investment. Several groups in Ohio are studying the possible
introduction of retail wheeling and stranded investment recovery. Retail
wheeling occurs when a customer obtains power from a utility company other than
its local utility. The term "stranded investment" generally refers to fixed
costs approved for recovery under traditional regulatory methods that would
become unrecoverable, or "stranded", as a result of legislative changes which
allow for widespread competition. The PUCO is sponsoring discussions among a
group of business, utility and consumer interests to explore ways of promoting
competitive options without unduly harming the interests of utility company
share owners or customers. The PUCO also has introduced two pilot projects, both
intended as initial steps to introduce competitive elements into the Ohio
electric utility business.
A bill to restructure the electric utility industry in Ohio has been introduced
in the Ohio House of Representatives. A bipartisan committee from both
legislative houses has been formed to study the issue. Centerior Energy
presented the Company's model for customer choice, called Energy Choice, to the
PUCO discussion group in August 1996. Under this model, full retail competition
should be introduced by 2002, but two essential elements, recovery of stranded
investment and levelization of tax burdens among energy suppliers, must be
resolved in the interim to assure share owners' recovery of and a fair return on
their investments.
Although competitive pressures are increasing, the traditional regulatory
framework remains in place and is expected to continue for the foreseeable
future. We cannot predict when and to what extent retail wheeling or other forms
of competition will be allowed. We believe that pure competition (unrestricted
retail wheeling for all
customer classifications) is at least several years away and that any transition
to pure competition will be in phases. The FERC and the PUCO have acknowledged
the need to provide at least partial recovery of stranded investment as greater
competition is permitted and, therefore, we believe that there will be a
mechanism developed for the recovery of at least some stranded investment.
However, due to the uncertainty involved, there is a risk in connection with the
introduction of retail wheeling that some of the Company's assets may not be
fully recovered.
Competition from municipal electric suppliers for retail business in our service
area is producing both favorable and unfavorable results in our business. All
existing customers in the City of Clyde now have the right to choose between the
municipal supplier and the Company, as a result of a November 1996 referendum
overturning a Clyde ordinance limiting such choice. In the City of Toledo, City
Council funded a consultant's study of alternatives to our service. A draft of
the consultant's report states that, if Centerior Energy and Ohio Edison merge,
a municipal system in Toledo could not compete with the Company because of the
rate reductions contained in the Plan approved by the PUCO. The consultant's
draft report also states that, if the merger does not occur, a municipal system
could be competitive with the Company in one portion of the City. However,
errors have been found in the draft report which may change the content of the
final consultant's report. The final report will be considered by the City's
Electric Franchise Review Committee before making its recommendation to City
Council later in 1997. Municipal expansion activity continues in areas
surrounding several towns serviced by municipal systems in our service area. We
continue to pursue legal remedies to halt illegal municipal expansion in our
service area.
The merger with Ohio Edison and the benefits of the Plan to our customers are
expected to better position us to deal with the structural changes taking place
in the industry and to improve our competitive position with respect to
municipalization.
NUCLEAR OPERATIONS
The Company has interests in three nuclear generating units -- Davis-Besse
Nuclear Power Station (Davis-Besse), Perry Nuclear Power Plant Unit 1 (Perry
Unit 1) and Beaver Valley Power Station Unit 2 (Beaver Valley Unit 2) -- and
operates the first one. Cleveland Electric operates Perry Unit 1.
All three units were out of service temporarily for refueling during 1996; thus,
plant availability factors for Davis-Besse, Perry Unit 1 and Beaver Valley Unit
2 were 85%, 76% and 70%, respectively, for 1996. The 1994-1996 availability
factors for the units were 91%, 72%, and 85%, for Davis-Besse, Perry Unit 1 and
Beaver Valley Unit 2, respectively. The comparable industry averages for a
three-year period (as of August 31, 1996) are 82% for pressurized water reactors
such as Davis-Besse and Beaver Valley Unit 2 and 78% for boiling water reactors
such as Perry Unit 1. Davis-Besse established a plant record with its 509-day
continuous run at or near full capacity
F-34
<PAGE> 100
before shutting down for its scheduled refueling outage in April 1996.
A significant part of the strategic plan involves ongoing efforts to increase
the availability and lower the cost of production of our nuclear units. In 1996,
we continued our progress toward increasing long-term unit availability while
continuing to lower production costs. The goal of our nuclear improvement
program is for Cleveland Electric to replicate Davis-Besse's operational
excellence and cost reduction gains at Perry Unit 1, while improving performance
ratings.
Our nuclear units may be impacted by activities or events beyond our control.
Operating nuclear units have experienced unplanned outages or extensions of
scheduled outages because of equipment problems or new regulatory requirements.
A major accident at a nuclear facility anywhere in the world could cause the
Nuclear Regulatory Commission (NRC) to limit or prohibit the operation or
licensing of any domestic nuclear unit. If one of our nuclear units is taken out
of service for an extended period for any reason, including an accident at such
unit or any other nuclear facility, we cannot predict whether regulatory
authorities would impose unfavorable rate treatment. Such treatment could
include taking our affected unit out of rate base, thereby not permitting us to
recover our investment in and earn a return on it, or disallowing certain
construction or maintenance costs. An extended outage coupled with unfavorable
rate treatment could have a material adverse effect on our financial condition,
cash flows and results of operations. Premature plant closings could also have a
material adverse effect on our financial condition, cash flows and results of
operations because the estimated cost to decommission a plant exceeds the
current funding in the decommissioning trust.
HAZARDOUS WASTE DISPOSAL SITES
The Company is aware of its potential involvement in the cleanup of several
sites. Although these sites are not on the Superfund National Priorities List,
they are generally being administered by various governmental entities in the
same manner as they would be administered if they were on such list. Allegations
that the Company disposed of hazardous waste at these sites, and the amount
involved, are often unsubstantiated and subject to dispute. Federal law provides
that all "potentially responsible parties" (PRPs) for a particular site be held
liable on a joint and several basis. If the Company were held liable for 100% of
the cleanup costs of all the sites referred to above, the cost could be as high
as $115 million. However, we believe that the actual cleanup costs will be
substantially lower than $115 million, that the Company's share of any cleanup
costs will be substantially less than 100% and that most of the other PRPs are
financially able to contribute their share. The Company has accrued a liability
totaling $3 million at December 31, 1996 based on estimates of the costs of
cleanup and its proportionate responsibility for such costs. We believe that the
ultimate outcome of these matters will not have a material adverse effect on our
financial condition, cash flows or results of operations.
A new Statement of Position issued by the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants, Inc.
effective January 1, 1997 provides guidance on the recognition and disclosure of
environmental remediation liabilities. Adoption of the statement in 1997 is not
expected to have a material adverse effect on our financial condition or results
of operations.
COMMON STOCK DIVIDENDS
The Company has not paid a common stock dividend to Centerior Energy since
February 1991. From 1993 through November 1996, the Company was prohibited from
paying a common stock dividend by a provision in its mortgage. See Capital
Resources and Liquidity-Liquidity below. The declaration and payment of future
common stock dividends is at the discretion of the Company's Board of Directors,
subject to applicable legal restrictions.
CAPITAL RESOURCES AND LIQUIDITY
1994-1996 CASH REQUIREMENTS
We need cash for normal corporate operations (including the payment of
dividends), retirement of maturing securities, and an ongoing program of
constructing and improving facilities to meet demand for electric service and to
comply with government regulations. Our cash construction expenditures totaled
$41 million in 1994, $53 million in 1995 and $47 million in 1996. Our debt and
preferred stock maturities and sinking fund requirements totaled $57 million in
1994, $83 million in 1995 and $58 million in 1996. In addition, we optionally
redeemed $184 million of securities in the 1994-1996 period, including $94
million of tax-exempt issues refunded in 1995.
As discussed in Note 1(j), in May 1996, the Company and Cleveland Electric began
to sell on a daily basis substantially all of their retail customer accounts
receivables and unbilled revenue receivables to Centerior Funding Corporation
(Centerior Funding), a wholly owned subsidiary of Cleveland Electric. In July
1996, Centerior Funding issued $150 million in AAA-rated accounts
receivable-backed investor certificates due in 2001 with an interest rate of
7.2%. The Company's share of the net proceeds from the accounts receivable
securitization was used to redeem higher-cost securities and for general
corporate purposes.
As a result of these activities, the embedded cost of the Company's debt at the
end of 1996 declined to 9.13% versus 9.23% in 1995 and 9.48% in 1994.
The Company is a party to a $125 million revolving credit facility which was
renewed in May 1996 for a one-year term. In 1996, portions of the nuclear fuel
lease financing vehicles for the Company and Cleveland Electric matured: $84
million of intermediate-term notes in September and a $150 million letter of
credit supporting short-term borrowing in October. These facilities were
replaced by $100 million of intermediate-term notes and a $100 million two-year
letter of credit. The net reduction in the facility size results from lower
nuclear fuel financing requirements.
F-35
<PAGE> 101
1997 AND BEYOND CASH REQUIREMENTS
Our anticipated 1997 cash requirements for construction are $61 million. Debt
and preferred stock maturities and sinking fund requirements are $51 million. Of
this amount, $10 million are for a tax-exempt issue secured by first mortgage
bonds and subject to optional tender by the owners on November 1, 1997, which we
expect to replace with a similar issue at a substantially lower interest rate.
We expect to meet remaining requirements with internal cash generation and cash
reserves. We also expect to be able to optionally redeem more debt in 1997 than
we did in 1996.
We expect to meet all of our 1998-2001 cash requirements with internal cash
generation. Estimated cash requirements for our construction program during this
period total $213 million. Debt and preferred stock maturities and sinking fund
requirements total $207 million for the same period. If economical, additional
securities may be redeemed with funding expected to be provided through internal
cash generation.
Consummation of the merger with Ohio Edison is expected to reduce the Company's
cash construction requirements and improve its ability to redeem fixed
obligations.
LIQUIDITY
Net cash flow from operating activities in 1996 was significantly increased from
1995 by implementation of the price increase effective in April 1996. A part of
the net proceeds from our accounts receivable securitization of $78 million was
used to redeem other higher-cost securities, producing net savings in our
overall cost of borrowing. In 1996, we reduced our fixed obligations for debt,
preferred stock and generation facilities leases by $82 million. At year-end
1996, we had $81 million in cash and temporary cash investments, down from $94
million at year-end 1995.
Additional first mortgage bonds may be issued by the Company under its mortgage
on the basis of property additions, cash or refundable first mortgage bonds. If
the applicable interest coverage test is met, the Company may issue first
mortgage bonds on the basis of property additions and, under certain
circumstances, refundable bonds. At December 31, 1996, the Company would have
been permitted to issue approximately $148 million of additional first mortgage
bonds. If FirstEnergy elects to apply purchase accounting to the Company if the
merger with Ohio Edison is completed, the Company's first mortgage bond capacity
would be adversely affected.
There are no restrictions on the Company's ability to issue preference stock.
Under its articles of incorporation, the Company cannot issue preferred stock
unless certain earnings coverage requirements are met. Based on its 1996
earnings, the Company could not issue additional preferred stock.
The Company and Cleveland Electric have $273 million in financing vehicles to
support their nuclear fuel leases, $83 million of which mature in 1997.
Replacement financing for the maturing issues may not be needed in 1997. The
Company is a party to a $125 million revolving credit facility which is expected
to be renewed when it matures in May 1997.
Current credit ratings for the Company are as follows:
<TABLE>
<CAPTION>
Standard Moody's
& Poor's Investors
Corporation Service, Inc.
----------- -------------
<S> <C> <C>
First mortgage bonds____________________ BB Ba2
Subordinate debt________________________ B+ B1
Preferred stock_________________________ B b2
</TABLE>
Following the FirstEnergy merger announcement, both rating agencies placed the
Company's securities on credit watch with positive implications.
Federal law prohibits the Company from paying dividends out of capital accounts.
The Company has since 1993 declared and paid preferred stock dividends out of
appropriated current net income included in retained earnings. At the times of
such declarations and payments, the Company had a deficit in its retained
earnings. At December 31, 1996, the Company had $223 million of appropriated
retained earnings for the payment of dividends. The Company also has a provision
in its mortgage applicable to approximately $94 million of outstanding first
mortgage bonds ($31 million of which mature in August 1997) that requires common
stock dividends to be paid out of its total balance of retained earnings, which
had been a deficit from 1993 through November 1996.
As part of a routine audit, the FERC is considering statements which it
requested and received from the Company and Cleveland Electric supporting the
payment of dividends out of appropriated current net income included in
retained earnings while total retained earnings were a deficit. At December 31,
1996, the Company's total retained earnings were $5 million. The final
disposition of this issue is a factor expected to be considered by FirstEnergy
in deciding whether to apply purchase accounting to the Company and
Cleveland Electric, one effect of which would be to reset retained earnings to
zero. If the merger is not consummated or if FirstEnergy determines not to
apply purchase accounting to the two companies, the Company and Cleveland
Electric intend to continue to support their position and pursue all available
alternatives to allow them to continue the declaration and payment of
dividends.
RESULTS OF OPERATIONS
1996 VS. 1995
Factors contributing to the 2.7% increase in 1996 operating revenues are as
follows:
<TABLE>
<CAPTION>
Millions
Increase (Decrease) in Operating Revenues of Dollars
- -------------------------------------------------- -----------
<S> <C>
Base Rates___________________________________ $11
KWH Sales Volume and Mix_____________________ 11
Wholesale Revenues___________________________ 4
Fuel Cost Recovery Revenues__________________ 1
Miscellaneous Revenues_______________________ (4)
---
Total____________________________________ $23
</TABLE> ===
F-36
<PAGE> 102
The increase in 1996 base rates revenues resulted primarily from the April 1996
rate order issued by the PUCO for the Company as discussed under Outlook-April
1996 Rate Order and in Note 7(b). The impact of the April 1996 price increase
was offset by a change in the implementation of summer prices. As a result of
this change, higher summer prices were in effect for most customers from June
through September 1996. Previously, higher summer prices were in effect from
May through September. Consequently, base rates revenues for the May 1996
billing period were lower relative to the May 1995 amount. Renegotiated
contracts for certain large industrial customers also resulted in a decrease
in base revenues which partially offset the effect of the general price
increase. Although total kilowatt-hour sales decreased 0.9% in 1996 from the
1995 amount, industrial and commercial kilowatt-hour sales increased 3% and
2.4%, respectively. Residential kilowatt-hour sales decreased 0.9% primarily
because of the cooler summer weather. The industrial sales growth reflected
increased sales to petroleum refineries, large primary metal and glass
manufacturers, and the broad-based, smaller industrial customer group. On a
weather-normalized basis, commercial and residential sales increased 4.7% and
1%, respectively. The number of commercial customers increased 3.4% in 1996.
Other sales (including wholesale sales) decreased 8%. Wholesale revenues
increased in 1996, although wholesale sales results were adversely affected by
the Beaver Valley Unit 2 refueling outage in 1996. See Note 2 for a discussion
of the Beaver Valley Unit 2 capacity sale to Cleveland Electric. A slight
increase in 1996 fuel cost recovery revenues resulted from an increase in the
fuel cost factors. The weighted average of these fuel cost factors increased
approximately 1%.
For 1996, operating revenues were 27% residential, 22% commercial, 28%
industrial and 23% other, and kilowatt-hour sales were 19% residential, 16%
commercial, 39% industrial and 25% other. The average prices per kilowatt-hour
for residential, commercial and industrial customers were 11.47, 10.82 and 5.87
cents, respectively.
Operating expenses increased 8% in 1996. The cessation of the Rate Stabilization
Program deferrals and the commencement of their amortization in December 1995
resulted in the increase in the net amortization of deferred operating expenses.
See Note 7(d). Depreciation and amortization expenses increased primarily
because of a $4 million net increase in depreciation related to changes in
depreciation rates, as discussed in Note 1(e), and the cessation of the
accelerated amortization of unrestricted investment tax credits under the Rate
Stabilization Program, which was reported in 1995 as a $5 million reduction of
depreciation. Fuel and purchased power expenses increased because of increased
purchased power requirements to meet retail customer sales throughout the year
but particularly during the refueling outages of Perry Unit 1 and Davis-Besse in
1996. Other operation and maintenance expenses in 1996 included a $6 million
one-time charge for the disposition of inventory as part of a reengineering of
the supply chain process. Reengineering the supply chain process increases the
use of technology, consolidates warehousing and uses just-in-time purchase and
delivery. Federal income taxes decreased as a result of lower pretax operating
income.
A nonoperating loss resulted in 1996 primarily from an $11 million write-down of
two inactive production facilities, as discussed in Note 14, and the Company's
share of merger-related expenses. The deferral of carrying charges related to
the Rate Stabilization Program ended in November 1995. The federal income tax
credit for nonoperating income increased in 1996 accordingly.
Interest charges and preferred dividend requirements decreased in 1996 because
of the redemption of securities and refundings at favorable terms in 1996 and
1995.
1995 VS. 1994
Factors contributing to the 1% increase in 1995 operating revenues are as
follows:
<TABLE>
<CAPTION>
Millions
Increase (Decrease) in Operating Revenues of Dollars
- --------------------------------------------------- ----------
<S> <C>
KWH Sales Volume and Mix __________________ $ 29
Wholesale Revenues_________________________ (9)
Fuel Cost Recovery Revenues________________ (10)
Miscellaneous Revenues_____________________ (1)
----
Total__________________________________ $ 9
====
</TABLE>
Total kilowatt-hour sales increased 2.2% in 1995 primarily because of the hot
summer weather. Residential and commercial kilowatt-hour sales increased 5.2%
and 2.2%, respectively, which included about 1% nonweather-related growth in
residential sales. Industrial kilowatt-hour sales increased 1.8% on the strength
of increased sales to large glass manufacturers and the broad-based, smaller
industrial customer group. Other sales increased 0.5%. Weather accounted for
approximately $13 million of the $21 million increase in 1995 base rate
revenues. Wholesale revenues decreased because of the lower revenues associated
with the Beaver Valley Unit 2 capacity sale to Cleveland Electric. Lower 1995
fuel cost recovery revenues resulted from favorable changes in the fuel cost
factors. The weighted average of these fuel cost factors decreased approximately
6%.
For 1995, operating revenues were 27% residential, 21% commercial, 29%
industrial and 23% other, and kilowatt-hour sales were 19% residential, 16%
commercial, 37% industrial and 28% other. The average prices per kilowatt-hour
for residential, commercial and industrial customers were 10.99, 10.51 and 6.09
cents, respectively. The changes from 1994 were not significant.
Operating expenses increased 0.1% in 1995. Federal income taxes increased as a
result of higher pretax operating income. Fuel and purchased power expenses
decreased because of lower purchased power requirements resulting from the
increased availability of the nuclear generating units in 1995.
Interest charges and preferred dividends decreased in 1995 because of the
redemption of securities and refundings at favorable terms in 1995 and 1994.
F-37
<PAGE> 103
REPORT OF INDEPENDENT
PUBLIC ACCOUNTANTS
To the Share Owners and
Board of Directors of
The Toledo Edison Company:
We have audited the accompanying balance sheet and statement of capitalization
of The Toledo Edison Company (a wholly owned subsidiary of Centerior Energy
Corporation) as of December 31, 1996 and 1995, and the related statements of
income, retained earnings and cash flows for each of the three years in the
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of The Toledo Edison Company as of
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
Arthur Andersen LLP
Cleveland, Ohio
February 14, 1997
F-38
<PAGE> 104
INCOME STATEMENT The Toledo Edison Company
<TABLE>
<CAPTION>
For the years ended
December 31,
----------------------
1996 1995 1994
---- ---- ----
(millions of dollars)
<S> <C> <C> <C>
OPERATING REVENUES (1)________________________________________ $897 $874 $865
---- ---- ----
OPERATING EXPENSES
Fuel and purchased power ___________________________________ 169 157 167
Other operation and maintenance ____________________________ 231 225 229
Generation facilities rental expense, net __________________ 104 104 104
---- ---- ----
Total operation and maintenance _________________________ 504 486 500
Depreciation and amortization_______________________________ 94 84 83
Taxes, other than federal income taxes______________________ 90 91 90
Amortization of deferred operating expenses, net____________ 17 (17) (21)
Federal income taxes________________________________________ 36 42 33
---- ---- ----
741 686 685
---- ---- ----
OPERATING INCOME_____________________________________________ 156 188 180
---- ---- ----
NONOPERATING INCOME (LOSS)
Allowance for equity funds used during construction________ 1 1 1
Other income and deductions, net___________________________ (10) 6 3
Deferred carrying charges__________________________________ -- 14 15
Federal income taxes--credit (expense) ____________________ 5 (2) (2)
---- ---- ----
(4) 19 17
---- ---- ----
INCOME BEFORE INTEREST CHARGES_______________________________ 152 207 197
---- ---- ----
INTEREST CHARGES
Debt interest 96 111 116
Allowance for borrowed funds used during construction______ (1) (1) (1)
---- ---- ----
95 110 115
---- ---- ----
NET INCOME 57 97 82
PREFERRED DIVIDEND REQUIREMENTS______________________________ 17 18 20
---- ---- ----
EARNINGS AVAILABLE FOR COMMON STOCK__________________________ $ 40 $ 79 $ 62
==== ==== ====
- ---------------
</TABLE>
(1) Includes revenues from all bulk power sales to Cleveland Electric of $105
million, $102 million and $111 million in 1996, 1995 and 1994, respectively.
RETAINED EARNINGS
<TABLE>
<CAPTION>
For the years ended
December 31,
------------------------
1996 1995 1994
---- ----- -----
(millions of dollars)
<S> <C> <C> <C>
RETAINED EARNINGS (DEFICIT) AT BEGINNING OF YEAR____________ $(35) $(113) $(175)
---- ----- -----
ADDITIONS
Net income________________________________________________ 57 97 82
DEDUCTIONS
Preferred stock dividends declared and other______________ (17) (19) (20)
---- ----- -----
Net Increase___________________________________________ 40 78 62
---- ----- -----
RETAINED EARNINGS (DEFICIT) AT END OF YEAR__________________ $ 5 $ (35) $(113)
==== ===== =====
</TABLE>
The accompanying notes are an integral part of these statements.
F-39
<PAGE> 105
BALANCE SHEET
<TABLE>
<CAPTION>
December 31,
----------------
1996 1995
------ ------
(millions of dollars)
<S> <C> <C>
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Utility plant in service_____________________________________________________ $2,929 $2,896
Less: accumulated depreciation and amortization___________________________ 1,020 942
------ ------
1,909 1,954
Construction work in progress________________________________________________ 22 28
------ ------
1,931 1,982
Nuclear fuel, net of amortization __________________________________________ 76 78
Other property, less accumulated depreciation_______________________________ 8 20
------ ------
2,015 2,080
------ ------
CURRENT ASSETS
Cash and temporary cash investments ________________________________________ 81 94
Amounts due from customers and others, net _________________________________ 13 68
Amounts due from affiliates ________________________________________________ 13 19
Notes receivable from affiliates ___________________________________________ 82 --
Unbilled revenues __________________________________________________________ 4 22
Materials and supplies, at average cost_____________________________________
Owned____________________________________________________________________ 33 49
Under consignment________________________________________________________ 10 --
Taxes applicable to succeeding years________________________________________ 68 71
Other_______________________________________________________________________ 4 4
------ ------
308 327
------ ------
REGULATORY AND OTHER ASSETS
Regulatory assets___________________________________________________________ 928 978
Nuclear plant decommissioning trusts________________________________________ 64 52
Other_______________________________________________________________________ 42 37
------ ------
1,034 1,067
------ ------
Total Assets $3,357 $3,474
====== ======
</TABLE>
The accompanying notes are an integral part of this statement.
