ML18038A472

Niagara Mohawk Power Corp Annual Rept,1988

ML18038A472
Person / Time
Site:	Nine Mile Point
Issue date:	12/31/1988
From:	Donlon W, Endries J, Terry C NIAGARA MOHAWK POWER CORP.
To:	NRC OFFICE OF INFORMATION RESOURCES MANAGEMENT (IRM)
References
NMP1L-0402, NMP1L-402, NUDOCS 8906050055
Download: ML18038A472 (45)

Text

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REGULRT ACCESSION NBR:8906050055 DOC.DATE: 88/12/31 FACIL:50-220 Nine Mile Point Nuclear Station, AUTH.NAME AUTHOR AFFILIATION DONLONPW.J.

Niagara Mohawk Power Corp.

ENDRIES,J.M.

Niagara Mohawk Power Corp.

TERRY,C.D.

Niagara Mohawk Power Corp.

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KS Y NIASAR m ~ vmawK NIAGARAMOHAWKPOWER CORPORATION/301 PLAINFIELDROAD, SYRACUSE. N.Y. 13212/TELEPHONE (315) 474-1511 May 26, l989 NMPlL 0402 U.S. Nuclear Regulatory Commission Attn:

Document Control Desk Washington, D.C.

20555 Re:

Nine Mile Point Unit 1

Docket No. 50-220 DPR-63 Gentlemen:

In accordance with Section 50.71(b) of the Commission's Regulations, enclosed is a copy of Niagara Mohawk Power Corporation's 1988 Annual Report.

Very truly yours, NIAGARA MOHAWK PO ER ORPORATION C.

D. Terry Vice President Nuclear Engineering and Licensing PEF/mlf 7127G Enclosures xc:

Regional Administrator, Region I (w/attachment)

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AD Capra, Director (w/attachment)

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H. H. Slosson, Project Manager (w/attachment)

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W. A. Cook, Resident Inspector (w/attachment)

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A Salance of Interests Niagara Mohawk has an extensive con-stituency of electric and gas customers, shareholders, employees, pensioners and suppliers, whose well-being is interrelated.

In New York, our ability to provide reliable, affordable energy has a direct impact on the upstate economy of S1 billion annually in wages and salaries, taxes, shareholder dividends and payments for New York goods and services. This $ 1 billion doesn' begin to approach the multiplier effect of service industry jobs that have flourished in the wake of our contributions to state and local economies.

In managing our company we strive to maintain a balance of interests among these constituencies in a complex and changing regulatory and economic envi-ronment.

In the pages that follow, you will read about our very difficult nuclear outages and our intensive efforts to remedy nuclear operations; our campaign to sensitize our employees to the changing customer envi-ronment; Iong-term energy procurement strategies designed to provide customers all the energy they need at competitive prices; energy conservation and varied pricing programs; economic development initiatives; customer outreach strategies; research and development activities; and other programs which we believe willwork to the mutual, long-term benefit of all our constituents. l3 Serving our Customers in Upstate NewYork Niagara Mohawk Power Corporation, an investor-owned utility,provides energy to the largest customer service area in New YorkState. Our electric system extends from Lake Erie to New England's borders, from Canada to Pennsylvania, and meets the needs of nearly 1.5 millionresidential, commercial and indus-trial customers. Power is supplied by hydroelectric, coaloil, natural gas-fired and nuclear generating units as well as through purchase contracts. Electric-ity is transmitted through an integrated operating network that is linked to other systems in the North-east foreconomic exchange and mutual reliability.

Our natural gas system serves approximately 458,000 residential and business customers with ac-cess to our 6,500-mile system ofpipelines and mains in central, eastern and northern New York.In addi-tion to the purchase, sale and distribution ofgas to retail customers, a growing part ofour business in-cludes the transportation ofnatural gas for those cus-tomers who are large users and have arranged their own supply.

We also operate subsidiary companies in the United States and Canada. Opinac Energy Corp. operates an exploration company and a utilityin Canada.

HYDRA-COEnterprises Inc. builds and operates power production facilities. NITECHInc. markets advanced instrumentation systems to the utilityin-dustry.H This report was designed, written and produced by N!agara Mohawk Peopfe.

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'NIAGARAMOIIAWKPOWI~IR CORPORATION aml SUIISII)IARYCOhlPANII~IS I

FinancialHi hli htsof 988 Contents 1988 1987 Change Earnings (loss) per common share

$ 1.21

$(4.78)

Earnings per common share (excluding the impact of the Nine MileTwo disallowance)..

Dividends per common share Common shares outstanding (average)

Utilityplant (gross)..

$ 1.21

$ 1.76 (31.3)

$ 1.20

$ 1.64 (26.8) 131,853,000 127,435,000 3.5

$ ?,967,625,000

$ 7,691,069,000 3.6 Construction work in progress...

315,644,000

$ 1,789,562,000 (82.4)

Gross additions to utilityplant..

353,859,000 447,230,000 (20.9)

Public kilowatt-hour sales......

33,263,000,000 31,530,000,000 5.5 Total kilowatt-hour sales.......

34,995,000,000 35,684,000,000 (1.9)

Electriccustomersatendofyear 1,482,000 1,459,000 1.6 Electric peak load (kiloivatts)....

',220,000 5,780,000 7.6 Natural gas sales (dekatherms)...

81,448,000 81,320,000

.2 Total operating revenues.......

$ 2,800,453,000

$ 2,623,430,000 6.7 Income available for (loss to) common stockholders........

159;65?,000 (609,231,000) 2 To our stockholders 4 Abalance ofinterests 6 Emphasis on partnership 8 Cultivating the highest standards 10 Exerting special care 12 Management's discussion and analysis offinancial condition 18 Consolidated financial statements 22 Notes to consolidated financial statements 35 Report of management 35 Report ofindependent accountants 36 Selected financial data 37 Market price ofcommon stock 38 Statistics 39 Directors, officers 40 Corporate information Natural gas transported (dekatherms)

Gas customers at end ofyear Maximum day gas sendout (dekatherms) 27,244,000 458,000 818,128 21,862,000 24.6 450,000 1.8 758,914 7.8 Onr Corporate Mission Niagara Mohawk willbe an innovative and respon-sive energy company, satisfying its customers'nergy needs with a diversified line ofquality and price-competitive products and services.

Electricity and gas products and services willcon-tinue to be the core ofthe company's business. Niag-ara Mohawk's driving force willbe to make its elec-tricityand gas products the preferred energy source for the largest possible number. ofenergy users and uses. During the next three years, the company will take action to:

o Promote efficiency in the supply, demand and end-use application ofenergy.

o Aggressively manage its market share in key markets.

o Expand business opportunities with existing customers.

o Develop new markets forexisting products and services.

In addition, Niagara Mohawk willexplore and de-velop attractive opportunities in advanced energy-related equipment and in value-added services.

In support ofthis business focus, the company will:

o Maintain a high level ofexpertise in its core business; o Selectively utilize resources to ensure high quality, price competitive products; and o Substantially increase its capability to understand and respond to the customers'pecific needs.G

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mrs eliabilityis the essence ofa utility.'Our custom-ers trust us to maintain the financial strength necessary to provide dependable, low-cost energy for their homes and businesses. Our share-holders look to us to produce a steady stream ofearn-ings, ensuring a fair return on their investment. Our hard-working and dedicated employees want assur-ance that their investment in learning our business willbe rewarded with satisfying careers.

In light of these facts, last year was very disappoint-ing. The company's performance in 1988 failed to meet our expectations and causes us considerable concern for the future.

Earnings were $ 159.7 millionor $ 1.21 per share, compared to $223.8 millionor $ 1.76 last year, exclud-ing the effect ofthe after-tax write-offofdisallowed Nine MileUnitTwo costs of $833 millionor $6.54 per share taken in 1987. With the write-off,the company reported a net loss of $609.2 millionor $4.78 per share in 1987.

Many ofthe factors that contributed to our 1988 earnings decline extend into the present year. These include:

~ the continuing impact ofa reduction in the com-pany's earnings base as a result ofthe 1987 write-off ofdisallowed costs ofNine MileUnitTwo, which began operations last spring;

~ electric and gas rate agreements with the New York Public Service Commission (PSC) and other state agencies that, because ofchanged conditions, did not account for the costs ofprograms the company is now incurring; (Over the past several years, nearly every major utilityin New York State has agreed to reduce or freeze rates.)

~ the lengthy outage ofNine MileUnit One, which began in December 1987 and continues, with Nu-clear Regulatory Commission (NRC) involvement, into 1989; the extension ofa planned outage at Nine MileTwo, which began in October and continues into the early months of 1989; and

+ increased expenses largely related to our efforts to remedy our nuclear problems and improve nuclear operations. Both units are receiving increased monitoring by the NRC.

The Year Ahead Return on common equity dropped to 8.7 percent in 1988, compared with 12.7 percent in 1987, excluding the write-offofdisallowed Nine MileTwo costs. This deterioration is expected to deepen in 1989 as a con-sequence of the uncertainties surrounding the Nine MileOne outage and the increased level ofexpense related to nuclear operations.

The outlook forfurther earnings decline places con-siderable pressure on our dividend in 1989. The com-pany announced a first quarter common stock divi-dend of 30 cents a share, which is the level we have been paying since the dividend was reduced 42 per-cent in the third quarter of 1987.

As we progress through the year, declaratiort offu-,

~

ture dividends and levels ofpayment are necessarily dependent upon a variety offactors, including future earnings; cash flow; financial requirements; the dura-tion of, and cost associated with, the outage ofNine MileOne; the adequacy and timeliness ofrate relief; and the level ofretained earnings. Restrictions under our charter and indenture and under federal and state law may also become a governing factor.

Early in 1989, the company agreed with the Public Service Commission that we would suspend collec-tion from ratepayers of $225,000 a day in replacement power costs attributable to the outage.

The temporary resolution ofthe replacement power cost issue allows us to focus our efforts on completing the work necessary to return Nine MileOne to service.

New York's attorney general, among others, had pressed hard for the PSC to begin hearings at the ear-liest possible time.

The suspension began in January and willcontinue until June 30, 1989, or the restart of the unit, whichever happens first. The possibility ofthe PSC mandating the same level ofreliefor undertaking even more stringent steps was very real, had we not entered into the agreement.

While the agreement with the PSC intentionally does not assign responsibility for the outage, the sus-pension ofreplacement power costs willreduce earn-ings by about 3 cents per share a month for the dura-tion of the agreement. Our abilityto recover this money in rates and our ability to avoid refunding about $76 millionofpurchased-power costs collected from customers in 1988 is subject to a PSC decision expected after restart ofthe uniton the causes of the outage. Meanwhile, we have been spending and willcontinue to spend substantial amounts for operation and maintenance work related to restart activities.

A Plan ofAction In December, we provided the Nuclear Regulatory Commission with a comprehensive plan forrestarting Nine MileOne. We are striving to return the plant to service as soon as possible, although our current as-sessment indicates restart is unlikely to occur before mid-1989. Ultimately, we must gain the approval of the NRC before we can restart the unit.

To strengthen leadership and provide new perspec-tive, we sought retired Rear Adm. Lawrence Burkhardt, a 32-year U.S. Navy nuclear veteran, to join the company as executive vice president ofnu-clear operations and as a member ofour board of directors.

Burkhardt, whose career covered a range ofhighly responsible nuclear and overall fleet and administra-tive posts, served as assistant deputy chiefofNaval operations with responsibility for 900,000 military and civilianpersonnel upon his retirement in 1986.

Before joining Niagara Mohawk, he was a consultant to the nuclear power industry.

Although he has only been with the company since mid-November, in our view his presence already has begun to make a positive difference in employee per-formance. While we can expect a very challenging time ahead, the most recent regulatory inspections at our nuclear facilities have been more favorable.

NIAGARAMOIIAWKPOWER CORPORATION Iul SUBSIDIARYCOMPANIES 2-3 Preserving Reliability Nevertheless, there is no question that 1989 willbe a difficultyear. Our areas ofexposure are clear, and we are taking steps to mitigate the potential impact.

Specifically, we have asked supervisors throughout our company to reassess their operating plans in 1989 foradditional cost-saving measures. While we have no intention ofcutting costs beyond our ability to provide reliable service, we willbe taking aggressive steps to effect reductions.

Niagara Mohawk operates an extensive infrastruc-ture ofgenerating, transmission and distribution facilities that are subject to the ravages of time and weather and which require a continuing program of preventive maintenance. To reduce vigilance would be a disservice to shareholders and customers alike.

We also intend to pursue the possibilities ofrelief to cover costs associated with our nuclear program.

Nine MileOne has offered an excellent value to our customers, providing more than $800 millionin fuel savings during its 19 years ofoperations.

A Balance ofInterests Niagara Mohawk's dilemma is that our very source of strength our uniquely diverse generating mix and our extensive distribution system also presents a significant challenge in the current regulatory envi-ronment. Our size and diversity help to keep our costs low. They guard against the possibility that any single event willsubstantially increase prices. But the diver-sity and associated complexity ofNiagara Mohawk's business heightens the likelihood that future condi-tions could vary from expense forecasts so closely scrutinized in the ratemaking process and to which we are so strictly held.

We are concerned that a balance ofinterests is not achieved iF the regulatory process tends only to iden-tifyand penalize weaknesses, while strengths brought about through shareholder investment go largely un-recognized and unrewarded.

We believe it is not equitable forour shareholders to suffer a significantly reduced return on investment whileour customers have received and willcontinue to receive the benefits ofour shareholders'nvestment

-low-cost nuclear power. There should be a balance ofinterests.

The key to 1989 willbe our ability to meet our Nine MileOne restart schedule and win NRC approval to bring this unit back to productive service. We are concentrating significant resources on this effort spe-cificallyand on nuclear operations in general.

1VilliarnJ. Doulorr Cirainuau ofthe Board aud ClriefExecrrrive Officer Jolur M. Errdries Presideur March 8, 1989 Our Inherent Strengths Longer term,,there are forces at work to help us bring about a gradual improvement in financial returns for our company. Our electric prices are relatively low compared with other regional suppliers. We believe this is an important factor in the renewed economic vitalitywe are experiencing in our service territorya revitalization that contributed the bulk ofa nearly 6 percent increase in electric usage in 1988.

Gas sales for the year also increased by more than 5 percent. To reduce costs and increase natural gas supply throughout our system, we announced plans in 1989 to participate in the development ofa pipeline linkto Canadian gas sources.

Our subsidiaries, Opinac Energy Corp. and HYDRA-COEnterprises Inc., while small parts ofour business, continue to register growth.

Without detracting from the gravity or seriousness ofthese times, we also believe we should never lose sight ofour strengths. We are encouraged that the strength and importance to society ofour core energy business, the growing vitalityofour service territory and the validityofour strategic plan willprovide the basis forus to move through this challenging period.

During 1988, we lost two members ofour board of directors. We willmiss the contributions ofLauman Martin, who served our company since the days ofits incorporation as an officerand a director, and Lewis A. Swyer, who lent his entrepreneurial know-how and community perspective to many ofour decisions.

We have always been fortunate in the talent and dedication of the people we'e attracted to our busi-ness and in the loyaltyshown by our customers and shareholders.Q

o neress edefining our concept ofcustomer service has been a major strategic initiativefor Niagara Mohawk in 1988 and willcontinue to be a critical planning factor in years to come.

We are facing increasing competition in all areas of our business. Programs that sharpen our customer and community focus serve the mutual interests ofall our constituencies shareholders, customers and employees alikebecause they help to ensure that we willmaintain leadership in our markets.

HSl'tOVll 8I'ur process for addressing this balance of interests has thrust us into new territory in 1988 as we de-veloped programs to:

o Train 5,500 employees to be more responsive in their customer contacts.

o Forge an innovative public-private partnership aimed at encouraging business development in our service territory.

o Explore new ways to meet long-term energy needs through energy conservation, demand-side man-agement and competitive bids by third-party suppliers.

c Provide customers with a greater degree ofcontrol over energy use and price through programs that enable them to:

participate in real-time energy pricing and other forms oftime-of-use rates; make more efficient use ofenergy through con-servation and demand-side management methodology; o Provide low-cost natural gas to a greater number of customers through aggressive marketing programs and by exploring new avenues ofgas availability.

o Enrich our portfolioofconsumer outreach pro-grams that emphasize one-on-one assistance.

o Get the best ofenergy through targeted research and development.

Electric Use Indicates New Economic Vitality Over the past decade, our base ofretail customers has grown steadily at a rate ofabout 1 percent a year, representing an average annual increase ofapproxi-mately 12,000 new electric customers and 3,000 new gas customers.

Last year was no exception in terms ofbase growth, but retail electric sales volume registered the sharpest increase in more than a decade up 5.5 percent for the year, reflecting across the board gains of7.5 per-cent in industrial, 4.3 percent in commercial and 4.6

'ercent in residential kilowatthours.

Unusually hot summer weather was partially re-sponsible, but we believe increased economic vitality in our service territory is the underlying cause ofour retail electric sales growth in 1988. Total electric sales declined slightly reflecting the marked downturn in sales to other utilities.

1989 REVENUE DOLLAR Residential customers 39'ommercial customers 34'ndustrial customers 17'll others 109

"NIAQRAMOIIAWKPOPOVER CORPORATION aii(l SUBSIDIARYCOMPANIKS 4-5 Direct sale ofgas, which has trended down sharply since deregulation, leveled offin 1988, led by growing demand in the residential sector ofour business. The changes in federal regulation that reduced sales vol-ume among our industrial customers have created a new business forus in gas transportation. In 1988, we registered a 25% volume increase against 1987 in transportation ofcustomer-owned gas.

New Data Brings Us Closer to Customers Two separate but concurrent programs in 1989 are aimed at developing more information about our customer base.

As part ofour "ThinkLike a Customer" initiative, we willbe expanding customer surveys in 1989 to derive a better measure ofcustomer perceptions of our service. We have also assembled teams of employees in each ofour operating regions to analyze customer service procedures and make recommen-dations to improve service.

R<<tel

<<X 8lllt At the same time, our Research &Development De-partment willbe undertaking a two-year study to pro-filethe kinds ofbusinesses most likelyto succeed in our service territory. This willbe the second phase of R&D's Industrial Technology Assessment Program which built a base ofinformation on industry in our service territory through surveys or visits with hun-dreds oflocal businesses.O Thinking LikeA Customer "Ifwe make mistakes with our customers," says John LaFalce, a Niagara Mohawk gas mechanic in Schenectady, "it's usually because we haven' done enough. We haven't listened well enough; we haven't provided enough information or haven't tried to see things from the customer' point of view."

This is part of the message LaFalce is taking to co-workers in training sessions this spring. He is one of 55 Niagara Mohawk people chosen for special schooling as a facilitator, or trainer, in a companywide program to increase employee re-sponsiveness to customer needs. Approximately 5,500 employees will participate in this training in 1989.

"It's not enough to say, 'I'm here to hook up your gas,'

LaFalce says. "You have to help the customer understand exactly what will take place, how much time is required and what we intend to do to restore any property disruption."

The 19-year Niagara Mohawk veteran says the training, which includes advice on dealing with irate customers and difficult situations, has application away from the job as well.

"I have more confidence," he says. "I under-stand how good communications can work in your favor to turn around a bad situation and make a good one that much better."D ANDWHERE ITWENT Fuel for the production of electricity 25tf and electricity purchased Interestandothercosts-net 22tf Income and other taxes 16<<f Wages, salaries, employee benefits 14tf Gas purchased 9'ividends to stockholders 7tt Depreciation 7<<t ELECTRICITYGENERATED ANDPURCHASED BYTYPE OF FUEL, 1988 Hydro 29'/o Various sources 23/o Coal 21%

Oil 19/o Nuclear 5%

Natural gas 3%

arly this year, Niagara Mohawk and New York State formed an Economic Development Partnership to create jobs in our service terri-tory. The alliance, which has its roots in our 1988 negotiated rate agreement, willearmark $4 million over a two-year span for the attraction or expansion of very specific types ofbusinesses.

Italso underscores the emphasis we are placing on formal and informal partnerships as we explore the opportunities and responsibilities inherent in our relationships with the individuals, businesses and communities we serve.

The strength ofour core utilitybusiness depends on the vitalityofour customer base. Atevery turn, we are confirming that what works to our customers'est interests also works to ours.

The Niagara Mohawk-New York State Economic Development Partnership is one illustration ofour commitment to develop mutually beneficial solutions to the long-and short-term energy needs ofour cus-tomers and our communities. Other examples of this commitment include expansion ofeconomic de-velopment rates; extension ofreal-time energy pric-ing and conservation programs; introduction ofa competitive bidding program to procure new electric resources and our efforts to obtain access to Canadian gas.

'(lROHH(l%1118, 1l1I NMDiscount Rates Spur Economic Development Niagara Mohawk offers discounted energy prices to attract new business to our service territory and to help existing business renew or expand operations.

We also work withcompanies to implement technological advances and other cost-saving systems and techniques.

Since 1984, more than 146 businesses have availed themselves ofone or more ofour economic develop-ment incentive rates contributing to the creation or retention ofapproximately 11,050 jobs.