F-40
<PAGE> 106
The Toledo Edison Company
<TABLE>
<CAPTION>
December 31,
----------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C>
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common stock equity_________________________________________________________ $ 803 $ 763
Preferred stock
With mandatory redemption provisions_____________________________________ 3 5
Without mandatory redemption provisions__________________________________ 210 210
Long-term debt______________________________________________________________ 1,003 1,068
------ ------
2,019 2,046
------ ------
CURRENT LIABILITIES
Current portion of long-term debt and preferred stock_______________________ 51 58
Current portion of nuclear fuel lease obligations___________________________ 36 40
Accounts payable____________________________________________________________ 46 56
Accounts and notes payable to affiliates____________________________________ 30 53
Accrued taxes_______________________________________________________________ 73 78
Accrued interest____________________________________________________________ 22 24
Other_______________________________________________________________________ 20 20
------ ------
278 329
------ ------
DEFERRED CREDITS AND OTHER LIABILITIES
Unamortized investment tax credits__________________________________________ 75 79
Accumulated deferred federal income taxes___________________________________ 566 573
Unamortized gain from Bruce Mansfield Plant sale____________________________ 179 188
Accumulated deferred rents for Bruce Mansfield Plant and Beaver Valley
Unit 2____________________________________________________________________ 39 54
Nuclear fuel lease obligations______________________________________________ 49 52
Retirement benefits_________________________________________________________ 102 103
Other_______________________________________________________________________ 50 50
------ ------
1,060 1,099
------ ------
Total Capitalization and Liabilities $3,357 $3,474
====== ======
</TABLE>
F-41
<PAGE> 107
CASH FLOWS The Toledo Edison Company
<TABLE>
<CAPTION>
For the years ended
December 31,
-------------------------
1996 1995 1994
----- ----- -----
(millions of dollars)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES (1)
Net Income $ 57 $ 97 $ 82
------ ------ ------
Adjustments to Reconcile Net Income to Cash from Operating Activities:
Depreciation and amortization_______________________________________ 94 84 83
Deferred federal income taxes_______________________________________ 18 16 46
Unbilled revenues___________________________________________________ (7) -- 3
Deferred fuel_______________________________________________________ 9 (3) 3
Deferred carrying charges___________________________________________ -- (14) (15)
Leased nuclear fuel amortization____________________________________ 33 54 44
Amortization of deferred operating expenses, net____________________ 17 (17) (21)
Allowance for equity funds used during construction_________________ (1) (1) (1)
Changes in amounts due from customers and others, net_______________ (2) (6) 1
Net proceeds from accounts receivable securitization________________ 78 -- --
Changes in materials and supplies___________________________________ 6 8 (2)
Changes in accounts payable_________________________________________ (10) 8 (15)
Changes in working capital affecting operations ____________________ (1) 4 (16)
Other noncash items_________________________________________________ (10) 9 10
----- ----- -----
Total Adjustments_________________________________________________ 224 142 120
----- ----- -----
Net Cash from Operating Activities_____________________________ 281 239 202
----- ----- -----
CASH FLOWS FROM FINANCING ACTIVITIES (2)
Notes payable to affiliates___________________________________________ (21) 21 --
First mortgage bond issues____________________________________________ -- 99 31
Maturities, redemptions and sinking funds ____________________________ (73) (215) (98)
Nuclear fuel lease obligations________________________________________ (39) (44) (49)
Dividends paid________________________________________________________ (17) (18) (20)
Premiums, discounts and expenses______________________________________ -- (6) --
----- ----- -----
Net Cash from Financing Activities____________________________ (150) (163) (136)
----- ----- -----
CASH FLOWS FROM INVESTING ACTIVITIES (2)
Cash applied to construction__________________________________________ (47) (53) (41)
Interest capitalized as allowance for borrowed funds used during
construction_______________________________________________________ (1) (1) (1)
Loans to affiliates___________________________________________________ (82) -- --
Contributions to nuclear plant decommissioning trusts_________________ (10) (11) (12)
Other cash applied____________________________________________________ (4) (5) (6)
----- ----- -----
Net Cash from Investing Activities____________________________ (144) (70) (60)
----- ----- -----
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS_______________________ (13) 6 6
----- ----- -----
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF YEAR________________ 94 88 82
----- ----- -----
CASH AND TEMPORARY CASH INVESTMENTS AT END OF YEAR______________________ $ 81 $ 94 $ 88
===== ===== =====
- ---------------
(1) Interest paid (net of amounts capitalized) _________________________ $ 92 $ 93 $ 94
===== ===== =====
Federal income taxes paid__________________________________________ $ 16 $ 23 $ 5
===== ===== =====
</TABLE>
(2) Increases in Nuclear Fuel and Nuclear Fuel Lease Obligations in the Balance
Sheet resulting from the noncash capitalizations under nuclear fuel
agreements are excluded from this statement.
The accompanying notes are an integral part of this statement.
F-42
<PAGE> 108
STATEMENT OF CAPITALIZATION The Toledo Edison Company
<TABLE>
<CAPTION>
December 31,
-----------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C>
COMMON STOCK EQUITY:
Common shares, $5 par value: 60 million authorized; 39.1 million outstanding in 1996 and
1995____________________________________________________________________________________ $ 196 $ 196
Premium on capital stock__________________________________________________________________ 481 481
Other paid-in capital_____________________________________________________________________ 121 121
Retained earnings (deficit)_______________________________________________________________ 5 (35)
------ ------
Total Common Stock Equity 803 763
------ ------
</TABLE>
<TABLE>
<CAPTION>
Current
1996 Shares Call Price
Outstanding Per Share
----------- ----------
<S> <C> <C> <C> <C>
PREFERRED STOCK:
$100 par value, 3,000,000 preferred shares authorized;
$25 par value, 12,000,000 preferred shares authorized
Subject to mandatory redemption:
$100 par $9.375_____________________________ 50,200 $100.99 5 7
Less: Current maturities 2 2
------ ------
Total Preferred Stock, with Mandatory
Redemption Provisions__________________________________ 3 5
------ ------
Not subject to mandatory redemption:
$100 par $4.25 ______________________________ 160,000 104.625 16 16
4.56 ______________________________ 50,000 101.00 5 5
4.25 ______________________________ 100,000 102.00 10 10
8.32 ______________________________ 100,000 102.46 10 10
7.76 ______________________________ 150,000 102.437 15 15
7.80 ______________________________ 150,000 101.65 15 15
10.00______________________________ 190,000 101.00 19 19
25 par 2.21 ______________________________ 1,000,000 25.25 25 25
2.365______________________________ 1,400,000 27.75 35 35
Series A Adjustable _______________ 1,200,000 25.00 30 30
Series B Adjustable _______________ 1,200,000 25.00 30 30
------ ------
Total Preferred Stock, without Mandatory
Redemption Provisions 210 210
------ ------
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
LONG-TERM DEBT:
First mortgage bonds:
6.125% due 1997 __________________________________________________________________________ 31 31
7.250% due 1999 __________________________________________________________________________ 85 100
7.500% due 2002 __________________________________________________________________________ 26 26
8.000% due 2003 __________________________________________________________________________ 36 36
7.875% due 2004 __________________________________________________________________________ 145 145
------ ------
323 338
------ ------
Tax-exempt issues secured by first mortgage bonds:
10.000% due 1998__________________________________________________________________________ 1 1
3.700% due 2011**________________________________________________________________________ 31 31
8.000% due 2019__________________________________________________________________________ 67 67
7.625% due 2020__________________________________________________________________________ 45 45
7.750% due 2020__________________________________________________________________________ 54 54
7.400% due 2022__________________________________________________________________________ 31 31
9.875% due 2022***_______________________________________________________________________ 10 10
7.550% due 2023__________________________________________________________________________ 37 37
6.875% due 2023__________________________________________________________________________ 20 20
8.000% due 2023__________________________________________________________________________ 50 50
------ ------
346 346
------ ------
</TABLE>
The accompanying notes are an integral part of this statement.
F-43
<PAGE> 109
STATEMENT OF CAPITALIZATION (CONTINUED)
<TABLE>
<CAPTION>
December 31,
-----------------
1996 1995
------ ------
(millions of
dollars)
<S> <C> <C>
LONG-TERM DEBT: (CONTINUED)
Medium-term notes secured by first mortgage bonds:
9.050% due 1996 ___________________________________________________________________ -- 10
9.000% due 1996 ___________________________________________________________________ -- 3
9.300% due 1998 ___________________________________________________________________ 26 26
8.000% due 1998 ___________________________________________________________________ 7 7
7.940% due 1998 ___________________________________________________________________ 5 5
8.470% due 1999 ___________________________________________________________________ 4 4
7.720% due 1999 ___________________________________________________________________ 15 15
7.500% due 2000 ___________________________________________________________________ * *
7.380% due 2000 ___________________________________________________________________ 14 14
7.460% due 2000 ___________________________________________________________________ 17 17
9.500% due 2001 ___________________________________________________________________ 21 21
8.500% due 2001 ___________________________________________________________________ 8 8
8.620% due 2002 ___________________________________________________________________ 7 7
8.650% due 2002 ___________________________________________________________________ 5 5
8.180% due 2002 ___________________________________________________________________ 17 17
7.820% due 2003 ___________________________________________________________________ 37 37
7.850% due 2003 ___________________________________________________________________ 15 15
7.760% due 2003 ___________________________________________________________________ 5 5
7.910% due 2003 ___________________________________________________________________ 3 3
7.780% due 2003 ___________________________________________________________________ 1 1
10.000% due 2021 ___________________________________________________________________ 15 15
9.220% due 2021 ___________________________________________________________________ 15 15
------ ------
237 250
Tax-exempt notes: ------ ------
5.750% due 2003 ___________________________________________________________________ 4 4
10.000% due 2010 ___________________________________________________________________ 1 1
------ ------
5 5
------ ------
Bank loans secured by subordinate mortgage:
9.050% due 1996 ___________________________________________________________________ -- 25
7.500% due 1996 ___________________________________________________________________ -- 2
------ ------
-- 27
------ ------
Notes secured by subordinate mortgage:
10.060% due 1996 ___________________________________________________________________ -- 14
8.750% due 1997 ___________________________________________________________________ 8 11
------ ------
8 25
------ ------
Debentures:
8.700% due 2002 ___________________________________________________________________ 135 135
------ ------
Unamortized premium (discount), net __________________________________________________ (2) (2)
------ ------
1,052 1,124
Less: Current maturities ___________________________________________________________ 49 56
------ ------
Total Long-Term Debt _____________________________________________________________ 1,003 1,068
------ ------
TOTAL CAPITALIZATION__________________________________________________________________ $2,019 $2,046
====== ======
<FN>
- ---------------
* Denotes debt of less than $1 million.
** Denotes variable rate issue with December 31, 1996 interest rate shown.
*** Subject to optional tender by the owners on November 1, 1997.
</TABLE>
F-44
<PAGE> 110
NOTES TO THE FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) GENERAL
The Company is an electric utility serving Northwest Ohio and a wholly owned
subsidiary of Centerior Energy. The Company follows the Uniform System of
Accounts prescribed by the FERC and adopted by the PUCO. Rate-regulated
utilities are subject to SFAS 71 which governs accounting for the effects of
certain types of rate regulation. Pursuant to SFAS 71, certain incurred costs
are deferred for recovery in future rates. See Note 7(a).
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses, and
the disclosure of contingent assets and liabilities. The estimates are based on
an analysis of the best information available. Actual results could differ from
those estimates.
The Company is a member of the Central Area Power Coordination Group (CAPCO).
Other members are Cleveland Electric, Duquesne Light Company, Ohio Edison and
its wholly owned subsidiary, Pennsylvania Power Company. The members have
constructed and operate generation and transmission facilities for their joint
use.
(B) RELATED PARTY TRANSACTIONS
Operating revenues, operating expenses and interest charges include those
amounts for transactions with affiliated companies in the ordinary course of
business operations.
The Company's transactions with Cleveland Electric are primarily for firm power,
interchange power, transmission line rentals and jointly owned power plant
operations and construction. See Notes 2 and 3. As discussed in Note 1(j),
beginning in May 1996, Cleveland Electric's wholly owned subsidiary, Centerior
Funding, began serving as the transferor in connection with the accounts
receivable securitization for the Company and Cleveland Electric.
Centerior Service Company (Service Company), a wholly owned subsidiary of
Centerior Energy, provides management, financial, administrative, engineering,
legal and other services at cost to the Company and other affiliated companies.
The Service Company billed the Company $60 million, $67 million and $59 million
in 1996, 1995 and 1994, respectively, for such services.
(C) REVENUES
Customers are billed on a monthly cycle basis for their energy consumption based
on rate schedules or contracts authorized by the PUCO or on ordinances of
individual municipalities. An accrual is made at the end of each month to record
the estimated amount of unbilled revenues for kilowatt-hours sold in the current
month but not billed by the end of that month.
A fuel factor is added to the base rates for electric service. This factor is
designed to recover from customers the costs of fuel and most purchased power.
It is reviewed and adjusted semiannually in a PUCO proceeding. See Management's
Financial Analysis -- Outlook-FirstEnergy Rate Plan.
(D) FUEL EXPENSE
The cost of fossil fuel is charged to fuel expense based on inventory usage. The
cost of nuclear fuel, including an interest component, is charged to fuel
expense based on the rate of consumption. Estimated future nuclear fuel disposal
costs are being recovered through base rates.
The Company defers the differences between actual fuel costs and estimated fuel
costs currently being recovered from customers through the fuel factor. This
matches fuel expenses with fuel-related revenues.
Owners of nuclear generating plants are assessed by the federal government for
the cost of decontamination and decommissioning of nuclear enrichment facilities
operated by the United States Department of Energy. The assessments are based
upon the amount of enrichment services used in prior years and cannot be imposed
for more than 15 years (to 2007). The Company has accrued a liability for its
share of the total assessments. These costs have been recorded as a regulatory
asset since the PUCO is allowing the Company to recover the assessments through
its fuel cost factors. See Note 7(a).
(E) DEPRECIATION AND DECOMMISSIONING
The cost of property, plant and equipment is depreciated over their estimated
useful lives on a straight-line basis. In its April 1996 rate order, the PUCO
approved changes in depreciation rates for the Company. An increase in the
depreciation rate for nuclear property from 2.5% to 2.95% increased annual
depreciation expense approximately $8 million. A reduction in the composite
depreciation rate for nonnuclear property from 3.36% to 3.13% decreased annual
depreciation expense by approximately $2 million. The changes in depreciation
rates were effective in April 1996 and resulted in a $4 million net increase in
1996 depreciation expense.
F-45
<PAGE> 111
The Company accrues the estimated costs of decommissioning its three nuclear
generating units. The accruals are required to be funded in an external trust.
The PUCO requires that the expense and payments to the external trusts be
determined on a levelized basis by dividing the unrecovered decommissioning
costs in current dollars by the remaining years in the licensing period of each
unit. This methodology requires that the net earnings on the trusts be
reinvested therein with the intent of having net earnings offset inflation. The
PUCO requires that the estimated costs of decommissioning and the funding level
be reviewed at least every five years.
In April 1996, pursuant to the PUCO rate order, the Company decreased its annual
decommissioning expense accruals to $10 million from the $11 million level in
1995. The accruals are reflected in current rates. The accruals are based on
adjustments to updated, site-specific studies for each of the units completed in
1993 and 1994. These estimates reflect the DECON method of decommissioning
(prompt decontamination), and the locations and cost characteristics specific to
the units, and include costs associated with decontamination and dismantlement
for each of the units. The estimate for Davis-Besse also includes the cost of
site restoration. The adjustments to the updated studies which reduced the
annual accruals beginning in April 1996 were attributable to changed assumptions
on radioactive waste burial cost estimates and the exclusion of site restoration
costs for Perry Unit 1 and Beaver Valley Unit 2. After the decommissioning of
these units in the future, the two plant sites may be usable for new power
production facilities or other industrial purposes.
The revised estimates for the units in current dollars and in dollars at the
time of license expiration, assuming a 4% annual inflation rate, are as follows:
<TABLE>
<CAPTION>
License
Expiration Future
Generating Unit Year Amount Amount
- ------------------------------- ---------- ------ ------
(millions of
dollars)
<S> <C> <C> <C>
Davis-Besse______________________ 2017 $166 $427
Perry Unit 1_____________________ 2026 85 309
Beaver Valley Unit 2_____________ 2027 44 165
---- ----
Total______________________ $295 $901
==== ====
</TABLE>
The classification, Accumulated Depreciation and Amortization, in the Balance
Sheet at December 31, 1996 includes $71 million of decommissioning costs
previously expensed and the earnings on the external trust funding. This amount
exceeds the Balance Sheet amount of the external Nuclear Plant Decommissioning
Trusts because the reserve began prior to the external trust funding. The trust
earnings are recorded as an increase to the trust assets and the related
component of the decommissioning reserve (included in Accumulated Depreciation
and Amortization).
The staff of the Securities and Exchange Commission
has questioned certain of the current accounting practices of the electric
utility industry, including those of the Company, regarding the recognition,
measurement and classification of decommissioning costs for nuclear generating
stations in the financial statements. In response to these questions, the
Financial Accounting Standards Board (FASB) is reviewing the accounting for
removal costs, including decommissioning. If current accounting practices are
changed, the annual provision for decommissioning could increase; the estimated
cost for decommissioning could be recorded as a liability rather than as
accumulated depreciation; and trust fund income from the external
decommissioning trusts could be reported as investment income rather than as a
reduction to decommissioning expense. The FASB issued an exposure draft on the
subject on February 7, 1996 and continues to review the subject.
(F) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at original cost less amounts
disallowed by the PUCO. Construction costs include related payroll taxes,
retirement benefits, fringe benefits, management and general overheads and
allowance for funds used during construction (AFUDC). AFUDC represents the
estimated composite debt and equity cost of funds used to finance construction.
This noncash allowance is credited to income. The AFUDC rate was 10.12% in 1996,
12.6% in 1995 and 9.87% in 1994.
Maintenance and repairs for plant and equipment are charged to expense as
incurred. The cost of replacing plant and equipment is charged to the utility
plant accounts. The cost of property retired plus removal costs, after deducting
any salvage value, is charged to the accumulated provision for depreciation.
(G) DEFERRED GAIN AND LOSS FROM SALES OF UTILITY PLANT
The sale and leaseback transactions discussed in Note 2 resulted in a net gain
for the sale of the Bruce Mansfield Generating Plant (Mansfield Plant) and a net
loss for the sale of Beaver Valley Unit 2. The net gain and net loss were
deferred and are being amortized over the terms of the leases. See Note 7(a).
These amortizations and the lease expense amounts are reported in the Income
Statement as Generation Facilities Rental Expense, Net.
F-46
<PAGE> 112
(H) INTEREST CHARGES
Debt Interest reported in the Income Statement does not include interest on
obligations for nuclear fuel under construction. That interest is capitalized.
See Note 6.
Losses and gains realized upon the reacquisition or redemption of long-term debt
are deferred, consistent with the regulatory rate treatment. See Note 7(a). Such
losses and gains are either amortized over the remainder of the original life of
the debt issue retired or amortized over the life of the new debt issue when the
proceeds of a new issue are used for the debt redemption. The amortizations are
included in debt interest expense.
(I) FEDERAL INCOME TAXES
The Company uses the liability method of accounting for income taxes in
accordance with SFAS 109. See Note 8. This method requires that deferred taxes
be recorded for all temporary differences between the book and tax bases of
assets and liabilities. The majority of these temporary differences are
attributable to property-related basis differences. Included in these basis
differences is the equity component of AFUDC, which will increase future tax
expense when it is recovered through rates. Since this component is not
recognized for tax purposes, the Company must record a liability for its tax
obligation. The PUCO permits recovery of such taxes from customers when they
become payable. Therefore, the net amount due from customers through rates has
been recorded as a regulatory asset and will be recovered over the lives of the
related assets. See Note 7(a).
Investment tax credits are deferred and amortized over the lives of the
applicable property as a reduction of depreciation expense.
(J) ACCOUNTS RECEIVABLE SECURITIZATION
In May 1996, the Company and Cleveland Electric began to sell on a daily basis
substantially all of their retail customer accounts receivable and unbilled
revenue receivables to Centerior Funding pursuant to a five-year asset-backed
securitization agreement.
In July 1996, Centerior Funding completed a public sale of $150 million of
receivables-backed investor certificates in a transaction that qualifies for
sale accounting treatment for financial reporting purposes.
(K) MATERIALS AND SUPPLIES
In December 1996, the Company sold substantially all of its materials and
supplies and fossil fuel inventories for certain generating units and other
storage locations to an independent entity at book value. The buyer now provides
all of these inventories under a consignment arrangement. In accordance with
SFAS 49 accounting for product financing arrangements, the inventories continue
to be reported as assets in the Balance Sheet even though the buyer owns the
inventories since the Company has guaranteed to be a buyer of last resort.
(2) UTILITY PLANT SALE AND LEASEBACK TRANSACTIONS
The Company and Cleveland Electric are co-lessees of 18.26% (150 megawatts) of
Beaver Valley Unit 2 and 6.5% (51 megawatts), 45.9% (358 megawatts) and 44.38%
(355 megawatts) of Units 1, 2 and 3 of the Mansfield Plant, respectively. These
leases extend through 2017 and are the result of sale and leaseback transactions
completed in 1987.
Under these leases, the Company and Cleveland Electric are responsible for
paying all taxes, insurance premiums, operation and maintenance expenses, and
all other similar costs for their interests in the units sold and leased back.
They may incur additional costs in connection with capital improvements to the
units. The Company and Cleveland Electric have options to buy the interests back
at certain times at a premium and at the end of the leases for the fair market
value at that time or to renew the leases. The leases include conditions for
mandatory termination (and possible repurchase of the leasehold interests) upon
certain events of default.
As co-lessee with Cleveland Electric, the Company is also obligated for
Cleveland Electric's lease payments. If Cleveland Electric is unable to make its
payments under the Mansfield Plant leases, the Company would be obligated to
make such payments. No such payments have been made on behalf of Cleveland
Electric.
Future minimum lease payments under the operating leases at December 31, 1996
are summarized as follows:
<TABLE>
<CAPTION>
For For
the Cleveland
Year Company Electric
- -------------------------------------- ------- ---------
(millions of dollars)
<S> <C> <C>
1997_________________________________ $ 102 $ 63
1998_________________________________ 102 63
1999_________________________________ 108 70
2000_________________________________ 111 76
2001_________________________________ 111 75
Later Years 1,696 1,170
------ ------
Total Future Minimum Lease
Payments_____________________ $2,230 $ 1,517
====== =======
</TABLE>
Rental expense is accrued on a straight-line basis over the terms of the leases.
The amount recorded in 1996, 1995 and 1994 as annual rental expense for the
Mansfield Plant leases was $45 million. The amounts recorded in 1996,
F-47
<PAGE> 113
1995 and 1994 as annual rental expense for the Beaver Valley Unit 2 lease were
$63 million, $63 million and $64 million, respectively. See Note 1(g). Amounts
charged to expense in excess of the lease payments are classified as Accumulated
Deferred Rents in the Balance Sheet.
The Company is selling 150 megawatts of its Beaver Valley Unit 2 leased capacity
entitlement to Cleveland Electric. Revenues recorded for this transaction were
$99 million, $98 million and $108 million in 1996, 1995 and 1994, respectively.
We anticipate that this sale will continue indefinitely. The future minimum
lease payments through 2017 associated with Beaver Valley Unit 2 aggregate
$1.265 billion.
(3) PROPERTY OWNED WITH OTHER UTILITIES AND INVESTORS
The Company owns, as a tenant in common with other utilities and those investors
who are owner-participants in various sale and leaseback transactions (Lessors),
certain generating units as listed below. Each owner owns an undivided share in
the entire unit. Each owner has the right to a percentage of the generating
capability of each unit equal to its ownership share. Each utility owner is
obligated to pay for only its respective share of the construction costs and
operating expenses. Each Lessor has leased its capacity rights to a utility
which is obligated to pay for such Lessor's share of the construction costs and
operating expenses. The Company's share of the operating expenses of these
generating units is included in the Income Statement. The Balance Sheet
classification of Property, Plant and Equipment at December 31, 1996 includes
the following facilities owned by the Company as a tenant in common with other
utilities and Lessors:
<TABLE>
<CAPTION>
Property,
Plant and
Ownership Equipment
Megawatts (Exclusive of Accumulated
Generating Unit (% Share) Nuclear Fuel) Depreciation
- ------------------------ ---------- ------------- -----------
(millions of dollars)
<S> <C> <C> <C>
Davis-Besse_____________ 429 (48.62%) $ 685 $ 235
Perry Unit 1____________ 238 (19.91) 1,048 244
Beaver Valley Unit 2 and
Common Facilities
(Note 2)________________ 13 (1.65) 209 58
------- -----
Total_____________ $ 1,942 $ 537
======= =====
</TABLE>
(4) CONSTRUCTION AND CONTINGENCIES
(A) CONSTRUCTION PROGRAM
The estimated cost of the Company's construction program for the 1997-2001
period is $282 million, including AFUDC of $8 million and excluding nuclear
fuel.
The Clean Air Act Amendments of 1990 (Clean Air Act) require, among other
things, significant reductions in the emission of sulfur dioxide and nitrogen
oxides by fossil-fueled generating units. Our strategy provides for compliance
primarily through greater use of low-sulfur coal at some of our units and the
use of emission allowances. Total capital expenditures from 1994 through 1996 in
connection with Clean Air Act compliance amounted to $4 million. The plan will
require additional capital expenditures over the 1997-2006 period of
approximately $16 million for nitrogen oxide control equipment and other plant
process modifications. In addition, higher fuel and other operation and
maintenance expenses will be incurred. Recently proposed particulate and ozone
ambient standards have the potential to increase future compliance costs.
(B) HAZARDOUS WASTE DISPOSAL SITES
The Company is aware of its potential involvement in the cleanup of several
sites. The Company has accrued a liability totaling $3 million at December 31,
1996 based on estimates of the costs of cleanup and its proportionate
responsibility for such costs. We believe that the ultimate outcome of these
matters will not have a material adverse effect on our financial condition, cash
flows or results of operations. See Management's Financial Analysis --
Outlook-Hazardous Waste Disposal Sites.
(5) NUCLEAR OPERATIONS AND CONTINGENCIES
(A) OPERATING NUCLEAR UNITS
The Company's three nuclear units may be impacted by activities or events beyond
our control. An extended outage of one of our nuclear units for any reason,
coupled with any unfavorable rate treatment, could have a material adverse
effect on our financial condition, cash flows and results of operations. See the
discussion of these and other risks in Management's Financial
Analysis -- Outlook-Nuclear Operations.
(B) NUCLEAR INSURANCE
The Price-Anderson Act limits the public liability of the owners of a nuclear
power plant to the amount provided by private insurance and an industry
assessment plan. In the event of a nuclear incident at any unit in the United
States resulting in losses in excess of the level of private insurance
(currently $200 million), the Company's maximum potential assessment under that
plan would be $70 million per incident. The assessment is limited to $9 million
per year for each nuclear incident. These assessment limits assume the other
CAPCO companies
F-48
<PAGE> 114
contribute their proportionate share of any assessment for the generating units
that they have an ownership or leasehold interest in.
The utility owners and lessees of Davis-Besse, Perry and Beaver Valley also have
insurance coverage for damage to property at these sites (including leased fuel
and cleanup costs). Coverage amounted to $1.3 billion for Davis-Besse and $2.75
billion for each of the Perry and Beaver Valley sites as of January 1, 1997.
Damage to property could exceed the insurance coverage by a substantial amount.
If it does, the Company's share of such excess amount could have a material
adverse effect on its financial condition, cash flows and results of operations.
In addition, the Company can be assessed a maximum of $10 million under these
policies during a policy year if the reserves available to the insurer are
inadequate to pay claims arising out of an accident at any nuclear facility
covered by the insurer.
The Company also has extra expense insurance coverage. It includes the
incremental cost of any replacement power purchased (over the costs which would
have been incurred had the units been operating) and other incidental expenses
after the occurrence of certain types of accidents at our nuclear units. The
amounts of the coverage are 100% of the estimated extra expense per week during
the 52-week period starting 21 weeks after an accident and 80% of such estimate
per week for the next 104 weeks. The amount and duration of extra expense could
substantially exceed the insurance coverage.
(6) NUCLEAR FUEL
Nuclear fuel is financed for the Company and Cleveland Electric through leases
with a special-purpose corporation. The total amount of financing currently
available under these lease arrangements is $273 million ($173 million from
intermediate-term notes and $100 million from bank credit arrangements). The
intermediate-term notes mature in the 1997 through 2000 period. The bank credit
arrangements terminate in October 1998. The special-purpose corporation may not
need alternate financing in 1997 to replace $83 million of maturing
intermediate-term notes. At December 31, 1996, $87 million of nuclear fuel was
financed for the Company. The Company and Cleveland Electric severally lease
their respective portions of the nuclear fuel and are obligated to pay for the
fuel as it is consumed in a reactor. The lease rates are based on various
intermediate-term note rates, bank rates and commercial paper rates.
The amounts financed include nuclear fuel in the Davis-Besse, Perry Unit 1 and
Beaver Valley Unit 2 reactors with remaining lease payments for the Company of
$43 million, $26 million and $14 million, respectively, at December 31, 1996.
The nuclear fuel amounts financed and capitalized also included interest charges
incurred by the lessors amounting to $2 million in both 1996 and 1995, and $4
million in 1994. The estimated future lease amortization payments for the
Company based on projected consumption are $36 million in 1997, $29 million in
both 1998 and 1999, $27 million in 2000 and $28 million in 2001.
(7) REGULATORY MATTERS
(A) REGULATORY ACCOUNTING REQUIREMENTS AND REGULATORY ASSETS
The Company is subject to the provisions of SFAS 71 and has complied with its
provisions. SFAS 71 provides, among other things, for the deferral of certain
incurred costs that are probable of future recovery in rates. We monitor changes
in market and regulatory conditions and consider the effects of such changes in
assessing the continuing applicability of SFAS 71. Criteria that could give rise
to discontinuation of the application of SFAS 71 include: (1) increasing
competition which significantly restricts the Company's ability to charge prices
which allow it to recover operating costs, earn a fair return on invested
capital and recover the amortization of regulatory assets and (2) a significant
change in the manner in which rates are set by the PUCO from cost-based
regulation to some other form of regulation. Regulatory assets represent
probable future revenues to the Company associated with certain incurred costs,
which it will recover from customers through the rate-making process.
Effective January 1, 1996, the Company adopted SFAS 121 which imposes stricter
criteria for carrying regulatory assets than SFAS 71 by requiring that such
assets be probable of recovery at each balance sheet date. The criteria under
SFAS 121 for plant assets require such assets to be written down if the book
value exceeds the projected net future undiscounted cash flows.
F-49
<PAGE> 115
Regulatory assets in the Balance Sheet are as follows:
<TABLE>
<CAPTION>
December 31,
--------------
1996 1995
---- ----
(millions of
dollars)
<S> <C> <C>
Amounts due from customers for future
federal income taxes, net_________________ $391 $416
Unamortized loss from Beaver Valley
Unit 2 sale_______________________________ 92 96
Unamortized loss on reacquired debt_________ 24 28
Pre-phase-in deferrals*_____________________ 215 222
Rate Stabilization Program deferrals________ 180 188
Other_______________________________________ 26 28
---- ----
Total___________________________________ $928 $978
==== ====
</TABLE>
* Represent deferrals of operating expenses and carrying charges for Perry Unit
1 and Beaver Valley Unit 2 in 1987 and 1988 which are being amortized over the
lives of the related property.
As of December 31, 1996, customer rates provide for recovery of all the above
regulatory assets. The remaining recovery periods for about $740 million of the
regulatory assets approximate 30 years. The remaining recovery periods for the
rest of the regulatory assets generally range from about two to 20 years.
Regulatory liabilities in the Balance Sheet at December 31, 1996 and 1995
totaled $13 million and $4 million, respectively.
(B) RATE ORDER
On April 11, 1996, the PUCO issued an order for the Company and Cleveland
Electric granting price increases aggregating $119 million in annualized
revenues ($35 million for the Company and $84 million for Cleveland Electric).
The PUCO rate order provided for recovery of all costs to provide regulated
services, including amortization of regulatory assets, in the approved prices.
The new prices were implemented in late April 1996. The average price increase
for the Company's customers was 4.7% with the actual percentage increase
depending upon the customer class. The Company and Cleveland Electric intend to
freeze prices through at least 2002, although they are not precluded from
requesting further price increases.
The PUCO also recommended that the Company and Cleveland Electric reduce the
value of their assets for regulatory purposes by an aggregate $1.25 billion
through 2001. This represents an incremental reduction beyond the normal level
in nuclear plant and regulatory assets. Implementation of the price increases
was not contingent upon a revaluation of assets. The PUCO invited the Company
and Cleveland Electric to file a proposal to effectuate the PUCO's
recommendation and expressed a willingness to consider alternatives to its
recommendation. The PUCO stated in its order that failure by the Company and
Cleveland Electric to follow the recommendation could result in a PUCO-ordered
write-down of assets for regulatory purposes. The PUCO approved a
return on common stock equity of 12.59% and an overall rate of return of 10.06%
for both companies. However, the PUCO also indicated the authorized return could
be lowered by the PUCO if the Company and Cleveland Electric do not implement
the recommendation. In August 1996, various intervenors appealed the PUCO rate
order to the Ohio Supreme Court. The Company and Cleveland Electric did not
appeal the order to the Ohio Supreme Court. In connection with the PUCO order
discussed in Management's Financial Analysis -- Outlook-FirstEnergy Rate Plan,
certain parties agreed to request a stay of their appeals until completion of
the pending merger with Ohio Edison.
(C) ASSESSMENT
The Company and Cleveland Electric agree with the concept of accelerating the
recognition of costs and recovery of assets as such concept is consistent with
the strategic objective to become more competitive. However, the Company and
Cleveland Electric believe that such acceleration must also be consistent with
the reduction of debt and the opportunity for Centerior Energy common stock
share owners to receive a fair return on their investment. Consideration of
whether to implement a plan responsive to the PUCO's recommendation to revalue
assets by $1.25 billion is pending the merger with Ohio Edison.
We have evaluated the Company's markets, regulatory conditions and ability to
bill and collect the approved prices, and conclude that the Company continues to
comply with the provisions of SFAS 71 and its regulatory assets remain probable
of recovery. If there is a change in our evaluation of the competitive
environment, regulatory framework or other factors, or if the PUCO significantly
reduces the value of the Company's assets or reduces the approved return on
common stock equity of 12.59% and overall rate of return of 10.06%, or both, for
future regulatory purposes, the Company may be required to record material
charges to earnings. In particular, if we determine that the Company no longer
meets the criteria for SFAS 71, the Company would be required to record a
before-tax charge to write off the regulatory assets shown above. In the more
likely event that only a portion of operations (such as nuclear operations) no
longer meets the criteria of SFAS 71, a write-off would be limited to regulatory
assets that are not reflected in the Company's cost-based prices established for
the remaining regulated operations. In addition, we would be required to
evaluate whether the changes in the competitive and regulatory environment which
led to discontinuing the application of
F-50
<PAGE> 116
SFAS 71 to some or all of the Company's operations would also result in a
write-down of property, plant and equipment pursuant to SFAS 121.
See Management's Financial Analysis -- Outlook-FirstEnergy Rate Plan for a
discussion of a regulatory plan for the Company and Cleveland Electric and its
effect on their compliance with SFAS 71.
(D) RATE STABILIZATION PROGRAM
The Rate Stabilization Program that the PUCO approved in October 1992 allowed
the Company to defer and subsequently amortize and recover certain costs not
being recovered in rates at that time. Recovery of both the costs no longer
being deferred and the amortization of the 1992-1995 deferrals began in late
April 1996 with the implementation of the price increase granted by the PUCO as
discussed above. The cost deferrals recorded in 1995 and 1994 pursuant to the
Rate Stabilization Program were $39 million and $43 million, respectively. The
amortization of the deferrals began in December 1995. The total amortization was
$8 million and $1 million in 1996 and 1995, respectively.
The regulatory accounting measures under the Rate Stabilization Program also
provided for the accelerated amortization of certain benefits during the
1992-1995 period. The total annual amount of such accelerated benefits was $18
million in both 1995 and 1994.
(8) FEDERAL INCOME TAX
The components of federal income tax expense recorded in the Income Statement
were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Operating Expenses:
Current__________________________ $ 23 $ 40 $ 18
Deferred_________________________ 13 2 15
---- ---- ----
Total Charged to Operating
Expenses_____________________ 36 42 33
---- ---- ----
Nonoperating Income:
Current__________________________ (10) (12) (29)
Deferred_________________________ 5 14 31
---- ---- ----
Total Expense (Credit) to
Nonoperating Income__________ (5) 2 2
---- ---- ----
Total Federal Income Tax Expense___ $ 31 $ 44 $ 35
==== ==== ====
</TABLE>
The deferred federal income tax expense results from the temporary differences
that arise from the different years when certain expenses are recognized for tax
purposes as opposed to financial reporting purposes. Such temporary differences
relate principally to depreciation and deferred operating expenses and carrying
charges.
Federal income tax, computed by multiplying income before taxes by the 35%
statutory rate, is reconciled to the amount of federal income tax recorded on
the books as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Book Income Before Federal Income Tax__ $88 $141 $117
--- --- ----
Tax on Book Income at Statutory Rate___ $31 $ 49 $ 41
Increase (Decrease) in Tax:
Depreciation_________________________ (4) (1) (3)
Rate Stabilization Program___________ -- (9) (9)
Sale and leaseback transactions and
amortization_______________________ 5 5 5
Other items__________________________ (1) -- 1
--- --- ----
Total Federal Income Tax Expense_______ $31 $ 44 $ 35
=== ==== ====
</TABLE>
The Company joins in the filing of a consolidated federal income tax return with
its affiliated companies. The method of tax allocation reflects the benefits and
burdens realized by each company's participation in the consolidated tax return,
approximating a separate return result for each company.
For tax reporting purposes, the Perry Nuclear Power Plant Unit 2 (Perry Unit 2)
abandonment was recognized in 1994 and resulted in a $122 million loss with a
corresponding $43 million reduction in federal income tax liability. Because of
the alternative minimum tax (AMT), $25 million of the $43 million was realized
in 1994. The remaining $18 million will not be realized until 1999.
Under SFAS 109, temporary differences and carryforwards resulted in deferred tax
assets of $162 million and deferred tax liabilities of $728 million at December
31, 1996 and deferred tax assets of $179 million and deferred tax liabilities of
$752 million at December 31, 1995. These are summarized as follows:
<TABLE>
<CAPTION>
December 31,
--------------
1996 1995
---- ----
(millions of
dollars)
<S> <C> <C>
Property, plant and equipment________________ $612 $627
Deferred carrying charges and operating
expenses___________________________________ 84 85
Net operating loss carryforwards_____________ (18) (44)
Investment tax credits_______________________ (44) (46)
Sale and leaseback transactions______________ -- (4)
Other________________________________________ (68) (45)
---- ----
Net deferred tax liability_______________ $566 $573
==== ====
</TABLE>
For tax purposes, net operating loss (NOL) carryforwards of approximately $51
million are available to reduce future taxable income and will expire in 2009.
The 35% tax effect of the NOLs is $18 million. Additionally, AMT credits of $100
million that may be carried forward indefinitely are available to reduce future
tax.
(9) RETIREMENT BENEFITS
(A) RETIREMENT INCOME PLAN
Centerior Energy sponsors jointly with its subsidiaries a noncontributing
pension plan (Centerior Pension Plan) which covers all employee groups. The
amount of retire-
F-51
<PAGE> 117
ment benefits generally depends upon the length of service. Under certain
circumstances, benefits can begin as early as age 55. The funding policy is to
comply with the Employee Retirement Income Security Act of 1974 guidelines.
Pension costs (credits) for Centerior Energy and its subsidiaries for 1994
through 1996 were comprised of the following components:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Service cost for benefits earned during
the period_________________________ $ 13 $ 10 $ 13
Interest cost on projected benefit
obligation_________________________ 28 26 26
Actual return on plan assets_________ (50) (53) (2)
Net amortization and deferral________ 2 9 (34)
---- ---- ----
Net costs (credits)________________ $ (7) $ (8) $ 3
==== ==== ====
</TABLE>
Pension costs (credits) for the Company and its pro rata share of the Service
Company's costs were $(2) million, $(3) million and $1 million for 1996, 1995
and 1994, respectively.
The following table presents a reconciliation of the funded status of the
Centerior Pension Plan. The Company's share of the Centerior Pension Plan's
total projected benefit obligation approximates 30%.
<TABLE>
<CAPTION>
December 31,
-------------
1996 1995
---- ----
(millions of
dollars)
<S> <C> <C>
Actuarial present value of benefit
obligations:
Vested benefits_______________________ $326 $304
Nonvested benefits____________________ 16 2
---- ----
Accumulated benefit obligation______ 342 306
Effect of future compensation levels__ 53 54
---- ----
Total projected benefit obligation__ 395 360
Plan assets at fair market value________ 421 394
---- ----
Funded status_______________________ 26 34
Unrecognized net gain from variance between
assumptions and experience____________ (56) (68)
Unrecognized prior service cost_________ 14 15
Transition asset at January 1, 1987 being
amortized over 19 years_______________ (32) (36)
---- ----
Net accrued pension liability_______ $(48) $(55)
==== ====
</TABLE>
A September 30 measurement date was used for 1996 and 1995 reporting. At
December 31, 1996, the settlement (discount) rate and long-term rate of return
on plan assets assumptions were 7.75% and 11%, respectively. The long-term rate
of annual compensation increase assumption was 3.5% for 1997 and 4% thereafter.
At December 31, 1995, the settlement rate and long-term rate of return on plan
assets assumptions were 8% and 11%, respectively. The long-term rate of annual
compensation increase assumption was 3.5% for 1996 and 1997 and 4% thereafter.
At December 31, 1996 and 1995, the Company's net accrued pension liability
included in Retirement Benefits in the Balance Sheet was $62 million and $64
million, respectively.
Plan assets consist primarily of investments in common stock, bonds, guaranteed
investment contracts, cash equivalent securities and real estate.
(B) OTHER POSTRETIREMENT BENEFITS
Centerior Energy sponsors jointly with its subsidiaries a postretirement benefit
plan which provides all employee groups certain health care, death and other
postretirement benefits other than pensions. The plan is contributory, with
retiree contributions adjusted annually. The plan is not funded. Under SFAS 106,
the accounting standard for postretirement benefits other than pensions, the
expected costs of such benefits are accrued during the employees' years of
service.
The components of the total postretirement benefit costs for 1994 through 1996
were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(millions of
dollars)
<S> <C> <C> <C>
Service cost for benefits earned during
the period____________________________ $1 $ 1 $ 1
Interest cost on accumulated
postretirement benefit obligation_____ 6 7 7
Amortization of transition obligation
at January 1, 1993 of $63 million
over 20 years_________________________ 2 2 3
--
--- ---
Total costs___________________________ $9 $10 $11
== === ===
</TABLE>
These amounts included costs for the Company and its pro rata share of the
Service Company's costs.
The accumulated postretirement benefit obligation and accrued postretirement
benefit cost for the Company and its share of the Service Company's obligation
are as follows:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
(millions of
dollars)
<S> <C> <C>
Accumulated postretirement benefit obligation
attributable to:
Retired participants_________________________ $(69) $(76)
Fully eligible active plan participants _____ (1) (1)
Other active plan participants_______________ (10) (9)
---- ----
Accumulated postretirement benefit
obligation_______________________________ (80) (86)
Unrecognized net gain from variance between
assumptions and experience___________________ (13) (9)
Unamortized transition obligation______________ 46 49
---- ----
Accrued postretirement benefit cost________ $(47) $(46)
==== ====
</TABLE>
The Balance Sheet classification of Retirement Benefits at December 31, 1996 and
1995 includes only the Company's accrued postretirement benefit cost of $40
million and $39 million, respectively, and excludes the Service Company's
portion since the Service Company's total accrued cost is carried on its books.
A September 30 measurement date was used for 1996 and 1995 reporting. At
December 31, 1996 and 1995, the settlement rate and the long-term rate of annual
compensation increase assumptions were the same as those dis-
F-52
<PAGE> 118
cussed for pension reporting in Note 9(a). At December 31, 1996, the assumed
annual health care cost trend rates (applicable to gross eligible charges) were
7.5% for medical and 7% for dental in 1997. Both rates reduce gradually to a
fixed rate of 4.75% by 2003. Elements of the obligation affected by contribution
caps are significantly less sensitive to the health care cost trend rate than
other elements. If the assumed health care cost trend rates were increased by
one percentage point in each future year, the accumulated postretirement benefit
obligation as of December 31, 1996 would increase by $3 million and the
aggregate of the service and interest cost components of the annual
postretirement benefit cost would increase by $0.2 million.
(10) GUARANTEES
The Company has guaranteed certain loan and lease obligations of a coal supplier
under a long-term coal supply contract. At December 31, 1996, the principal
amount of the loan and lease obligations guaranteed by the Company under the
contract was $11 million.
The prices under the contract which includes certain minimum payments are
sufficient to satisfy the loan and lease obligations and mine closing costs over
the life of the contract. If the contract is terminated early for any reason,
the Company would attempt to reduce the termination charges and would ask the
PUCO to allow recovery of such charges from customers through the fuel factor.
See Management's Financial Analysis -- Outlook-FirstEnergy Rate Plan.
(11) CAPITALIZATION
(A) CAPITAL STOCK TRANSACTIONS
Preferred stock shares retired during the three years ended December 31, 1996
are listed in the following table.
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
(thousands of shares)
<S> <C> <C> <C>
Subject to Mandatory Redemption:
$100 par $9.375___________________ (17) (17) (17)
25 par 2.81____________________ -- (400) (800)
--- ---- ----
Total_________________________ (17) (417) (817)
=== ==== ====
</TABLE>
(B) EQUITY DISTRIBUTION RESTRICTIONS
Federal law prohibits the Company from paying dividends out of capital accounts.