Managing Electric Demand Provides Benefits forAll Customer electric use created new demand peaks on three occasions during the year, setting a year-end record peak on Dec. 12 of 6,220 megawatts-a level we did not expect until the early 1990's.

This growth, led by industrial demand which in-creased 7.5 percent during the year, demonstrates the vitalityofbusiness in our service territory.

But it also presents a challenge. Ensuring the best service at the lowest possible price means we must maintain ample and efficient supplies ofelectricity, while skillfullykeeping expenses and the need to acquire or build new capacity at a minimum.

During 1989, Niagara Mohawk willbe engaged in the development and implementation ofa range of energy pricing and conservation programs to make the customer and the company winners.

For instance, technological advances and innova-tive pricing are giving some of the company's largest industrial customers a look at tomorrow's electricity prices today. These customers can reshuffle manufac-turing steps to realize substantial savings, because each day they are given prices based on the costs of production at the time.

In 1989, we willbegin extending time-of-use pricing to our largest residential customers. Time-of-use rates willnot only give homeowners the ability to control their electric costs, itwillalso help us shift electric demand away from peak hours ofthe day.

And, in the months ahead, Niagara Mohawk willbe considering a number ofprograms that use simple energy conservation tactics to reduce peak load.

These demand-side efforts willtend to shift electric usage to off-peak hours and may reduce revenues over the short term. This is a factor under consideration in the regulatory process. Longer term, strategic load shifting can help defer the need fornew generating capacity.

'NIAGARA i)IOIIAWKPOWER CORPORATIONl an(l SIIIISIIARYCOMPANIES 0 7 Competitive Bidding Promises Alternatives to Construction The substantial financial risk in building large elec-tricplants today makes few utilities eager to embark on major new construction projects.

In the near term, additional electric capacity prob-ably willcome from relatively small, widely scattered independent power plants and from conservation and load-shifting programs.

Niagara Mohawk's territory, rich in both natural resources and industrial customers, has drawn a flood ofproposals from independent developers. The chal-lenge now is adding that new capacity in a sensible and cost-effective manner.

The most promising alternative is a public bidding program. Competitive bidding could allow Niagara Mohawk to add capacity as customer demand grows and to increase the number ofproductive partnerships itenjoys with many independent power producers.

Bids could include proposals fornew generators, energy conservation or other steps that would post-pone the need fornew plants.

The company submitted a bidding proposal to the New YorkState Public Service Commission in October. In 1989, we expect to conduct our first auc-tion for 350 megawatts ofcapacity, which would be-come available in 1994.

NMPlans Strategic Linkto Canadian Gas Natural gas continues to be the heating fuel ofpref-erence fornew home builders in our service territory.

It's also the number one choice ofhomeowners con-templating furnace replacements.

Co-generation is another market we are actively exploring. Gas transportation contracts with indus-trial users offeropportunities for enhanced revenues along with the potential forbalancing the sharp winter demand peaks typical ofresidential gas use patterns.

As we move to capitalize on this demand through an aggressive program ofcontacts with industrial customers and franchise expansion, we are also exploring avenues ofnew supply-especially Canadian natural gas.

We signed an agreement with TransCanada PipeLine Ltd. early this year to pursue plans to build a 25-mile line across the St. Lawrence River. The transaction, which also includes a contract for natu-ral gas supply, doesn't rule out several other options at our disposal including the proposed Iroquois pipeline through Central New York.But, at this juncture, itappears to be the most timely, cost-effective choice.

Ifwe are successful in obtaining the necessary reg-ulatory approvals and rights ofway, we could have the new pipeline in service as early as November 1990.

Access to Canadian gas is important for several reasons:

1) itstrengthens our abilityto supply our rapidly growing market; 2) its lower price reduces our overall cost to customers; and 3) itprovides a strategic linkto additional suppliers.

In 1988, we added 7,500 new customers and 194 miles ofnew gas main. We also won the right to serve three new franchises last year and are pursuing the benefits ofoffering service to the many additional areas that have become attractive in recent years due to urban expansion.

Prospects continue strong fornatural gas service, which accounted forapproximately 16 percent ofour total corporate revenue in 1988. Deregulation and at-tractive prices are creating new avenues ofsupply and demand.Q Emphasis on Partnerships Energy-cost reduction wasn't just a goal, it was a life-or-death proposition for Crucible Specialty Metals four years ago. Francis Petro; who be-came president of the Syracuse-based division of Crucible Materials Corp., shortly after a 1985 management buyout, said the specialty steel producer was literallysmelting its profits away.

"To compete in the global marketplace for steel, we need 100 percent electrical reliability at the lowest possible cost," Petro recalls telling Niagara Mohawk. "Is that unreasonable?"

Through a program that included industrial gas conversion, time-of-use rates and economic development incentive rates, Niagara Mohawk helped Crucible slash its energy bill. Petro says this was a major component in a larger program the 1,450-employee company undertook to make its steel more price-competitive.

"The average price of all our products is more competitive in the world market than it was in 1979," Petro says. "And we'e selling in at least 12 countries and growing, where we didn't have a foothold two years ago."Cl

ommercial operation ofNine MileTwo in 1988 was the final installment in a major building program. During the past 25 years, Niagara Mohawk has added nearly 3,500 megawatts ofelectric power to the New York Power Pool and increased our system capacity almost 88 percent with the con-struction ofNine MilePoint Units One and Two; Oswego Steam Units Five and Six; and the Granby Hydroelectric Station.

The legacy of Niagara Mohawk's construction era is a low-cost mix ofnuclear, hydroelectric, coal, oil and natural gas generating capacity. Combined with pur-chased power arrangements, we have confidence that we can meet our customers'eeds into the next cen-tury, without embarking on another cycle of major plant construction.

As we make the transition from a construction era to an operations era, our strategy is to:

o maintain the low-cost advantage ofour existing plants through judicious refurbishment and high operating standards; o balance growing demand, where possible, with demand-side management and conservation methodology; o employ third-party producers, through competitive bidding, when new capacity is required; o increase customer access to natural gas, a plentiful, economical energy source.

llEC M Fossil Plants Take Advantage Of 1988 Oil Price Decline Niagara Mohawk's fossil (coal, oil and natural gas-fired) plants set new production records in 1988, demonstrating the versatility and flexibilityofthis generating source.

We maximized the use ofoil-burning units in Albany and Oswego as the price offuel oil declined as much as 25 percent below prior-year levels. This oil price decline, while partly due to market forces, was also a result ofour success in renegotiating a long-term oilsupply contract forour Oswego Station. The new contract terms resulted in a savings ofapproxi-mately $ 15 millionin fuel oil costs in 1988. Late in 1988, we successfully pursued yet another, though much more modest, long-term oilcontract improvement which willresult in some additional savings in 1989.

Withhydroelectric production down 6.8 percent due to unusually dry weather and with Nine MileOne offline, fossil generation was a low-cost alternative to expensive purchased power.

Our strategy on fossil generation is to take fullad-vantage ofthe economies ofour existing facilities. En-couraged by the continuing low price ofoil and off-system sales opportunities, we plan to add about 170 megawatts offossil generation capacity in 1989 by revitalizing an older oil-firedunit and two gas tur-bines. Much of this additional power is targeted for sale to the wholesale market.

Moreover, our continuing life-extension studies in-dicate that our fossil units, builtfor45 years ofpro-ductive service, are capable ofat least 60 years'pera-tion with modest repairs. While we plan to weigh the cost ofrefurbishment against demand-side manage-ment and non-utilityproduction alternatives, we are encouraged by the integrity ofour existing plants.

NM's People Accept Nuclear Challenge Our nuclear plants are a significant asset, represent-ing about 19 percent ofour generating capability.

Nine MileOne, a nuclear power industry pioneer, will celebrate the 20th anniversary ofits commercial op-eration in 1989. Nine MileTwo, a new and more com-plex facility,is just beginning what promises to be a long and productive life.

Atyear end, both units were listed on the Nuclear Regulatory Commission's roster ofplants requiring closer monitoring. Nine Mile One, shut down since

'NIAIIARAMOlbOVKPOWilR CORPORATION an(I SIIIISIIARYCOMPANILS 8-9 Dec. 19, 1987, was placed on the list last June. Nine MileTwo was added to the list in December, reflect-ing the NRC's concern followingthe plant's uneven firstyear ofoperation.

Nine MileTwo currently is under no restrictions for operations but our ability to restart Nine MileOne is subject to approval of NRC Region 1 stafE, based on our successful completion oEa restart action plan.

The problems underscored by the NRC are more managerial than technical and reveal the regulatory body's concern for the preparedness ofpeople en-trusted with day-to-day nuclear operations. Our chal-lenge is to complete the work planned in the Unit One restart program filed with the NRC this past De-cember, and achieve progress on our nuclear im-provement program. This willrevitalize the morale and spirit ofour nuclear workers, who have been laboring long and hard to bring the sophisticated, new Nine MileTwo to maximum efficiency and to prepare the older Nine MileOne forits remaining 15-year sprint or longer ifits operating license is extended.

for them to provide. Over time, we'e managed to take advantage oflowhydroelectric power costs through programs that extend the lives and pro-ductivityy ofour plants.

This process has become increasingly complex, however, as we endeavor to work in good faith to satisfy a growing list ofwaterway interest groups, ranging from recreationalists, environmentalists, and fishing enthusiasts to civicand industry groups, pri-vate businesses and non-utilitypower producers.

Our strategy recently has been to redevelop plants through jointventures with independent power pro-ducers, using designs that address the concerns ofall interests. The Glen Park and Union Falls stations, opened in 1987 and 1988, respectively, and the Middle Falls station, currently under construction, are good examples.

Further plans forredevelopment are dependent on our progress in retaining federal operating licenses. Iri 1993, federal relicensing decisions are due on nearly halE ofour hydroelectric plants.%

lLIP WlI3 3 Our people have ensured that Nine MileOne's pro-ductivity, during its two decades ofservice, has con-sistently ranked with the best reactors ofits kind and has provided over $800 millionin fuel savings-with approximately half that total accumulated between 1983 and 1987. In 1987, Nine MileOne set the pro-ductivity record for U.S. boiling water reactors.

We are keenly aware of the costs incurred each day this facilityis out ofservice. We are committed to meeting our schedule on Nine MileOne and having both nuclear plants in productive operation in 1989.

NMPursues New Strategies To Extend Hydro Legacy Our company not only derives its name from two riv-ers but about one-third ofits power comes from Up-state New York's abundant waterways. We generate low-cost hydroelectric power at 77 sites in our system and buy additional supplies under a long-term con-tract with the New York Power Authority.In 1988, we agreed in principle with NYPA to extend this contract until 2007.

While the average age ofour hydro stations is ap-proximately 60 years, they remain capable ofhighly efficient operations. For example, in 1988 they pro-duced 94 percent ofthe energy theoretically possible Building a Winning Team Larry Burkhardt, Niagara Mohawk's new execu-tive vice president of nuclear operationsbe-lieves he was recruited "to build a winning team" and often reminds his colleagues that they are "running this race to win."

"Second best just gets mud in your face," says Burkhardt, who uses sports analogies to remove some of the abstraction from the term "excel-lence" and to help drive home the importance of discipline and teamwork.

A 32-year Navy nuclear veteran who, on his 1986 retirement as a rear admiral, held adminis-trative and policy responsibility for 900,000 mili-tary and civilian personnel, Burkhardt is encour-aged by the company's goal of becoming "the best" nuclear utility.

"We have technical competence, loyalty and dedication," Burkhardt says of the nuclear work-force. "Now, we just have to improve our effec-tiveness and get into the habit of winning beginning with a few small successes and build-ing on them until we'e come to expect nothing less."Q

s energy demand climbs in our service territory and unemployment declines, it's tempting to paint a picture ofunremitting prosperity. But our people dealing day-to-day with customers tell a different story.

Meter readers, customer representatives, service personnel and other Niagara Mohawk people who work closely with the public, present us with a por-trait ofa growing number ofcustomers who have dif-ficultymanaging their daily affairs.

As at other utilities, we have been actively develop-ing programs to provide assistance.

These include energy conservation activities, health and safety pro-grams and our efforts to improve the readability and content ofour bills. But increasingly, we are focusing our efforts on those who require special care.

RIIRSI $1I1jSR I10W Our interests are bottom-line oriented as well as humanitarian. We know there's help available forthe elderly, the disabled, the poor and the otherwise dis-advantaged, who make up the largest proportion of our uncollectibles. But often, they need assistance in getting the help they need.

Four programs, introduced in 1988, are especially noteworthy:

Club SENIORITYCustomers age 60 years and older frequently need special services. Through an aggressive advertising and customer outreach pro-gram, we identified 119,000 senior citizens, or approximately one-third of the estimated total in our territory by asking them to enroll in Club SENIORITY.The drive continues in 1989.

Membership entitles customers to a special news-letter and assures them ofspecial attention from our consumer services personnel.

Energy Packaging Energy-related programs de-vised forthe low-income elderly are often undersub-scribed because this interest group can least afford to participate. In 1988, Niagara Mohawk provided money that enables five New Yorkcounty agencies involved with aging to hire individuals called "Energy Packagers" who willhelp low-income elderly households take advantage ofa wide range ofavail-able services, including home weatherization and repair, furnace-replacement and billpayment programs.

To date, special assistance is being provided to 180 homes or individuals through this program, which is conducted through the State Office for the Aging and extends through 1989.

Consumer Advocates In 1988, Niagara Mohawk completed its first fullyear ofoperating a team of specially trained employees, withbackgrounds in so-cial work or social services, to act as ombudsmen for customers in five regions. Consumer advocates inter-vene in difficultand emergency situations, using company programs and help from human-service agencies to promptly solve customer problems.

Gatekeeper Jointly sponsored by Niagara Mohawk and the State Office for the Aging, this program trains those employees, who frequently come in contact with customers, to be sensitive to conditions that in-dicate economic, emotional or health problems in homes-particularly those ofsenior citizens. Through referrals provided by Niagara Mohawk people, human-service agencies receive the information they need to take appropriate action.

'IIIAGARAiMOIIAIVKPOPOVER CORPORATION aml SIJIISIDIARYCOi)IPAWIilS 10-11 Subsidiary Growth Represents Commitment to Diversification Niagara Mohawk's subsidiaries, Opinac Energy Corp.

and HYDRA-COEnterprises, Inc., continued their record ofgrowth in 1988.

lIV8M MlS R Atyear end, the Canadian-based Opinac Explora-tion, Ltd. had estimated proven reserves of 173 billion cubic feet ofnatural gas and 1.8 millionbarrels of crude oilfor a combined value of $82 million(U.S.).

This compares with 138 billioncubic feet ofnatural gas and 1.4 millionbarrels ofcrude-oil proven re-serves in 1987 fora combined value of$65 million (U.S.). Opinac Energy also operates Canadian Niag-ara Power Co., Ltd., which generates electricity at Niagara Falls, Ontario.

HYDRA-COEnterprises Inc., Niagara Mohawk's presence in the fieldofco-generation and independent power production, brought an additional 36 megawatts ofpower on line in 1988 with the comple-tion ofa wind power and a hydroelectric project.

By December, the small power producer had the ability to generate 173 megawatts ofelectricity, with 203 megawatts ofgenerating capacity under con-struction and 113 megawatts in development.

Niagara Mohawk also maintains an investment in NITECHInc., which was developed to produce and market the Power-Donut (tm) Sensor Line Monitoring System, originallya Niagara Mohawk research project.

Niagara Mohawk's diversification strategy is to own and operate energy-related businesses.

NMMaintains Active Investor Program Our Investor Relations and Shareholder Services de-partments conduct a program ofregular communica-tions with shareholders, which includes annual and quarterly reports and a quarterly "InThe Know" newsletter forshareholders who have requested addi-tional information.

Company representatives meet regularly with the security analysts and portfolio managers who advise a broad range ofretail and institutional clients. On Dec. 31, institutions held about 26 percent ofthe company's common shares outstanding.

Dividend Reinvestment Plan Atyear-end 1988, some 62,945 dividend-reinvestment plan participants held approximately 19.5 million shares of the company's stock, or 14.5 percent of the company's outstanding common shares. This partici-pation resulted in the reinvestment ofmore than

$23.1 millionin dividends in Niagara Mohawk stock during the year.

Aprospectus describing the plan and an authoriza-tion form to join may be obtained by writing Niagara Mohawk's Dividend Reinvestment Plan, P.O. Box 7058, Syracuse, New York 13261.9 Delivering Extra Help Leo Reiter says his job hasn't skipped a beat since he left the Erie County Department of So-cial Services to join Niagara Mohawk recently as a consumer advocate. Leo's job is to make sure that people entitled to special help in paying their energy bills, get it.

"I know all the social service aciencies.

I know the rules. We have good working relations,"

Reiter says. Further, he believes that agencies such as the County Departments of Social Serv-ices, the Offices for the Aging, Red Cross and Catholic Charities, to name a few, appreciate having a local company contact who under-stands their workings.

His clients are frequently elderly or disabled people, or families with deep financial problems.

They are either unaware of, or physically or men-tally unable to secure, available energy related, support.

Referrals typically come through Niagara Mohawk's Credit Department, but meter readers and service representatives also make a signifi-cant contribution. "No business enters people' homes with the regularity we do. We have a unique opportunity to solve some of our own problems by helping others."U,

Management's Discussion and Analysis ofFinancial Condition and Results ofOperations A number of significant events have oc-curred during the past several years which have had an impact on the Com-pany's financial condition and results of operations.

Some of the more notable events include:

o commercial operation of Nine Mile Point Nuclear Station Unit No. 2 (Unit 2), approval of the Unit 2 cost settle-ment agreement and associated write-off of disallowed costs in 1987 (see Note 10 of Notes to Consolidated Financial Statements),

o a 42% reduction in the common stock dividend to the current level, o negotiated two-year electric (the Stipulation Agreement) and gas rate moratoriums and the resolution of other outstanding issues (as defined below) with the Public Service Com-mission (PSC), discussed in more de-tail below, o continued emphasis on improving customer service and identifying market opportunities, enhancing sys-tem reliability and revitalizing the nu-clear program with a resultant in-crease in the level of operating ex-penditures, and othe continuing outage of Nine Mile Point Nuclear Station Unit No. 1 (Unit

1) which began in December

1987, and the implementation of an interim relief agreement with respect to re-placement power costs associated with the Unit 1 outage, beginning with the fuel cost month of January

1989, in connection with the proceeding es-tablished by the PSC to investigate the Unit 1 outage (see Note 10 of Notes to Consolidated Financial Statements).

The eftects of these and other events will continue to influence the Com-pany's financial results in 1989 and pos-sibly beyond.

EARNED RATE OF RETURN ON COMMON EQUITY 14 cP/,

15 D/o 13.6%

12.7/o 87%

1984 1985 1986 1987 1988 RESULTS OF OPERATIONS For 1988, earnings per share decreased 31% to $ 1.21 per share compared to 1987's $1.76 per share earned prior to reflecting the loss of $833 million ($6.54 per share) relating to the write-oft of disallowed Unit 2 costs in 1987 (see Note 10 of Notes to Consolidated Fi-nancial Statements).

This decrease is attributable to a number of significant factors, including a full year's impact of the reduction in the Company's earn-ings base resulting from the Unit 2 write-off as initially reflected in the Company's March 1987 rate order, cer-tain provisions of the electric and gas stipulation agreements, which because of changed conditions did not account for the costs of programs that the Com-pany is now incurring, the Unit 1 ex-tended outage (see Note 10 of Notes to

, Consolidated Financial Statements) and a further write-down of the Company's investment in N M Uranium, Inc. (see Note 3 ot Notes to Consolidated Finan-cial Statements) which were offset in part by an increase in electric sales to the public. Non-cash earnings, consist-ing primarily of allowance for funds used during construction and unbilled

revenue, represented approximately 10% of the balance of income available for common stockholders in 1988 and are expected to increase to nearly 40%

in 1989.

As a reflection of these events, the Company achieved an 8.7% return on common equity in 1988 as compared with 12.7% (excluding the Unit 2 write-off) in 1987 and 13.6% in 1986. Although no authorized return on equity was es-tablished in the Stipulation Agreement, the Company had anticipated a return on equity of approximately 10.0% in consideration of the provisions of the Stipulation Agreement and an estimate of the incremental costs of the Unit 1 outage. The authorized return on equity at December 31, 1987 and 1986 was 13.0% and 13.5%, respectively. The re-turn on equity for 1989, while based upon certain assumptions that cannot be predicted with accuracy, is expected to be less than the actual earned return on equity for 1988 as a consequence of, among other things, the continuing un-certainties surrounding the Unit 1 out-age and the associated PSC prudency investigation (see Unit 1 outage discus-sion below) as well as a continuation of or increase in the level of operating ex-penses experienced by the Company.

In May 1988, the Company, PSC Staff and several intervening parties (includ-ing the New York State Consumer Pro-tection Board, the New York Depart-ment of Law, the New York Department of Economic Development and others) entered into a comprehensive Joint Stipulation and Agreement (the Stipula-tion Agreement) concerning the Com-pany's then pending electric rate filing and several other pending matters. The Stipulation Agreement was approved by the PSC in an order issued August 30, 1988. The major provisions of the Stipu-lation Agreement were as follows:

o The Company agreed to no increase in base rates for electric service through June 30, 1990.

o The Company agreed to refund to ratepayers $14 million over the twelve month period ending June 30, 1989.

o The PSC proceeding ordered in 1987 to inquire into the cost of past fuel procurement practices was dis-

missed, based upon the provisions of the Stipulation Agreement, in its entirety.

o The PSC, in connection with its inves-tigation into the fossil fuel procure-ment practices of the Company, will continue its examination of the exist-ing fuel adjustment clause (which was subsequently expanded into a state-wide generic proceeding).

However, modification to the existing fuel ad-justment clause, if any, shall not be made etfective for the Company prior to July1,1990.

o The Company will be allowed to keep amounts earned up to 13.8% and 14.0% return on equity for the twelve month periods ending June 30, 1989 and June 30, 1990, respectively, sub-ject to certain assumptions and rate-making conventions used in the Stipulation Agreement, with an equal

"- NIAGARAMOIIAiVKPOWER CORPORATION Nld SUBSIDIARYCOMPANIES I2-13 sharing with consumers of any earn-ings in excess of those amounts; however, the Company expects to earn substantially less than the return on equity caps established.

o The Company will be allowed to re-flect in income approximately $50 mil-lion in unbilled electric revenues, rep-resenting non-cash earnings, to offset otherwise required increases in costs over the two year period.

o The Company was permitted to re-cover approximately $41 million of its

$47 million investment in the Lake Erie Generating Station Project. The remaining

$6 million of the Com-pany's investment was charged against Other Income Deductions.

o For the Company's ratemaking pur-poses, April5, 1988 willbe recognized as the commercial operation date for Unit 2. The Company deferred all costs of operating Unit 2 from April 5, 1988 to June 30, 1988 including carry-ing charges.

Such deferred costs shall be amortized and recovered over the life of Unit 2.

o The Company willspend $4 millionon economic development programs to be developed in conjunction with the New York Department of Economic Development.

The effect of the recognition of the

$14 millionrefund, the write-offof a por-tion of the Lake Erie Generating Station Project costs, the accrual of unbilled electric revenues and the accrual of economic development program ex-penditures on 1988 results of opera-tions was to reduce earnings per share by $.15.

As discussed further in Note 10 of Notes to Consolidated Financial State-ments, Unit 1 was taken out of service in December 1987, and currently remains out of service. On September 8, 1988, the PSC instituted a proceeding to in-vestigate the prudence of the Unit 1

outage. Through the function of the fuel adjustment clause sharing mechanism, the Company has absorbed through December 31, 1988 approximately $17.2 million of replacement power costs necessitated by the Unit 1 outage and has collected from ratepayers approxi-mately $75.9 million. The Company has also absorbed approximately $26.7 mil-lion of incremental Unit 1 operating and maintenance costs in excess of amounts provided for in the ratesetting process.

The Company entered into an interim relief agreement with the PSC Staff and other intervenors, which was approved by the PSC in January 1989, to suspend collection from ratepayers of $225,000 per day through the fuel adjustment clause, commencing with the fuel cost month of January 1989 until the earlier of restart of Unit1 or June30,1989. This will reduce the Company's cash flow through the agreement period by ap-proximately $6.75 million per month.

The suspension of collection from ratepayers will also serve to reduce earnings per share through the agree-ment period by approximately $.03 per month.

If Unit 1 is not returned to service by June 30, 1989, the parties to the interim agreement will be free to seek an exten-sion of interim relief in whatever form they think appropriate.

The Company cannot predict what form an extension of interim relief might take, ifsought, or the resultant impact on the Company's financial condition, results of opera-tions or external financing require-ments. However, should the outage be extended beyond June 30, 1989 and interim relief is secured in essentially the same form, earnings would be ad-versely affected by approximately $.07 to $.09 per month (approximately $9.5 million to $12.3 million per month re-duction in cash flow) dependent upon the level of replacement power costs absorbed by the Company through the normal operation of the fuel adjustment clause, the amount of incremental ex-penses necessitated by an extension of the outage and the continued suspen-sion of collection of replacement power costs billed to customers under the fuel adjustment clause.

These amounts exclude expenditures to be incurred in 1989 relative to the long-term nuclear improvement program, which will exert additional upward pressure on ex-penses.

The Company is unable to predict the results of the PSC's prudence investiga-tion, what sanctions, if any, may ulti-mately be imposed and the adverse im-pact on the Company's financial condi-tion, results of operations or level of re-tained earnings which might result if any such sanctions are imposed.

The followingdiscussion and analysis highlights items having a significant ef-fect on operations during the three-year period ended December 31, 1988. It may not be indicative of future operations or earnings. It should be read in conjunc-tion with the Notes to Consolidated Fi-nancial Statements and other financial and statistical information appearing elsewhere in this report.

Electric revenues increased

$247.3 million or 11.8% over the three-year period. This increase results primarily from increased sales to ultimate con-sumers reflecting a combination of weather-related sales and load growth in the Company's service territory, base rate increases and the recording of un-billed electric revenues in accordance with the Stipulation Agreement, offset in part by decreased sales to other elec-tric systems, as indicated in the table below:

37,086 6,964 35,296 5,286 0,1 0,01 ELECTRIC SALES 34,347 3,579 30,768 35,684 4,154 1,530 34,995 1,732 3,263 UJ I

MlIsons of Kw.hrs.

Electric revenues Increase in base rates Fuel and purchased power cost revenues Sales to ultimate consumers.............

Sales to other electric systems...........

Unbilled electric revenues...............

Miscellaneous operating revenues.......

Increase (decrease) from prioryear ln millions ofdollars 1988 1987 1986 Total

$ 12.9 39.8 82.0 (57.8) 62.5 34.1

$ 49.7

$ 52.3 (53.8) 12.6 43.4 61.5 22.2 (100.3)

(23.1) 9.3

$114.9 (1.4) 186.9 (135.9) 62.5 20.3

$173.5

$ 38.4

$ 35.4

$247.3 1984 1985 1986 1987 1988

On March 12, 1986, the PSC approved a 2.1% electric rate increase to provide the Company additional annual rev-enues of $39,974,000, based on (i) fore-cast sales for the twelve months ended March 31, 1987, (ii) a 13.5% return on common equity and (iii)the inclusion of

$680 million of Construction Work in Progress (CWIP) in electric rate base.

The new rates were put into effect on March 17, 1986. On August 23, 1986, in connection with a second-stage filing involving this rate decision, the PSC approved additional annual electric revenues of $7,475,000 for items which were not considered in the March 1986 decision.

On March 13, 1987, the PSC approved a 4.0% electric rate increase to provide the Company additional annual rev-enues of $74,898,000 based on (i) fore-cast sales for the twelve months ended March 31, 1988, (ii) a 13.0% return on equity, and (iii) the inclusion of $1.625 billion of CWIP in electric rate base

($1.5 billion relating to Unit 2). The new rates, put into effect on March 16, 1987, reflect tax law changes of the Tax Re-form Act of 1986 and a reduction to 13.0% from the 14.0% return on equity requested by the Company. No adjust-ment to gas rates was requested by the Company in connection with either of these rate decisions.

TOTALELECTRIC ANDGAS OPERATING REVENUES Miilionsofdollars Class of service 1988

%Increase (decrease) from prioryear

%of Electric 1988 1987 1986 Revenues Revenues Sales Revenues Sales Revenues Sales Residential...........

34.4%

9 0o/o 4.P/o 5.2/o 3.2/o 8.5%

4.3o/o Commercial..........

35.3 5.7 4.3 2.1 3.3 8.2 4.7 Industrial.............

19.5 5.2 7.5 (3.0) 1.1 2.6 (0.8)

Municipal service.....

1.8 1.5

.8 (1.0), 0.4 4.6 (2.9)

Total to ultimate consumers.........

91.0 6.7 5.5 2.0 2.5 6.9 2.5 Other electric systems 2.6 (49.0)

(58.3) 23.2 16.1 (51.1)

(32.3)

Miscellaneous........

6.4 179.2

(30.0)

13.7 Rate action initiated in 1987 sought $119.5 million (5.8%) additional blectiic'evenues based upon forecast operations for the rate year ending June 30, 1989

"'nd a 14.25% return on equity. The Company, as discussed above, reached a

negotiated resolution of this request which resulted in, among other things, no increase in base electric rates through June 30, 1990. As a result of the continuing effects of the events discussed above and other factors, the Company willneed to seek additional electric rate relief to become effective in July 1990. The form and extent of such rate relief is currently being considered.

Changes in fuel and purchase power cost revenues are generally margin-neutral while sales to other utilities, based upon regulatory sharing mechanisms, generally result in low margin contribution. Thus, fluctuations in these revenue components do not have a significant impact on net operating income. The Company was per-mitted to recognize in earnings unbilled electric revenues in an amount equal to the revenue required to amortize $39 million of the Company's investment in the discontinued Lake Erie Generation Station and to recoup other specified costs, therefore the effect of accrual of unbilled electric revenues on net operating in-come was minimal. Included in fuel and purchased power cost revenues is approx-imately $75.9 millionof replacement power costs associated with the Unit 1 outage.

Electric kilowatt-hour sales were 35.0 billion in 1988, a decrease of 1.9% from 1987 and an increase of 1.9% from 1986. The 1988 decrease reflects increased sales in all customer classifications, offset by a substantial decline in sales to other electric systems caused by unfavorable price competition in the wholesale energy market. (See Electric and Gas Statistics-Electric Sales appearing on page 38).

Details of the changes in electric revenues and kilowatt-hour sales by customer group are highlighted in table below:

Total..

...100.0o/o 8.P/o (1.9)%

1.8o/o 3.9o/o 1.7o/o (2.7)%

$2,786

$2,135

$651

$2,695

$2,096

$59

$2,660

$2,13

$52

$2,623

$2,170

$2,800

$2,343

$ 57 Gas revenues decreased

$141.7 million or 23.7% over the three-year period. As shown by the table below, this decrease is attributable to lower costs for purchased gas, coupled with certain large commercial and industrial customers now purchas-ing gas directly from producers and only having the Company transport the gas to them, offset partly by increased residential sales. Rates for transported gas gener-ally yield margins similar to margins on gas sold directly by the Company. As a result, substantial decreases in gas revenues caused by the migration of customers to the transported gas classification have not had a significant impact on earnings from gas operations. Also, changes in purchased gas adjustment clause revenues are generally margin-neutral.

1984 1985 1986 1987 1988 Gas revenues Increase (decrease) from prioryear ln millions ofdollars 1988 1987 1986 Total GAS SALES 115.0 108.4 100.8 I 4:9 I

9.

Millionsof dekatherrns 108.7 27.3 Increase in base rates.............

Purchased gas adjustment clause revenues Increase (decrease) in residential sales................

Increase (decrease) in commercial and industrial sales.............

Transportation of customer-owned gas Miscellaneous operating revenues

$ 3.0 3.0 (6.2)

(12.0)

(20.0)

(38.2) 18.9 (8.8) 13.2 23.3 2.3 3.6 s s.s 9.3 (1.8)

$ (75.2) 2.2 0.2 s (70.0) 13.8 2.0

$ (141.7)

(15.1)

(61.9)

'68.6)

(145.6) 1984 1985 1986 1987 1988 Gas sales, excluding transportation of customer-owned gas, were 81.4 million dekatherms in 1988, a slight increase from 1987 (see Electric and Gas Statistics-Gas Sales appearing on page 38). The increase for 1988 reflects a 6.3% increase in sales in the residential class reflecting a combination of weather-related sales and load growth offset by a 41% decrease in sales in the industrial class because of

NIA(jARAi>IOIIAWKPOWER CORPORATION alIII SUBSIDIARY COMPANIES I4-I5 1988

% Increase (decrease) from prior year

%of Gas 1988 1987 1986 Class of service Revenues Revenues Sales Revenues Sales Revenues Sales Residential Commercial..

Industrial....

63.3o/o 3.F/o 6.3o/o (5.6)%

(2.8)%

6.0o/o 4.4%

26.2 (1.0) 1.8 (15.2)

(13.6)

(3.3) 0.8 4.2 (36.1)

(41.0)

(56.6)

(53.5)

(48.7)

(46.7)

Total to ultimate consumers.........

93.7 (0.7)

.6 (15.2)

(14.5)

(11.8)

(10.9)

Other gas systems....

2.1 6.4 (13.8)

(38.4)

(32.8)

(23.5)

(23.6)

Transportation of customer-owned gas................

3.0 19.8 24.6 414.8 349.1 Miscellaneous.......

1.2 189.9

(49.7)

68.6 Total

.. 100.F/o 0.8o/o 5.3o/o (14.2)%

2.3/o (11.7)% (11.5)%

In January 1988, the PSC approved a gas rate settlement proposed by the Company and interested parties, which will maintain current gas base rates through June 1990 while refunding ap-proximately $5.7 million to gas custom-ers to reflect changes resulting princi-pally from the Tax Reform Act of 1986.

In accordance with this agreement, the Company will be allowed to retain all gas segment earnings up to a 13.0% re-turn on equity and 30% of any earnings in excess of 13.0%. The Company ex-pects to seek additional gas rate relief to become effective in July 1990, and is currently considering the form and ex-tent of such rate relief.

In 1988, electric fuel and purchased power, costs increased to $704 million from $666 million in 1987 and $672 mill-ion in 1986. The increase in 1988 is the result of a $58.5 million increase in fuel and purchased power costs incurred offset by a $20.0 million net decrease in costs deferred and recovered through the operation of the fuel adjustment clause.

Included in electric'fuel and purchased power costs for 1988 is $93.1 million of replacement power costs as-sociated with the Unit 1 outage, of which $75.9 million was recovered from ratepayers through the fuel adjustment clause.

Although generation and kilowatt hour purchases decreased 3.2%, fuel and purchased power costs incurred increased because of the use of higher cost fossil-fired generation to replace nuclear generation due to the outage at Unit 1 during 1988. (see Elec-tric and Gas Statistics Electricity Gen-erated and Purchased appearing on Page 38).

The total cost of gas purchased de-creased 1.1% in 1988, 20.8% in 1987, and 17.8% in 1986. The decrease for 1988 is the result of a 1.2% increase in dekatherms purchased to meet cus-tomer demand, offset by lower rates charged by the Company's principal supplier and favorable spot market pur-chases and a decrease in purchased gas costs recognized and recovered through the purchased gas adjustment clause.

In 1988, the Company pur-chased 37% of its gas supply require-ments on the spot market, the maximum allowable under its contract with its principal supplier. The Company's net cost per dekatherm purchased de-creased to $3.19 in 1988 from $3.27 in 1987 and $3.52 in 1986.

Through the energy and purchased gas adjustment

clauses, costs of fuel, purchased power and gas purchased, above or below the levels allowed in ap-proved rate schedules, are billed or credited to customers.

The Company's electric fuel adjustment clause provides for partial pass-through of fuel and pur-chased power cost fluctuations from those forecast in rate proceedings, with the Company absorbing a specific por-tion of increases or retaining a portion of decreases to a maximum of $15 mil-lion per rate year. In December 1987,'he PSC established a proceeding to examine the operation of the existing fuel adjustment clause.

Also, as dis-cussed above, the Company will, for a portion of 1989, suspend collection of

$225,000 per day in accordance with an interim relief agreement relating to re-placement power costs occasioned by the Unit 1 outage. (See Note 10 of Notes to Consolidated Financial Statements.)

Other operation and maintenance ex-penses increased

$ 120.2 million or 22.1% in 1988, after having decreased competition from oil and the ability of customers to purchase gas directly from producers. The Company transported 27.2 million dekatherms for customers pur-chasing gas directly from producers and expects a continued increase in such transportation activities. To the extent the increase is due to existing customers electing to purchase gas directly from suppliers, there will be a corresponding reduction in gas revenues. Changes in gas revenues and dekatherm sales by cus-tomer group are detailed in the table below:

slightly in 1987 and increasing 7.6% in 1986. This substantial increase results primarily from Unit 2 becoming com-mercial in 1988 and increased costs re-suiting from the continuing outage at Unit 1 and the mid-cycle outage at Unit

2. Further, the Company embarked on a number of customer service, generating station life-extension and nuclear im-provement programs in 1988 which in-creased the level of expenses as com-pared to 1987. Increases in 1986 were primarily the result of increases in maintenance costs associated with the Company's electric distribution system and scheduled costs coincident with the refueling of Unit 1.

Depreciation and amortization ex-pense for 1988 increased 15.6% over 1987 and 17.3% over 1986, principally from Unit 2 becoming commercial.

Net Federal and foreign income taxes for 1988 decreased as a result of a re-duction in taxable income and the statutory tax rate. The increase in taxes other than income taxes in the three year period is due principally to higher property taxes resulting from property additions and the reflection of Unit 2 taxes that are now being charged to operations.

Other income and deductions, excluding Federal income taxes, in-creased $166 million from 1987. This in-crease is primarily the result of the rec-ognition in 1987 of $218 million of disal-lowed plant costs (net of tax) offset by a

$ 15 million decrease in AFC and a de-crease of other items of $37 million.The decrease in AFC is attributable to lower AFC rates, lower interest bearing plant balances as a result of the write-off of disallowed plant costs and increased CWIP in rate base through March 1988.

The decrease in other items (net) is primarily the result of the recording of the $14 million refund to customers in accordance with the Stipulation Agreement, coupled with a $11.1 million decline in earnings during 1988 by Opinac Energy Corporation primarily because of nonrecurring gains recog-nized in 1987 from the sale of the St.

Lawrence Power Company and certain other investments.

Net interest charges increased

$7.6 million in 1988, primarily the result of a

$4.4 million decrease in the credit for the borrowed funds component of AFC.

Dividends on Preferred Stock de-creased

$2.9 million in 1988 as a result of net reductions in amounts outstand-ing. The weighted average long-term debt interest rate and preferred divi-dend rate paid, reflecting the actual cost of variable rate issues, decreased to 8.92% and 7.90%, respectively, in 1988, from 8.99/o and 7.93%, respec-tively, in 1987, as a result of the Com-pany's refinancing efforts.

MAINTENANCEANDOTHER OPERATION EXPENSE MillionaOfdollars TOTALTAXESINCLUDING INCOMETAXES MillionsOfdollars 494.6 353.6 508.3 364.0 546.8 397.7 542.8 383.9 663.0 462,0 410

'424 482 437 141.0 144.3 1984 1985 149.1 1986 158,9 201.0 I 1987 1988 1984 1985 1986 1987 1988 Effects of Changing Prices. The rate of inflation continued to be moderate in 1988.

The Company is especially sensitive to inflation because o'f the amount of capital it must raise to finance its construction program and because its prices are regulated using a rate base that reflects the historical cost of utilityplant.

The Company's consolidated financial statements are based on historical events and transactions when the purchasing power of the dollar was substantially differ-ent from the present. The effects of inflation on most utilities, including the Com-pany, are most significant in the areas of depreciation and utilityplant. The Com-pany could not replace its utilityplant and equipment forthe historical cost value at which they are recorded on the books. In addition, the Company would probably not replace these assets with identical ones due to technological advances and regulatory changes which have occurred. In light of these considerations, the de-preciation charges in operating expenses do not reflect the current cost of provid-ing service. The Company, however, willseek additional revenue to cover the costs of maintaining service as assets are replaced.

During a period of inflation, holders of monetary assets suffer a loss of general purchasing power while holders of monetary liabilities experience a gain. The gain from the decline in purchasing power of net amounts owed is primarilyattributable to the substantial amount of debt which has been used to finance utility plant.

Since the depreciation on utilityplant is limited to the recovery of historical costs, the Company does not have the opportunity to realize a holding gain on debt and is limited to recovery only of the embedded cost of debt capital. The following table presents selected financial data restated for the effects of changing prices in aver-age 1988 dollars.

1988 1987 1986 Operating Revenues ($000's)...

Gain from decline in purchasing power on net amountsowed($ 000's)......

Per Common Share:

Cash dividends declared.....

Market price at year end......

Average Consumer Price Index

$2r800,453

$2,723,620

$2,862,840 145,124 153,056 39,191 1.20 13.00 353.4 1.70 12.46 340.4 2.24 18.02 328.4 Financial Position. The Company's capital structure and earnings base has been weakened by the 1987 write-off of Unit 2's disallowed costs. The capital structure at December 31, 1988 was 55.1% long-term debt, 10.7% preferred stock and 34.2% common equity as compared to 47.0%, 10.5% and 42.5%,

respectively, at December 31, 1986

-prior to such write-off, and 54.9%,

12.0%

and 33.1%,

respectively, at December 31, 1987. Book value of the common stock was $13.87 per share at December 31, 1988 as compared to

$20.23 per share at December 31, 1986 and $13.82 per share at December 31, 1987.

The ratio of earnings to fixed charges for 1988 was 2.10. This is an im-provement from the 1987 ratio of 1.65 (excluding the cumulative effect of adoption of SFAS No. 90) which was negatively impacted by the Unit 2 write-off.The ratio in 1986 was 2.98. The Unit 2 write-off and its resultant impact on the Company's earnings capability necessitated a reduction in the common stock dividend rate in 1987 to a current annual level of $ 1.20 per share (See also: Market Price of Common Stock and Related Stockholder Matters).