The Company has since 1993 declared and paid preferred stock dividends out of
appropriated current net income included in retained earnings. At the times of
such declarations and payments, the Company had a deficit in its retained
earnings. At December 31, 1996, the Company had $223 million of appropriated
retained earnings for the payment of dividends. The Company also has a provision
in its mortgage applicable to approximately $94 million of outstanding first
mortgage bonds ($31 million of which mature in August 1997) that requires common
stock dividends to be paid out of its total balance of retained earnings, which
had been a deficit from 1993 through November 1996. At December 31, 1996, the
Company's total retained earnings were $5 million. See Management's Financial
Analysis -- Capital Resources and Liquidity-Liquidity.
(C) PREFERRED AND PREFERENCE STOCK
Amounts to be paid for preferred stock which must be redeemed during the next
five years are $1.665 million in each year 1997 through 1999 only.
The annual preferred stock mandatory redemption provisions are as follows:
<TABLE>
<CAPTION>
Shares Price
To Be Beginning Per
Redeemed in Share
-------- --------- -----
<S> <C> <C> <C>
$100 par $9.375____________________ 16,650 1985 $100
</TABLE>
The annualized preferred dividend requirement at December 31, 1996 was $17
million.
The preferred dividend rates on the Company's Series A and B fluctuate based on
prevailing interest rates and market conditions. The dividend rates for these
issues averaged 7.11% and 7.75%, respectively, in 1996.
Preference stock authorized for the Company is 5,000,000 shares with a $25 par
value. No preference shares are currently outstanding.
With respect to dividend and liquidation rights, the Company's preferred stock
is prior to its preference stock and common stock, and its preference stock is
prior to its common stock.
(D) LONG-TERM DEBT AND OTHER BORROWING ARRANGEMENTS
Long-term debt which matures or is subject to put options during the next five
years is as follows: $49 million in 1997, $39 million in 1998, $104 million in
1999, $31 million in 2000 and $30 million in 2001.
The Company's mortgage constitutes a direct first lien on substantially all
property owned and franchises held by the Company. Excluded from the lien, among
other things, are cash, securities, accounts receivable, fuel, supplies and
automotive equipment.
Certain credit agreements of the Company contain covenants relating to fixed
charge coverage ratios and limitations on secured financing other than through
first mortgage bonds or certain other transactions. The Company was in
compliance with all such covenants as of December 31, 1996. The Company and
Cleveland Elec-
F-53
<PAGE> 119
tric have letters of credit in connection with the sale and leaseback of Beaver
Valley Unit 2 that expire in June 1999. The letters of credit are in an
aggregate amount of approximately $225 million and are secured by first mortgage
bonds of the Company and Cleveland Electric in the proportion of 60% and 40%,
respectively. At December 31, 1996, the Company had outstanding $8 million of
notes secured by subordinated mortgage collateral.
(12) SHORT-TERM BORROWING ARRANGEMENTS
Centerior Energy has a $125 million revolving credit facility through May 1997.
Centerior Energy and the Service Company may borrow under the facility, with all
borrowings jointly and severally guaranteed by the Company and Cleveland
Electric. Centerior Energy plans to transfer any of its borrowed funds to the
Company and Cleveland Electric. The credit agreement is secured with first
mortgage bonds of the Company and Cleveland Electric in the proportion of 60%
and 40%, respectively. The credit agreement also provides the participating
banks with a subordinate mortgage security interest on the properties of the
Company and Cleveland Electric. The banks' fee is 0.625% per annum payable
quarterly in addition to interest on any borrowings. There were no borrowings
under the facility at December 31, 1996. Also, the Company and Cleveland
Electric may borrow from each other on a short-term basis. At December 31, 1996,
the Company had outstanding $82 million of notes receivable from Cleveland
Electric with a weighted average interest rate of 6.18%.
(13) FINANCIAL INSTRUMENTS
The estimated fair values at December 31, 1996 and 1995 of financial instruments
that do not approximate their carrying amounts in the Balance Sheet are as
follows:
<TABLE>
<CAPTION>
December 31,
----------------------------------
1996 1995
---------------- ----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- ------
(millions of dollars)
<S> <C> <C> <C> <C>
Capitalization and Liabilities:
Long-Term Debt_____________ $1,054 $1,086 $1,126 $1,137
</TABLE>
Noncash investments in the Nuclear Plant Decommissioning Trusts are summarized
in the following table. In 1996, the Company and Cleveland Electric transferred
the bulk of their investment assets in existing trusts into Centerior Energy
pooled trust funds for the two companies. The December 31, 1996 amounts in the
table represent the Company's pro rata share of the fair value of such noncash
investments.
<TABLE>
<CAPTION>
December 31,
-------------
1996 1995
---- ----
(millions of
dollars)
<S> <C> <C>
Type of Securities:
Debt Securities:
Federal Government_____________________ $10 $21
Municipal______________________________ -- 11
Other__________________________________ 3 --
--- ---
13 32
Equity Securities________________________ 39 --
--- ---
Total________________________________ $52 $32
=== ===
Maturities of Debt Securities:
Due within one year______________________ $-- $ 1
Due in one to five years_________________ 7 9
Due in six to 10 years___________________ 3 11
Due after 10 years_______________________ 3 11
--- ---
Total $13 $32
==== ===
</TABLE>
The fair value of these trusts is estimated based on the quoted market prices
for the investment securities and approximates the carrying value. The fair
value of the Company's preferred stock, with mandatory redemption provisions,
and long-term debt is estimated based on the quoted market prices for the
respective or similar issues or on the basis of the discounted value of future
cash flows. The discounted value used current dividend or interest rates (or
other appropriate rates) for similar issues and loans with the same remaining
maturities.
The estimated fair values of all other financial instruments approximate their
carrying amounts in the Balance Sheet at December 31, 1996 and 1995 because of
their short-term nature.
(14) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of operations
for the two years ended December 31, 1996.
<TABLE>
<CAPTION>
Quarters Ended
----------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
--------- -------- --------- --------
(millions of dollars)
<S> <C> <C> <C> <C>
1996
Operating Revenues_______ $ 211 $211 $ 252 $223
Operating Income_________ 33 31 52 42
Net Income_______________ 3 8 28 18
Earnings (Loss)
Available for Common
Stock__________________ (1) 3 24 14
1995
Operating Revenues_______ $ 206 $215 $ 246 $206
Operating Income_________ 43 45 59 41
Net Income_______________ 20 22 33 22
Earnings Available for
Common Stock___________ 15 17 29 18
</TABLE>
Earnings for the quarter ended March 31, 1996 were decreased by $7 million as a
result of an $11 million write-down of the net book value of two inactive
production facilities. The write-down resulted from a decision that the
facilities are no longer expected to provide revenues.
Earnings for the quarter ended September 30, 1996 were decreased by $4 million
as a result of a $6 million charge
F-54
<PAGE> 120
for the disposition of materials and supplies inventory. The sale and disposal
of inventory was part of the reengineering of the supply chain process.
(15) PENDING MERGER OF CENTERIOR ENERGY AND OHIO EDISON
On September 13, 1996, Centerior Energy and Ohio Edison entered into an
agreement and plan of merger to form a new holding company, FirstEnergy.
Following the merger, FirstEnergy will directly hold all of the issued and
outstanding common stock of the Company, Cleveland Electric and Ohio Edison. As
a result of the merger, the common stock share owners of Centerior Energy and
Ohio Edison will own all of the issued and outstanding shares of FirstEnergy
common stock. Centerior Energy share owners will receive 0.525 of a share of
FirstEnergy common stock for each share of Centerior Energy common stock owned.
Ohio Edison share owners will receive one share of FirstEnergy common stock for
each share of Ohio Edison common stock owned.
FirstEnergy plans to account for the merger as a purchase in accordance with
generally accepted accounting principles. If FirstEnergy elects to apply, or
"push down", the effects of purchase accounting to the financial statements of
the Company and Cleveland Electric, the Company and Cleveland Electric would
record adjustments to: (1) reduce the carrying value of nuclear generating plant
by $1.25 billion to fair value; (2) recognize goodwill of $865 million; (3)
reduce common stock equity by $401 million; (4) reset retained earnings of the
Company and Cleveland Electric to zero; and (5) reduce the related deferred
federal income tax liability by $438 million. These amounts reflect
FirstEnergy's estimates of the pro forma combined adjustments for the Company
and Cleveland Electric as of September 30, 1996. The actual adjustments to be
recorded could be materially different from these estimates. FirstEnergy has not
decided whether to push down the effects of purchase accounting to the financial
statements of the Company and Cleveland Electric if the merger with Ohio Edison
is completed, nor has FirstEnergy estimated the allocations between the two
companies if push-down accounting is elected.
In addition to the approvals by the share owners of Centerior Energy and Ohio
Edison common stock, various aspects of the merger are subject to the approval
of the FERC and other regulatory authorities. A rate reduction and economic
development plan for the Company and Cleveland Electric has been approved by the
PUCO. From the date of consummation of the merger through 2006, the plan
provides for rate reductions, frozen fuel cost factors, economic development
incentive prices, an energy-efficiency program, an earnings cap and an
accelerated reduction in nuclear and regulatory assets for regulatory purposes.
The plan will require the Company and Cleveland Electric to write off certain
regulatory assets at the time the merger becomes probable, which is expected to
be after obtaining the aforementioned approvals of the merger. The write-off
amounts for the Company and Cleveland Electric to be charged against earnings,
estimated by FirstEnergy to total approximately $750 million, will be determined
based upon the plan's regulatory accounting and cost recovery details to be
submitted by FirstEnergy to the PUCO staff for approval. The Company's share of
the write-off is expected to be about one-third of this amount.
If the merger is not consummated, the plan would be null and void. See
Management's Financial Analysis -- Outlook-Pending Merger with Ohio Edison and
- -FirstEnergy Rate Plan for a discussion of the proposed merger and the plan.
(16) PENDING MERGER OF THE COMPANY INTO CLEVELAND ELECTRIC
In March 1994, Centerior Energy announced a plan to merge the Company into
Cleveland Electric. The merger agreement between Centerior Energy and Ohio
Edison requires the approval of Ohio Edison prior to consummation of the
proposed merger of the Company into Cleveland Electric. Ohio Edison has not yet
made a decision. All necessary regulatory approvals have been obtained, except
the NRC's approval. This application was withdrawn at the NRC's request pending
Ohio Edison's decision whether to complete this merger.
In June 1995, share owners of the Company's preferred stock approved the merger
and share owners of Cleveland Electric's preferred stock approved the
authorization of additional shares of preferred stock. If and when the merger
becomes effective, share owners of the Company's preferred stock will exchange
their shares for preferred stock shares of Cleveland Electric having
substantially the same terms. Debt holders of the merging companies will become
debt holders of Cleveland Electric.
For the merging companies, the combined pro forma operating revenues were $2.554
billion, $2.516 billion and $2.422 billion and the combined pro forma net income
was $174 million, $281 million and $268 million for the years 1996, 1995 and
1994, respectively. The pro forma data is based on accounting for the merger on
a method similar to a pooling of interests. The pro forma data is not
necessarily indicative of the results of operations which would have been
reported had the merger been in effect during those years or which may be
reported in the future. The pro forma data does not reflect any potential
effects related to the consummation of the Centerior Energy and Ohio Edison
merger. The pro forma data should be read in conjunction with the audited
financial statements of both the Company and Cleveland Electric.
F-55
<PAGE> 121
FINANCIAL AND STATISTICAL REVIEW
OPERATING REVENUES (millions of dollars)
<TABLE>
<CAPTION>
Total
Total Operating
Year Residential Commercial Industrial Other Retail Wholesale Revenues
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1996 $ 246 194 253 67 760 137 $ 897
1995 238 184 254 65 741 133 874
1994 227 181 251 64 723 142 865
1993 229 180 244 71 724 147 871
1992 215 175 236 61 687 158 845
1986 189 134 214 24 561 13 574
</TABLE>
- --------------------------------------------------------------------------------
OPERATING EXPENSES (millions of dollars)
<TABLE>
<CAPTION>
Other Generation Amortization of Federal
Fuel & Operation Facilities Depreciation Taxes, Deferred Income
Purchased & Rental & Other Than Operating Taxes
Year Power Maintenance Expense, Net Amortization FIT Expenses, Net (Credit)
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1996 $ 169 231 104 94 90 17 36
1995 157 225 104 84 91 (17) 42
1994 167 229 104 83 90 (21) 33
1993 173 352(a) 104 76 91 (4)(b) (10)
1992 169 236 106 77 91 (17) 33
1986 160 168 -- 38 51 -- 41
<CAPTION>
Total
Operating
Year Expenses
- ------------------------------------------------------------------------
<S> <<C>
1996 $ 741
1995 686
1994 685
1993 782
1992 695
1986 458
</TABLE>
- --------------------------------------------------------------------------------
INCOME (LOSS) (millions of dollars)
<TABLE>
<CAPTION>
Federal Income
Other Deferred Income (Loss)
Income & Carrying Taxes-- Before
Operating AFUDC-- Deductions, Charges, Credit Interest
Year Income Equity Net Net (Expense) Charges
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996 $ 156 1 (10) -- 5 $ 152
1995 188 1 6 14 (2) 207
1994 180 1 3 15 (2) 197
1993 89 1 (232)(c) (161)(b) 129 (174)
1992 150 1 1 41 (1) 192
1986 116 130 (2) -- 52 296
</TABLE>
- --------------------------------------------------------------------------------
INCOME (LOSS) (millions of dollars)
<TABLE>
<CAPTION>
Earnings
(Loss)
Net Preferred Available for
Debt AFUDC-- Income Stock Common
Year Interest Debt (Loss) Dividends Stock
<S> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------
1996 $ 96 (1) 57 17 $ 40
1995 111 (1) 97 18 79
1994 116 (1) 82 20 62
1993 116 (1) (289) 23 (312)
1992 122 (1) 71 24 47
1986 174 (55) 177 45 132
</TABLE>
- --------------------------------------------------------------------------------
(a) Includes early retirement program expenses and other charges of $107
million.
(b) Includes write-off of phase-in deferrals of $241 million, consisting of $55
million of deferred operating expenses and $186 million of deferred carrying
charges.
F-56
<PAGE> 122
The Toledo Edison Company
ELECTRIC SALES (millions of KWH)
ELECTRIC CUSTOMERS
RESIDENTIAL USAGE
(thousands at year end)
<TABLE>
<CAPTION>
Industrial
Year Residential Commercial Industrial Wholesale Other Total Residential Commercial & Other
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------- ---------------------------------------
- ---------------------------
1996 2 145 1 790 4 301 2 330 488 11 054 262 27 4
1995 2 164 1 748 4 174 2 563 500 11 149 260 27 4
1994 2 056 1 711 4 099 2 548 499 10 913 257 26 4
1993 2 039 1 672 3 776 2 146 490 10 123 255 26 4
1992 1 941 1 619 3 563 2 753 478 10 354 255 26 5
1986 1 941 1 495 3 482 348 449 7 715 247 25 4
<CAPTION>
Average Average
Year Total Customer KWH Customer
<S> <C> <C> <C> <C>
=========
1996 293 8 284 11.47c $950.10
1995 291 8 384 10.99 921.23
1994 287 8 044 11.04 888.30
1993 285 7 997 11.23 897.65
1992 286 7 632 11.08 845.99
1986 276 7 881 9.75 768.43
</TABLE>
- --------------------------------------------------------------------------------
LOAD (MW & %) ENERGY (millions of KWH)
FUEL
<TABLE>
<CAPTION>
Net Company Generated
Seasonal Peak Capacity Load ----------------------------- Purchased Fuel Cost
Year Capability Load Margin Factor Fossil Nuclear Total Power Total Per KWH
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------- ----------------------------------------------------
- -----------------------
1996 1 951 1 758 9.9% 62.1% 5 173 5 575 10 748 870 11 618 1.26c
1995 1 651 1 738 (5.3) 62.4 4 576 6 761 11 337 299 11 636 1.32
1994 1 726 1 620 6.1 64.7 5 160 5 419 10 579 773 11 352 1.35
1993 1 726 1 568 9.2 64.3 5 548 4 791 10 339 196 10 535 1.42
1992 1 759 1 514 13.9 63.2 4 656 6 293 10 949 (82) 10 867 1.41
1986 1 760 1 423 19.1 64.8 6 462 12 6 474 1 795 8 269 1.82
<CAPTION>
BTU Per
Year KWH
<S> <<C>
============
1996 10 295
1995 10 341
1994 10 298
1993 10 146
1992 10 284
1986 9 860
</TABLE>
- --------------------------------------------------------------------------------
INVESTMENT (millions of dollars)
<TABLE>
<CAPTION>
Construction
Utility Work In Total
Plant Accumulated Progress Nuclear Property, Utility
In Depreciation & Net & Perry Fuel and Plant and Plant Total
Year Service Amortization Plant Unit 2 Other Equipment Additions Assets
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------
- ------- ------
1996 $2 929 1 020 1 909 22 84 $ 2 015 $ 49 $3 357
1995 2 896 942 1 954 28 98 2 080 56 3 474
1994 2 899 892 2 007 30 125 2 162 41 3 502
1993 2 837 788 2 049 40 142 2 231 43 3 510
1992 2 847 760 2 087 280 164 2 531 44 3 939
1986 1 443 416 1 027 2 130 269 3 426 463 3 774
</TABLE>
- --------------------------------------------------------------------------------
CAPITALIZATION (millions of dollars & %)
<TABLE>
<CAPTION>
Preferred
Preferred Stock,
Stock, without
with Mandatory Mandatory
Common Stock Redemption Redemption
Year Equity Provisions Provisions Long-Term Debt Total
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1996 $ 803 40% 3 --% 210 10% 1 003 50% $2 019
1995 763 38 5 -- 210 10 1 068 52 2 046
1994 685 34 7 -- 210 10 1 154 56 2 056
1993 623 30 28 1 210 10 1 225 59 2 086
1992 935 39 50 2 210 9 1 178 50 2 373
1986 1 075 36 149 5 260 9 1 481 50 2 965
</TABLE>
- --------------------------------------------------------------------------------
(c) Includes write-off of Perry Unit 2 of $232 million.
F-57
<PAGE> 123
CENTERIOR ENERGY/CLEVELAND
ELECTRIC/TOLEDO EDISON
COMBINED QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1997
[THE INCOME STATEMENT, THE BALANCE SHEET,
THE STATEMENT OF CASH FLOWS AND
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS HAVE BEEN OMITTED
FOR CENTERIOR ENERGY]
F-58
<PAGE> 124
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 1997
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
<TABLE>
<CAPTION>
COMMISSION REGISTRANT; STATE OF INCORPORATION; I.R.S. EMPLOYER
FILE NUMBER ADDRESS; AND TELEPHONE NUMBER IDENTIFICATION NO.
- ----------- ----------------------------------------- ------------------
<C> <S> <C>
1-9130 CENTERIOR ENERGY CORPORATION 34-1479083
(An Ohio Corporation)
6200 Oak Tree Boulevard
Independence, Ohio 44131
Telephone (216) 447-3100
1-2323 THE CLEVELAND ELECTRIC 34-0150020
ILLUMINATING COMPANY
(An Ohio Corporation)
c/o Centerior Energy Corporation
6200 Oak Tree Boulevard
Independence, Ohio 44131
Telephone (216) 622-9800
1-3583 THE TOLEDO EDISON COMPANY 34-4375005
(An Ohio Corporation)
300 Madison Avenue
Toledo, Ohio 43652
Telephone (419) 249-5000
</TABLE>
Indicate by check mark whether each of the registrants (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
On May 9, 1997, there were 148,025,928 shares of Centerior Energy
Corporation Common Stock outstanding. Centerior Energy Corporation is the sole
holder of the 79,590,689 shares and 39,133,887 shares of common stock of The
Cleveland Electric Illuminating Company and The Toledo Edison Company,
respectively, outstanding on that date.
================================================================================
F-59
<PAGE> 125
This combined Form 10-Q is separately filed by Centerior Energy Corporation
("Centerior Energy"), The Cleveland Electric Illuminating Company ("Cleveland
Electric") and The Toledo Edison Company ("Toledo Edison"). Centerior Energy,
Cleveland Electric and Toledo Edison are sometimes referred to collectively as
the "Companies". Cleveland Electric and Toledo Edison are sometimes collectively
referred to as the "Operating Companies". Information contained herein relating
to any individual registrant is filed by such registrant on its behalf. No
registrant makes any representation as to information relating to any other
registrant, except that information relating to either or both of the Operating
Companies is also attributed to Centerior Energy.
Centerior Energy has made forward-looking statements in this Form 10-Q
which statements are subject to risks and uncertainties, including the impact on
the Companies if: (1) competitive pressure in the electric utility industry
increases significantly; (2) state and federal regulatory initiatives are
implemented that increase competition, threaten costs and investment recovery
and impact dividends or rate structures; or (3) general economic conditions,
either nationally or in the area in which the combined company will be doing
business are less favorable than expected.
F-60
<PAGE> 126
CENTERIOR ENERGY CORPORATION AND SUBSIDIARIES,
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY,
AND THE TOLEDO EDISON COMPANY
NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED)
(1) INTERIM FINANCIAL STATEMENTS
Centerior Energy Corporation (Centerior Energy) is the parent company of
Centerior Service Company (Service Company); two electric utilities, The
Cleveland Electric Illuminating Company (Cleveland Electric) and The Toledo
Edison Company (Toledo Edison); and three other wholly owned subsidiaries. The
two utilities are referred to collectively herein as the "Operating Companies"
and individually as an "Operating Company". Centerior Energy, Cleveland Electric
and Toledo Edison are referred to collectively herein as the "Companies".
The comparative income statement and balance sheet and the related
statement of cash flows of each of the Companies have been prepared from the
records of each of the Companies without audit by independent public
accountants. In the opinion of management, all adjustments necessary for a fair
presentation of financial position at March 31, 1997 and results of operations
and cash flows for the three months ended March 31, 1997 and 1996 have been
included. All such adjustments were normal recurring adjustments, except for the
write-down of inactive production facilities in the first quarter of 1996
discussed in Note 6.
A new Statement of Position issued by the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants, Inc.
effective January 1, 1997 provides guidance on the recognition and disclosure of
environmental remediation liabilities. The Companies' adoption of this statement
in 1997 did not materially affect their results of operations or financial
positions.
These financial statements and notes should be read in conjunction with the
financial statements and notes included in the Companies' combined Annual Report
on Form 10-K for the year ended December 31, 1996 (1996 Form 10-K). These
interim period financial results are not necessarily indicative of results for a
12-month period.
(2) EQUITY DISTRIBUTION RESTRICTIONS
The Operating Companies can make cash available to fund Centerior Energy's
common stock dividends by paying dividends on their respective common stock,
which is held solely by Centerior Energy. Federal law prohibits the Operating
Companies from paying dividends out of capital accounts. Cleveland Electric has
since 1993 declared and paid preferred and common stock dividends out of
appropriated current net income included in retained earnings. At the times of
such declarations and payments, Cleveland Electric had a deficit in its retained
earnings. From 1993 through 1996, Toledo Edison declared and paid preferred
stock dividends out of appropriated current net income included in retained
earnings. At the times of such declarations and payments, Toledo Edison had a
deficit in its retained earnings from 1993 through November 1996. Toledo Edison
also has a provision in its mortgage applicable to approximately $94 million of
outstanding first mortgage bonds ($31 million of which mature in August 1997)
that requires common stock dividends to be paid out of its total balance of
retained earnings. At March 31, 1997, Toledo Edison's total retained earnings
were $10 million. At March 31, 1997, Cleveland Electric and Toledo Edison had
$120.4 million and $227.7 million, respectively, of appropriated retained
earnings for the payment of dividends. See "Management's Financial
Analysis -- Capital Resources and Liquidity-Liquidity" contained in Item 7 of
the 1996 Form 10-K for a discussion of a Federal Energy Regulatory Commission
(FERC) audit issue regarding the declaration and payment of dividends.
F-61
<PAGE> 127
CENTERIOR ENERGY CORPORATION AND SUBSIDIARIES,
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY,
AND THE TOLEDO EDISON COMPANY
NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED
(3) COMMON STOCK DIVIDENDS
Cash dividends per common share declared by Centerior Energy during the
three months ended March 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Paid February 15..................................................... $.20 $.20
Paid May 15.......................................................... .20 .20
</TABLE>
Common stock cash dividends declared by Cleveland Electric during the three
months ended March 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1996 1997
----- -----
(MILLIONS)
<S> <C> <C>
Paid in February................................................... $29.6 $29.6
</TABLE>
Toledo Edison did not declare any common stock dividends during the three
months ended March 31, 1997 and 1996.
(4) FINANCING ACTIVITY
During the three months ended March 31, 1997, the Operating Companies
redeemed preferred stock and debt securities as follows:
CLEVELAND ELECTRIC
Mandatory redemptions consisted of $15 million of Serial Preferred Stock,
$9.125 Series N.
TOLEDO EDISON
Mandatory redemptions consisted of $8 million of notes secured by
subordinated mortgage collateral.
(5) SHORT-TERM BORROWING ARRANGEMENTS
In May 1997, Centerior Energy renewed a $125 million revolving credit
facility until May 7, 1998 on the same terms as the existing agreement.
Centerior Energy and the Service Company may borrow under the facility, with all
borrowings jointly and severally guaranteed by the Operating Companies.
Centerior Energy plans to transfer any of its borrowed funds to the Operating
Companies. There have not been any borrowings under the facility.
(6) WRITE-DOWN OF INACTIVE PRODUCTION FACILITIES
In the first quarter of 1996, Toledo Edison wrote down the net book value
of two inactive production facilities, $11.3 million, to "Other Income and
Deductions, Net" resulting in nonoperating losses for Toledo Edison and
Centerior Energy for that period. The net write-down was $7.2 million after
taxes or, for Centerior Energy, $.05 per common share. The write-down resulted
from a decision that the facilities were no longer expected to provide revenues.
(7) COMMITMENTS AND CONTINGENCIES
Various legal actions, claims and regulatory proceedings covering several
matters are pending against the Companies. See "Item 3. Legal Proceedings" in
the 1996 Form 10-K and "Part II, Item 5. Other Information" in this Quarterly
Report on Form 10-Q.
F-62
<PAGE> 128
CENTERIOR ENERGY CORPORATION AND SUBSIDIARIES,
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY,
AND THE TOLEDO EDISON COMPANY
NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED
In September 1996, Centerior Energy and Ohio Edison Company (Ohio Edison)
entered into an agreement and plan of merger to form a new holding company,
FirstEnergy Corp. (FirstEnergy). On March 27, 1997, Centerior Energy and Ohio
Edison common stock share owners approved the merger. Various aspects of the
merger are subject to the approval of the FERC and other regulatory authorities.
FirstEnergy plans to account for the merger as a purchase in accordance
with generally accepted accounting principles. If FirstEnergy elects to apply,
or "push down", the effects of purchase accounting to the financial statements
of the Operating Companies, Cleveland Electric would record adjustments to: (1)
reduce the carrying value of its nuclear generating plant by $880 million to
fair value; (2) recognize goodwill of $675 million; (3) reduce its common stock
equity by $258 million; (4) reset its retained earnings to zero; and (5) reduce
its related deferred federal income tax liability by $308 million; and Toledo
Edison would record adjustments to: (1) reduce the carrying value of its nuclear
generating plant by $370 million to fair value; (2) recognize goodwill of $307
million; (3) reduce its common stock equity by $124 million; (4) reset its
retained earnings to zero; and (5) reduce its related deferred federal income
tax liability by $130 million. These amounts reflect FirstEnergy's estimates of
the pro forma adjustments for the Operating Companies as of December 31, 1996.
The actual adjustments to be recorded could be materially different from the
estimates. FirstEnergy has not decided whether to push down the effects of
purchase accounting to the financial statements of the Operating Companies if
the Ohio Edison-Centerior Energy merger is completed.
F-63
<PAGE> 129
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
INCOME STATEMENT
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1997 1996
-------- --------
<S> <C> <C>
OPERATING REVENUES....................................................... $431,627 $427,526
OPERATING EXPENSES
Fuel and Purchased Power (1)........................................... 110,530 103,726
Other Operation and Maintenance........................................ 91,447 105,132
Generation Facilities Rental Expense, Net.............................. 13,892 13,892
Depreciation and Amortization.......................................... 53,297 50,816
Taxes, Other Than Federal Income Taxes................................. 56,686 60,010
Amortization of Deferred Operating Expenses, Net....................... 6,567 6,368
Federal Income Taxes................................................... 19,203 11,805
-------- --------
Total Operating Expenses............................................ 351,622 351,749
-------- --------
OPERATING INCOME......................................................... 80,005 75,777
NONOPERATING INCOME (LOSS)
Allowance for Equity Funds Used During Construction.................... 327 498
Other Income and Deductions, Net....................................... (4,649) 1,649
Federal Income Taxes -- Credit (Expense)............................... 658 (752)
-------- --------
Total Nonoperating Income (Loss).................................... (3,664) 1,395
-------- --------
INCOME BEFORE INTEREST CHARGES........................................... 76,341 77,172
INTEREST CHARGES
Long-Term Debt......................................................... 54,393 60,160
Short-Term Debt........................................................ 2,177 692
Allowance for Borrowed Funds Used During Construction.................. (459) (519)
-------- --------
Net Interest Charges................................................ 56,111 60,333
-------- --------
NET INCOME............................................................... 20,230 16,839
Preferred Dividend Requirements........................................ 9,315 10,032
-------- --------
EARNINGS AVAILABLE FOR COMMON STOCK...................................... $ 10,915 $ 6,807
======== ========
(1) Includes purchased power expense for purchases from Toledo Edison.... $ 28,920 $ 26,672
</TABLE>
The accompanying notes as they relate to Cleveland Electric are an integral part
of this statement.
F-64
<PAGE> 130
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
BALANCE SHEET
(THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Utility Plant In Service....................................................... $ 6,960,941 $ 6,938,535
Accumulated Depreciation and Amortization...................................... (2,306,322) (2,252,321)
----------- -----------
4,654,619 4,686,214
Construction Work In Progress.................................................. 62,173 56,853
----------- -----------
4,716,792 4,743,067
Nuclear Fuel, Net of Amortization.............................................. 100,764 113,030
Other Property, Less Accumulated Depreciation.................................. 51,553 53,547
----------- -----------
4,869,109 4,909,644
CURRENT ASSETS
Cash and Temporary Cash Investments............................................ 26,698 30,273
Amounts Due from Customers and Others, Net..................................... 146,187 189,547
Amounts Due from Affiliates.................................................... 347 5,634
Materials and Supplies, at Average Cost
Owned........................................................................ 50,777 51,686
Under Consignment............................................................ 23,497 23,655
Taxes Applicable to Succeeding Years........................................... 156,147 181,609
Other.......................................................................... 11,416 15,237
----------- -----------
415,069 497,641
REGULATORY AND OTHER ASSETS
Regulatory Assets.............................................................. 1,341,785 1,349,693
Nuclear Plant Decommissioning Trusts........................................... 83,067 75,573
Other.......................................................................... 60,725 44,980
----------- -----------
1,485,577 1,470,246
----------- -----------
$ 6,769,755 $ 6,877,531
=========== ===========
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common Stock Equity............................................................ $ 1,034,701 $ 1,044,283
Preferred Stock
With Mandatory Redemption Provisions......................................... 186,118 186,118
Without Mandatory Redemption Provisions...................................... 238,325 238,325
Long-Term Debt................................................................. 2,441,297 2,441,215
----------- -----------
3,900,441 3,909,941
CURRENT LIABILITIES
Current Portion of Long-Term Debt and Preferred Stock.......................... 129,874 144,668
Current Portion of Lease Obligations........................................... 49,266 51,592
Accounts Payable............................................................... 57,092 82,694
Accounts and Notes Payable to Affiliates....................................... 170,966 171,433
Accrued Taxes.................................................................. 253,143 315,998
Accrued Interest............................................................... 60,247 52,487
Dividends Declared............................................................. 5,692 15,228
Other.......................................................................... 40,156 43,672
----------- -----------
766,436 877,772
DEFERRED CREDITS AND OTHER LIABILITIES
Unamortized Investment Tax Credits............................................. 174,158 176,130
Accumulated Deferred Federal Income Taxes...................................... 1,316,529 1,305,601
Unamortized Gain from Bruce Mansfield Plant Sale............................... 291,993 295,730
Accumulated Deferred Rents for Bruce Mansfield Plant........................... 99,351 98,767
Nuclear Fuel Lease Obligations................................................. 64,968 73,947
Retirement Benefits............................................................ 74,512 72,843
Other.......................................................................... 81,367 66,800
----------- -----------
2,102,878 2,089,818
COMMITMENTS AND CONTINGENCIES (Note 7)
----------- -----------
$ 6,769,755 $ 6,877,531
=========== ===========
</TABLE>
The accompanying notes as they relate to Cleveland Electric are an integral part
of this statement.
F-65
<PAGE> 131
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
CASH FLOWS
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1997 1996
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income............................................................. $ 20,230 $ 16,839
-------- --------
Adjustments to Reconcile Net Income to Cash from Operating Activities:
Depreciation and Amortization....................................... 53,297 50,816
Deferred Federal Income Taxes....................................... 10,736 14,388
Deferred Fuel....................................................... 7,696 (2,639)
Leased Nuclear Fuel Amortization.................................... 13,411 11,339
Amortization of Deferred Operating Expenses, Net.................... 6,567 6,368
Allowance for Equity Funds Used During Construction................. (327) (498)
Changes in Amounts Due from Customers and Others, Net............... 43,360 1,678
Changes in Materials and Supplies................................... 1,067 6,643
Changes in Accounts Payable......................................... (25,602) 27,758
Changes in Working Capital Affecting Operations..................... (27,289) (31,665)
Other Noncash Items................................................. 2,336 (9,791)
-------- --------
Total Adjustments.............................................. 85,252 74,397
-------- --------
Net Cash from Operating Activities............................. 105,482 91,236
CASH FLOWS FROM FINANCING ACTIVITIES
Notes Payable to Affiliates............................................ 2,781 (5,000)
Maturities, Redemptions and Sinking Funds.............................. (15,000) (15,800)
Nuclear Fuel Lease Obligations......................................... (12,450) (18,194)
Dividends Paid......................................................... (39,141) (39,865)
-------- --------
Net Cash from Financing Activities............................. (63,810) (78,859)
CASH FLOWS FROM INVESTING ACTIVITIES
Cash Applied to Construction........................................... (32,812) (25,105)
Interest Capitalized as Allowance for Borrowed Funds Used During
Construction........................................................ (459) (519)
Contributions to Nuclear Plant Decommissioning Trusts.................. (2,928) --
Other Cash Received (Applied).......................................... (9,048) 3,486
-------- --------
Net Cash from Investing Activities............................. (45,247) (22,138)
-------- --------
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS........................ (3,575) (9,761)
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD............... 30,273 69,770
-------- --------
CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD..................... $ 26,698 $ 60,009
======== ========
Other Payment Information:
Interest (net of amounts capitalized).................................. $ 47,000 $ 47,000
Federal Income Taxes................................................... 8,300 --
</TABLE>
The accompanying notes as they relate to Cleveland Electric are an integral part
of this statement.
F-66
<PAGE> 132
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES AND LIQUIDITY
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in Item 7 of the 1996 Form 10-K.
The information under "Capital Resources and Liquidity" remains unchanged with
the following exceptions:
During the first quarter of 1997, Cleveland Electric redeemed preferred
stock as discussed in Note 4.
Cleveland Electric is a party to a $125 million revolving credit facility
which Centerior Energy renewed in May 1997 until May 7, 1998 as discussed in
Note 5. Centerior Energy plans to transfer any of its borrowed funds under the
facility to the Operating Companies.
RESULTS OF OPERATIONS
Factors contributing to the 1% increase in 1997 first quarter operating
revenues are shown as follows:
<TABLE>
<CAPTION>
CHANGES FROM
FIRST QUARTER 1996
FACTORS OPERATING REVENUES
------------------------------------------------------------------- ------------------
(MILLIONS)
<S> <C>
Base Rates......................................................... $ 18.7
Kilowatt-hour Sales Volume and Mix................................. (15.0)
Wholesale Revenues................................................. 7.5
Fuel Cost Recovery Revenues........................................ 2.3
Miscellaneous Revenues............................................. (9.4)
------
Total.............................................................. $ 4.1
======
</TABLE>
The increase in first quarter 1997 base rates revenues resulted primarily
from the April 1996 rate order issued by the PUCO. Renegotiated contracts for
certain large industrial customers resulted in a decrease in base rates which
partially offset the effect of the general price increase.
Percentage changes between 1997 and 1996 first quarter billed electric
kilowatt-hour sales are summarized as follows:
<TABLE>
<CAPTION>
CUSTOMER CATEGORIES % CHANGE
- ---------------------------------------- --------
<S> <C>
Residential............................. 0.5%
Commercial.............................. 1.2
Industrial.............................. (1.7)
Other................................... 78.5
Total................................... 8.0
</TABLE>
Despite milder weather, first quarter 1997 total kilowatt-hour sales rose
as increases in residential and commercial sales along with a 99% increase in
wholesale sales (included in the "Other" category) were partially offset by a
decline in industrial sales. Weather-normalized residential and commercial sales
increased 5.4% and 2.2%, respectively, for the 1997 period. The number of
commercial customers at March 31, 1997 was 1.3% above the March 31, 1996 number.
Industrial sales decreased primarily because of fewer sales to large automotive
manufacturers and steel industry customers.
F-67
<PAGE> 133
The increase in fuel cost recovery revenues included in customer bills
resulted from a 3% increase in the weighted average of the fuel cost recovery
factors used in the first quarter of 1997 to calculate these revenues compared
to the 1996 first quarter average.
First quarter miscellaneous revenues in 1997 decreased from the 1996 amount
primarily because of the reclassification of certain revenues as credits to
operating expenses commencing in the second quarter of 1996 and a first quarter
1997 refund payment related to a canceled generating plant lease agreement.
First quarter operating expenses in 1997 were virtually the same as in
1996. Higher fuel and purchased power expenses resulted from increased purchased
power requirements in the 1997 period. Depreciation and amortization expenses
increased primarily because of changes in depreciation rates approved in the
April 1996 PUCO rate order. Federal income taxes increased as a result of higher
pretax operating income. Other operation and maintenance expenses decreased as a
result of ongoing cost cutting and work force reductions; a shift of certain
payroll expenses to the nonoperating classification for work related to the Ohio
Edison-Centerior Energy merger; and the aforementioned reclassification of
certain expense reimbursements as credits to operating expenses. Taxes, other
than federal income taxes, decreased primarily because of lower property and
payroll tax accruals.
A first quarter 1997 nonoperating loss resulted primarily from both
Cleveland Electric's share of merger-related expenses and certain costs
associated with an accounts receivable securitization.
First quarter 1997 interest charges and preferred dividend requirements
decreased because of the redemption of securities in 1996.
NEW ACCOUNTING STANDARD
In February 1997, the FASB issued a new statement of financial accounting
standards for the disclosure of information about capital structure effective
for year-end December 31, 1997 reporting. Cleveland Electric's adoption of the
statement in 1997 will not affect its financial condition.
F-68
<PAGE> 134
THE TOLEDO EDISON COMPANY
INCOME STATEMENT
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1997 1996
-------- --------
<S> <C> <C>
OPERATING REVENUES (1)................................................... $217,060 $210,793
OPERATING EXPENSES
Fuel and Purchased Power............................................... 43,314 38,768
Other Operation and Maintenance........................................ 56,317 56,519
Generation Facilities Rental Expense, Net.............................. 25,961 25,961
Depreciation and Amortization.......................................... 23,814 22,416
Taxes, Other Than Federal Income Taxes................................. 22,794 23,853
Amortization of Deferred Operating Expenses, Net....................... 4,291 4,175
Federal Income Taxes................................................... 8,212 6,227
-------- --------
Total Operating Expenses............................................ 184,703 177,919
-------- --------
OPERATING INCOME......................................................... 32,357 32,874
NONOPERATING INCOME (LOSS)
Allowance for Equity Funds Used During Construction.................... 332 413
Other Income and Deductions, Net....................................... (427) (9,153)
Federal Income Taxes -- Credit (Expense)............................... (225) 3,195
-------- --------
Total Nonoperating Income (Loss).................................... (320) (5,545)
-------- --------
INCOME BEFORE INTEREST CHARGES........................................... 32,037 27,329
INTEREST CHARGES
Long-Term Debt......................................................... 22,111 23,159
Short-Term Debt........................................................ 1,190 1,218
Allowance for Borrowed Funds Used During Construction.................. (104) (325)
-------- --------
Net Interest Charges................................................ 23,197 24,052
-------- --------
NET INCOME............................................................... 8,840 3,277
Preferred Dividend Requirements........................................ 4,194 4,204
-------- --------
EARNINGS (LOSS) AVAILABLE FOR COMMON STOCK............................... $ 4,646 $ (927)
======== ========
(1) Includes revenues from bulk power sales to Cleveland Electric........ $ 28,920 $ 26,672
</TABLE>
The accompanying notes as they relate to Toledo Edison are an integral part of
this statement.
F-69
<PAGE> 135
THE TOLEDO EDISON COMPANY
BALANCE SHEET
(THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Utility Plant In Service....................................................... $ 2,932,203 $ 2,928,657
Accumulated Depreciation and Amortization...................................... (1,045,988) (1,019,836)
----------- -----------
1,886,215 1,908,821
Construction Work In Progress.................................................. 26,443 21,479
----------- -----------
1,912,658 1,930,300
Nuclear Fuel, Net of Amortization.............................................. 67,361 76,118
Other Property, Less Accumulated Depreciation.................................. 8,456 8,460
----------- -----------
1,988,475 2,014,878
CURRENT ASSETS
Cash and Temporary Cash Investments............................................ 63,416 81,454
Amounts Due from Customers and Others, Net..................................... 15,948 16,308
Amounts Due from Affiliates.................................................... 130,574 95,336
Materials and Supplies, at Average Cost
Owned........................................................................ 32,127 33,160
Under Consignment............................................................ 10,994 10,383
Taxes Applicable to Succeeding Years........................................... 59,766 68,352
Other.......................................................................... 3,628 3,479
----------- -----------
316,453 308,472
REGULATORY AND OTHER ASSETS
Regulatory Assets.............................................................. 921,175 927,629
Nuclear Plant Decommissioning Trusts........................................... 69,818 64,093
Other.......................................................................... 39,483 42,408
----------- -----------
1,030,476 1,034,130
----------- -----------
$ 3,335,404 $ 3,357,480
=========== ===========
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common Stock Equity............................................................ $ 807,883 $ 803,237
Preferred Stock
With Mandatory Redemption Provisions......................................... 3,355 3,355
Without Mandatory Redemption Provisions...................................... 210,000 210,000
Long-Term Debt................................................................. 1,003,055 1,003,026
----------- -----------
2,024,293 2,019,618
CURRENT LIABILITIES
Current Portion of Long-Term Debt and Preferred Stock.......................... 43,365 51,365
Current Portion of Lease Obligations........................................... 35,105 36,244
Accounts Payable............................................................... 52,987 46,496
Accounts Payable to Affiliates................................................. 25,454 30,016
Accrued Taxes.................................................................. 56,203 72,829
Accrued Interest............................................................... 24,998 22,348
Other.......................................................................... 16,437 18,722
----------- -----------
254,549 278,020
DEFERRED CREDITS AND OTHER LIABILITIES
Unamortized Investment Tax Credits............................................. 74,434 75,417
Accumulated Deferred Federal Income Taxes...................................... 565,331 565,600
Unamortized Gain from Bruce Mansfield Plant Sale............................... 176,760 179,027
Accumulated Deferred Rents for Bruce Mansfield Plant and Beaver Valley Unit
2............................................................................ 38,675 39,188
Nuclear Fuel Lease Obligations................................................. 41,699 48,491
Retirement Benefits............................................................ 104,210 102,214
Other.......................................................................... 55,453 49,905
----------- -----------
1,056,562 1,059,842
COMMITMENTS AND CONTINGENCIES (Note 7)
----------- -----------
$ 3,335,404 $ 3,357,480
=========== ===========
</TABLE>
The accompanying notes as they relate to Toledo Edison are an integral part of
this statement.
F-70
<PAGE> 136
THE TOLEDO EDISON COMPANY
CASH FLOWS
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1997 1996
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income........................................................... $ 8,840 $ 3,277
-------- --------
Adjustments to Reconcile Net Income to Cash from Operating
Activities:
Depreciation and Amortization..................................... 23,814 22,416
Deferred Federal Income Taxes..................................... (269) 4,403
Deferred Fuel..................................................... 2,567 623
Leased Nuclear Fuel Amortization.................................. 9,442 9,349
Amortization of Deferred Operating Expenses, Net.................. 4,291 4,175
Allowance for Equity Funds Used During Construction............... (332) (413)
Changes in Amounts Due from Customers and Others, Net............. 360 3,784
Changes in Materials and Supplies................................. 422 881
Changes in Accounts Payable....................................... 6,491 32,445
Changes in Working Capital Affecting Operations................... (15,042) (12,698)
Other Noncash Items............................................... 4,540 (2,672)
-------- --------
Total Adjustments............................................ 36,284 62,293
-------- --------
Net Cash from Operating Activities........................... 45,124 65,570
CASH FLOWS FROM FINANCING ACTIVITIES
Notes Payable to Affiliates.......................................... -- (20,950)
Maturities, Redemptions and Sinking Funds............................ (8,000) (28,750)
Nuclear Fuel Lease Obligations....................................... (8,617) (13,969)
Dividends Paid....................................................... (4,193) (4,226)
Premiums, Discounts and Expenses..................................... -- (50)
-------- --------
Net Cash from Financing Activities........................... (20,810) (67,945)
CASH FLOWS FROM INVESTING ACTIVITIES
Cash Applied to Construction......................................... (10,149) (14,595)
Interest Capitalized as Allowance for Borrowed Funds Used During
Construction...................................................... (104) (325)
Loans to Affiliates.................................................. (32,582) --
Contributions to Nuclear Plant Decommissioning Trusts................ (2,459) --
Other Cash Received.................................................. 2,942 3,451
-------- --------
Net Cash from Investing Activities........................... (42,352) (11,469)
-------- --------
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS...................... (18,038) (13,844)
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD............. 81,454 93,669
-------- --------
CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD................... $ 63,416 $ 79,825
======== ========
Other Payment Information:
Interest (net of amounts capitalized)................................ $ 19,000 $ 21,000
Federal Income Taxes................................................. 4,300 --
</TABLE>
The accompanying notes as they relate to Toledo Edison are an integral part of
this statement.