Construction and Other Capital Re-quirements. The Company's overall re-FINANCIALPOSITION, LIQUIDITYANDCAPITALRESOURCES quirements consist of amounts for the Company's construction

program, working capital needs, maturing debt issues and sinking fund'provisions on outstanding debt and preferred stock and have been affected by the Com-pany's efforts in recent years to lower capital costs through refinancing. Using the maximum rates payable on variable rate securities, the year-end average cost of long-term and preferred divi-dend rates including sinking fund re-quirements and current maturities were 9.87% and 9.15%, respectively, repre-senting the lowest such average capital costs since 1985. Total capital needs have been decreasing since 1987 as Unit 2 approached completion and as budgeted construction expenditures were curtailed. Annual expenditures for the years 1986-1988 for construction and nuclear fuel, including related AFC and overheads capitalized, were $774.1 million, $447.2 million and $353.9 mil-lion, respectively.

The 1989 estimate for construction additions, overheads capitalized and nuclear fuel, and excluding AFC, is ap-proximately $429 million, of which 54%

is expected to be funded by internal sources.

Mandatory and optional debt and preferred stock retirements and other requirements are expected to add approximately another $117 million to the Company's capital requirements, for a total of $546 million. Current esti-mates of total capital requirements for the years 1990-1993 are $570 million,

$521 million, $633 million, and $529 mil-lion, respectively. Such estimates take into consideration, among other things, the 1988 Stipulation Agreement and the effects of the outage at Unit 1 through June 30, 1989. Future capital require-ments rely on life-extension of the Company's existing facilities and the proposed competitive bidding proce-dures in New York State for indepen-dent power production to satisfy future capacity requirements.

Therefore, they do not include any current plans by the Company to construct new base load generating facilities.

Also, in connection with the Com-pany's Restart Action Plan for Unit 1 and its overall nuclear improvement program, operating expenditures are expected to increase over presently forecasted levels.

The Nuclear Regulatory Commission (NRC) has issued regulations which could require the Company to acceler-ate funding requirements for decom-missioning of its nuclear units by amounts which cannot currently be de-termined'. The Company currently uses the internal reserve method of ac-cumulating decommissioning

costs, which does not require internal segre-gation of funds collected. The NRC reg-ulations require the establishment of an external trust to accumulate decommis-sioning costs, which will decrease the Company's sources of cash in the fu-

~ NIAGARAMOHAWKPOWER CORPORATION aiIII SIIBSIDIARYCOMPANIES 10-17 ANNUALEXTERNAL FINANCINGBYTYPE 780.5 7.

Millionsofdollars 614.3 50.0 189.6 374.7 584.1

.0 185.3 323,8 700.9 346.5 297.0 407.2 90.7 316.5 ED ID ca cn I

CI 1984 1985 1986 1987 1988 ture. The impact on capital require-ments resulting from the NRC regula-tions could be substantial considering the Company's current forecast of de-commissioning costs and the re-coveries of such costs currently allowed by the PSC (see Note 10 of Notes to Consolidated Financial Statements).

Liquidity and Capital Resources.

Cash flows to meet the Company's require-ments for operating, investing and financing activities during the past three years are reported in the Consoli-dated Statement of Cash Flows on page 21.

During 1988, the Company raised ap-proximately $407.2 million through ex-ternal sources, consisting of $269.8 mil-lion of debt, $90.7 million of common stock from the issuance of 6,679,672 new shares through the Dividend Rein-vestment and Employee Stock Plans and a net increase of $46.7 million of short-term debt and intermediate term bank revolving credit obligations. The Company also completed $12.6 million of capital lease financing and raised

$100 million internally through the sale of a portion of its accounts receivable.

The Company expects external financing of approximately $297 million in 1989, which reflects the cash flow impact of the Interim Relief Agreement relative to the Unit 1 outage. The level of external financing could be substan-tially increased should the company be required to fund its guarantee of $150 million of tax-exempt obligations of Long Island Lighting Company (see Note 11 of Notes to Consolidated Fi-nancial Statements) or should the Unit 1 outage extend beyond June 30, 1989.

With respect to the guarantee obliga-tion, the Company has credit facilities in place to fund its obligation if necessary.

To minimize the dilutive effect on earn-ings per share of the issuance of new common stock, the Company intends to temporarily suspend sales of new com-mon stock under the Dividend Rein-vestment and Employee Stock Plans ef-fective during the first quarter of 1989 but expects to purchase its require-ments on the open market. The antici-pated amount of external financing in 1989 reflects this decision. Although ex-ternal financing plans for 1990 to 1993 have not been finalized, the aggregate level of financing during this four year period is expected to be substantially greater than previous estimates reflect-ing, among other things, the substantial concerns relating to the Company's nuclear operations, the potential addi-tional requirements to meet the NRC's new decommissioning regulations, the effects of rate regulation and the need to improve the Company's financial position. The nature, timing and amount of such future financings will also de-pend, in part, on construction expendi-ture levels, duration of and costs as-sociated with the Unit 1 outage, retire-ments of securities, timeliness and ade-quacy of rate relief, the level of inter-nally generated funds and dividend

payments, the availability and cost of capital and the abilityof the Company to meet its interest and preferred stock div-idend coverage requirements, to satisfy legal requirements and restrictions in governing instruments and to maintain an adequate credit rating.

The Company believes that tradition-ally available sources of financing should be sufficient to satisfy the Com-pany's external financing needs during this period. As of December 31, 1988, under the applicable earnings test set forth in the indenture, the Company would be permitted to issue up to $1.35 billion of First Mortgage Bonds assum-ing a 10.75% interest rate and the exis-tence of sufficient Additional Property, as defined in the Company's indenture, to secure that level of indebtedness.

However, based on the amount of Addi-tional Property currently certified and available, the Company could only issue approximately

$468 million of First Mortgage Bonds. In addition, the Com-pany may issue approximately $972 mil-lion of First Mortgage Bonds at De-cember 31, 1988 on the basis of retired bonds without regard to the earnings test. $100 million of Preference Stock is currently authorized for sale if needed.

The Company does not expect to be able to issue additional Preferred Stock until 1991, except for refunding issues, as a result of a restrictive provision in the Company's charter. The Company willalso continue to explore and utilize, as appropriate, other methods of raising funds including the sale of additional accounts receivable.

The Company's ratings at December 31, 1988 on its secured and unsecured debt respectively, were:

Secured Unsecured Preferred Standard &

Poors Corporation BBB+

BBB BBB Moody's Investors Service Baa1 Baa2 baa2 Duff& Phelps 8

9 9

Fitch Investors Services BBB BBB-BBB-On February 7, 1989, Moody's Inves-tors Service downgraded the Com-pany's secured and unsecured debt rat-ings to Baa2 and Baa3, respectively and its preferred stock rating to baa3.

On February 8, 1989, Duff8 Phelps lowered its ratings on the Company's secured debt and unsecured debt to 9 and 10, respectively.

Further, Duff & Phelps lowered its rating on the Company's preferred stock from 9 to 12, or below investment grade.

Reductions of the Company's credit ratings, and the at-tendant adverse effect on the interest or dividend rates that may be required in future issues of its securities, especially if ratings were to fall or remain below investment

grade, may reduce the Company's financing flexibilityand ad-versely affect its capital structure and financial positiori.

Ordinarily, construction related short-term borrowings are refunded with long-term securities on a continu-ing basis.

Bank credit arrangements which, at December 31, 1988, totaled

$335 million, (including $150 million of revolving credit and term loan agreements,

$85 million in lines of credit and a $100 million Bankers Ac-ceptance Facility Agreement) are used by the Company to enhance flexiblility as to the type and timing of its long-term security sales.

Such credit arrange-ments were reduced in 1988 from $555 million at December 31, 1987, to enable the Company to better control its bor-rowing costs with less stringent terms than were contained in previous bank credit agreements.

In January 1989, the Company arranged a short-term

$50 millionline of credit which is secured by equipment.

The unsecured debt limitation im-posed by the Company's charter is 10%

of consolidated capitalization plus $50 million, which, as of January 1, 1989, equates to approximately $565 million and against which the Company has outstanding unsecured debt of $456 million. The Company intends to negotiate additional credit facilities that would enable it to borrow unsecured debt up'to the permissible limit and to add other borrowing capability on a se-cured basis as required.

Consolidated Balance Sheets AtDecember 31, In thousands ofdollars 1988 1987 ASSETS Utilityplant, at original cost (Note 1):

Electric plant Nuclear fuel (Note 3)

Gas plant.

Common plant.

Construction work in progress (Note 10)

Total utilityplant Less accumulated depreciation and amortization Net utilityplant

$6,497,398 404,686 611,671 138,226 315,644 7,967,625 2,090,170 5,877,455

~

$4,777,519 408,427 577,201 138,360 1,789,562 7,691,069 1,913,687 5,777,382 Other property and investments Current assets:

Cash, including time deposits of $11,335 and $9,017, respectively Accounts receivable (less allowance for doubtful accounts of $3,600)(Note 11)

Unbilled electric revenues(Note 1)

Materials and supplies, at average cost:

Coal and oil forproduction of electricity.

Other Prepayments:

Taxes Other 155,257 19,027 228,914 126,000 47,382 76,950 39,914 26,642 564,829 115,076 29,791 305,028 47,863 71,336 30,971 21,624 506,613 Deferred debits:

Unamortized debt expense Deferred recoverable energy costs.

Deferred finance charges (Note 1)

Other 128,520 32)239 239,880 77,861 478,500

$7,076,041 125,108 8,436 202,044 59,439 395,027

$6,794,098

"'IAQRAMOIMVKPOPOVER CORPORATION mid SUBSIDIARYCOMPANIES IS-19 CAPITALIZATIONANDLIABILITIES AtDecember 31, In thousands ofdollars 1988 1987 Capitalization (Note 7):

Common stockholders'quity:

Common stock, issued 135,633,096 and 128,953,424 shares, respectively Capital stock premium and expense Retained earnings.

Non-redeemable preferred stock Redeemable preferred stock.....

Long-term debt Total capitalization Current liabilities:

Short-term debt (Note 4)

Long-term debt due within one year Sinking fund requirements on redeemable preferred stock (Note 7)

Accounts payable Payable on outstanding bank checks Customers'eposits Accrued taxes Accrued interest Accrued vacation pay Due to cotenants under Cotenant Agreement (Note 10)..

Other..

Deferred credits:

Mandated refunds to customers Accumulated deferred Federal income taxes Deferred finance charges (Note 1)

Unbilled electric revenues(Note 1)

Other......

Commitments and contingencies (Notes 3, 10 and 11) 135,633 1)640,593 105,168 1)8811394 290,000 295,510 2,995,748 5,462,652 108,000 110,571 17,980 219,798 82,279 9,985 16,132 71,842 29,904 39,640 706,131 51613 562,811 239,880 63i534 35,420 907,258

$7,076,041 128,953 1,548,826 103,739 1,781,518 290,000 355,490 2,903,921 5,330,929 50,005 77,508 14,980 164,350 48,253 9,680 19,761 70,411 29,862 171,100 44,418 700,328 36,167 476,768 202,044 47,862 762,841

$6,794,098

For the year ended December 31 ~

1988 Consolidated Statements of Income and Retained Earnings ln thousands ofdollars 1987

~

y r

1986 Operating revenues:

Electric.

Gas Operating expenses:

Operation:

Fuel for electric generation Electricity purchased Gas purchased Other operation expenses Maintenance Depreciation and amortization Federal and foreign income taxes Othertaxes Amortization of investment in generating station project (Note 2)

Operating income Other income and deductions:

Allowance for other funds used during construction.....

Federal income taxes Current year effect of adoption of SFAS No. 90(Note 10):

Disallowed plant costs Related income taxes Other items (net)

Income before interest charges Interest charges:

Interest on long-term debt.

Other interest Allowance for borrowed funds used during construction Income before cumulative effect of accounting change Cumulative effect on prior years of adoption of SFAS No.90(Note10)

Net income (loss)

Dividends on preferred stock Balance available forcommon stock Dividends on common stock Retained earnings at beginning of year..

Retained earnings at end of year Average number of shares of common stock outstanding (in thousands)

Per average share of common stock:

Balance available forcommon stock before cumulative effect of accounting change......

Cumulative effect on prior years of adoption of SFAS No. 90 (Note 10)

Balance available for common stock

$2,343,732 456,721 2>800,453 360,373 343,511 265,033 462,060 200,969 182,209 134,451 329,869 39,813 2,318,288 482,165 5,149 13,587 (25,758)

(7,022) 475,143 264,866 7,336 (5,873) 266,329 208>814 208,814 49,157 159,657 158,228 1,429 103,739 105,168 131,853 1.21 1.21

$2,170,191 453,239 2,623,430 339,382 326,152 268,099 383,874 158,939 157,631 195,472 308,483 2,138,032 485,398 20,563 17,622 (268,400) 50,400 10,947 (168,868) 316,530 264,472 4,587 (10,315) 258,744 57,786 (615,000)

(557,214) 52,017 (609,231) 208,881 (818,112) 921,851 103,739 127,435 0.5 (4.83)

(4.78)

$2,131,833 528,486 2,660,319 319,834 352,126 338,634 397,714 149,124 155,311 211,237 295,165 2,219,145 441,174 121,932 32,293 37,539 191,764 632,938 264,054 14,880 (43,861) 235,073 397,865 397,865 53,817 344,048 264,312 79,736 842,115 921,851 127,076 2.71 2.71 Dividends paid Proforma amounts assuming effects of adoption of SFAS No. 90 applied retroactively:

Balance available for common stock..............

Balance available per share of common stock......

() Denotes deduction 1.20 1.64 5,769

.05 2.08 16,048

.13

.-NIAGARAMOIIAEVKPOWER CORPORATION alIII SUBSIDIARYCOMPANIES 20-2I Consolidated Statements of Cash Flows Increase (Decrease) in Cash For the year ended December 31, 1988 In thousands ofdollars 1987 1986 Cash flows from operating activities:

Net income (loss)

Adjustments to reconcile net income to net cash provided by operating activities:

Cumulative effect on prior years of adoption of SFAS No. 90.....

Disallowed plant costs Depreciation and amortization.

Amortization of nuclear fuel Provision fordeferred Federal income taxes Allowance forother funds used during construction............

Deferred recoverable energy costs Gain on sale of investments Unbilled electric revenues Decrease in mandated refunds to customers..................

(Increase) decrease in net accounts receivable (Increase) decrease in materials and supplies Increase (decrease) in accounts payable and accrued expenses Increase (decrease) in accrued interest and taxes..............

Changes in other assets and liabilities.

222,022 16,362 82,477 (5,149)

(23,803)

(62,466)

(30,554) 76,114 (3>000) 46,727 (2,198)

(26,925) 615,000 268,400 157,631 28,748 97,934 (20,563) 1,499 (13,000)

(27,062)

(15,678)

(3,452) 38,667 11,181 (21,526)

$208,814

$ (557,214) 397,865 155,311 18,257 133,743 (121,932) 22,585 (16,771)

(5,388) 17,848 (29,270)

(4,726)

(10,204)

Net cash provided by operating activities Cash flows from investing activities:

Construction additions................................

Nuclear fuel Less: Allowance forother funds used during construction Acquisition of utilityplant (Increase) decrease in materials and supplies..................

Increase (decrease) in accounts payable and accrued expenses Sale of utilityplant Repayment of construction advances Payments under Cotenant Agreement Sale of LILCOGeneral &Refunding Bonds........

(Increase) decrease in other investments Cotenant prepayments to Nine Mile Point Nuclear..............

Unit No. 2 project fund Other Net cash used In Investing activities Cash flows from financing activities:

Proceeds from sale of common stock Proceeds from sale of preferred stock Sale of first mortgage bonds.

Issuance of other long-term debt.

Redemption of preferred stock Reductions of long-term debt Net change in short-term debt and revolving credit agreement Dividends paid Other Net cash provided by (used In) financing activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year Supplemental disclosures of cash flowInformation:

Cash paid during the year for:

Interest Income taxes.

Supplemental schedule of noncash investing and financing activities:

Net increase in capital lease obligations 498,421 (349>823)

(3,759)

',149 (348,433)

(2,133) 12,877 (171,100)

(41,200) 9,197 (540,792) 90,683 200>000 69,800 (56>980)

(137,193) 46,736 (177,168)

(4,271) 31,607 (10,764) 29,791

$ 19,027

$299,351 42,348 227 560,565 (409,068)

(28,765) 20,563 (417,270) 772 (6,334)

(22,823)

(331) 12,664 (433,322) 24,459 25,000 100,000 270,060 (62,380)

(273,005)

(72,987)

(268,591)

(15,987)

(273,431)

(146,188) 175,979

$ 29,791

$284,348 44,479 9,397 557,318 (736,242)

(23,536) 121,932 (637,846)

(4,463)

(11,864) 128,000 92,847 140,000 72,596 (83,808)

(10,675)

(315,213) 4,603 75,000 500,000 98,900 (60,050)

(439,315) 101,976 (320,255)

(71,918)

(111,059) 131,046 44,933

$ 175,979

$ 301,224 47,770 14,284

Notes to Consolidated Financial Statements NOTE 1. Summary of Significant Accounting Policies The Company is subject to regulation by the New York State Public Service Commission (PSC) and the Federal Energy Regulatory Commission (FERC) with respect to its rates for service and the maintenance of its accounting records. The Company's accounting policies conform to generally accepted accounting principles, as applied to regulated public utilities, and are in accordance with the accounting requirements and ratemaking practices of the regulatory authorities.

Statement of Cash Flows: In November 1987, Statement of Fi-nancial Accounting Standards No. 95, (SFAS No. 95), "State-ment of Cash Flows" was issued by the Financial Accounting Standards Board (FASB). The Company adopted SFAS No. 95 for the year ended December 31, 1988 and has restated the consolidated statements of changes in financial position for 1987 and 1986 to conform with the 1988 presentation of cash flows. The Company considers all highly liquid investments, purchased with a remaining maturity of three months or less, to be cash equivalents.

Principles of Consolidation: The consolidated financial state-ments include the Company and its wholly-owned subsidiaries.

All significant intercompany balances and transactions have been eliminated. Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect at the balance sheet date. Revenue and expense accounts are translated at the average exchange rate in effect during the year. Currency translation adjustments are recorded as a com-ponent of equity and do not have a significant impact on finan-cial condition.

Utility Plant: The cost of additions to utility plant and of re-placements of retirement units of property is capitalized. Cost includes direct material, labor, overhead and an allowance for funds used during construction (AFC). The cost of current re-pairs and maintenance is charged to expense. Whenever utility plant is retired, its original cost, together with the cost of re-moval, less salvage, is charged to accumulated depreciation.

Allowance for Funds Used During Construction: The Company capitalizes AFC in amounts equivalent to the cost of funds devoted to plant under construction. AFC rates are determined in accordance with FERC and PSC regulations.,The AFC rate in effect December 31, 1988 was 10.40k. AFC is segregated into its two components, borrowed funds and other funds, and is reflected in th'e Interest Charges section and the Other Income and Deductions section, respectively, of the Consolidated Statement of Income.

Effective April 1985, pursuant to a PSC authorization, the Company discontinued accruing AFC on $320 million of con-struction work in progress (CWIP) for which a cash return was being allowed through inclusion in rate base of that portion of the investment in the Nine Mile Point Nuclear Station Unit No. 2 (Unit 2). This amount was increased to $680 million in April 1986 and $1,625 million (including $125 million of other CWIP) in April 1987. Amounts equal to the Unit 2's AFC which was no longer accrued on the CWIP included in rate base have been accumulated in deferred debit and credit accounts up to the commercial operation date of Unit 2. The balance in the de-ferred accounts, amounting to $239.9 million at December 31, 1988, await future ratemaking disposition by the PSC. A por-tion of the deferred credit could be utilized to reduce future revenue requirements over a period shorter than the lifeof Unit 2 with a like amount of deferred debit amortized and recovered in rates over the remaining life of Unit 2, as has been the ex-perience of other New York State utilities.

Depreciation, Amortization and Nuclear Generating Plant De-commissioning Costs: For accounting purposes, depreciation is computed on the straight-line basis using the average or-remaining service lives by classes of depreciable property. In addition, certain costs associated with the discontinued Lake Erie Generating Station Project (see Note 2) were amortized over shorter periods as approved by the PSC. For Federal in-come tax purposes, the Company computes depreciation using accelerated methods and shorter allowable depreciable lives. Estimated decommissioning costs (costs to remove the plant from service in the future) for the Company's Nine Mile Point Nuclear Station Unit No.

1 and its share of decommis-sioning costs of Unit 2 are being recovered in rates through an annual allowance and charged to operations through depre-ciation charges (see Note 10).

Amortization of Nuclear Fuel: Amortization of the cost of nu-clear fuel is determined on the basis of the quantity of heat produced for the generation of electric energy. The cost of disposal of nuclear fuel, which presently is $.001 per kilowatt-hour of net generation, is based upon a contract with the U.S.

Department of Energy. These costs are charged to operating expense and recovered from customers through base rates or through the fuel adjustment clause.

Revenues:

Revenues are based on cycle billings rendered to certain customers monthly and others bi-monthly. Although the Company commenced the accrual in 1988 of electric rev-enues for energy consumed and not billed at the end of the fiscal year, the impact of such accruals have not yet been fully recognized in the Company's results of operations in accor-dance with the Stipulation Agreement. Approximately $62.5 million of such accrued electric revenues is included in the results of operations for the year ended December 31, 1988, and the remainder is included in Deferred Credits. The amounts included in the Deferred Credit may be used to re-duce future revenue requirements.

The Company's tariffs include electric and gas adjustment clauses under which energy and purchased gas costs, respec-tively, above or below the levels allowed in approved rate schedules, are billed or credited to customers. The Company, as authorized by the PSC, charges operations for energy and purchased gas cost increases in the period of recovery. The PSC has periodically authorized the Company to make changes in the level of allowed energy and purchased gas costs included in approved rate schedules.

As a result of such periodic changes, a portion of energy costs deferred at the time of change would not be recovered or may be overrecov-ered under the normal operation of the electric and gas ad-justment clauses.

However, the Company has been permitted to amortize and bill or credit such portions to customers, through the electric and'gas adjustment

clauses, over a specified period of time from the effective date of each change.

The Company's electric fuel adjustment clause provides for partial pass-through of fuel cost fluctuations from amounts forecast with the Company absorbing a specific portion of in-creases or retaining a portion of decreases up to a maximum of

$15 million per rate year (However, see Note 10 "Interim Agreement on Unit 1 Outage Replacement Power Costs" ).

Federal income Taxes: In accordance with PSC requirements, the tax effect of book and tax timing differences is flowed through unless authorized by the PSC to be deferred.

The Company provides deferred taxes on certain benefits realized from depreciation, on deferred energy and purchased gas costs, on nuclear fuel disposal costs accrued prior to April 1983, on nuclear generating plant decommissioning costs, on certain construction overheads and on certain other items (see Note 9). As directed by the PSC, the Company defers any amounts payable pursuant to the alternative minimum tax rules. In conformity with ratemaking practices of the PSC, the Company has not provided deferred taxes on the cumulative

'-'NIAGARAMOIIAWKPOWR COIIPORATIOlt aml SIIIISIDIARYCOMPANIES 22-23 amount of approximateiy $1.6 billion of other tax deductions which include certain depreciation differences and various construction overheads deductible currently for tax purposes and capitalized for accounting and ratemaking purposes. The Company has claimed investment tax credits and deferred the benefits of such credits as realized in accordance with PSC directives. Deferred investment credit is amortized to Other Income and Deductions over the useful life of the underlying property. For purposes of computing capital cost recovery de-ductions and normalization, the asset basis has been reduced by all or a portion of the credit claimed consistent with then current tax laws. The imputed tax benefit of the borrowed funds component of AFC on transitional property is recorded in Other Income and Deductions.

The FASB has issued Statements of Financial Accounting Standards No. 96 and No. 100 (SFAS No. 96 and No. 100) "Ac-counting for Income Taxes" which require the adoption of SFAS 96 for fiscai years beginning after 1989. The pronounce-ment continues the present comprehensive inter-period tax al-location rules, but shifts to the use of the liability method for accounting for deferred taxes rather than the deferred method required under APB Opinion No. 11. Regulated utilities are not exempt from the provisions of SFAS No. 96, which specifically prohibits net-of-tax accounting and reporting and requires (i) recognition of a deferred tax liabilityfor tax benefits that are flowed through to customers when temporary differences originate and (ii) adjustment of a deferred tax liabilityor asset for an enacted change in tax laws or rates. However, any im-pact of the pronouncement should be considered within the ratesetting environment. The adoption of the requirements of SFAS No. 96 is not expected to significantly impact the Com-pany's financial condition or results of operations.

Amortization of Debt issue Costs: The premium or discount and debt expenses on long-term debt issues and on certain debt retirements prior to maturity, are amortized ratably over the lives of the related issues and included in interest on long-term debt (see Note 7).

NOTE 2. Depreciation and Amortization The total provision fordepreciation and amortization, includ-ing amounts charged to clearing accounts, was $183,385,000 for 1988, $158,761,000 for 1987 and $156,494,000 for 1986. The 1988 provision excludes approximately $39,800,000 resulting from the amortization of costs associated with the discon-tinued Lake Erie Generating Station Project (LEGS) in accor-dance with the Stipulation Agreement (see discussion of the Stipulation Agreement in Management's Discussion and Analysis of Financial Condition and Results of Operations).

The remaining unrecovered cost of LEGS of approximately

$6,200,000, representing a portion of carrying charges accrued on LEGS, was charged primarily against Other Income and Deductions forthe year ended December 31, 1988. The percen-tage relationship between the total provision for depreciation and average depreciable property was 2.7% in 1988 and 3.0% in 1987 and 1986. The Company performs depreciation studies on a continuing basis and, upon approval by the PSC, periodically adjusts the rates of its various classes of depreci-abie property.

NOTE 3. N M Uranium, Inc.

During 1976, through a wholly-owned subsidiary, N M Uranium, Inc. (NMU), the Company purchased a 50 percent undivided interest in uranium deposits and associated mining equipment to be held by a jointly-owned mining venture. Ac-quisition of this interest was made primarily to provide a more assured future supply of nuclear fuel. Mining operations are now complete and site restoration activities are underway. The investment in the subsidiary, which includes costs incurred since acquisition and AFC accrued through March 31, 1981, has been reduced by the proceeds from the sale of uranium, net of tax, transfers of uranium to the Company and write-offs of portions of the Company's investment, and is included in the consolidated financial statements as part of the nuclear fuel component of utility plant. Such investment, net of valuation reserves of $20.5 million and $13.0 million at December 31, 1988 and 1987, respectively, totaled $44.9 million at December 31, 1988 and $52.5 millionat December 31, 1987.

In connection with the Company's rate decisions in March 1984, and March 1986 and the Stipulation Agreement, the PSC has allowed, as the cost of approximately 1,313,000 lbs. of NMU uranium utilized in the 1984, 1986 and current reloads of the Company's Nine Mile Point Nuclear Unit No. 1 and approx-imately 107,000 lbs. utilized for a portion of the initial core at Nine Mile Point Nuclear Unit No. 2, a price which represents the average United States delivery price for the year of transfer, as reported by the U.S. Department of Energy (DOE). The total allowed value of these transfers using DOE prices is approxi-mately $45.0 millionwhile the Company's cost is approximately

$63.0 million. The differential between the Company's cost of this NMU uranium and that amount allowed to be recovered in rates charged to customers has been deferred subject to the PSC approval of the comparison of cost to market on an aggregate basis over the life of the project and is reflected in the Company's investment in NMU.

In October 1988, NMUtransferred approximately 186,000 lbs.

of uranium to the Company (with a cost of approximately $8.6 million) to be used in the 1990 refueling of Nine Mile Point Nuclear Unit No. 2. Although the allowable value for this mate-rial is expected to be the appropriate DOE price, such costs must still be reviewed in the Company's next rate proceeding.

Approximately 955,000 pounds of uranium remain to be trans-ferred, with the final transfer currently scheduled for 1991.

Based upon DOE's recently issued forecast which reflects a continued decline in average delivery prices from previous forecasts and the anticipated further decline in average de-livery prices, the Company expects that based upon costs al-lowed in rates to date and the estimated value of remaining transfers, a minimum of $20.5 million of its investment in NMU may not be recoverable in rates. Accordingly, the Company has reduced the carrying value of such investment by $13 million in 1987 and $7.5 million in 1988. The Company can provide no assurance that all of its remaining investment in NMUwill ulti-mately be recovered.

NOTE 4. Bank Credit Arrangements At December 31, 1988, the Company had $335 million of bank credit arrangements with 30 banks. These credit ar-rangements consisted of $150 million in commitments under a Revolving Credit Agreement,

$72 million in short-term com-mitments under Credit Agreements,

$13 million in lines of credit and $100 million under a Bankers Acceptance Facility Agreement. The Revolving Credit Agreement extends into 1991 and the interest rate applicable to borrowing is based on cer-tain rate options available under the Agreement. All of the other bank credit arrangements are subject to review on an ongoing basis with interest rates negotiated at the time of use.

The Company also issues commercial paper.

Unused bank credit facilities are held available to support the amount of commercial paper outstanding, including amounts currently issued in connection with Interest Rate Exchange Agreements (see Note 7). The Revolving Credit Agreement contains rep-resentations which, if not met or re-negotiated, would prevent the Company from making new borrowings under such agreements.

The Company is presently in compliance with these convenants and restrictions.

The Company pays fees for substantially all of its bank credit

AtDecember 31:

fn thousands ofdollars 1988 1987 arrangements.

The Bankers Acceptance Facility Agreement, which is used to finance the fuel inventory for the Company's generating stations, provides for the payment of fees only at the time of issuance of each acceptance.

Additional bank credit arrangements in connection with the Company's guarantee of certain obligations of LILCO are discussed in Note 11.

In January 1989, the Company arranged a short-term $50 million line of credit which is secured by equipment.

Amounts outstanding under Interest Rate Exchange Agree-ments and Revolving Credit Agreements totaled $75 million at December 31, 1988 and are recorded as long-term debt.

The following table summarizes additional information applicable to'short-term debt:

NOTE 6. Information Regarding the Electric and Gas Businesses The Company is engaged in the electric and natural gas util-:

ity businesses.

Certain information regarding these segments is set forth in the followingtable. General corporate expenses, property common to both segments and depreciation or such common property have been allocated to the segments in ac-cordance with practice established for regulatory purposes.

Identifiable assets include net utility plant, unbilled electric

revenues, materials and supplies, deferred finance charges, deferred recoverable energy costs and other deferred debits.

Corporate assets consist of other property and investments, cash, accounts receivable, prepayments, unamortized debt expense and other deferred debits.

Short-term debt:

Commercial paper....

Notes payable........

Bankers acceptances Weighted average interest rate(a)..

For ear ended December 31:

$ 811000

$ 27,000 5

27,000 23,000

$1081000

$ 50,005 9.28%

7.46%

Operating revenues:

Electric...........

Gas fn thousands ofdollars 1988 1987 1986

$2,343,732

$2,170,191

$2,131,833 456,721 453,239 528,486 Dailyaverage outstanding......

Dailyweighted average interest rate(a)

Maximum amount outstandin (a) Excluding fees.

7.58%

$173,100 6.63%

$154,000

$ 46,254

$ 51,256 Total

$2,800,453

$2,623,430

$2,660,319 Operating Income before taxes:

Electric...................

570,088 637,120 596,864 Gas..

46,528 43,750 55,547 fn thousands ofdollars Percentage Construction owner-Utility Accumulated work in ship plant depreciation progress Roseton Steam Station Units No. 1 and 2(a) 25

$ 83,823

$31,427 Oswego Steam Station Unit No.6(b).......

76

$262,108

$60,638 Nine Mile Point Nuclear Station Unit No. 2(c) 41 $1,468,075 $25,544 92

$1,742

$ 530 NOTE 5. Jointly-Owned Generating Facilities The following table reflects the Company's share of jointly-owned generating facilities at December 31, 1988. The Com-pany is required to provide its respective share of financing for any additions to the facilities. The Company's share of ex-penses associated with the facilities is included in the appro-priate operating expenses in the Consolidated Statement of Income.

Total 616,616 680,870 652,411 Pretax operating Income, Including AFC:

Electric...................

580,239 667,610 762,362 Gas 47,399 44,138 55,842 Total...................

Income taxes................

Other income and deductions Interest charges.............

Cumulative effect of accountin change........

627,638 711,748 134,451 195,472 (12,171)

(189,431) 272,202 269,059 615,000 818,204 211,237 69,832 278,934 Net income(/oss) 208,814 $

(557,214 397,865 Depreciation and amortization:

Electric...................

167,566 143,508 141,663 Gas.....

14,643 14,123 13,648 Total 182,209 157,631 155,311 (a) The remaining ownership interests are Central Hudson Gas and Electric Corporation, the operator of the plant (35%)

and Consolidated Edison Company of New York, Inc.

(40%).

(b) The Company is the operator. The remaining ownership interest is Rochester Gas and Electric Corporation (24%).

Output of Oswego Unit No. 6, which has a capability of 850,000 kw., is shared in the same proportions as the co-tenants'espective ownership interests.

(c) The Company is the operator.

The remaining ownership interests are Long Island Lighting Company (18%), New York State Electric and Gas Corporation (18%), Rochester Gas and Electric Corporation (14%), and Central Hudson Gas and Electric Corporation (9%). Output of Unit 2, which has a capability of 1,084,000 kw., is shared in the same proportions as the cotenants'espective ownership interests.

Construction expenditures (including nuclear fuel):

Electric..................

Gas Total Identifiable assets:

Electric...........

Gas Total..........

Corporate assets Total assets 304,515 408,008 734,348 49,344 39,222 39,714 353,859 447,230 774,062

$5,9101897

$5,626,117

$6,424,656 539,309 491,315 468,299 6,450,206 6,117,432 6,892,955 625,835 676,666 718,248

$7,076,041

$6,794,098

$7,611,203

Nli'AGARAMOIIAWKPO)VER CORPORATION aml SUBSIDIARYCOMPANIES 24-25 NOTE 7. Capitalization CAPITALSTOCK The following table summarizes the shares of capital stock authorized, issued and outstanding:

At December 31, 1988 1987 1986 Common stock, $1 par value:

Authorized Issued &outstandin 150,000,000 150,000,000 150,000,000 135,633,096 128,953,424 127,140,994 Preferred stock, $100 par value:

Authorized Issued &outstandin 3,400,000 2,644,000 3,400,000 2,927,000 3,400,000 3,260,000 Preferred stock, $25 par value:

Authorized Issued &outstandin 19,600>000 13,563,602 19,600,000 19,600,000 14,710,801 14,874,000 Preference stock, $25 par value:

Authorized Issued &outstandin 4,000,000 0

4,000,000 0

4,000,000 0

The table below summarizes changes in capital accounts for 1986, 1987 and 1988:

Preferred Stock Common Stock

$ 1 par value

$ 100 par vafue Non-Redeem-Redeem-Shares able'ble'25 par value Capital Stock Non-Premium and Redeem-Redeem-Expense Shares able'ble (Net)'alance January 1, 1986 Salesln1986............

Issued to stock purchase plans in 1986...........

Redemptions............

Foreign currency translation ad'ustment Balance December31,1986 Salesin1987.............

Issued to stock purchase plans in 1987............

Redemptions.............

Foreign currency translation adjustment...

152,300 152 (58,000)

(5,800)

(2,170,000)

(54,250) 2,821 437 603 127,140,994 127,141 3,260,000 210,000 116,00Q'a) 14,874,000 80,000 1,000,000 291,850(a) 1,522,499 25,000 (423) 1,812,430 1,812 (333,000)

(33,300)

(1,163,199)

(29.080) 22,442 577 3,731 126,928,340

$126,928 3,318,000

$210,000

$ 121,800)a) 14,044,000

$80,000

$271,100(a)

$1,519,577 60,354 61 3,000,000

75,000 (939)

Balance December 31,1987 128,953,424 Sales in 1988.............

Issued to stock purchase plans in 1988............

6,679,672 Redemptions.............

Foreign currency translation ad ustment....

128,953 2,927,000 6,680 210,000 82,700]a) 14,710,801 80,000 287,770(e) 1,548,826 83,937 672 (283,000)

(28,300)

(1,147,199)

(28,680) 7,158 Balance December31,1988 135,633,096

$ 135,633 2,644,000

$210,000

$54,40Q'a) 13.563.602

$80,000

$259.09Q'a)

$1,640,593

• Inthousands oldollars (a) Includes sinking fund requirements due withinone year

NON-REDEEMABLE PREFERRED STOCK (Optionally Redeemable)

The Company has certain issues of preferred stock which provide for optional redemption as follows:

At December 31, In thousands ol dollars 1988 1987 Redemption price per share (Belore adding accumulated dividends)

Eventual 1986 December 31, 1988 minimum Preferred $100 par value:

3.40% Series; 200,000 shares.........

3.60% Series; 350,000 shares.........

3.90% Series; 240,000 shares......,..

4.10% Series; 210,000 shares.........

4.85% Series; 250,000 shares.........

5.25% Series; 200,000 shares.........

6.10% Series; 250,000 shares.........

7.72% Series; 400,000 shares.........

Preferred $25 par value:

Adjustable Rate SeriesA; 1,200,000 shares.........-.........

Adjustable Rate Series C; 2,000,000 shares..................

$ 20>000 35,000 24,000 21,000 25,000 20,000 25>000 40,000 30,000 50,000

$ 20,000 35,000 24,000 21,000 25,000 20,000 25,000 40,000 30,000 50.000

$ 20,000 35,000 24,000 21,000 25,000 20,000 25,000 40,000 30,000 50,000

$103.50 104.85 106.00 102.00 102.00 102.00 101.00 103.51 25.75 (a)

$103.50 104.85 106.00 102.00 102.00 102.00 101.00 102.36 25.00 25.00

$290,000

$290,000

$290,000 (a) Not redeemable until 1990.

MANDATORILYREDEEMABLEPREFERRED STOCK The Company has certain issues of preferred stock which provide for mandatory and optional redemption as follows:

Redemption price per share (Belore adding accumulated dividends)

In thousands ol dollars Eventual At December 31, 1988 1987 1986 December 31, 1988 minimum Preferred $100 par value:

7.45% Series; 384,000, 402,000, and 420,000 shares..

10.13% Series; none, 225,000 and 250,000 shares.....

10.60% Series; 160,000, 200,000 and 240,000shares 12.75% Series; none and 250,000 shares.............

Preferred $25 par value:

8.375% Series; 1,000,000, 1,100,000 and 1,200,000 shares 8.70% Series; 1,000,000 shares 8.75% Series; 3,000,000 shares 9.75%Series;606,000,672,000,and738,000shares 9.75% Series (second); none and 816,000 shares 10.13% Series; none, 900,000 and 1,000,000 shares...

10.75% Series; 1,600,000 shares 12.25% Series; 613,880, 656,940 and 700,000 shares...

12.50% Series; 543,722, 581,861 and 620,000shares...

Ad'ustable Rate Series B; 2,000,000 shares............

25,000 25,000 75>000 15>150 40,000 15,347 13,593 50,000 27,500 25,000 75,000 16,800 22,500 40,000 16,423 14,547 50,000 30,000 75,000 18,450 20,400 25,000 40,000 17,500 15,500 50,000

$ 38,400

$ 40,200

$ 42,000 22,500 25,000 16,000 20,000 24,000 25,000

$103.85 107.95 25.99 (a)

(a) 25.9075 26.19 (b)

(b)

(c)

$100.00 102.65 25.00 25.00 25.00 25.00 25.00 25.00 25.00 25.00 Less sinkin fund and redemption re uirements 313>490 17,980 370,470 14,980 407,850 60,380

$295,510

$355,490

$347,470 (a) Not redeemable until 1992.

(b) Not redeemable until 1S91.

(c) Not redeemable until 1S89.

These series require mandatory sinking funds for annual redemption and provide optional sinking funds through which the Company may redeem, at par, a like amount of additional shares (limited to 120,000 shares of the 7.45% series and 300,000 shares of the 9.75% series). The option to redeem additional amounts is not cumulative.

t ~

19AGARA MOIIAWKPOWER CORPORATION ail(l SIIIISIDIARYCOMPANIKS 20-27 The Company's five-year mandatory sinking fund redemption requirements for preferred stock are as follows:

No. of shares Commencing 1989 In thousands ofdollars 1990 1991 1992 1993 Preferred $100 par value:

7.45% Series..........

10.6(P/o Series

. ~... ~....

Preferred $25 par value:

8.375% Series....

~

~ ~

~

~

~

8.70/o Series...........

8.75%Series........

~

~

~

9.75%Series........

~

~

~

10.75% Series...........

12.25% Series...........

12.5(y/>> Series...........

Ad'ustabie Rate Series B 18,000 20,000 100,000 200,000 600,000 66,000 320,000 43,060 38,139 50,000 6/30/77 3/31/80 4/1/83 6/30/93 12/31/92 10/1/80 6/30/89 3/31/87 3/31/87 9/30/93

$ 1,800 2,000 2,500 1,650 8,000 1,077 953

$ 1,800 2,000 2,500 1,650 8,000 1,077 953

$ 1,800 2,000 2,500 1,650 8,000 1,077 953

$ 1,800 2,000 2,500 15,000 1,650 8,000 "1,077 953

$ 1,800 2,000 2,500 5,000 15,000 1,650 8,000 1,077 953 1,250

$17,980

$17,980

$ 17,980

$32.980

$39,230 LONG-TERM DEBT Long-term debt and long-term debt due within one year consisted of the following:

In thousands ofdollars AtDecember 31 ~

1988 1987 In thousands oIdollars At December 31, 1988 1987 First mortgage bonds:

3r/s% Series due June1, 1988.........

12%Seriesdue March1,1989..........

'Vs%SeriesdueOctober1

~ 1989......

4V4%SeriesdueApril 1,1990.........

4Vs%SeriesdueNovember1,1991 12.73% Series due February 1 ~ 1992.....