F-71
<PAGE> 137
THE TOLEDO EDISON COMPANY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES AND LIQUIDITY
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in Item 7 of the 1996 Form 10-K.
The information under "Capital Resources and Liquidity" remains unchanged with
the following exceptions:
During the first quarter of 1997, Toledo Edison redeemed notes as discussed
in Note 4.
Toledo Edison is a party to a $125 million revolving credit facility which
Centerior Energy renewed in May 1997 until May 7, 1998 as discussed in Note 5.
Centerior Energy plans to transfer any of its borrowed funds under the facility
to the Operating Companies.
RESULTS OF OPERATIONS
Factors contributing to the 3% increase in 1997 first quarter operating
revenues are shown as follows:
<TABLE>
<CAPTION>
CHANGES FROM
FIRST QUARTER 1996
FACTORS OPERATING REVENUES
------------------------------------------------------------------- ------------------
(MILLIONS)
<S> <C>
Base Rates......................................................... $ 3.4
Kilowatt-hour Sales Volume and Mix................................. 2.4
Wholesale Revenues................................................. 2.9
Fuel Cost Recovery Revenues........................................ (1.5)
Miscellaneous Revenues............................................. (0.9)
-----
Total.............................................................. $ 6.3
=====
</TABLE>
The increase in first quarter 1997 base rates revenues resulted primarily
from the April 1996 rate order issued by the PUCO. Renegotiated contracts for
certain large industrial customers also resulted in a decrease in base rates
which partially offset the effect of the general price increase.
Percentage changes between 1997 and 1996 first quarter billed electric
kilowatt-hour sales are summarized as follows:
<TABLE>
<CAPTION>
CUSTOMER CATEGORIES % CHANGE
- ---------------------------------------- --------
<S> <C>
Residential............................. (3.1)%
Commercial.............................. 2.9
Industrial.............................. 8.2
Other................................... 21.0
Total................................... 8.1
</TABLE>
First quarter 1997 total kilowatt-hour sales increased because of increases
in industrial and commercial sales along with a 26% increase in wholesale sales
(included in the "Other" category). Industrial sales growth reflected increased
sales to large primary metals, automotive and glass manufacturers and the
broad-based, smaller industrial customer group. Industrial sales for the 1997
period included sales to the new North Star BHP Steel facility. Commercial sales
increased despite milder weather because of a 3.3% increase in the number of
commercial customers and greater economic activity. Residential sales declined
because of the milder weather. However, weather-normalized commercial and
residential sales increased 3.6% and 0.3%, respectively, for the 1997 period.
F-72
<PAGE> 138
The decrease in fuel cost recovery revenues included in customer bills
resulted from a 5% decrease in the weighted average of the fuel cost recovery
factors used in the first quarter of 1997 to calculate these revenues compared
to the 1996 first quarter average.
First quarter operating expenses in 1997 increased 3.8% from the 1996
amount. Higher fuel and purchased power expenses resulted from increased
purchased power requirements in the 1997 period. Depreciation and amortization
expenses increased primarily because of changes in depreciation rates approved
in the April 1996 PUCO rate order. Federal income taxes increased as a result of
higher pretax operating income. Taxes, other than federal income taxes,
decreased primarily because of lower property and payroll tax accruals.
The first quarter 1997 total nonoperating loss was smaller than the first
quarter 1996 total nonoperating loss. The first quarter 1997 nonoperating loss
resulted primarily from both Toledo Edison's share of expenses related to the
Ohio Edison-Centerior Energy merger and certain costs associated with an
accounts receivable securitization. The first quarter 1996 nonoperating loss
resulted primarily from the write-down of two inactive production facilities as
discussed in Note 6.
First quarter 1997 interest charges and preferred dividend requirements
decreased slightly because of the redemption of securities in 1996.
NEW ACCOUNTING STANDARD
In February 1997, the FASB issued a new statement of financial accounting
standards for the disclosure of information about capital structure effective
for year-end December 31, 1997 reporting. Toledo Edison's adoption of the
statement in 1997 will not affect its financial condition.
F-73
<PAGE> 139
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
1. CENTERIOR ENERGY
a. A Special Meeting of Centerior Energy's common stock share owners was
held on March 27, 1997.
b. The only matter submitted to share owners at the Special Meeting was for
the approval and adoption of an Agreement and Plan of Merger between Ohio Edison
and Centerior Energy. The vote on this issue was as follows:
<TABLE>
<CAPTION>
BROKER
FOR AGAINST ABSTAIN NON-VOTE
- ------------ ---------- ------- ---------------
<S> <C> <C> <C>
112,633,407 2,219,786 935,047 Not Applicable
</TABLE>
2. CENTERIOR ENERGY
a. Centerior Energy's Annual Meeting of share owners was held on May 8,
1997.
b. Proxies for the Annual Meeting were solicited pursuant to Regulation 14
under the Securities Exchange Act of 1934. There was no solicitation in
opposition to management's nominees for directors as listed in the proxy
statement dated April 3, 1997, and all such nominees were elected.
c. Three matters were submitted to share owners for a vote at the Annual
Meeting.
Issue 1 was the election of 11 directors of Centerior Energy. The vote on this
issue was as follows:
<TABLE>
<CAPTION>
BROKER
NOMINEE FOR WITHHELD NON-VOTE
- ------------------- ------------ ---------- ----------
<S> <C> <C> <C>
R. P. Anderson 116,211,692 4,643,968 7,108,921
A. C. Bersticker 116,326,706 4,528,954 7,108,921
T. A. Commes 116,397,916 4,457,744 7,108,921
W. F. Conway 116,246,440 4,609,220 7,108,921
W. R. Embry 116,141,102 4,714,558 7,108,921
R. J. Farling 116,097,124 4,758,536 7,108,921
R. A. Miller 113,866,343 6,989,317 7,108,921
F. E. Mosier 116,226,823 4,628,837 7,108,921
Sr. M. M. Reinhard 116,098,360 4,757,301 7,108,921
R. C. Savage 116,274,966 4,580,694 7,108,921
W. J. Williams 116,236,011 4,619,649 7,108,921
</TABLE>
Issue 2 was the ratification of the appointment by the Board of Directors of
Arthur Andersen LLP as the independent accountants of Centerior Energy,
Cleveland Electric and Toledo Edison for 1997.
The vote on this issue was as follows:
<TABLE>
<CAPTION>
BROKER
FOR AGAINST ABSTAIN NON-VOTE
- ------------ ---------- ------- ----------
<S> <C> <C> <C>
118,514,019 1,254,749 1,086,892 7,108,921
</TABLE>
Issue 3 was a share owner proposal to eliminate all discretionary voting when
the individual share owner has not actually voted by marking the proxy card. The
vote on this issue was as follows:
<TABLE>
<CAPTION>
BROKER
FOR AGAINST ABSTAIN NON-VOTE
- ------------ ---------- ------- ----------
<S> <C> <C> <C>
15,700,936 79,222,813 4,893,382 28,147,450
</TABLE>
F-74
<PAGE> 140
3. CLEVELAND ELECTRIC
a. In lieu of an Annual Meeting, Cleveland Electric's sole share owner,
Centerior Energy (the sole share owner of all 79,590,689 outstanding shares of
Cleveland Electric common stock), elected directors of Cleveland Electric
through a Written Action of Sole Share Owner on May 8, 1997.
b. The directors elected pursuant to the Written Action were:
Robert J. Farling
Murray R. Edelman
Fred J. Lange, Jr.
c. No other matters were addressed in the Written Action in lieu of an
Annual Meeting.
4. TOLEDO EDISON
a. In lieu of an Annual Meeting, Toledo Edison's sole share owner,
Centerior Energy (the sole share owner of all 39,133,887 outstanding shares of
Toledo Edison common stock), elected directors of Toledo Edison through a
Written Action of Sole Share Owner on May 8, 1997.
b. The directors elected pursuant to the Written Action were:
Robert J. Farling
Murray R. Edelman
Fred J. Lange, Jr.
c. No other matters were addressed in the Written Action in lieu of an
Annual Meeting.
ITEM 5. OTHER INFORMATION
1. 1996 RATE ORDER
For background relating to this topic see "Item 1. Business-Electric
Rates-1996 Rate Order" in the Companies Annual Report on Form 10-K for the year
ended December 31, 1996 ("1996 Form 10-K").
The City of Cleveland, the Office of the Ohio Consumer's Counsel ("OCC"),
the Ohio Council of Retail Merchants, the Empowerment Center of Greater
Cleveland, the City of Toledo, the Lucas County Board of Commissioners and
Congresswoman Marcy Kaptur filed appeals with the Ohio Supreme Court from the
PUCO's April 11, 1996 rate order for the Operating Companies. The Ohio Supreme
Court granted the Operating Companies' motions to dismiss the appeals of the
Lucas County Board of Commissioners and Congresswoman Marcy Kaptur on November
20, 1996. On April 4, 1997, the OCC filed a motion to stay the appeal because of
the Rate Stipulation agreed to by the OCC regarding the FirstEnergy merger, and
the Operating Companies filed a memorandum in support of the stay on April 14,
1997. The Ohio Supreme Court granted OCC's motion to stay on April 21, 1997.
2. JOINT SELECT COMMITTEE HEARINGS
Ohio's General Assembly has commissioned a Joint Committee to study
electric utility deregulation. The Joint Committee is conducting hearings
concerning various issues regarding electric utility deregulation and plans to
have a report completed by October 1997 to present to the full General Assembly
for its consideration. The Operating Companies and other interested parties will
be providing testimony on the issues as the hearings continue throughout the
summer.
3. RACHEL TRANSMISSION LINE
On March 24, 1997, the Ohio Power Siting Board ("OPSB") granted Cleveland
Electric a Certificate of Environmental Compatibility and Public Need
("Certificate") to construct its nine-mile "Rachel" 138,000-volt transmission
line in Geauga County, Ohio. The transmission line is necessary to provide
high-quality and reliable electric service to the general area, which has
experienced above average load growth over the last several decades. On April
24, 1997, Citizens for a Better Way filed an Application for Rehearing of the
F-75
<PAGE> 141
OPSB's decision; however, because the Application for Rehearing was filed late,
it is anticipated that the OPSB will not entertain substantive modifications to
the Certificate.
4. CHASE BRASS
For background relating to this topic, see "Item 1.
Business-Operations-Competitive Conditions-Toledo Edison" in the 1996 Form 10-K.
Chase Brass & Copper Co., Inc. ("Chase Brass"), a former Toledo Edison
customer, and other surrounding businesses and residences in Jefferson Township,
Ohio, have sought incorporation as a municipality to be named the Village of
Holiday City. The Williams County (Ohio) Board of Commissioners and the Williams
County Court of Common Pleas issued an order permitting the area to be
incorporated. Toledo Edison previously appealed the Court's order to the Sixth
District Court of Appeals, but the Court of Appeals ruled against Toledo Edison,
finding a lack of standing. Toledo Edison then appealed to the Ohio Supreme
Court. On April 23, 1997, the Ohio Supreme Court denied Toledo Edison's appeal.
Toledo Edison does not plan to apply for reconsideration at the Court.
The new municipality can negotiate with other utilities for electric power.
The other businesses in the proposed municipality previously terminated their
service with Toledo Edison and are receiving electric service from the Village
of Montpelier, one of the consortium now supplying Chase Brass.
5. DAVIS-BESSE PLANT OUTAGE
The Davis-Besse Nuclear Power Station automatically shut down on Sunday,
May 4, 1997, when a fire suppression system on the station's main transformer
malfunctioned. Although there was no fire, protective circuitry disconnected the
transformer from the electrical system. Safety systems automatically take the
plant offline under these conditions. Plant personnel are investigating the
cause of the malfunction. It is anticipated that the plant will be back on line
by the end of May, 1997. This is the first unplanned shut down at the plant in
three years.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
See Exhibit Index following.
B. REPORTS ON FORM 8-K
During the quarter ended March 31, 1997, Centerior Energy, Cleveland
Electric and Toledo Edison each filed two Current Reports on Form 8-K with the
Securities and Exchange Commission.
A Form 8-K dated January 28, 1997 and filed that date included one item
under "Item 5. Other Events". That item, "Recent Financial Results (Unaudited)",
reported Centerior Energy's operating revenues, net income and earnings per
share for 1996.
A Form 8-K dated January 30, 1997 and filed on February 6, 1997 included
one item under "Item 5. Other Events". That item, "Rate Reduction and Economic
Development Plan", discussed a rate reduction plan approved by the PUCO for the
Operating Companies which would take effect upon the consummation of the merger
of Centerior Energy with Ohio Edison.
F-76
<PAGE> 142
SIGNATURES
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. The person signing this report on behalf
of each such registrant is also signing in his capacity as each registrant's
Chief Accounting Officer.
/s/ CENTERIOR ENERGY CORPORATION
--------------------------------------
(Registrant)
/s/ THE CLEVELAND ELECTRIC
ILLUMINATING COMPANY
--------------------------------------
(Registrant)
/s/ THE TOLEDO EDISON COMPANY
--------------------------------------
(Registrant)
By: /s/ E. LYLE PEPIN
--------------------------------------
E. Lyle Pepin, Controller and Chief
Accounting
Officer of each Registrant
Date: May 15, 1997
F-77
<PAGE> 143
[THIS PAGE INTENTIONALLY LEFT BLANK]
F-78
<PAGE> 144
CENTERIOR ENERGY/CLEVELAND
ELECTRIC/TOLEDO EDISON
COMBINED QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1997
[THE INCOME STATEMENT, THE BALANCE SHEET,
THE STATEMENT OF CASH FLOWS AND
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS HAVE BEEN OMITTED
FOR CENTERIOR ENERGY]
F-79
<PAGE> 145
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 1997
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
<TABLE>
<CAPTION>
COMMISSION REGISTRANT; STATE OF INCORPORATION; I.R.S. EMPLOYER
FILE NUMBER ADDRESS; AND TELEPHONE NUMBER IDENTIFICATION NO.
- ----------- ----------------------------------------- ------------------
<C> <S> <C>
1-9130 CENTERIOR ENERGY CORPORATION 34-1479083
(An Ohio Corporation)
6200 Oak Tree Boulevard
Independence, Ohio 44131
Telephone (216) 447-3100
1-2323 THE CLEVELAND ELECTRIC 34-0150020
ILLUMINATING COMPANY
(An Ohio Corporation)
c/o Centerior Energy Corporation
6200 Oak Tree Boulevard
Independence, Ohio 44131
Telephone (216) 622-9800
1-3583 THE TOLEDO EDISON COMPANY 34-4375005
(An Ohio Corporation)
300 Madison Avenue
Toledo, Ohio 43652
Telephone (419) 249-5000
</TABLE>
Indicate by check mark whether each of the registrants (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
On August 8, 1997, there were 148,024,178 shares of Centerior Energy
Corporation Common Stock outstanding. Centerior Energy Corporation is the sole
holder of the 79,590,689 shares and 39,133,887 shares of common stock of The
Cleveland Electric Illuminating Company and The Toledo Edison Company,
respectively, outstanding on that date.
================================================================================
F-80
<PAGE> 146
This combined Form 10-Q is separately filed by Centerior Energy Corporation
("Centerior Energy"), The Cleveland Electric Illuminating Company ("Cleveland
Electric") and The Toledo Edison Company ("Toledo Edison"). Centerior Energy,
Cleveland Electric and Toledo Edison are sometimes referred to collectively as
the "Companies". Cleveland Electric and Toledo Edison are sometimes collectively
referred to as the "Operating Companies". Information contained herein relating
to any individual registrant is filed by such registrant on its behalf. No
registrant makes any representation as to information relating to any other
registrant, except that information relating to either or both of the Operating
Companies is also attributed to Centerior Energy.
F-81
<PAGE> 147
CENTERIOR ENERGY CORPORATION AND SUBSIDIARIES,
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY,
AND THE TOLEDO EDISON COMPANY AND SUBSIDIARY
NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED)
(1) INTERIM FINANCIAL STATEMENTS
Centerior Energy Corporation (Centerior Energy) is the parent company of
Centerior Service Company (Service Company); two electric utilities, The
Cleveland Electric Illuminating Company (Cleveland Electric) and The Toledo
Edison Company (Toledo Edison); and three other wholly owned subsidiaries. The
two utilities are referred to collectively herein as the "Operating Companies"
and individually as an "Operating Company". Centerior Energy, Cleveland Electric
and Toledo Edison are referred to collectively herein as the "Companies".
The comparative income statement and balance sheet and the related
statement of cash flows of each of the Companies have been prepared from the
records of each of the Companies without audit by independent public
accountants. In the opinion of management, all adjustments necessary for a fair
presentation of financial position at June 30, 1997 and results of operations
and cash flows for the three months and six months ended June 30, 1997 and 1996
have been included. All such adjustments were normal recurring adjustments,
except for the write-down of inactive production facilities in the first quarter
of 1996 discussed in Note 6.
In June 1997, Toledo Edison formed a subsidiary, Toledo Edison Capital
Corporation (TECC), to serve as an equity partner in a trust in connection with
the financing transaction discussed in Note 4. The subsidiary was capitalized
with Toledo Edison having a 90% interest and Cleveland Electric having a 10%
interest.
These financial statements and notes should be read in conjunction with the
financial statements and notes included in the Companies' combined Annual Report
on Form 10-K for the year ended December 31, 1996 (1996 Form 10-K) and the
Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 (First
Quarter 1997 Form 10-Q). These interim period financial results are not
necessarily indicative of results for a 12-month period.
(2) EQUITY DISTRIBUTION RESTRICTIONS
The Operating Companies can make cash available to fund Centerior Energy's
common stock dividends by paying dividends on their respective common stock,
which is held solely by Centerior Energy. Federal law prohibits the Operating
Companies from paying dividends out of capital accounts. Cleveland Electric has
since 1993 declared and paid preferred and common stock dividends out of
appropriated current net income included in retained earnings. At the times of
such declarations and payments, Cleveland Electric had a deficit in its retained
earnings. From 1993 through June 1997, Toledo Edison declared and paid preferred
stock dividends out of appropriated current net income included in retained
earnings. At the times of such declarations and payments, Toledo Edison had a
deficit in its retained earnings from 1993 through November 1996. Toledo Edison
also has a provision in its mortgage applicable to approximately $94 million of
outstanding first mortgage bonds ($31 million of which matured August 1, 1997)
that requires common stock dividends to be paid out of its total balance of
retained earnings. At June 30, 1997, Toledo Edison's total retained earnings
were $19 million. At June 30, 1997, Cleveland Electric and Toledo Edison had
$95.6 million and $236.6 million, respectively, of appropriated retained
earnings for the payment of dividends. See "Management's Financial
Analysis -- Capital Resources and Liquidity-Liquidity" contained in Item 7 of
the 1996 Form 10-K for a discussion of a Federal Energy Regulatory Commission
(FERC) audit issue regarding the declaration and payment of dividends.
F-82
<PAGE> 148
CENTERIOR ENERGY CORPORATION AND SUBSIDIARIES,
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY,
AND THE TOLEDO EDISON COMPANY AND SUBSIDIARY
NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED
(3) COMMON STOCK DIVIDENDS
Cash dividends per common share declared by Centerior Energy during the six
months ended June 30, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Paid February 15..................................................... $.20 $.20
Paid May 15.......................................................... .20 .20
Paid August 15....................................................... .20 .20
</TABLE>
Common stock cash dividends declared by Cleveland Electric during the six
months ended June 30, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1996 1997
----- -----
(MILLIONS)
<S> <C> <C>
Paid in February................................................... $29.6 $29.6
Paid in May........................................................ 29.6 46.6
</TABLE>
Toledo Edison did not declare any common stock dividends during the six
months ended June 30, 1997 and 1996.
(4) NEW FINANCINGS
In a June 1997 offering (Offering), the Operating Companies pledged $720
million aggregate principal amount of first mortgage bonds due in 2000, 2004 and
2007 to a trust as security for the issuance of a like principal amount of
secured notes due in 2000, 2004 and 2007 (Secured Notes). Cleveland Electric
pledged $175 million principal amount of 7.19% First Mortgage Bonds due 2000,
$280 million principal amount of 7.67% First Mortgage Bonds due 2004 and $120
million principal amount of 7.13% First Mortgage Bonds due 2007, and Toledo
Edison pledged $45 million principal amount of 7.19% First Mortgage Bonds due
2000, $70 million principal amount of 7.67% First Mortgage Bonds due 2004 and
$30 million principal amount of 7.13% First Mortgage Bonds due 2007. The
obligations of the Operating Companies under the Secured Notes are joint and
several.
Also in June 1997 in connection with the Offering, the Companies arranged
for $155 million of short-term borrowings with variable interest rates (at that
time, with a weighted average interest rate of 6.8%). Centerior Energy borrowed
$30 million under a $125 million revolving credit facility which was renewed in
May 1997. See Note 5 to the financial statements in the First Quarter 1997 Form
10-Q. The Operating Companies also had unsecured borrowings totaling $100
million guaranteed by Centerior Energy, and Centerior Energy had $25 million of
unsecured borrowings jointly and severally guaranteed by the Operating
Companies. While the $25 million amount is outstanding, Centerior Energy has
agreed not to use $25 million of the revolving credit facility.
Using available cash, the short-term borrowings and the net proceeds from
the Offering, the Operating Companies invested $906.5 million in the Mansfield
Capital Trust (MCT), an unaffiliated business trust, in June 1997. The MCT used
these funds to purchase lease notes and redeem all $873.2 million aggregate
principal amount of 10 1/4% and 11 1/8% secured lease obligation bonds (SLOBs)
due 2003 and 2016 in July 1997. The SLOBs were issued by a special purpose
funding corporation in 1988 on behalf of lessors in the Operating Companies'
1987 sale and leaseback transaction for the Bruce Mansfield Generating Plant.
F-83
<PAGE> 149
CENTERIOR ENERGY CORPORATION AND SUBSIDIARIES,
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY,
AND THE TOLEDO EDISON COMPANY AND SUBSIDIARY
NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED
The transaction allows the Operating Companies to capture the benefit of
lower interest rates through the spread between (1) the interest rates on the
Operating Companies' investments in the MCT and the return on TECC's investment
and (2) the cost of funds for the Operating Companies and TECC, resulting in
lower annual lease expense for the Operating Companies.
For supplemental information on this transaction, see "1. Refinancing of
Mansfield SLOBs" under "Item 5. Other Events" in the Companies' combined Current
Report on Form 8-K dated July 8, 1997 (July 8, 1997 Form 8-K).
(5) OTHER FINANCING ACTIVITY
During the three months ended June 30, 1997, the Operating Companies also
redeemed preferred stock and debt securities as follows:
CLEVELAND ELECTRIC
Mandatory redemptions consisted of $3 million of Serial Preferred
Stock, $88.00 Series E; $10.7 million of Serial Preferred Stock,
$91.50 Series Q; and $0.3 million of tax-exempt notes.