13.06% Series due February 1, 1992.....

12.73% Series due February 20, 1992....

12.68% Series due February 28, 1992....

11% Series due May 1, 1993............

8%%Series due August 1, 1994.......

4%% Series due December 1, 1994....

9>/s% Series due October 1 ~ 1996......

Sr/s% Series due November 1, 1996....

9Vs%Seriesdue July1,1997..........

6>/4% Series due August 1, 1997.......

9Vs%Series due May1,1998..........

6>/s%SeriesdueAugust1,1998 9Vs% Series due December 1, 1999....

12.95% Series due October 1,2000.....

7s/s% Series due February 1, 2001......

7%% Series due February 1, 2002......

7s/4%SeriesdueAugust1,2002 8>/4%Seriesdue December1,2003....

9Vs% Series due December 1, 2003....

9.95% Series due September 1, 2004...

10.20% Series due March 1, 2005.......

8.35% Series due August 1, 2007......

8Vs%Seriesdue December1,2007....

12r/s% Series due March 1, 2013........

'11>/4%Series due July 1 ~ 2014..........

20,000 13,000 50,000 40,000 20>000 50,000 10,000 20,000 50>000 150,000 40,000 100,000 45,000 100,000 40>000 200,000 60,000 75,000 48,002 65,000 80,000 80,000 80,000 44,118 80,000 30,478 66,640 38,000 75,690 50,000 20,000 13,000 50,000 40,000 20,000 50,000 10,000 20,000 50,000 150,000 40,000 100,000 45,000 100,000 40,000 60,000 75,000 58,668 65,000 80,000 80,000 80,000 47,059 85,000 31,578 66,640 40,000 65,486 75,690

• 11s/s% Series due October 1 ~ 2014...

10'/oSeriesdue June1,2016........

10/o Series due November 1, 2016...

8Vs%Series due November1,2025 Total First Mortgage Bonds.........

Promissory notes:

• 8% Series Adue June 1 ~ 2004.......

Adjustable Rate Series due July 1, 2015 December 1, 2023.

December 1, 2025 December 1 ~ 2026 March 1, 2027 July 1, 2027 Unsecurednotes payable:

Medium Term Notes, Various rates, due 1989-1994 Swiss Franc Bonds due December 15, 1995..

15.02/o Unsecured Notes due 1990.........

Notes, Interest Rate Exchange Agreement...

Revolving credit agreement, Oswego Facilities Trust.................

Other Unamortized premIum discount TOTALLONG-TERM DEBT.............

Less long-term debt due within one year

'axwxempt pollution control related issues 40,015 150,000 100,000 75,000 40,015 150,000 100,000 75,000 100>000 69>800 75,000 50,000 25,760 93>200 100,000 75 000 50,000 25,760 93,200 200>000 50,000 50,000 75>000 135>909 (893 200,000 50,000 50,000 50,000 36,259 131

~180 294 3,106,319 2,981,429 110,571 77,508

$2,995,748

$2,903,921 2,135,943 2,073,136 46,600 46,600 Several series of First Mortgage Bonds and Notes were is-sued to secure a like amount of tax-exempt revenue bonds and notes issued by the New York State Energy Research and Development Authority (NYSERDA). Approximately

$414,000,000 of such securities bear interest at a daily adjusta-ble interest rate (with a Company option to convert to a fixed interest rate which would require the Company to issue First Mortgage Bonds to secure the debt) which averaged 4.60% for 1988 and are supported by bank direct pay letters of credit.

Pursuant to agreements between NYSERDAand the Company, proceeds from such issues were used for the purpose of financing the construction of certain pollution control facilities at the Company's generating facilities.

Notes Payable include a ten-year Swiss franc bond issue equivalent to $50,000,000 in U.S. funds. Simultaneously with the sale of these bonds, the Company entered into a currency exchange agreement to fullyhedge against currency exchange rate fluctuations.

The Company has Interest Rate Exchange Agreements ex-tending into 1991 for $75,000,000. The'agreements require the Company to make fixed rate payments which, calculated on a semi-annual bond basis, are equivalent to 7.53% and, in ex-change, receive a LIBOR based floating rate payment from a bank. The Company generally uses its own commercial paper notes as the source of funding. The related interest expense is recorded on a net basis.

Such Interest Rate Exchange Agreements include a $25,000,000 agreement previously held by the Oswego Facilities Trust (Trust). The Trust te"npotarify discontinued issuing commercial paper in July 1988 and thi interest rate exchange agreement was transferred to the Com-pany.

Other long-term debt in 1988 consists of obligations under capital leases of $65,854,000 (see Note 11) and a liabilityto the U.S. Department of Energy for nuclear fuel disposal of

$70,055,000.

1992 Certain of the Company's debt securities provide for a mandatory sinking fund for annual redemption. The Company's five-year mandatory sinking fund redemption requirements are as follows:

Principal In thousands ofdollars Amount Commencing 1989 1990 1991 1993 First Mortgage Bonds:

10.20% Series due March 1 ~ 2005......

8.35% Series due August 1, 2007.....

6%% Series due December 1, 2007...

9.95% Series due September 1, 2004 12.95% Series due October 1, 2000....

9~h% Series due De'cember 1 ~ 2003...

PromIssory Notes:

8% Series A due June 1 ~ 2004........

$1,500 750 2,000 5,000 5,333 2,941 500 3/1/76 8/1/62 12/1/83 9/1/85 10/1/66 12/1/67 6/1/90

$ 1,478(a)

(a) 2,000 5,000 5,333 2,941

$ 1,500 (a) 2,000 5,000 5,333 2,941 500

$ 1,500 (a) 2,000 5,000 5,333 2,941 500

$ 1,500 (a) 2,000 5,000 5,333 2,941 600

$ 1,500 64qa) 2,000 5,000 5,333 2,941 600

"$16,752

$17,274

$ 17,274

$17,374

$18.014 (a) Requirements, or a portion thereof, have been met by advance purchases.

Additionally, certain other series of mortgage bonds provide for a debt retirement fund whereby payment requirements may be met, in lieu of cash, by certification of additional property, the waiver of the issuance of additional bonds or the retirement of outstanding bonds. The 1988 requirements for these series were satisfied by the certification of additional property. The Com-pany anticipates that the 1989 requirements for these series will be satisfied by other than payment in cash. Total annual debt retirement fund requirements for these series, based upon mortgage bonds outstanding December 31, 1988, are $6,550,000.

Net ension cost.

$ 26,000

$ 30,200 In addition to providing pension benefits, the Company and its subsidiaries provide certain health care and life insurance benefits for retired employees.

Substantially all of the Com-pany's employees may become eligible for these benefits if they reach retirement age while working for the Company.

These benefits are provided through an insurance company whose premiums are based on the claims paid during the year.

The cost of providing these benefits to retired employees amounted to approximately $12,600,000 for 1988, $8,800,000 for 1987 and $7,900,000 for 1986.

NOTE 8. Pension and Other Retirement Plans The Company and its subsidiaries have non-contributory, defined-benefit pension plans covering substantially all their employees.

Benefits are based on years of service and the employee's compensation level. The pension cost was

$26,000,000 for 1988, $30,200,000 for 1987, $41,400,000 for 1986 (of which $7,800,000 for 1988, $11,400,000 for 1987 and

$15,600,000 for 1986 was related to construction labor and, accordingly, was charged to construction projects). The Com-pany's general policy is to fund the pension costs accrued with consideration given to the maximum amount that can be de-ducted for Federal income tax purposes. Contributions are in-tended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.

Net pension cost for 1988 and 1987 included the following components:

In thousands of dollars At December 31, 1988 1987 Service cost-benefits earned during the period

$ 22,900

$ 26,900 interest cost on projected benefit obligation...

56,300 53,900 Return on Plan assets.

(56,000)

(53,400)

Amortization of net obli ation................

2,600 2,800 The following table sets forth the plan's funded status and amounts recognized in the Company's Consolidated Balance Sheets:

In thousands of dollars At December 31

~

1988 1987 Actuarial present value of accumulated benefit obligations:

Vested benefits Non-vested benefits Accumulated benefit obligations..

Additional amounts related to pro'ected pa increases........

Projected benefits obligation for service rendered to date.........

Plan assets at fair value, consisting primarily of listed stocks, bonds, other fixed income obligations and insurance contracts Plan assets in excess of projected benefit obligations Unrecognized net obligation at January 1, 1987 being recognized over approximately 19 years..................

Unrecognized net gain from past experience different from that assumed and effects of changes in assumptions...

Prior service cost not yet recognized in net periodic pension cost...............

$516,014

$493,625 34,401 37,362 550,415 530,987 194,405 201,415 744,620 732,402 811,094 739,219 66,274 6,817 46,354 49,146 119,040 49,565 210 Prepaid (accrued) pension costs included in Other current assets and liabilities.......

6,202) 6,398 In 1988 and 1987, the discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations were 8.25%

and 4.5% (plus merit increases) and 8.0% and 5.0% (plus merit increases), respectively. The expected long-term rate of return on plan assets was 8.75% in 1988 and 8.0% in 1987.

WIACiARAMOIIAIVKPOWER CORPORATION ml(l SIIIISIDIARYCOi>IPAi)ITS 28-29 NOTE 9. Federal and Foreign Income Taxes Income Tax Reform: In October 1986, the Tax Reform Act of 1986 (Act) was signed into law. One of the provisions of the Act lowered the statutory corporate Federal income tax rate from 46% to 34% effective July 1, 1987. The deferred Federal income taxes below relating to book/tax timing differences have been provided at 34% in 1988, the blended statutory rate of approx-imately 40% for 1987 and at 46% in 1986.

United States..............

Foreign Consolidatin eliminations Income before income taxes and the cumulative effect of the accounting change in 1987

$322,814

$180,213

$570,113 16,485 28,594 14,311 (9,621) 23,571 7,61

$329,678

$185,236

$576,809 Components of United States and foreign income beforein-come taxes:

In thousands oldollars 1988 1987 1986 Following is a summary of the components of Federal and foreign income tax and a reconcilation between the amount of Federal income tax expense reported in the Consolidated Statement of Income and the computed amount at the statutory tax rate:

Summary Analysis:

In thousands ofdollars 1988 1987 1986 Components of Federal and foreign Income taxes:

Current tax expense: Federal.

Forei n

Deferred Federal income tax ex ense Income taxes included in Operating Expenses Current Federal income tax expense included in Other Income and Deductions Current Federal tax credits associated with disallowed plant depreciation.......

Deferred Federal income tax expense (credits) included in Other Income and Deductions Total.

S 60,173 7,282 67,455 66,996 134,451 (29,068) 15,481

$120,864

$ 39,574 9,012 48,586 146,886 195,472 (19,070) 48,952

$127,450 S 24,959 6,767 31,726 179,511 211,237 13,475 45,768

$178,944 Components ofdeferred Federal Income taxes(Note 1)t Depreciation.

Investment tax credit Alternative minimum tax Benefit associated with disallowed plant costs Construction overheads Recoverable energy and purchased gas costs.........

Unbilled electric revenues Gain on disposition of property Reacquisition of bonds Other Deferred Federal income taxes net

$109,920 (392)

(33,?86)

(2,826) 8,664 4,912 (2,463) 1,552)

$ 82,477

$ 96,812 49,303 (50,400) 14,492 (3,858)

(15,181) 3,299 3,467

$ 97,934

$ 50,399 48,252 26,111 (9,309)

(15,374) 15,700 17,964

$133.743 Reconciliation between Federal and foreign Income taxes and the tax computed at prevailing U.S. statutory rate on Income before Income taxes:

Computed tax Reduction attributable to flow-through of certain tax adjustments:

Depreciation.

Allowance forfunds used during construction Taxes, pensions and employee benefits capitalized foraccounting purposes..

Real estate taxes on an assessment date basis Deferred taxes provided at other than the statutory rate.

Tax adjustments associated with disallowed plant costs Other Federal and torei n income taxes

$112,091 (18,959) 3,747 3>929 2>537 7,929 7,95 8,773

$120,864 S 74,002 (24,160) 12,336 (798) 859 10,439 (56,826) 4,702 53,448

$127,450

$265,332 (18,235) 76,266 1,645 4,074 7,210 15,428 86,388

$178,944

NOTE 10. Nuclear Operations The Company is the owner and operator of Nine Mile Point Nuclear Station Unit No. 1 (Unit 1) and the operator and a 41/o co-owner of Nine Mile Point Nuclear Station Unit No. 2 (Unit 2)

(See Note 5). Contingencies involving the Company's owner-ship of these facilities are discussed below.

Unit 1 Outage and Restart Action Plan: Unit 1 was taken out of service in December 1987 for repairs to its feedwater system.

During these repairs, the Company decided to proceed from this outage into refueling of Unit 1, an activity that was previ-ously scheduled to begin in March 1988. The Unit 1 outage was further extended to complete the in-service inspection re-quired by the Nuclear Regulatory Commission (NRC) regula-tions. Such inspections are continuing. During March 1988, the NRC imposed a $100,000 civil penalty against the Company for failure to take corrective action and to comply with these NRC regulations relating to performing and evaluating the in-service inspections at Unit 1.

In April 1988, the Staff of the NRC (NRC Staff) completed a Systematic Appraisal of Licensee Performance (SALP) at Unit 1 covering the twenty-four month period ended February 1988.

In this assessment, the NRC Staff identified certain areas in addition to the in-service inspection program which required increased management and NRC attention and expressed concern that these certain identified areas, if unattended, could give rise to significant performance problems.

During July 1988, the Company received a letter from the NRC Staff stating the Unit 1 was identified as having weaknesses that warrant increased NRC attention and require close monitoring. The NRC Staff contrasted certain weakness-es at Unit 1 with the satisfactory performance at Unit 2 (How-ever, see "NRC Assessment of Nine Mile Point Station Per-formance" below). Citing the civil penalty relating to in-service inspections discussed above, the April 1988 SALP review and operator training and attitude concerns, the NRC Staff iden-tified a trend that, in their view, is "ofsignificant concern."

The NRC held a public meeting July 13, 1988 and, among other things, reviewed the performance of operating nuclear power plants licensed by the NRC. At this meeting, the NRC Staff indicated that Unit 1 would not be allowed to restart until such time as a comprehensive plan addressing and rectifying the NRC Staff's concerns is developed and approval for restart is received from the NRC Staff.

The Company developed a comprehensive plan to correct the. root causes of the concerns raised by the NRC Staff and submitted this Restart Action Plan to the NRC Region I Admin-istrator in December 1988. Restart of Unit 1 is conditioned upon the NRC Region I Administrator's concurrence that Unit 1 and management are ready to restart. Based upon a present assessment by the Company of the tasks to be completed prior to notification to the NRC of its readiness to restart, the Com-pany anticipates that Unit 1 will not return to service prior to mid-1989. However, the Company can provide no assurance that the current scope of effort to be completed prior to notifi-cation of readiness to restart will not be expanded by future events of which the Company is not currently aware.

the refund of any imprudently incurred costs, to investighte <<he Unit 1 outage. The further relief sought by the Attorney General was denied subject to the possibility of being reconsidered at a later date.

The Company, the PSC Staff, the Attorney General, the Con-sumer Protection Board and Multiple Intervenors reached an interim relief agreement (the "Interim Relief Agreement" ),

which was approved by the PSC in an order issued January 26, 1989. The Interim Relief Agreement provides that the Com-pany, commencing with the fuel cost month of January 1989 until the earlier of restart of Unit 1 or June 30, 1989, will tem-poraiily suspend collection from ratepayers of $225 thousand per day through the fuel adjustment clause mechanism, which approximates the incremental replacement power costs relat-ing to the outage which would otherwise be funded by ratepayers.

This will reduce the Company's cash flow during the period by approximately $6.75 millionper month.

The Company will defer such amounts for regulatory pur-poses, with appropriate carrying charges, for future recovery pending the results of the PSC's prudence investigation. How-ever, the degree of uncertainty associated with the ultimate outcome of the PSC's prudence investigation willpreclude the accrual of these revenues for financial reporting purposes, which will have the result of reducing earnings per share dur-ing the period by approximately $.03 per month. The Company willalso continue to absorb its share of the replacement power costs as provided for in the fuel adjustment clause mechanism and the incremental operating expenses incurred during the outage not provided for in rates. The replacement power cost associated with the Unit 1 outage is approximately $250 to

$300 thousand per day, the precise amount of which is depen-dent upon seasonal factors and relative demand.

These amounts do not include additional expenses as-sociated with preparing for the restart of Unit 1 and complying with NRC requirements relating to the Company's manage-ment of operations at its nuclear facilities. (see "Results of Operations" in Management's Discussion and Analysis)

The Interim Relief Agreement obviated the need for the Company to litigate at this time the question of the appropri-ateness of interim rate relief and thus permits continued con-centration of the Company's resources on the effort to restart Unit 1. The Interim Relief Agreement does not resolve any is-sues of responsibility which may arise during the conduct of the prudence investigation and is not an admission of impru-dence by the Company. If Unit 1 is not returned to service by June 30, 1989, the parties to the Interim Relief Agreement will be free to seek an extension of interim relief in whatever form they think appropriate. The Company cannot predict what form an extension of interim relief might take, if sought, or the resultant impact on the Company's financial condition or re-sults of operations.

(see"Results of Operations" in Manage-ment's Discussion and Analysis)

Through December 31, 1988, the Company has collected from ratepayers approximately $75.9 million of increased fuel adjustment clause revenues occasioned by the Unit 1 outage.

These revenues are subject to full or partial refund ifthe Com-pany is found to have acted imprudently in a way which caused or extended the outage. The Company is unable to predict the results of the PSC's prudence investigation, what sanctions may ultimately be imposed and the impact on the Company's financial condition, results of operations or level of retained earnings which might result ifany such sanctions are imposed.

Interim Agreement on Unit 1 Outage Replacement Power Costs: On May 23, 1988, the Attorney General of the State of New York filed a petition with the PSC requesting that the PSC,

1) cease recovery of replacement power costs incurred by the Company as a result of the Unit 1 outage discussed above, 2) institute a proceeding to determine whether the Company should refund replacement power costs already collected and

3) remove Unit 1 from the Company's rate base until Unit 1 returns to service. In an order issued September 8, 1988, the PSC instituted a proceeding, based upon its authority to order Unit 2 Mid-cycle Outage:

On October 1, 1988, Unit 2 began a scheduled maintenance and inspection mid-cycle outage which was expected to be completed by the end of December 1988. The outage has been extended to March 1989 to effect repair and retest of a main steam isolation valve, repair of generator retaining rings, replacement of a generator cou-pling, repair and retest of six valves in the residual heat re-moval system and conduct required surveillance tests.

'ÃI GARA MOHAEVKI'OWER CORI'ORATIOIYall(l SUBSIDIARYCOMPAi]lllS 30-31 NRC Assessment of Nine Mile Point Station Performance:

In December 1988, NRC senior managers conducted their bian-nual review of the performance of nuclear power plants licensed by the NRC. As a result of this review, the Company was advised on December 20, 1988, that the Nine Mile Point Station (Units 1 and 2) was being categorized as requiring close monitoring by the NRC. The conclusion was based on current NRC assessment of Unit 2's overall performance in certain areas during the first year of its operation and a June 1988 assessment of the overall performance of Unit 1 (See Unit 1 Outage and Restart Action Plan above). Further, the NRC Staff observed that increased licensee and NRC management attention is needed to ensure that performance improvement at the Nine Mile Point Station is achieved. A public meeting of the NRC was held on December 21, 1988, wherein the need for increased licensee and NRC management attention was con-firmed.

Unit 2 Ratemaking and Cost Settlement:

In September

1986, the PSC approved an agreement entitled "Specifications of Terms and Conditions of Offer of Settlement" (the Settlement) that constitutes a complete disposition of a July 1985 PSC pro-ceeding established to investigate the prudence of costs in-curred for the construction of Unit 2. The Settlement contains, among other stipulations, key terms and conditions which pro-vide that the maximum amount of Unit 2's construction expen-ditures to be included in the cotenants'ate bases would be

$4.16 billion and that each cotenant would waive any and all claims it may have against any other cotenant concerning the design, engineering or construction of Unit 2.

In order to induce concurrence among the cotenants while the Settlement was being negotiated, the Company entered into an agreement with the other cotenant companies (Coten-ant Agreement) whereby it reimbursed the cotenant com-panies, upon commercial operation of Unit 2 as ultimately rec-ognized by the PSC, for $ 171 million representing the coten-ants'hare of the $290 million difference between the Settle-ment's originally proposed allowed cost of $4.450 billion and the approved settlement value of $4.160 billion. Payment to the cotenants did not cause a reallocation of ownership interests in Unit 2.

In connection with the Company's rate case decided in March 1987, the PSC adopted their Staff's position on Settle-ment implementation issues, which included, for ratesetting

purposes, the recognition of tax benefits at primarily a 34%

rate rather than preservation at a 46% rate, the recording of deferred Federal income tax benefits in present value dollars, exclusion from rate base of unrealized tax benefits, the disal-lowance of certain plant-related costs, such as common facilities, and a write-off of disallowed costs, net of Federal income taxes, entirely against common equity. These require-ments have had a detrimental impact on the financial condition and results of operations of the Company. The Company be-lieves that the implementation requirements ordered by the PSC are contrary to the terms and intent of the Settlement and, in July 1987, the Company and Cotenant companies appealed the PSC's decision to the State of New York Supreme Court-Albany County. The Company is unable to predict the results of such action.