TOLEDO EDISON
Mandatory redemptions consisted of $1.7 million of 9 3/8% Cumulative
Preferred Stock, $100 par value, and $0.2 million of tax-exempt notes.
(6) WRITE-DOWN OF INACTIVE PRODUCTION FACILITIES
In the first quarter of 1996, Toledo Edison wrote down the net book value
of two inactive production facilities, $11.3 million, to "Other Income and
Deductions, Net" resulting in nonoperating losses for Toledo Edison and
Centerior Energy for that period. The net write-down was $7.2 million after
taxes or, for Centerior Energy, $.05 per common share.
(7) COMMITMENTS AND CONTINGENCIES
Various legal actions, claims and regulatory proceedings covering several
matters are pending against the Companies. See "Item 3. Legal Proceedings" in
the 1996 Form 10-K; "Part II, Item 5. Other Information" in this Quarterly
Report on Form 10-Q and in the First Quarter 1997 Form 10-Q; and "Item 5. Other
Events" in the Companies' combined Current Report on Form 8-K dated June 11,
1997.
In September 1996, Centerior Energy and Ohio Edison Company (Ohio Edison)
entered into an agreement and plan of merger to form a new holding company,
FirstEnergy Corp. (FirstEnergy). The merger remains subject to the approval of
the FERC and the Securities and Exchange Commission. For a discussion of the
status of the FERC approval process, see "2. Pending Merger with Ohio Edison"
under "Item 5. Other Events" in the July 8, 1997 Form 8-K and "1. Pending Merger
with Ohio Edison" under "Part II, Item 5. Other Information" in this Quarterly
Report on Form 10-Q.
F-84
<PAGE> 150
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
INCOME STATEMENT
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
OPERATING REVENUES.................................... $428,246 $434,025 $859,873 $861,551
OPERATING EXPENSES
Fuel and Purchased Power (1)........................ 102,090 98,216 212,620 201,942
Other Operation and Maintenance..................... 101,409 99,083 192,856 204,215
Generation Facilities Rental Expense, Net........... 13,891 13,891 27,783 27,783
Depreciation and Amortization....................... 53,224 53,033 106,521 103,849
Taxes, Other Than Federal Income Taxes.............. 57,274 59,750 113,960 119,760
Amortization of Deferred Operating Expenses, Net.... 6,567 6,575 13,134 12,943
Federal Income Taxes................................ 16,353 17,565 35,556 29,370
-------- -------- -------- --------
Total Operating Expenses......................... 350,808 348,113 702,430 699,862
-------- -------- -------- --------
OPERATING INCOME...................................... 77,438 85,912 157,443 161,689
NONOPERATING INCOME (LOSS)
Allowance for Equity Funds Used During
Construction..................................... 398 601 725 1,099
Other Income and Deductions, Net.................... (7,031) (1,016) (11,680) 633
Federal Income Taxes -- Credit...................... 1,412 1,034 2,070 282
-------- -------- -------- --------
Total Nonoperating Income (Loss)................. (5,221) 619 (8,885) 2,014
-------- -------- -------- --------
INCOME BEFORE INTEREST CHARGES........................ 72,217 86,531 148,558 163,703
INTEREST CHARGES
Long-Term Debt...................................... 56,211 60,626 110,604 120,786
Short-Term Debt..................................... 2,288 1,372 4,465 2,064
Allowance for Borrowed Funds Used During
Construction..................................... (252) (627) (711) (1,146)
-------- -------- -------- --------
Net Interest Charges............................. 58,247 61,371 114,358 121,704
-------- -------- -------- --------
NET INCOME............................................ 13,970 25,160 34,200 41,999
Preferred Dividend Requirements..................... 9,096 9,813 18,411 19,845
-------- -------- -------- --------
EARNINGS AVAILABLE FOR COMMON STOCK................... $ 4,874 $ 15,347 $ 15,789 $ 22,154
======== ======== ======== ========
(1) Includes purchased power expense for purchases
from Toledo Edison................................ $ 29,454 $ 25,908 $ 58,374 $ 52,580
</TABLE>
The accompanying notes as they relate to Cleveland Electric are an integral part
of this statement.
F-85
<PAGE> 151
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
BALANCE SHEET
(THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Utility Plant In Service....................................................... $ 7,053,571 $ 6,938,535
Accumulated Depreciation and Amortization...................................... (2,400,777) (2,252,321)
----------- -----------
4,652,794 4,686,214
Construction Work In Progress.................................................. 67,121 56,853
----------- -----------
4,719,915 4,743,067
Nuclear Fuel, Net of Amortization.............................................. 97,922 113,030
Other Property, Less Accumulated Depreciation.................................. 14,999 53,547
----------- -----------
4,832,836 4,909,644
CURRENT ASSETS
Cash and Temporary Cash Investments............................................ 22,126 30,273
Amounts Due from Customers and Others, Net..................................... 160,110 189,547
Amounts Due from Affiliates.................................................... 3,160 5,634
Materials and Supplies, at Average Cost
Owned........................................................................ 52,453 51,686
Under Consignment............................................................ 27,028 23,655
Taxes Applicable to Succeeding Years........................................... 130,591 181,609
Other.......................................................................... 47,530 15,237
----------- -----------
442,998 497,641
REGULATORY AND OTHER ASSETS
Regulatory Assets.............................................................. 1,333,979 1,349,693
Mansfield Capital Trust........................................................ 569,389 --
Nuclear Plant Decommissioning Trusts........................................... 85,995 75,573
Other.......................................................................... 72,259 44,980
----------- -----------
2,061,622 1,470,246
----------- -----------
$ 7,337,456 $ 6,877,531
=========== ===========
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common Stock Equity............................................................ $ 1,009,866 $ 1,044,283
Preferred Stock
With Mandatory Redemption Provisions......................................... 172,404 186,118
Without Mandatory Redemption Provisions...................................... 238,325 238,325
Long-Term Debt................................................................. 3,011,080 2,441,215
----------- -----------
4,431,675 3,909,941
CURRENT LIABILITIES
Current Portion of Long-Term Debt and Preferred Stock.......................... 134,874 144,668
Current Portion of Lease Obligations........................................... 46,329 51,592
Notes Payable to Banks and Others.............................................. 70,000 --
Accounts Payable............................................................... 71,373 82,694
Accounts and Notes Payable to Affiliates....................................... 129,282 171,433
Accrued Taxes.................................................................. 242,541 315,998
Accrued Interest............................................................... 53,932 52,487
Dividends Declared............................................................. 5,686 15,228
Other.......................................................................... 39,689 43,672
----------- -----------
793,706 877,772
DEFERRED CREDITS AND OTHER LIABILITIES
Unamortized Investment Tax Credits............................................. 172,186 176,130
Accumulated Deferred Federal Income Taxes...................................... 1,328,181 1,305,601
Unamortized Gain from Bruce Mansfield Plant Sale............................... 288,256 295,730
Accumulated Deferred Rents for Bruce Mansfield Plant........................... 101,750 98,767
Nuclear Fuel Lease Obligations................................................. 63,429 73,947
Retirement Benefits............................................................ 75,750 72,843
Other.......................................................................... 82,523 66,800
----------- -----------
2,112,075 2,089,818
COMMITMENTS AND CONTINGENCIES (Note 7)
----------- -----------
$ 7,337,456 $ 6,877,531
=========== ===========
</TABLE>
The accompanying notes as they relate to Cleveland Electric are an integral part
of this statement.
F-86
<PAGE> 152
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
CASH FLOWS
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------------
1997 1996
---------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income........................................................ $ 34,200 $ 41,999
-------- --------
Adjustments to Reconcile Net Income to Cash from Operating
Activities:
Depreciation and Amortization.................................. 106,521 103,849
Deferred Federal Income Taxes.................................. 22,197 22,905
Deferred Fuel.................................................. 12,775 (52)
Leased Nuclear Fuel Amortization............................... 25,186 20,338
Amortization of Deferred Operating Expenses, Net............... 13,134 12,943
Allowance for Equity Funds Used During Construction............ (725) (1,099)
Changes in Amounts Due from Customers and Others, Net.......... 14,965 (35,708)
Changes in Materials and Supplies.............................. (4,140) 7,415
Changes in Accounts Payable.................................... (11,321) 4,886
Changes in Working Capital Affecting Operations................ (55,980) (31,895)
Other Noncash Items............................................ 5,636 (12,856)
-------- --------
Total Adjustments............................................ 128,248 90,726
-------- --------
Net Cash from Operating Activities........................... 162,448 132,725
CASH FLOWS FROM FINANCING ACTIVITIES
Bank Loans, Commercial Paper and Other Short-Term Debt............ 70,000 100,000
Notes Payable to Affiliates....................................... (40,967) 41,411
Secured Note Issues............................................... 575,000 --
Maturities, Redemptions and Sinking Funds......................... (29,014) (50,614)
Nuclear Fuel Lease Obligations.................................... (25,861) (29,533)
Dividends Paid.................................................... (77,952) (96,388)
Premiums, Discounts and Expenses.................................. (53) (249)
-------- --------
Net Cash from Financing Activities........................... 471,153 (35,373)
CASH FLOWS FROM INVESTING ACTIVITIES
Cash Applied to Construction...................................... (54,261) (51,455)
Interest Capitalized as Allowance for Borrowed Funds Used During
Construction................................................... (711) (1,146)
Contributions to Nuclear Plant Decommissioning Trusts............. (5,856) (3,204)
Investment in Mansfield Capital Trust............................. (569,389) --
Purchases of Accounts Receivable from Affiliate................... -- (76,326)
Other Cash Received (Applied)..................................... (11,531) 6,174
-------- --------
Net Cash from Investing Activities........................... (641,748) (125,957)
-------- --------
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS................... (8,147) (28,605)
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD.......... 30,273 69,770
-------- --------
CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD................ $ 22,126 $ 41,165
======== ========
Other Payment Information:
Interest (net of amounts capitalized)............................. $110,000 $119,000
Federal Income Taxes (Refund)..................................... 8,300 (6,200)
</TABLE>
The accompanying notes as they relate to Cleveland Electric are an integral part
of this statement.
F-87
<PAGE> 153
THE CLEVELAND ELECTRIC ILLUMINATING COMPANY AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES AND LIQUIDITY
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in Item 7 of the 1996 Form 10-K
and in the First Quarter 1997 Form 10-Q. The information under "Capital
Resources and Liquidity" remains unchanged with the following exceptions:
As discussed in Note 4, the Operating Companies refinanced high-cost fixed
obligations through a lower cost transaction.
During the second quarter of 1997, Cleveland Electric redeemed various
securities as discussed in Note 5.
S&P and Moody's raised the credit ratings for Cleveland Electric's
securities in July and August 1997, respectively, in anticipation of Centerior
Energy's pending merger with Ohio Edison. S&P indicated that, should the merger
not be consummated, its prior ratings would be restored. Current credit ratings
for Cleveland Electric are as follows:
<TABLE>
<CAPTION>
SECURITIES S&P MOODY'S
------------------------------------------------------------------ ---- -------
<S> <C> <C>
First Mortgage Bonds.............................................. BB+ Ba1
Subordinate Debt.................................................. BB- Ba3
Preferred Stock................................................... BB- b1
</TABLE>
In the third quarter of 1997, Cleveland Electric plans to refinance with
lower-cost securities $180.6 million principal amount of first mortgage bonds
issued as security for certain tax-exempt bonds issued by public authorities.
Additional first mortgage bonds may be issued by Cleveland Electric under
its mortgage on the basis of property additions, cash or refundable first
mortgage bonds. If the applicable interest coverage test is met, Cleveland
Electric may issue first mortgage bonds on the basis of property additions and,
under certain circumstances, refundable bonds. At June 30, 1997, Cleveland
Electric would not have been permitted to issue a material amount of additional
first mortgage bonds, except in connection with refinancings. If FirstEnergy
elects to apply purchase accounting to Cleveland Electric upon completion of
Centerior Energy's pending merger with Ohio Edison, Cleveland Electric's
available bondable property would be reduced to below zero.
Cleveland Electric expects its foreseeable future cash needs to be
satisfied with internally generated cash and available credit facilities and,
therefore, that it will not need to issue first mortgage bonds, except in
connection with planned refinancings.
F-88
<PAGE> 154
RESULTS OF OPERATIONS
Factors contributing to the 1.3% and 0.2% decreases in 1997 operating
revenues from 1996 for the second quarter and six months, respectively, are
shown as follows:
<TABLE>
<CAPTION>
CHANGES FOR PERIOD
ENDED JUNE 30, 1997
-------------------
THREE SIX
FACTORS MONTHS MONTHS
--------------------------------------------------------------- ------ ------
(MILLIONS)
<S> <C> <C>
Kilowatt-hour Sales Volume and Mix............................. $(9.5) $(8.8)
Unbilled Revenues.............................................. 6.0 (6.0)
Wholesale Revenues............................................. 1.9 9.4
Base Rates..................................................... (6.7) 8.3
Fuel Cost Recovery Revenues.................................... 0.2 2.5
Miscellaneous Revenues......................................... 2.3 (7.1)
----- -----
Total.......................................................... $(5.8) $(1.7)
===== =====
</TABLE>
Percentage changes between 1997 and 1996 billed electric kilowatt-hour
sales are summarized as follows:
<TABLE>
<CAPTION>
CHANGES FOR PERIOD
ENDED JUNE 30, 1997
-------------------
THREE SIX
CUSTOMER CATEGORIES MONTHS MONTHS
- ---------------------------------------- ------ ------
<S> <C> <C>
Residential............................. (5.3)% (2.0)%
Commercial.............................. (4.1) (1.4)
Industrial.............................. 2.0 0.1
Other................................... 20.3 52.7
Total................................... 0.4 4.4
</TABLE>
Second quarter 1997 total kilowatt-hour sales increased slightly as
increases in industrial and other sales were partially offset by fewer
residential and commercial sales. Industrial sales increased on the strength of
increased sales to the broad-based, smaller industrial customer group and large
primary metals industry customers, which were partially offset by fewer sales to
large automotive manufacturers. Other sales increased as a 39% increase in
wholesale sales was partially offset by fewer sales to public authorities.
Residential and commercial sales declined because of a change in the meter
reading schedule in June 1997, which reduced the number of days in the billing
cycles, and the milder weather in the 1997 period. Weather-normalized
residential and commercial sales decreased 3.1% and 3%, respectively, for the
1997 period. Kilowatt-hour sales data does not reflect a significant portion of
the effect of hot weather in the second half of June 1997 because those sales
were not billed by the end of the month. However, the estimated revenues from
those sales have been recorded.
Total kilowatt-hour sales increased for the six-month period in 1997 as
increased wholesale sales were partially offset by fewer residential and
commercial sales. Industrial sales increased slightly primarily because of
increased sales to the broad-based, smaller industrial customer group. Wholesale
sales increased 73%. Residential and commercial sales declined because of the
milder weather in the 1997 period. On a weather-normalized basis, residential
sales increased 1.7% for the 1997 period, while commercial sales decreased 0.4%.
Wholesale sales in 1996 were suppressed by soft market conditions and
limited power availability for bulk power transactions because of nuclear
generating plant refueling and maintenance outages.
The net changes in 1997 base rates revenues resulted from the April 1996
rate order issued by the PUCO and renegotiated contracts for certain large
industrial customers which resulted in a decrease in base rates for those
customers.
F-89
<PAGE> 155
The increases in 1997 fuel cost recovery revenues included in customer
bills resulted from increases in the fuel cost recovery factors used in 1997 to
calculate these revenues compared to those used in 1996. The increases in the
weighted averages of the fuel cost recovery factors for 1997 were about 0.3% and
2% for the second quarter and six months, respectively.
Second quarter miscellaneous revenues in 1997 increased from the 1996
amount primarily because of the retroactive effect of a reclassification of
certain revenues as credits to operating expenses. The reclassification was
recorded in the 1996 second quarter. A significant portion of the six-month
decrease in miscellaneous revenues in 1997 related to a canceled generating
plant lease agreement for which a refund payment was made in the 1997 first
quarter.
Second quarter operating expenses in 1997 increased 0.8% from the 1996
amount. Fuel and purchased power expenses increased as higher purchased power
expense was partially offset by lower fuel expense. A change in the system
generating mix (more nuclear generation and less coal-fired generation in the
1997 period than in the 1996 period) accounted for a large part of the lower
fuel expense for the 1997 period. Taxes, other than federal income taxes,
decreased primarily because of lower property and payroll tax accruals. Federal
income taxes decreased as a result of lower pretax operating income.
The second quarter 1997 nonoperating loss resulted primarily from both
Cleveland Electric's share of expenses related to Centerior Energy's pending
merger with Ohio Edison and certain costs associated with an accounts receivable
securitization.
Second quarter 1997 interest charges and preferred dividend requirements
decreased primarily because of the redemption of securities in 1996 and 1997.
Six-month operating expenses in 1997 increased 0.4% from the 1996 amount.
Fuel and purchased power expenses increased for the same reasons cited for the
second quarter 1997 increase in these expenses. Federal income taxes increased
as a result of higher pretax operating income. Depreciation and amortization
expenses increased primarily because of changes in depreciation rates approved
in the April 1996 PUCO rate order. Other operation and maintenance expenses
decreased as a result of ongoing cost cutting and work force reductions. Taxes,
other than federal income taxes, decreased for the same reason cited for the
second quarter 1997 decrease in these expenses.
The six-month 1997 nonoperating loss resulted primarily from both Cleveland
Electric's share of merger-related expenses and certain costs associated with an
accounts receivable securitization.
Six-month 1997 interest charges and preferred dividend requirements
decreased primarily because of the same reason cited for the second quarter 1997
decrease in these charges.
NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued two new statements of financial accounting
standards, one for the reporting of comprehensive income and one for the
disclosures about segments of an enterprise and related information. Both
statements are effective for 1998 reporting. Cleveland Electric has not
completed analyses to determine the effects of adopting the new standards.
F-90
<PAGE> 156
THE TOLEDO EDISON COMPANY AND SUBSIDIARY
INCOME STATEMENT
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
OPERATING REVENUES (1).......................... $222,144 $210,940 $439,204 $421,733
OPERATING EXPENSES
Fuel and Purchased Power...................... 44,501 40,652 87,815 79,420
Other Operation and Maintenance............... 55,455 58,244 111,772 114,763
Generation Facilities Rental Expense, Net..... 25,923 25,962 51,884 51,923
Depreciation and Amortization................. 23,516 23,689 47,330 46,105
Taxes, Other Than Federal Income Taxes........ 22,601 23,572 45,395 47,425
Amortization of Deferred Operating Expenses,
Net........................................ 4,291 4,293 8,582 8,468
Federal Income Taxes.......................... 9,780 3,872 17,992 10,099
-------- -------- -------- --------
Total Operating Expenses.............. 186,067 180,284 370,770 358,203
-------- -------- -------- --------
OPERATING INCOME................................ 36,077 30,656 68,434 63,530
NONOPERATING INCOME (LOSS)
Allowance for Equity Funds Used During
Construction............................... 54 186 386 599
Other Income and Deductions, Net.............. 900 374 473 (8,779)
Federal Income Taxes -- Credit (Expense)...... (601) 115 (826) 3,310
-------- -------- -------- --------
Total Nonoperating Income (Loss)...... 353 675 33 (4,870)
-------- -------- -------- --------
INCOME BEFORE INTEREST CHARGES.................. 36,430 31,331 68,467 58,660
INTEREST CHARGES
Long-Term Debt................................ 21,956 22,704 44,067 45,863
Short-Term Debt............................... 1,369 1,145 2,559 2,363
Allowance for Borrowed Funds Used During
Construction............................... (11) (146) (115) (471)
-------- -------- -------- --------
Net Interest Charges.................. 23,314 23,703 46,511 47,755
-------- -------- -------- --------
NET INCOME...................................... 13,116 7,628 21,956 10,905
Preferred Dividend Requirements............... 4,211 4,229 8,405 8,433
-------- -------- -------- --------
EARNINGS AVAILABLE FOR COMMON STOCK............. $ 8,905 $ 3,399 $ 13,551 $ 2,472
-------- -------- -------- --------
(1) Includes revenues from bulk power sales to
Cleveland Electric.......................... $ 29,454 $ 25,908 $ 58,374 $ 52,580
</TABLE>
The accompanying notes as they relate to Toledo Edison are an integral part of
this statement.
F-91
<PAGE> 157
THE TOLEDO EDISON COMPANY AND SUBSIDIARY
BALANCE SHEET
(THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
1996
JUNE 30, ------------
1997
-----------
(UNAUDITED)
<S> <C> <C>
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Utility Plant In Service....................................................... $ 2,945,663 $ 2,928,657
Accumulated Depreciation and Amortization...................................... (1,066,369) (1,019,836)
---------- ----------
1,879,294 1,908,821
Construction Work In Progress.................................................. 23,883 21,479
---------- ----------
1,903,177 1,930,300
Nuclear Fuel, Net of Amortization.............................................. 64,848 76,118
Other Property, Less Accumulated Depreciation.................................. 7,003 8,460
---------- ----------
1,975,028 2,014,878
CURRENT ASSETS
Cash and Temporary Cash Investments............................................ 22,502 81,454
Amounts Due from Customers and Others, Net..................................... 29,007 16,308
Amounts Due from Affiliates.................................................... 92,949 95,336
Materials and Supplies, at Average Cost
Owned........................................................................ 31,601 33,160
Under Consignment............................................................ 10,170 10,383
Taxes Applicable to Succeeding Years........................................... 51,898 68,352
Other.......................................................................... 2,498 3,479
---------- ----------
240,625 308,472
REGULATORY AND OTHER ASSETS
Regulatory Assets.............................................................. 914,600 927,629
Mansfield Capital Trust........................................................ 337,099 --
Nuclear Plant Decommissioning Trusts........................................... 72,277 64,093
Other.......................................................................... 32,669 42,408
---------- ----------
1,356,645 1,034,130
---------- ----------
$ 3,572,298 $ 3,357,480
========== ==========
CAPITALIZATION AND LIABILITIES
CAPITALIZATION
Common Stock Equity............................................................ $ 816,795 $ 803,237
Preferred Stock
With Mandatory Redemption Provisions......................................... 1,690 3,355
Without Mandatory Redemption Provisions...................................... 210,000 210,000
Long-Term Debt................................................................. 1,121,783 1,003,026
---------- ----------
2,150,268 2,019,618
CURRENT LIABILITIES
Current Portion of Long-Term Debt and Preferred Stock.......................... 69,465 51,365
Current Portion of Lease Obligations........................................... 33,367 36,244
Notes Payable to Banks and Others.............................................. 30,000 --
Accounts Payable............................................................... 44,574 46,496
Accounts and Notes Payable to Affiliates....................................... 81,964 30,016
Accrued Taxes.................................................................. 64,849 72,829
Accrued Interest............................................................... 22,337 22,348
Other.......................................................................... 17,162 18,722
---------- ----------
363,718 278,020
DEFERRED CREDITS AND OTHER LIABILITIES
Unamortized Investment Tax Credits............................................. 73,451 75,417
Accumulated Deferred Federal Income Taxes...................................... 562,474 565,600
Unamortized Gain from Bruce Mansfield Plant Sale............................... 174,454 179,027
Accumulated Deferred Rents for Bruce Mansfield Plant and Beaver Valley Unit
2............................................................................ 39,960 39,188
Nuclear Fuel Lease Obligations................................................. 41,303 48,491
Retirement Benefits............................................................ 104,332 102,214
Other.......................................................................... 62,338 49,905
---------- ----------
1,058,312 1,059,842
COMMITMENTS AND CONTINGENCIES (NOTE 7)
---------- ----------
$ 3,572,298 $ 3,357,480
========== ==========
</TABLE>
The accompanying notes as they relate to Toledo Edison are an integral part of
this statement.
F-92
<PAGE> 158
THE TOLEDO EDISON COMPANY AND SUBSIDIARY
CASH FLOWS
(UNAUDITED)
(THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------
1997 1996
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income........................................................... $ 21,956 $ 10,905
-------- --------
Adjustments to Reconcile Net Income to Cash from Operating
Activities:
Depreciation and Amortization..................................... 47,330 46,105
Deferred Federal Income Taxes..................................... (3,126) 13,368
Deferred Fuel..................................................... 6,116 1,643
Leased Nuclear Fuel Amortization.................................. 17,634 15,461
Amortization of Deferred Operating Expenses, Net.................. 8,582 8,468
Allowance for Equity Funds Used During Construction............... (386) (599)
Changes in Amounts Due from Customers and Others, Net............. (5,103) (4,461)
Sales of Accounts Receivable to Affiliate......................... -- 76,326
Changes in Materials and Supplies................................. 1,772 1,689
Changes in Accounts Payable....................................... (1,922) 2,553
Changes in Working Capital Affecting Operations................... (3,947) (30,245)
Other Noncash Items............................................... 9,886 (12,787)
-------- --------
Total Adjustments............................................ 76,836 117,521
-------- --------
Net Cash from Operating Activities........................... 98,792 128,426
CASH FLOWS FROM FINANCING ACTIVITIES
Bank Loans, Commercial Paper and Other Short-Term Debt............... 30,000 --
Notes Payable to Affiliates.......................................... 55,000 (20,950)
Secured Note Issues.................................................. 145,000 --
Maturities, Redemptions and Sinking Funds............................ (9,865) (43,865)
Nuclear Fuel Lease Obligations....................................... (18,060) (23,318)
Dividends Paid....................................................... (8,397) (8,437)
Premiums, Discounts and Expenses..................................... (28) (225)
-------- --------
Net Cash from Financing Activities........................... 193,650 (96,795)
CASH FLOWS FROM INVESTING ACTIVITIES
Cash Applied to Construction......................................... (25,004) (23,850)
Interest Capitalized as Allowance for Borrowed Funds Used During
Construction...................................................... (115) (471)
Loans to Affiliates.................................................. 11,166 (46,411)
Contributions to Nuclear Plant Decommissioning Trusts................ (4,919) (2,693)
Investment in Mansfield Capital Trust................................ (337,099) --
Other Cash Received.................................................. 4,577 397
-------- --------
Net Cash from Investing Activities........................... (351,394) (73,028)
-------- --------
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS...................... (58,952) (41,397)
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD............. 81,454 93,669
-------- --------
CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD................... $ 22,502 $ 52,272
======== ========
Other Payment Information:
Interest (net of amounts capitalized)................................ $ 44,000 $ 46,000
Federal Income Taxes................................................. 4,300 10,400
</TABLE>
The accompanying notes as they relate to Toledo Edison are an integral part of
this statement.
F-93
<PAGE> 159
THE TOLEDO EDISON COMPANY AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES AND LIQUIDITY
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in Item 7 of the 1996 Form 10-K
and in the First Quarter 1997 Form 10-Q. The information under "Capital
Resources and Liquidity" remains unchanged with the following exceptions:
As discussed in Note 4, the Operating Companies refinanced high-cost fixed
obligations through a lower cost transaction.
During the second quarter of 1997, Toledo Edison redeemed various
securities as discussed in Note 5.
S&P and Moody's raised the credit ratings for Toledo Edison's securities in
July and August 1997, respectively, in anticipation of Centerior Energy's
pending merger with Ohio Edison. S&P indicated that, should the merger not be
consummated, its prior ratings would be restored. Current credit ratings for
Toledo Edison are as follows:
<TABLE>
<CAPTION>
SECURITIES S&P MOODY'S
-------------------------------------------------------- ---- -------
<S> <C> <C>
First Mortgage Bonds.................................... BB+ Ba1
Subordinate Debt........................................ BB- Ba3
Preferred Stock......................................... BB- b1
</TABLE>
In the third quarter of 1997, Toledo Edison plans to refinance with
lower-cost securities $10.1 million principal amount of first mortgage bonds
issued as security for certain tax-exempt bonds issued by public authorities.
Additional first mortgage bonds may be issued by Toledo Edison under its
mortgage on the basis of property additions, cash or refundable first mortgage
bonds. If the applicable interest coverage test is met, Toledo Edison may issue
first mortgage bonds on the basis of property additions and, under certain
circumstances, refundable bonds. At June 30, 1997, Toledo Edison would not have
been permitted to issue a material amount of additional first mortgage bonds,
except in connection with refinancings. If FirstEnergy elects to apply purchase
accounting to Toledo Edison upon completion of Centerior Energy's pending merger
with Ohio Edison, Toledo Edison's available bondable property would be reduced
to below zero.
Toledo Edison expects its foreseeable future cash needs to be satisfied
with internally generated cash and available credit facilities and, therefore,
that it will not need to issue first mortgage bonds, except in connection with
planned refinancings.
F-94
<PAGE> 160
RESULTS OF OPERATIONS
Factors contributing to the 5.3% and 4.1% increases in 1997 operating
revenues from 1996 for the second quarter and six months, respectively, are
shown as follows:
<TABLE>
<CAPTION>
CHANGES FOR PERIOD
ENDED JUNE 30,
1997
------------------
THREE SIX
FACTORS MONTHS MONTHS
---------------------------------------------------------------- ------ -------
(MILLIONS)
<S> <C> <C>
Kilowatt-hour Sales Volume and Mix.............................. $ 10.2 $ 16.4
Unbilled Revenues............................................... 7.0 4.0
Wholesale Revenues.............................................. 4.2 7.1
Base Rates...................................................... (6.0) (3.4)
Fuel Cost Recovery Revenues..................................... (3.0) (4.5)
Miscellaneous Revenues.......................................... (1.2) (2.1)
----- -----
Total........................................................... $ 11.2 $ 17.5
===== =====
</TABLE>
Percentage changes between 1997 and 1996 billed electric kilowatt-hour
sales are summarized as follows:
<TABLE>
<CAPTION>
CHANGES FOR PERIOD
ENDED JUNE 30,
1997
------------------
THREE SIX
CUSTOMER CATEGORIES MONTHS MONTHS
--------------------------------------------------------- ------ -------
<S> <C> <C>
Residential.............................................. (2.4)% (2.8)%
Commercial............................................... (1.5) 0.7
Industrial............................................... 11.9 10.0
Other.................................................... 21.1 21.0
Total.................................................... 9.4 8.7
</TABLE>
Second quarter 1997 total kilowatt-hour sales increased primarily because
of increased industrial and wholesale sales. Industrial sales increased on the
strength of increased sales to large primary metals industry customers
(including the new North Star BHP Steel facility) and the broad-based, smaller
industrial customer group. Wholesale sales (included in the "Other" category)
increased 22%. Residential and commercial sales declined because of the milder
weather in the 1997 period. On a weather-normalized basis, residential sales
increased 0.9% for the 1997 period. Kilowatt-hour sales data does not reflect a
significant portion of the effect of hot weather in the second half of June 1997
because those sales were not billed by the end of the month. However, the
estimated revenues from those sales have been recorded.
Total kilowatt-hour sales increased for the six-month period in 1997
primarily because of increased industrial and wholesale sales. Industrial sales
growth reflected increased sales to large primary metals, automotive and glass
manufacturers and the broad-based, smaller industrial customer group. Wholesale
sales increased 24%. While residential sales declined because of the milder
weather in the 1997 period, commercial sales increased slightly.
Weather-normalized residential and commercial sales increased 0.5% and 1.9%,
respectively, for the 1997 period.
Wholesale sales in 1996 were suppressed by soft market conditions and
limited power availability for bulk power transactions because of nuclear
generating plant refueling and maintenance outages.
Renegotiated contracts for certain large industrial customers resulted in a
decrease in base rates which entirely offset the effect of the general price
increase under the April 1996 rate order issued by the PUCO, resulting in
decreases in 1997 base rates revenues.
The decreases in 1997 fuel cost recovery revenues included in customer
bills resulted from decreases in the fuel cost recovery factors used in 1997 to
calculate these revenues compared to those used in 1996. The decreases in the
weighted averages of the fuel cost recovery factors for 1997 were about 10% and
7% for the second quarter and six months, respectively.
F-95
<PAGE> 161
Second quarter operating expenses in 1997 increased 3.2% from the 1996
amount. Fuel and purchased power expenses increased as higher purchased power
expense was partially offset by lower fuel expense. A change in the system
generating mix (more nuclear generation and less coal-fired generation in the
1997 period than in the 1996 period) accounted for a large part of the lower
fuel expense for the 1997 period. Federal income taxes increased as a result of
higher pretax operating income. Other operation and maintenance expenses
decreased as a result of ongoing cost cutting and work force reductions. Taxes,
other than federal income taxes, decreased primarily because of lower property
and payroll tax accruals.
Second quarter 1997 interest charges and preferred dividend requirements
decreased slightly primarily because of the redemption of securities in 1996 and
1997.
Six-month operating expenses in 1997 increased 3.5% from the 1996 amount.
Fuel and purchased power expenses increased for the same reasons cited for the
second quarter 1997 increase in these expenses. Federal income taxes increased
as a result of higher pretax operating income. Depreciation and amortization
expenses increased primarily because of changes in depreciation rates approved
in the April 1996 PUCO rate order. Other operation and maintenance expenses and
taxes, other than federal income taxes, decreased for the same reasons cited for
the second quarter 1997 decreases in these expenses.
The six-month 1996 nonoperating loss resulted primarily from the write-down
of two inactive production facilities as discussed in Note 6.
Six-month 1997 interest charges and preferred dividend requirements
decreased primarily because of the same reason cited for the second quarter 1997
decrease in these charges.
NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued two new statements of financial accounting
standards, one for the reporting of comprehensive income and one for the
disclosures about segments of an enterprise and related information. Both
statements are effective for 1998 reporting. Toledo Edison has not completed
analyses to determine the effects of adopting the new standards.
F-96
<PAGE> 162
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
1. PENDING MERGER WITH OHIO EDISON
For additional information relating to this topic, see "Outlook-Pending
Merger with Ohio Edison" under "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Companies' Annual Report
on Form 10-K for the year ended December 31, 1996 ("1996 Form 10-K") and
"Pending Merger with Ohio Edison" under "Item 5. Other Events" in the Companies'
Form 8-K Current Reports dated June 11, 1997 and July 8, 1997.
On August 8, 1997, Ohio Edison Company and the Companies filed a revised
analysis, additional testimony and proposed mitigation measures fully responsive
to the FERC's July 16, 1997 Order. While the revised analysis suggests potential
anticompetitive effects in certain markets under certain limited circumstances,
the Companies believe that the mitigation measures more than adequately address
these concerns through a variety of transmission solutions which are intended to
ensure that the proposed merger's effects are procompetitive. As a result of the
mitigation measures, municipal electric systems in Ohio Edison's and the
Companies' service areas will be able to take full advantage of additional third
party generation sources made available to them as a result of FirstEnergy's
open access transmission tariff. Accordingly, whether or not the FERC grants
their separate request to shorten the comment period from 60 to 30 days, the
Companies continue to believe the FERC will approve the proposed merger prior to
year end.
2. CONJUNCTIVE ELECTRIC SERVICE ("CES")
In December 1996, The Public Utilities Commission of Ohio ("PUCO") ruled
that all Ohio electric utilities were required to file tariffs which would
provide for a new type of electric service in which various customers could
aggregate together and negotiate their electric rates with the utilities. The
Operating Companies filed their version of a CES tariff on March 31, 1997. On
April 28, 1997, Cleveland Electric and Toledo Edison, as well as three other
Ohio utilities, appealed the PUCO's order to the Ohio Supreme Court. The City of
Toledo and Enron Capital and Trade Resources have moved to intervene. The
Operating Companies have filed merit briefs asserting that the PUCO is without
statutory authority to require utilities to file tariffs which will permit
customers to aggregate and negotiate their electric rates with the utilities.
3. FIRSTENERGY RATE PLAN
For additional information relating to this topic, see "Management's
Financial Analysis -- Outlook-FirstEnergy Rate Plan" in the Companies' 1996 Form
10-K.
Various intervenors have filed a motion at the PUCO seeking clarification
of the status of the FirstEnergy Rate Plan in light of their assertions that
PUCO approval of such plan was conditioned upon an acceptable CES tariff, and
that the Operating Companies' CES tariff, discussed in Item 2 above, is
unacceptable. FirstEnergy and the Operating Companies have responded that the
PUCO lacks authority to impose CES tariffs and that the PUCO has not yet
determined whether the Operating Companies' filed version of a CES tariff is
acceptable.
4. PLANTS TO BE DECOMMISSIONED
On June 24, 1997, Cleveland Electric's Board of Directors authorized the
decommissioning later this year of several older coal-fired units with aggregate
generating capacity of 266 MW. This capacity can be economically replaced by
purchasing power, and the planned decommissioning will not materially adversely
affect Cleveland Electric's results of operations.
5. OHIO ABANDONS NUCLEAR WASTE PROJECT
The six-state Midwest Compact Commission has abandoned planning a facility
to store low-level radioactive waste from nuclear power plants and other
producers. Officials from the compact, which included Ohio, said a facility is
no longer needed and would cost too much to build. Disposal sites in South
Carolina
F-97
<PAGE> 163
and Utah are now open to waste generators. The decision has no immediate impact
on the Companies' operations or costs, while long-term implications are under
study.
6. NEW FEDERAL RULES
For additional information relating to this topic, see "Environmental
Regulation -- Air Quality Control" under "Item 1. Business" in the Companies'
1996 Form 10-K.
The U.S. Environmental Protection Agency has issued new clean air standards
for ozone and fine particulates that could require the Operating Companies to
install additional air pollution control equipment and/or switch fuel sources at
the Operating Companies' fossil-fueled plants after 2002. Compliance would be
required by 2004. The new rules have been challenged in court by trade
associations. The PUCO estimates the new rules will cost Ohio utilities
approximately $760 million per year, and increase the average cost of
electricity by 7%. The Companies are evaluating their options.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
See Exhibit Index following.
B. REPORTS ON FORM 8-K
During the quarter ended June 30, 1997, Centerior Energy, Cleveland
Electric and Toledo Edison each filed one Current Report on Form 8-K with the
Securities and Exchange Commission.
A Form 8-K dated June 11, 1997 and filed June 18, 1997 included one item
under "Item 5. Other Events". That item, "Pending Merger with Ohio Edison",
reported on agreements reached with the City of Cleveland and American Municipal
Power-Ohio and the withdrawal of their opposition to the pending merger of
Centerior Energy and Ohio Edison Company.
F-98
<PAGE> 164
SIGNATURES
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. The person signing this report on behalf
of each such registrant is also signing in his capacity as each registrant's
Chief Accounting Officer.
/s/ CENTERIOR ENERGY CORPORATION
--------------------------------------
(Registrant)
/s/ THE CLEVELAND ELECTRIC
ILLUMINATING COMPANY
--------------------------------------
(Registrant)
/s/ THE TOLEDO EDISON COMPANY
--------------------------------------
(Registrant)
By: /s/ E. LYLE PEPIN
--------------------------------------
E. Lyle Pepin, Controller and Chief
Accounting Officer
of each Registrant
Date: August 14, 1997
F-99
<PAGE> 165
APPENDIX I
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A-1
<PAGE> 166
APPENDIX I
[SPECIMEN]
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AMBAC Ambac Assurance Corporation
c/o CT Corporation Systems
44 East Mifflin Street, Madison, Wisconsin 53703
Financial Guaranty Insurance Policy Administrative Office:
One State Street Plaza, New York, New York 10004
Telephone: (212) 668-0340
</TABLE>
Obligor: Policy Number:
Obligations: Premium:
AMBAC ASSURANCE CORPORATION (AMBAC) A Wisconsin Stock Insurance Company in
consideration of the payment of the premium and subject to the terms of this
Policy, hereby agrees to pay to United States Trust Company of New York, as
trustee, or its successor (the "Insurance Trustee"), for the benefit of the
Obligees, that portion of the principal of and interest on the above-described
obligations (the "Obligations") which shall become Due for Payment but shall be
unpaid by reason of Nonpayment by the Obligor.
Ambac will make such payments to the Insurance Trustee within one (1) business
day following notification to Ambac of Nonpayment. Upon an Obligee's
presentation and surrender to the Insurance Trustee of such unpaid Obligations
or appurtenant coupons, uncanceled and in bearer form free of any adverse claim,
the Insurance Trustee will disburse to the Obligee the face amount of principal
and interest which is then Due for Payment but is unpaid. Upon such
disbursement, Ambac shall become the owner of the surrendered Obligations and
coupons and shall be fully subrogated to all of the Obligee's rights to payment.
In cases where the Obligations are issuable only in a form whereby principal is
payable to registered Obligees or their assigns, the Insurance Trustee shall
disburse principal to an Obligee as aforesaid only upon presentation and
surrender to the Insurance Trustee of the unpaid Obligation, uncanceled and free
of any adverse claim, together with an instrument of assignment, in form
satisfactory to the Insurance Trustee duly executed by the Obligee or such
Obligee's duly authorized representative, so as to permit ownership of such
Obligation to be registered in the name of Ambac or its nominee. In cases where
the Obligations are issuable only in a form whereby interest is payable to
registered Obligees or their assigns the Insurance Trustee shall disburse
interest to an Obligee as aforesaid only upon presentation to the Insurance
Trustee of proof that the claimant is the person entitled to the payment of
interest on the Obligation and delivery to the Insurance Trustee of an
instrument of assignment, in form satisfactory to the Insurance Trustee, duly
executed by the claimant Obligee or such Obligee's duly authorized
representative, transferring to Ambac all rights under such Obligation to
receive the interest in respect of which the insurance disbursement was made.
Ambac shall be subrogated to all of the Obligees' rights to payment on
registered Obligations to the extent of the insurance disbursements so made.
In the event that a trustee or paying agent for the Obligations has notice that
any payment of principal of or interest on an Obligation which has become Due
for Payment and which is made to an Obligee by or on behalf of the Obligor has
been deemed a preferential transfer and theretofore recovered from the Obligee
pursuant to the United States Bankruptcy Code in accordance with a final,
nonappealable order of a court of competent jurisdiction, such Obligee will be
entitled to payment from Ambac to the extent of such recovery if sufficient
funds are not otherwise available.
As used herein, the term "Obligee" means any person other than the Obligor who,
at the time of Nonpayment, is the owner of an Obligation or of a coupon
appertaining to an Obligation. As used herein, "Due for Payment", when
referring to the principal of Obligations, is when the stated maturity date or
mandatory redemption date for the application of a required sinking fund
installment has been reached and does not refer to any earlier date on which
payment is due by reason of call for redemption (other than by application of
required sinking fund installments), acceleration or other advancement of
maturity; and, when referring to interest on the Obligations, is when the
stated date for payment of interest has been reached. As used herein,
"Nonpayment" means the failure of the Obligor to have provided sufficient funds
to the paying agent for payment in full of all principal of and interest on the
Obligations which are Due for Payment.
This Policy is noncancelable. The premium on this Policy is not refundable for
any reason, including payment of the Obligations prior to maturity. This
Policy does not insure against loss of any prepayment or other acceleration
payment which at any time may become due in respect of any Obligation, other
than at the sole option of Ambac, nor against any risk other than Nonpayment.
In witness whereof, Ambac has caused this Policy to be affixed with a
facsimile of its corporate seal and to be signed by its duly authorized
officers in facsimile to become effective as its original seal and signatures
and binding upon Ambac by virtue of the countersignature of its duly
authorized representative.
/s/ P. Lassiter AMBAC ASSURANCE CORPORATION /s/ _______ A. Cooke
President SEAL Secretary
WISCONSIN
Effective Date: Authorized Representative
UNITED STATES TRUST COMPANY OF NEW YORK /s/ H. William Weber
acknowledges that it has agreed to perform
the duties of Insurance Trustee under this Authorized Officer
Policy.
Form No.: 2B-0012(7/97)
<PAGE> 167
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No dealer, salesperson or other individual has been authorized to give any
information or to make any representations in connection with the Exchange Offer
other than those contained or incorporated by reference in this Prospectus and
the accompanying Letter of Transmittal. If given or made, such information or
representations must not be relied upon as having been authorized by the
Companies or the Exchange Agent. Neither this Prospectus nor the accompanying
Letter of Transmittal, or both together, constitute an offer to sell, or a
solicitation of an offer to buy, Secured Notes in any jurisdiction where, or to
any person to whom, it is unlawful to make such offer or solicitation. Neither
the delivery of this Prospectus nor the accompanying Letter of Transmittal, or
both together, nor any sale made hereunder shall, under any circumstances,
create an implication that there has not been a change in the facts set forth in
this Prospectus or in the affairs of the Companies since the date hereof.
UNTIL DECEMBER 8, 1997, ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
------------------------
TABLE OF CONTENTS
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Available Information.................. 3
Incorporation of Certain Documents by
Reference............................ 3
Summary Information.................... 4
Risk Factors........................... 12
Selected Financial Information for
Cleveland Electric................... 16
Selected Financial Information for
Toledo Edison........................ 17
The Companies.......................... 18
Pending Merger of Centerior Energy and
Ohio Edison.......................... 28
Pending Merger of Cleveland Electric
and Toledo Edison.................... 30
Combined Pro Forma Condensed Balance
Sheets of Cleveland Electric and
Toledo Edison........................ 32
Combined Pro Forma Condensed Income
Statements of Cleveland Electric and
Toledo Edison........................ 34
The Exchange Offer..................... 36
Description of the New Notes........... 43
Credit Enhancement of Secured Notes due
2007................................. 49
Descriptions of Cleveland Electric
Bonds and Toledo Edison Bonds........ 51
Certain Tax Considerations............. 60
Plan of Distribution................... 63
Legal Matters.......................... 63
Experts................................ 63
Index to Financial Statements
Section.............................. F-1
Financial Guaranty Insurance Policy.... Appendix 1
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======================================================
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$720,000,000
EXCHANGE OFFER
THE CLEVELAND ELECTRIC
ILLUMINATING COMPANY
THE TOLEDO EDISON
COMPANY
OFFER TO EXCHANGE
7.19% SERIES B SECURED NOTES DUE 2000,
7.67% SERIES B SECURED NOTES DUE 2004 OR
7.13% SERIES B SECURED NOTES DUE 2007
FOR ANY AND ALL OUTSTANDING
7.19% SERIES A SECURED NOTES DUE 2000,
7.67% SERIES A SECURED NOTES DUE 2004 OR
7.13% SERIES A SECURED NOTES DUE 2007, RESPECTIVELY
PROSPECTUS
SEPTEMBER 25, 1997
======================================================