Several intervening parties petitioned the PSC for rehearing of its decision in connection with the Settlement and such petitions were denied. In April 1987, the Consumer Protection Board and the Attorney General of the State of New York filed a lawsuit asking that the PSC decision be annulled and that the PSC be directed to conduct a full prudence investigation with respect to Unit 2. The Company is unable to predict the ulti-mate outcome of this proceeding.

Based upon the Settlement as implemented by the PSC, the commercial operation date of April 5, 1988 as provided for in the Stipulation Agreement (see discussion in Management's Discussion and Analysis of Financial Condition and Results of Operations), the $171 millionpayment to the cotenants and the disallowance of certain plant related costs, approximately

$1,147 million of the Company's share of project costs willnot be recoverable in rates. See "Unit2.Financial Accounting Rec-ognition" below.

Unit 2 Financial Accounting Recognition: In December

1986, the FASB issued Statement of Financial Accounting Standards No. 90, "Regulated Enterprises-Accounting for Abandon-ments and Disallowances of Plant Costs," an amendment of FASB Statement No. 71 (SFAS No. 90). Among other things, SFAS No. 90 requires that when it becomes probable that part of the cost of a generating facility will be disallowed for ratemaking purposes and a reasonable estimate of the amount of the disallowance can be made, the estimated amount of the probable disallowance shall be deducted from the reported cost of the plant and recognized as a loss.

The Company adopted SFAS No. 90 in 1987 and recognized as a loss for financial accounting purposes the disallowance of Unit 2 costs, including the cost of disallowed plant related facilities, of approximately $1,147 million, reduced to $833 mil-lion ($6.54 per share) net of Federal income taxes. The ultimate amount of the disallowance is dependent upon a final determi-nation of the cost of Unit 2 and subsequent approval by the PSC.

Pursuant to the Stipulation Agreement entered into by the Company and other parties and approved by the PSC, a sepa-rate, non-rate case proceeding was established to litigate re-maining Unit 2 settlement cap issues.

The proceeding is to begin following the conclusion of the current mid-cycle out-age. The Company is unable to predict the outcome of the proceeding or the resultant impact on its financial condition or results of operation.

Unit 2 Contractor Litigation: In connection with problems en-countered with Unit 2's original Main Steam Isolation Valves (MSIV's), which caused a major delay in the completion of Unit 2, the Company and the cotenant companies have initiated a lawsuit in New York State Supreme Court in Syracuse, New York, seeking damages of approximately $500 million against Gulf + Western, Inc., Crosby Valve and Gage Company and Wickes Manufacturing Company, the companies having con-tractual responsibility for the design and fabrication of Unit 2's original MSIV's. The defendants have filed their answer which disagrees with the Company's claim. The Company is unable to predict the ultimate outcome of the lawsuit.

On August 1, 1988, the Company and the cotenant com-panies initiated a lawsuit in federal court in Syracuse, New York, against three corporations involved in the construction of Unit 2, Stone & Webster Engineering Corp. (the architect-engineer and construction manager for Unit 2), ITT Fluid Prod-ucts Corp. and ITT Fluid Technology Corp. (successor com-panies to ITTGrinnell, a major piping contractor of Unit 2). The lawsuit seeks damages for, among other things, breach of con-tractual and professional obligations in their performance under their contracts which resulted in delays and cost over-runs. Stone 8 Webster Engineering Corporation has filed its answer which disagrees with the Company's claim. Filing of answers by the other two defendants has been delayed pend-ing resolution of their motion to dismiss portions of the com-

plaint. The Company is unable to predict the ultimate outcome of the lawsuit.

In connection with the Unit 2 contractor litigation discussed.

above, the Company must submit its proposed accounting for any settlement proceeds received to the PSC forapproval.

The Company and cotenant companies have entered into an agreement with General Electric Company (GE) relating to cer-tain disputes which arose in connection with the Nuclear Steam Supply System (NSSS) portion of the construction of Unit 2, providing for settlement, mutual releases, and confiden-tiality of the specific elements of the agreement.

The agree-ment provides that GE willsupply certain goods and services to the Company and cotenant companies over a period of years without cost or at a reduced cost. Among other things, GE will supply engineering services which will improve Unit 2's tech-nical specifications and which may ultimately result in the in-creased capacity of Unit 2; software designed to help avoid unplanned outages; other goods and services in support of Unit 2; and other goods and services relating to turbine up-grading and maintenance at the Company's and cotentant companies'enerating facilities.

GE will receive indemnification, including limited reim-bursement of legal expenses, from the Company and cotenant companies against any future judgments against GE brought by other Unit 2 contractors related to the NSSS portion of the construction of Unit 2, to the extent such judgments result from successful Company and cotenant company claims against the contractors.

While the Company does not believe that current treatment of the agreement is material to its financial position, the Com-pany regards this as a favorable settlement.

No part of the Agreement has been included in income pending determina-tion by the PSC of the allocation of the benefits thereof be-tween the Company's shareholders and its ratepayers.

Nuclear LiabilityInsurance:

In August 1988, amendn.enS were enacted to the Price-Anderson Act (the Act) which significantfy increase liabilitylimits under the Act and extend its effective-ness to the year 2002. The public liabilitylimitwith respect to a-nuclear accident at a licensed reactor increased from $710 million to approximately $7.1 billion, with the excess over commercially available insurance to be funded by assessments of up to $63 million per licensed facilityfor each nuclear inci-dent, payable at a rate not to exceed $10 millionper year. Such assessments are subject to periodic inflation-indexing and to a 5'/o surcharge if funds prove insufficient to pay claims. The Company's interest in Units 1 and 2 could expose it to a poten-tial loss, for each accident, of $88.8 million through as-sessments of $14.1 millionper year in the event of a sufficiently serious nuclear accident at its own or another U.S. commercial nuclear reactor. The amendments also provide, among other things, that insurance and indemnity will cover precautionary evacuations whether or not a nuclear incident actually occurs.

NOTE 11. Commitments and Contingencies Construction Program: The Company is committed to an ongo-ing construction program to assure reliable delivery of its elec-tric and gas services. The Company presently estimates that the construction program for the years 1989 through 1993 will require approximately $1.5 billion, excluding AFC, nuclear fuel and certain overheads capitalized. For the years 1989 through 1993, the estimates are $307 million,$298 million,$283 million,

$317 million and $294 million, respectively.

Nuclear Plant Decommissioning:

Based on a study completed in 1986, the cost of decommissioning Unit 1, which is expected to begin in the year 2005, is estimated by the Company to be approximately $442,000,000 at that time ($229,000,000 in 1988 dollars). The Company's 41'k share of costs to decommission Unit 2, which is expected to begin in the year 2027, is estimated by the Company to be approximately

$565,000,000

($116,900,000 in 1988 dollars). The current annual allowances for recovery are based on total estimated decommissioning costs over the life of these units as previously authorized in rates, which amount to $195,300,000 and $256,400,000 (in fu-ture dollars), respectively, to be available in the year of de-commissioning. Through December 31, 1988, the Company has recovered $31,200,000 of decommissioning costs in rates for both units. The Company continues to review the estimated requirements for decommissioning and plans to seek rate ad-justments when appropriate. There is no assurance that the decommissioning allowance recovered in rates will ultimately aggregate a sufficient amount to decommission the units. The Company believes that decommissioning costs, if higher than currently estimated, will ultimately be recovered in the rate process, although no such assurance can be given.

The NRC has recently issued regulations requiring owners of nuclear power plants to place costs associated with specific decommissioning activities into an external trust at a substan-tiallyaccelerated rate from what has heretofore been required.

Further, the NRC established guidelines for determining minimum amounts that must be available in the trust for these specified decommissioning activities at the time of decommis-sioning. The Company anticipates that the NRC minimum will exceed the basis of current cost recovery for total decommis-sioning costs associated with the Units. As a result, the NRC regulations, which have not been considered in the rate setting environment, could require the Company to increase its capital requirements by an amount which cannot currently be deter-mined. The Company has until July 1990 to file a decommis-sioning plan for each unit with the NRC.

Long-term Contracts for the Purchase of Electric Power: At January 1, 1989, the Company had long-term contracts to purchase electric power from the following generating facilities owned by the New York Power Authority (NYPA):

Facility Niagara-hydroelectric project..

Blenheim-Gilboa-pumped storage generating station.....

FitzPatrick-nuclear plant.........

Expiration Purchased Estimated date of capacity annual contract in kw.

capacity cost 1990 1,077,000

$14,515,000 2002 295,000 6,346,000 year-to-53,000 (a) 5,735,000 year basis 1.425,000

$26,596,000 (a) 21,000 kw for summer ol 1989; 45,000 kw, for winter ol 1989-90.

The purchase capacities shown above are based on the con-tracts currently in effect. The estimated annual capacity costs are subject to price escalation and are exclusive of applicable energy charges. Total cost of purchases under these contracts amounted to $46.3 million, $57.2 million and $68.5 million for the years 1988, 1987 and 1986, respectively. The Company and NYPA have reached an agreement in principle to extend the Niagara project contract into 2007. This extension is currently in the approval process.

Under the requirements of the Federal Public Utility Reg-ulatory Policy Act, the Company is required to purchase power generated by Qualifying Facilities as defined therein. Approxi-mately $95 million was paid to Qualifying Facilities in 1988 for 1,497,000,000 kwh of energy and associated capacity. Through December 31, 1988, the Company has entered into agreements with numerous current and prospective independent pro-ducers, including Qualifying Facilities, which may substantially increase its future purchase power commitments.

, AQRA MOIIAWKPOWER CORPORATION II(1 SIJIISIDIARYCOMPANIES 32-33 Lease Commitments:

The Company leases certain property and equipment which meet the accounting criteria for capitali-zation. Such leases, having a net book value of $65.9 million and $65.6 million at December 31, 1988 and 1987, respectively, are included in the accompanying Consolidated Balance Sheets. Since current rate-making practice treats all leases as operating leases, the capitalization of these leases has no im-pact on the Company's Consolidated Statements of Income.

The Company recognizes as a charge against income an amount equal to the rental expense allowed for rate purposes.

The Company's future minimum rental commitments under these capital leases and non-cancellable operating leases aggregate approximately $650 million, a substantial portion of which relates to a 41-year lease of a transmission line facility.

Annual future minimum rental commitments for the period 1989-1 993 range between $24 millionand $33 million.

Sale of Customer Receivables:

During 1988, the Company en-tered into an agreement whereby it can sell an undivided inter-est in'a designated pool of customer receivables up to a maximum of $100,000,000. At December 31, 1988, $100,000,000 of receivables were sold under this agreement. The undivided interest in the designated pool of receivables was sold with limited recourse.

For receivables sold, the Company has re-tained collection and administrative responsibilities as agent for the purchaser.

Litigation: The Board of Trustees of the Town of Brookhaven (Long Island) instituted a lawsuit on March 3, 1987 against the Company, the General Electric Company and Monsanto Com-pany in the United States District Court for the Eastern District of New York alleging damages in the amount of $300,000,000 as a result of the disposal of polychlorinated biphenyls (PCB's) in the Hudson River which is alleged to have impacted the striped bass and other commercial fisheries off of eastern Long Island. A further allegation in the complaint against the Company is that the removal of its Fort Edward Dam, located in the Hudson River, in the Village of Fort Edward, Washington County, New York, caused PCB's which had previously been impounded thereby to be transported downstream to the det-riment of such fisheries. Since fishing restrictions off of east-ern Long Island have been relaxed, the plaintiffs have discon-tinued the lawsuit with prejudice.

In May 1988, a stockholders'erivative suit was commenced in the United States District Court, Northern District of New York, against certain members of the Board of Directors and several officers of the Company. The complaint purported to state claims on behalf of the Company for alleged violations of the federal securities laws and state law in connection with the Nine Mile Point Unit No. 2 project. The defendants filed a mo-tion to dismiss the action. The plaintiffs opposed the motion but also filed an amended complaint adding new counts and a new party plaintiff. In October, the Court granted the defen-dents'otion to dismiss the original complaint. At the same time, the Court permitted plaintiffs the opportunity to file a second amended complaint, with certain restrictions concern-ing the scope of their federal securities law claim.

On January 17, 1989, the plaintiffs filed a second amended complaint. As in the first amended complaint, the new com-plaint purports to state a claim on behalf of the Company for alleged violations of the federal securities laws and for alleged negligence, mismanagement, waste and breaches of fiduciary duty, all in connection with the Nine Mile Point Unit 2 project.

The amount of damage claimed is not specified. The defen-dants intend to contest this suit vigorously.

As permitted by law and by its by-laws, the Company has indemnified its officers and directors for loss and expense, including judgments or settlements, incurred in connection with the defense of such actions, and has directors and officers liability insurance to cover all or part of its indemnification obligation.

The Company is unable to predict the ultimate outcome of the action.

Guarantee of Nine Mile Point Nuclear Unit No. 2 Cotenant's Debt: Under the terms of an agreement (Capital Funds Agree-ment) with Long Island Lighting Company (LILCO), the Com-pany provided its guarantee in December 1985 for a period of approximately three years through March 16, 1989 of up to

$165 million of LILCO's reimbursement obligations in connec-tion with $150 million principal 'amount of tax-exempt pollution control bonds issued on behalf of LILCO on December 31, 1985. On February 3, 1989 the Company consented to an ex-tension of the tax-exempt arrangement for approximately two years through March 1991. LILCO is required to pay certain fees to the Company in connection with the guarantee.

If and to the extent LILCO does not honor its obligations to the banks, the Company would be required to do so and has ar-ranged for three-year term loans to fund its guarantee obliga-tions. Upon payment of the LILCO obligation, the Company would become the holder of LILCO's debt, which would bear interest at 16%. The Company has an interest of $85 million in LILCO's third mortgage, which serves as partial security in the event its guarantee is required to be honored. However, in the event of a LILCO bankruptcy, the Company can provide no assurance as to its ability to realize the full value of its third mortgage interest. If the Company's First Mortgage Bond credit rating is below investment grade and the Company owes amounts to the banks under its three-year term loan, the banks have the right to require the Company to issue First Mortgage Bonds as security.

Securities and Exchange Commission filings of LILCO in-dicate that LILCO continues to face severe financial and legal difficulties and may be forced to seek 'relief in bankruptcy.

LILCO's auditors qualified their opinion on the 1987 financial statements, questioning LILCO's ability to remain financially viable.

During December 1988, the proposed Settlement involving LILCO's Shoreham Plant failed to gain ratification by the New York legislature. Although efforts to revive the Settlement in some form continue, the form any ultimate Settlement may take, if achieved, cannot currently be determined. In addition, Suffolk County obtained a jury verdict against LILCO in De-cember 1988 for $23 million in connection with claimed perjury by LILCO which allegedly resulted in certain rate increases being awarded to LILCO by the New York Public Service Com-mission. Motions in Federal Court to certify the action as a class action, to overturn the verdict and on other related mat-ters were heard on February 2, 1989, with no action taken. The judge in the case has stated that LILCO's potential liability in connection with a class action on the issue could exceed

$4 billion, which is substantially in excess of LILCO's stockhold-ers'quity. The above factors could adversely impact the con-tractual obligations of the Company with respect to LILCO and LILCO to the Company and have substantially reduced or eliminated the possibility of a substitute guarantor being ob-tained by LILCOunder the current arrangement. The Company willcontinue to monitor the LILCOsituation with a view to best protecting the Company's financial interest.

NOTE 12. Quarterly Financial Data (Unaudited)

Operating revenues, operating income, net income and earnings per common share by quarters for 1988, 1987 and 1986 are

shown in the following table. The Company, in its opinion, has included all adjustments necessary for a fair presentation of the results of operations for the quarters. Due to the seasonal nature of the utilitybusiness, the annual amounts are not generated evenly by quarter during the year. The proforma amounts for Net Income (loss) and Earnings per common share presented in the table below reflect the retroactive application for SFAS No. 90 for comparative purposes.

ln thousands ofdollars F'roforma Amounts Quarter ended Operating revenues Operating income Net Earnings Net Earnings income per common income per common (loss) share (loss) share Dec. 31, 1988 1987 1986

$678,858

$ 68,245

$ (3,808)

$ (.12)

S 653,906 114,509 (32,649)*

(.36)

(32,649)

(.36) 637,896 104,633 84,698

.57 4,302

.13)

Sept. 30, 1988

$608,393

$115,691

$ 52,297

$.31

'1987 556,845 98,958 44,829

.25 44,829

.25 1986 554,546 92,640 74,909

.49 33,909

.17 June 30, 1988 1987 1986

$702)678 624,628 636,859

$128,008 102,810 97,585

$ 46,823 48,711 85,535 S.27 S

S

.29 48,711

.29

.56 100,465)

(.90)

March 31, 1988 1987 1986

$810,524 788,051 831,018

$170,221 169,121 146,316

$113>502 S.77

(618,105)'4.96)*

(3,105)

(.13) 152,723 1.08 140,723

.99

• See Note 10 regarding first and fourth quarter 1987 adjustments relating to the adoption of SFAS No. 90.

Year end adjustments to annual estimates of taxes and expense accruals made in the fourth quarter of 1988 had the effect of decreasing net income for the quarter by approximately $14 million or $.11 per common share. In addition, in the fourth quarter of 1988 and 1987 the Company accrued

$7.5 million ($.04 per common share) and $13.0 million ($.08 per common share),

respectively, relating to its investment in NM Uranium, Inc. ~ resulting in a decrease in net income for each quarter (see Note 3).

I'iN IIA iWIIAWKPONtjlR CORPORATION an(l SIlIISII)IARYCOMPAi)IIlS 34-35 Report ofManagement The consolidated financial statements of Niagara Mohawk Power Corporation and its subsidiaries were prepared by and are the responsibility of management.

Financial infor-mation contained elsewhere in this Annual Report is consis-tent with that in the financial statements.

To meet its responsibilities with respect to financial in-formation, management maintains and enforces a system of internal accounting controls, which is designed to provide reasonable assurance, on a cost effective basis, as to the integrity, objectivity and reliability of the financial records and protection of assets. This system includes communica-tion through written policies and procedures, an organiza-tional structure that provides for appropriate division of re-sponsibility and the training of personnel. This system is also tested by a comprehensive internal audit program. In addition, the Company has a Code of Conduct which re-quires all employees to maintain the highest level of ethical standards and requires key management employees to for-mally affirm their compliance with the Code.

The financial statements have been examined by Price Waterhouse, the Company's independent accountants, in accordance with generally accepted auditing standards.

As part of their examination, they made a study and evaluation of the Company's system of internal accounting control.

The purpose of such study was to establish a basis for re-liance thereon in determining the nature, timing and extent of other auditing procedures that were necessary for ex-pressing an opinion as to whether the financial statements are presented fairly in all material respects. Their examina-tion resulted in the expression of their opinion which fol-lows this report. The independent accountants'xamination does not limit in any way management's responsibility for the fair presentation of the financial statements and all other information, whether audited or unaudited, in this Annual Report.

The Audit Committee of the Board of Directors, consisting of four directors who are not employees, meets regularly with management, internal auditors and Price Waterhouse to review and discuss internal accounting controls, audit examinations and financial reporting matters.

Price Wa-terhouse and the Company's internal auditors have free ac-cess to meet individually with the Audit Committee at any time, without management present.

Report ofIndependent Accountants I+ice Haterhouse To the Stockholders and Board of Directors of Niagara Mohawk Power Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and retained earnings and of cash flows present fairly, in all material respects, the financial position of Niagara Mohawk Power Corporation and its subsidiaries at December 31, 1988 and 1987, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1988, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our respon-sibility is to express an opinion on these financial state-ments based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

An audit includes examining, on a test basis, evidence support-ing the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.

We believe that our audits provide a reasonable basis forthe opinion expressed above.

As described in Note 10, the Company adopted in 1987 Statement of Financial Accounting Standards No. 90, "Reg-ulated Enterprises Accounting for Abandonments and Disallowances of Plant Costs." The adoption of this State-ment resulted in the disallowed portion of the Company's investment in the Nine Mile Point Nuclear Station No. 2 (Unit 2) being recognized as a loss in the 1987 financial statements.

As a result of continuing uncertainties with respect to Unit 2 discussed in Note 10, management is unable to predict whether further regulatory actions by the New York State Public Service Commission (PSC) with respect to its in-vestment in the Unit will have, in the aggregate, a material effect on its financial position or results of operations. Ac-cordingly, no provision for any additional loss that may re-sult upon resolution of these uncertainties has been made in the accompanying financial statements.

As discussed in Note 10, in 1988 the PSC instituted a pro-ceeding, based upon its authority to order the refund of any imprudently incurred costs, to investigate the Nine Mile Point Nuclear Station Unit No.

1 (Unit 1) outage. Manage-ment is unable to predict whether further regulatory actions by the PSC related to the Unit 1 outage will have a material effect on its financial position or results of operations. Ac-cordingly, no provision for loss that may result upon resolu-tion of this uncertainty has been made in the accompanying 1988 financial statements.

Syracuse, New York January 26, 1989

)

~~ ~

Selected Financial Data As discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements, certain of the tollowing selected financial data may not be indicative ot the Company's future financial condition or results of operations. Certain of 1987 data is not presented since it is either not meaningful or not applicable in light of the adoption of SFAS No. 90 which required the write-offof disallowed Unit 2 costs and resulted in a net loss for the year.

1984 I986 1987 Operations: (000's)

Operating revenues.

Income before cumulative eftect of accounting change Cumulative effect on prior years of adoption of SFAS No. 90 Net income (loss).

Proforma balance available for common stock giving effect to the retroactive application of SFAS No. 90 Common stock data:

Book value per share at year end Market price at year end.

Ratio of market price to book value at year end..

Dividend yield at year end Earnings per average common share before cumulative effect of accounting change......

Cumulative effect on prior years of adoption of SFAS No. 90 per average common share......

Earnings per average common share...........

Proforma earnings per average common share giving effect to the retroactive application of SFAS No. 90 Rate of return on common equity..............

Dividends paid per common share.............

Dividend payout ratio Capitalization: (000's)

Common equity Non-redeemable preterred stock Redeemable preferred stock Long-term debt

$2,800,453

$2,623,430

$2,660,319

$2,694,940

$2,785,546 208,814 57,786 397,865 411,430 359,734 (615,000) 208,814 (557,214) 397,865 411,430 359,734 5,769 16,048 64,871 359,734 S 13.87 13 93.7o/o 9.2'lo

$13.82 12 86.8o/o 10.IP/o

$20.23 1674 82.P/o 12.4%

$ 19.61

$18.89 20'/2 173)f) 104.5o/o 92.IP/o 10.1%

11.5o/o S

1.21

.05 S 2.71

$ 2.88 2.84 1.21 (4.83)

(4.78) 2.71 2.88 2.84

.05

.13

.53 2.84 8.7o/o 12.7o/o'3.6o/o 1 5.IP/o 1 4.PYo 1.20

$ 1.64

$ 2.08 S 2.06 S 1.98 99.2%

76.8%

71.5o/o 69.7Yo

$1,881)394

$1,781,518

$2,571,491

$2,488,620

$2,207,117 2901000 290,000 290,000 290,000 240,000 295,510 355,490 347,470 379,850 367,900 2,995,748 2,903,921 2,799,605 2,643,094 2,395,471 Total First mortgage bonds maturing within one year 5,462)652 5,330,929 6,008,566 33,000 50,000 50,000 5,801,564 5,210,488 30,000 47,450 Total Capitalization ratios:(incfuding firstmortgage bonds maturing within one year):

Common stock equity.

Preferred stock.

Long-term debt Financial ratios:

Ratio ot earnings to fixed charges...................

Ratio of earnings to tixed charges without AFC.......

Ratio of AFC to balance available for common stock..

Ratio of earnings to fixed charges and preferred stock dividends Proforma Ratios-giving ettect to the retroactive application of SFAS No. 90:

Earnings to fixed charges Earnings to fixed charges and preferred stock dividends Other ratios-% of operating revenues:

Fuel, purchased power and purchased gas........

Maintenance, depreciation and amortization.......

Total taxes Operating income Balance available for common stock..............

34.FYo 33.1%

42.5o/o 42.7o/o 42.IP/o 10.7 12.0 10.5 11.5 11.5 55.1 54.9 47.0 45.8 46.5 2.10 1.65" 2.98 3.07 3.11 2.06 1.54" 2.42 2.37 2.43 6.9%

48.2%

53.2/o 52.4%

1.67 1.04" 2.35 2.36 2.39 1.65 1.04 1.28 1.05 1.40 1.17 3.11 2.39 34.6o/o 15.1 16.1 17.2 5.7 35.6o/o 12.1 16.7 18.5 38.(P/o 11.4 18.1 16.6 12.9 43 4%

10.9 15.7 15.3 13.1 46.9/o 10.1 14.7 14.1 11.1

$5,495,652

$5,380,929

$6,058,566

$5,831,564

$5,257,938 Miscellaneous: (000's)

Gross additions to utilityplant Total utilityplant Accumulated depreciation and amortization..

Total assets S

353,859 7,967)625 2,090,170 7,076,041 447,230 7,691,069 1,913,687 6,794,098 774,062 771,120 S

769,846 8,445,993',640,905 6,903,184 1,763,443 1,629,437 1,501,282 7,611,203 7,013,837

• 6,233,401

'Excludes the effect of the adoption of SFAS No. 90 amounting to $833 million.

'*Excudes the cumulative effect of the adoption of SFAS No. 90 amounting to $61 5 million.

Al'AG RA MOIIAWKPOWER CORPORATION ail(l SIJIISIDIARYCOMPANIES 30-37 Market Price ofCommon Stock and Related Stockholder Matters 1988 Dividend paid Price range per share High Low 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 30

$14

$ 12

.30 15'/2 122/e

.30 152/e 127/e

.30 14'/4 12'/2

$1.20 1987 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

$.52

$19'/e

$157/e

.52 17'/4 147/e

.30 17 14

.30 14e/e 111/e The Company's common stock and cer-tain of its preferred series are listed on the New York Stock Exchange. The common stock is also traded on the Boston, Cin-cinnati, Midwest, Pacific and Philadelphia stock exchanges.

Common stock options are traded on the American Stock Ex-change. The ticker symbol is "NMK".

Preferred and common stock dividends were paid on March 31, June 30, Sep-tember 30 and December 31. The Com-pany presently estimates that none of the 1988 common or preferred stock div-idends will constitute a return of capital and therefore all of such dividends are subject to Federal income tax as ordinary income.

The table below shows dividends per share for the Company's common stock and quoted market prices:

The common dividend rate was re-duced effective the third quarter of 1987. The Company is currently paying cash dividends quarterly. Declaration of future dividends and levels of payments are necessarily dependent on future

earnings, cash flow, financial require-ments, the duration of, and costs as-sociated with, the outage at Nine Mile Point Nuclear Station Unit No. 1 (Unit 1),

the adequacy and timeliness of rate re-lief, the level of retained earnings out of which dividends can be declared and other uncertainties facing the Company (see Management's Discussion and Analysis of Financial Condition and Re-sults of Operations and Notes 10 and 11 of Notes to Consolidated Financial Statements).

Also, restrictions in gov-erning instruments and provisions of state law and the Federal Power Act may affect the declaration and payment of dividends. While the Company ex-pects to continue the payment of div-idends, management and the Board of Directors must take into account, in re-spect of future quarterly dividend decla-rations and the level of such dividends, the facts and elements referred to above in evaluating the decision to declare a dividend.

The holders of Common Stock are en-titled to one vote per share but may not cumulate their votes for the election of Directors. Whenever dividends on Pre-ferred Stock are in default in an amount equivalent to four full quarterly divi-dends and thereafter until all dividends thereon are paid or declared and set aside for payment, the holders of such stock can elect a majority of the Board of Directors. Whenever dividends on any Preference Stock are in default in 1 to 99 51,662 100 to 999 99,227 1,000 or more 10,661 161,550 1,530,043 25,298,708 108,804,345 135,633,096 an amount equivalent to six full quar-terly dividends and thereafter until all dividends thereon are paid or declared and set apart for payment, the holders of such stock can elect two members to the Board of Directors. No dividends on Preferred Stock are now in arrears and no Preference Stock is now outstand-ing.

Upon any dissolution, liquidation or winding up of the Company's business, the holders of Common Stock are enti-tled to receive a pro rata share of all of the Company's assets remaining and available for distribution after the full amounts to which holders of Preferred and Preference Stock are entitled have been satisfied.

The indenture securing the Com-pany's mortgage debt provides that surplus shall be reserved and held un-available for the payment of dividends on Common Stock to the extent that expenditures for maintenance and re-pairs plus provisions for depreciation do not exceed 2.25% of depreciable property as defined therein. Such pro-visions have never restricted the Com-

'pany's surplus.

At year end, about 162,000 stockhold-ers owned common shares of Niagara Mohawk and about 7,000 held Preferred Stock. The chart below summarizes common stockholder ownership by size of holding:

Size of holding Total Total shares (Shares) stockholders held EARNINGS ANDDIVIDENDS PAID PER COMMON SHARE COMMON STOCK PRICES CAPITALIZATIONRATIOS

$2.84

$2.88

$ 1.98

$2.71

$2.08 fsh76>

1,6

$ 1.21 co Co Eox O

U C/>

rh 5 0 CI

$17.75 17.39

$ 12.00

$21.88

$20.50

$16.38 16.75

$ 15.50

$25.50

$19.13

$11.13 11 5%

42 oo/o 46 5%

11.5%

42 7o/o 45 8%

10.5%

42.5%

47.0o/o 12.0o/o 33,1o/o 10.7%

34.2o/o 55.1%

cc cur R rxr DLu

~O 1984 1985 1986 1987 1988 o excluding the effeel of the write offof disallowed Nine MileUnit No. 2 costs ($e.54 per share).

1984 1985 1986 1987 1988 1984 1985 1986 Dg Qcf 1987 1988

Thermal:

Coal fuel Huntley, Niagara River..

Dunkirk, Lake Erie.....

Total coal fuel..

715 10 715 715 560 7

560 555 1,275 17 1,275 1,270 Electric and Gas Statistics ELECTRIC CAPABILITY Thousands ofkilowatts AtJanuary 1, 1989 1988 1987 ELECTRIC STATISTICS Electric sales(Millions ofkw-hrs)

Residential................

Commercial...............

Industrial..................

Municipal service..........

Other electric systems......

1988 10,099 11,182 11,745 237 1,732 34,995

.1987 9,655 10,718 10,922 235 4,154 35,684 198Ci 9,359 10,374 10,801 234 3,579 34,347 Residual oilfuel Albany, Hudson River"...

Oswego, Lake Ontario"'.

Roseton, Hudson River...

Middle distillate oilfuel 19 Combustion turbine and diesel units..........

400 6

400 400 1,571 21 1,572 1,563 300 4

300 299 237 3

237 237 Electric revenues (Thousands of dollars)

Residential................

805,523 Commercial...............

827,918 Industrial..................

458,332 Municipal service..........

41,231 Other electrical systems....

60,214 Miscellaneous.............

150,514 739,034 783,103 435,518 40,603 118,021 53,912 702,309 766,815 448,855 41,031 95,809 77,014 Total oilluel Nuclear fuel Nine Mile Point, Lake Ontario Purchased-firm contract Power Authority-FitzPatrick, Lake Ontario...

Total nuclear fuel 2,508 34 2,509 2,499 1,054 14 610 610 53 1

59 153 1,107 15 669 763 Electric customers(Average)

Residential................

Commercial...............

Industrial..................

Other.....................

$2,343,732

$2,170,191

$2,131,833 1,324,367 1,307,946 1,291,111 140,237 138,193 136,304 2,322 2,374 2,481 3,182 3,400 3,282 Total thermal sources..

4,890 66 4,453 4,532 9

695 684 15 1,076 1 ~111 295 4

270 270 294 4

285 262 Hydro:

Owned and leased hydro stations (78). '95 Purchased-firm contracts Power Authority-Niagara River....

1,077-Power Authority-Blenheim-Gilboa Pumped Storage Plant...........

Other Residential(Average)

Annual kw-hr. use per customer............

Cost to customer per kw-hr..

Annual revenue per customer............

7,626 7.98tt

$608.23 7,382 7.65/

$565.03 7,249 7.50tf

$543.96 1,470,108 1,451,913 1,433,178 Total h dro sources..

Other urchases.....

Totalcapability',361 32 2,326 2,327 121 2

97 80 7,372 100 6,876 6,939 GAS STATISTICS 1988 1987 1986 Etectric peak load during ear..

1988 6,220 1987 1986 5,780 5,724

'Available capability can be increased during heavy load periods by purchases from neighboring interconnected systems. Hydro station capability is based on average December stream-flow conditions.

"Has capability to burn natural gas'(as well as oil) as a fuel.

"'Oswego Unit 3 burns natural gas only.

The Nine Mile Point Unit No. 2, increased capability by 444,000 KW representing the Company's share of the output.

ELECTRICITYGENERATED AND PURCHASED Millionsofkw-hrs.

1988 1987 1986

,Thermal:

Generated Coal...........

Oil.............

Nuclear........

Natural gas.....

Purchased-Nuclear from Power Authorit Total thermal Hydro:

Generated..........

Purchased from Power Authority...

Other............

Totalh dro 7,894 21 7,185 18 6,140 16 7,444 19 4,256 11 5,811 16 1,460 4

4,753 12 3,147 8

1,070 3

1,785 4

177 1

306 1

700 2

1,284 3

18,174 48 18,679 47 16,559 44 3,171 8

3,396 8

4,140 11 7,014 18 7,378 19 7,683 20 978 3

1,017 3

565 2

11,163 29 11,791 30 12,388 33 Total generated and purchased 38,141 100 39,412 100 37,639 100 Other purchased power-varlous sources......

8,804 23 8,942 23 8,692 23 Gas Sales(Thousands ofdekatherms)

Residential................

51,065 Commercial...............

23,951 Industrial..................

4,274 Other gas systems..........

2,158 48,054 23,520 7,242 2,504 49,430 27,218 15,575 3,724 Total sales.........

Transportation of customer-owned gas 81,448 27,244 81,320 21,862 95,947 4,868 Gas revenues(Thousands ofdollars)

Residential................

$289,026 Commercial...............

119,929 Industrial..................

19,008 Other gas systems..........

9,363 Transportation of customer-owned gas.....

13,841 Miscellaneous.............

5,554

$280,092 121

~145 29,733 8,802 11,551 1,916

$296,853 142,807 68,476 14,300 2,244 3,806

$456,721

$453,239

$528,486 Gas customers(Average)

Residential...............

Commercial..............

Industrial.................

Other Transportation...........'.

4171360 35,017 323 2

403 453,105 411,566 33,974 395 2

184 446,121 407,546 33,248 465 2

40 441,301 ResIdential (Average):

Annual dekathermuse-per customer.........

Cost to customer per dekatherm........

Annual revenue per customer.........

Maximum day gas send out (dekatherms) 122.4 116.8 121.3

$5.66

$5.83

$6.01

$692.51

$680.55

$728.39 818,128 758,914 786,165 Total gas delivered.....

108,692 103,182 100,815

I)IitG~RA iMOIIAWKPOWll3 COIIPORATION an(l SUIISII)IAIIYCOiMPANIKS 38-39 Directors Officers WilliamF. Allyn(E,F)

President &Chief Executive OfficerWelch Allyn,Inc.,

Skaneateles Falls James Bartlett (Retired May 2, 1988)

Former Executive Vice President, Syracuse Lawrence Burkhardt, III(F) (Elected October 24, 1988)

Executive Vice President, Nuclear Operations Edmund M. Davis(A,B,E)

Partner, Hiscock &Barclay, at torncys-at-law, Syracuse WilliamJ. Donlon (A)

Chairman ofthc Board and Chief Executive Officer Edward W. Duffy(A, B, C, F)

Former Chairman ofthe Board and Chief Executive Officer, Marine Midland Banks, Inc. a bank holding company, Buffalo John M. Endries President John G. Haehl, Jr.

Former Chairman ofthe Board and Chief Executive OAicer Lauman Martin (Retired May 2,1988; DiedJtate 2,1988)

Consultant (formerly Senior Vice President and General Counsel), Syracuse Baldwin Maull (A,B)

Corporate Director, New York Martha Hancock Northrup (C, D)

Homemaker, former President, Crousc-Irving Memorial Hospital Board, Syracuse Henry A. Panasci, Jr. (B, E)

Chairman ofthc Board and Chief Executive Officer, Fay's Drug Company, Inc., Liverpool Patti McGillPeterson (C, D)

President, St. Lawrence University, Canton Frank P. Piskor(A,C,F)

President Emeritus, St. Lawrence University, Canton Donald B. Riefler (E, F)

Chairman, Market Risk Committee, Morgan Guaranty Trust Company ofNew York, Ncw York Steven Browning Sample (D, F)

Prcsidcnt, State University ofNew Yorkat Buffalo, Bulfalo Lewis A. Swyer (Died December 25, 1988)

Chairman, L,A.Swycr Co., Inc., builders and construction managers, Albany John G. Wick (D, E)

Partner, Falk &Sicmcr, attorneys-at-law, Buffalo WilliamJ. Donlon Chairman ofthe Board and Chief Executive Officer (Elected Jane 1, 1988)

John M. Endries President (Elected Jane 1, 1988)

Lawrence Burkhardt, III Executive Vice President, Nuclear Operations Anthony J. Baratta, Jr.

Senior Vice Prcsidcnt John P. Hennessey Senior Vice President Charles V. Mangan Senior Vice President John W. Powers Senior Vice President and Trcasurcr Michael P. Ranalli Senior Vice President Joseph T. Ash Vice President, Consumer Services Thomas H. Baron Vice President, Fossil Generation Michael J. Cahill Vice President, Regional Operations Robert M. Cleary, Jr.

Vice President, Regional Operations Richard E.A. Duffy Vice President, Public Alfairs&

Corporate Communications Gerald D. Garcy Vice President, Power Contracts James P. Gorman Vice Prcsidcnt, Corporate Audits Edward F. Hoffman Vice President, Engineering (Non-Nuclear)

Darlene D. Kerr Vice President, System Electric Operations Gary J. Lavine Vice President, General Counsel and Secretary Samuel F. Manno Vice President, Purchasing &

Materials Management Thomas J. Perkins Vice President, Nuclear (Died November 24, 1988)

James A. Perry Vice President, Quality Assurance Nicholas L. Prioletti, Jr.

Controller Richard H. Ryczek Vice President, Gas Jack R. Swartz Vice President, Regional Operations Carl D. Terry Vice President, Nuclear Engineering and Licensing Perry B. Woods, Jr.

Vice Prcsidcnt, Human Resources Harold J. Bogan Assistant Secretary Joseph F. Cleary Assistant Sccrctary John J. Hennigan Assistant Sccrctary John W. Keib Assistant General Counsel Frederick C. McCal1, Jr.

Assistant Sccrctary Arthur W. Roos Assistant Treasurer Robert A. Sanguine Assistant Controller Steven W. Tasker Assistant Controller Ronald A. Ungerer Assistant Controller Richard N. Wescott Assistant Treasurer Henry B. Wightman, Jr.

Assistant Controller, Nuclear A. Memberof the Executive Committee B. Membcrof thc Compensation Committee C. Member ofthe Audit Committee D. Member ofthe Committee on Corporate Public Policy E. Mcmbcr ofthe Finance Committee F. Member ofthe Nuclear Oversight Committee

NIAGARAMOIIAWKPOWHR COIIPORATION aft(l SUBSIDIARY COMPANIHS

' 4',

Corporate Information Annual Meeting The annual meeting ofshareholders willbc held in thc auditorium ofthe Everson Museum ofArt,401 Harrison Street, Syracuse, N.Y. 13202 at 10:30 a.m. Tuesday, May 2, 1989. A notice ofthe meeting, proxy statement and form ofproxy will be sent to holders ofcommon stock in early April.

Shareholder Inquiries Questions regarding ownership ofNiagara Mohawk stock or the status ofan account may be directed to the Company's Shareholder Services Department, (315) 428-6750 (Syracuse) 1-800-962-3236 (New YorkState) 1-800-448-5450 (elsewhere in continental U.S.)

Analyst Inquiries Analyst inquiries should be directed to Leon T. Mazur, Manager-Investor Relations, (315) 428-3134.

Dividend Reinvestmcnt Plan Shareholders and customers interested in purchasing common stock through the Dividend Reinvestment and Common Stock Purchase Plan should call or write our Shareholder Services Department at P.O. Box 7058, Syracuse, N.Y. 13261.

SEC Form 10-K Report A copy ofthe Company's Form 10-K Report filed annually with thc Securities and Exchange Commission is available without charge after March 31, 1989, by writingthe Investor Relations Department at 300 Erie Boulevard West, Syracuse, N.Y. 13202.

Disbursing Agent Preferred and Coniinon Stocks:

Niagara Mohawk Power Corporation 300 Erie Boulevard West, Syracuse, N.Y. 13202 Bonds:

Marine Midland Bank, N.A.

140 Broadway, New York, N.Y. 10015 Transfer Agents and Registrars Preferred and Cornnron Stocks:

Morgan Shareholder Services Trust Company ofNew York 30 West Broadway, New York, N.Y. 10015 Bonds:

Marine Midland Bank, NA,.

140 Broadway, New York, N.Y. 10015 Stock Exchanges Cornrnon Stock and Certain Preferred Series:

Listed and traded on the New YorkStock Exhange.

Connnon Stock: Also traded on the Boston, Cincinnati, Midwest, Pacific and Philadelphia stock exchanges.

Bonds: Traded on the New YorkStock Exchange.

Ticker Symbol: NMK Corporate Headquarters 300 Erie Boulevard West Syracuse, New York 13202 (315) 474-1511 The Information in this report is not given in connection with the sale of, or offer to buy, any security.

Printed in U.S.A.